Determining Proper Position Size When Day Trading Stock
Your position size, or trade size, is more important than your entry and exit when day trading stocks. The best strategy in the world won't compensate for a trade size that is too big or small—you'll either take on too much or too little risk. Too much risk is more of a concern than too little, as risking too much can evaporate a trading account quickly.
Your position size is the number of shares you take on a trade. Your total risk is broken down into two parts—trade risk and account risk. You should have a good understanding of how these elements fit together. This will give you an ideal position size, no matter what the market conditions are, what the trade setup is, or what strategy you're using.
Set Your Account Risk Limit Per Trade
This is the most important step for determining day trading position size in stocks. Set a percentage or dollar risk limit you'll risk on each trade. Most professional traders risk 1$ or less of their accounts.
For example, with a $45,000 day-trading account, you could risk up to $450 per trade if you risk 1% of your account. If you risk 0.5% of the account, then you can risk $225 on one trade.
You can also use a fixed dollar amount—ideally, this should still be below 1% of your account. For example, risk $350 per trade. As long as your account balance is more than $35,000 then you'll be risking 1% or less.
While other variables in a trade may change, account risk is kept constant. Try not to vary the amount of risk you take (e.g., 5% on one trade, 1% on the next, and then 3% on another). If you choose 1% as your account risk limit per trade, then every trade should risk the same amount.
Determine "Cents at Risk" on the Trade
After determining the maximum acceptable account risk on each trade, turn your attention to the trade you have in front of you.
"Cents at risk" is your trade risk, and is determined by the difference between the trade entry point and where you place your stop-loss order. The stop-loss closes the trade if it loses a certain amount of money (by reaching a predetermined price set by you). This is how risk on each trade is kept within the account risk limit discussed previously.
When you make a trade, consider both your entry point and your stop loss location. You want your stop loss as close to your entry point as possible, but not so close that the trade is stopped out (exited with a loss) before the price move you're expecting occurs.
Once you know how far away from your entry point your stop will be (in cents), then you can calculate your ideal position size for that trade.
Determine Position Size for Trade
Money at risk is the maximum you can risk on any trade (step 1), and the cents at risk is your trade risk (step 2). With these figures, you can determine the shares traded, which is your ideal position size.
Ideal position size is a simple mathematical formula:
Money at Risk ÷ Cents at Risk = Ideal Position Size
Assume you have a $45,000 account and risk 1% of your account on each trade. You can risk up to $450 (money at risk), and want to trade XYZYX stock. You want to buy at $50.10 and place a stop loss at $49.99—putting $0.11 at risk (cents at risk).
Divide $450 by $0.11 to get 4090. This is the maximum position size (number of shares) you can take on the trade at your risk level of 1%. You should round it down to the nearest full lot (increments of 100 shares, which is the lot size of most stocks). The ideal position for this trade is 4000 shares. This position size is precisely calibrated to your account size and specifications for trading.
Commission charges were not included in the above calculations.
Thoughts to Takeaway
Proper position sizing is key to successful trading. Establish a set percentage you'll risk on each trade, 1% or less is recommended—but don't get too low. Remember, if you risk too little your account won't grow; if you risk too much your account can be depleted in a hurry.
Then establish your cents at risk on each individual trade. Based on account risk and cents at risk, you can determine your position size in shares.