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. You can have the best strategy in the world, but if your trade size is too big or small you'll either take on too much or too little risk. The former scenario is more of a concern, as risking too much can evaporate a trading account quickly.
Your position size is the number of shares you take on a trade. Your risk is broken down into two parts--trade risk and account risk. Here's how these elements fit together to give you the 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 account.
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 the trade.
You can also use a fixed dollar amount, but ideally, this should 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 of a trade may change, account risk is kept constant. Don't risk 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 about 1%.
Determine "Cents at Risk" on the Trade
You now know what your maximum account risk is on each trade. Turn your attention to the trade 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. This is how risk on each trade is kept within the account risk limit discussed above.
Each trade may be different, though, based on volatility or strategy. Sometimes a trade may have a 5 cent risk, and another trade may have 50 cents of risk.
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 before the price move you're expecting occurs.
Once you know how far away from your entry point (in cents) your stop will be, then you can calculate your ideal position size for that trade.
Determine Position Size for Trade
Ideal position size is a simple mathematical formula equal to:
Money at Risk / Cents at Risk = Shares Traded
We already know the Money at Risk figure, because this is the maximum we can risk on any trade (step 1). We also know the Cents at Risk (step 2).
Based on that, what you need to figure out is the Shares Traded, which is the position size.
Assume you have a $45,000 account and risk 1% of your account on each trade. You can risk up to $450, and see a trade in 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. Round it down to the nearest full lot (100 share increments). The ideal position for this trade is at 4000 shares. This position size is precisely calibrated to the account size and the specifications of the trade.
Plug any numbers into the formula to get your ideal position size (in shares).
If you wish to risk $300 on a trade and have $0.30 at risk, then the position size is $300 / $0.30 = 1000 shares.
Commission charges were not included in the above calculations.