Position Sizing in Stock and Options Trading
Stock Market Guides is not a financial advisor. Our content is strictly educational and should not be considered financial advice.
When it comes to buying and selling stock and options, position sizing can play a major role in how much your account grows or shrinks.
Some investors think position sizing is just a critical a decision as which stocks to buy.
This guide can help you understand more about what position sizing is and which approach might work best for you.
What is Position Sizing in Trading?
Position Sizing refers to how many shares of stock you buy for one trade or investment (or, for options, how many contracts you buy).
So for example, imagine you have a $1,000 trading account. And imagine you buy a share of Apple stock for $100.
Your position size for that Apple stock investment could be described in any of these ways:
- One share
- 10% of your account
All three of those are different ways of referring to the position size for that investment.
Stock Market Guides
Stock Market Guides identifies stock and option trading opportunities that have a historical track record of profitability in backtests.
Position Sizing Calculator
One way to manage your position sizes is to use our free position sizing calculator. It calculates stock position sizes as well as option position sizes.
We have two types of position size calculators on that page. One calculates a position size based on the percentage of your account balance you want to invest in the position. For example, if you have a $10,000 account and you want to use 5% of your account to buy Amazon stock, then our calculator will tell you how many shares to buy.
We also have an ATR Position Size Calculator. That one bases the position size on how the average true range of the stock relates to your account balance.
Position Sizing Strategies
There are seemingly countless different ways that a trader can go about position sizing. They range from simple to complex.
We'll walk you through some of them and highlight the pros and cons of each one.
Our Preferred Position Sizing Approach
At Stock Market Guides, we do a lot of research on trading strategies. Part of that research involves identifying a position sizing approach that optimizes the balance between risk and reward.
Toward that end, we've found that so long as your trading approach involves a true edge, then a position sizing approach with the following characteristics might be beneficial to use:
Compound Position Sizing
We like a compound position sizing approach. In other words, as your account grows, you increase your position size with each new trade.
It can have a multiplying impact on your profitability if you’re trading with an edge. The power of compounding is strong.
One way to do this is to set up each trade to have a risk amount equal to a particular percentage of your account balance. That way, as the account balance goes up, your position size is going up.
Use ATR to Measure Stock Price Movements
To make sure each trade has an equal potential impact on the account balance, we focus on a metric called ATR. It stands for Average True Range and represents the average distance a stock price has moved each day in the recent past. This metric is helpful because it allows us to measure each stock’s price movement in an “apples to apples” way.
So based on all this, here are our preferred respective position sizing formulas:
Swing Trades and Longer-Term Investments
Stocks: 1% change in account balance per 1 ATR move in the stock price
Options: 2% change in account balance per 1 ATR move in the stock price. Note: this can be higher than stocks due to the increased leverage that options offer.
3% change in account balance per 1 ATR move in the stock price.
Keep in mind that those are aggressive position sizing approaches based on making trades that have a bonafide edge in your favor. That position sizing approach may not match your risk preferences, and you can change the percentages accordingly.
If that approach seems complicated, keep in mind that we offer a position sizing calculator that incorporates those elements and does all the calculations for you.
Fixed Shares Position Sizing Strategy
Another position sizing approach is to buy the same number of shares or contracts for each position.
A benefit of that approach is that it's super simple, which makes it easy on you mentally and in terms of time needed to make the trade.
A downside of that approach is that it gives you an unequal distribution of trade profits. The trades that have larger share prices end up having a bigger weight on your account performance, whether they're better trades or not.
For example, if you buy 10 shares of Amazon for a total of $1,000 and 10 shares of Netflix for a total of $4,000, then your account balance is going to be more sensitive to the Netflix trade outcome.
Fixed Dollar Amount Position Sizing Strategy
This position sizing approach calls for each position size to be the same dollar amount.
For example, you might decide that each position size will be equal to $1,000. So if the stock costs $100, you'll be 10 shares. If the stock costs $500, you'll buy 2 shares.
A benefit of this position sizing approach is that you always put the same amount at risk on each trade. Its formulaic and consistent.
A drawback to this approach is that as your account changes in size, you are not changing your position size and you therefore do not get any compounding benefit (unless you manually adjust the dollar amount of your position size as the account grows).
Another drawback is that you have to take the time to run a calculation before making a trade. It's normally just a matter of seconds to punch it into a calculator, but it's just another step that adds more time and effort to making the trade.
FAQs About Position Sizing
Question: Do I have to use the position size you suggest?
Answer: Definitely not. You can use whatever position sizing approach you want. When we post a position size next to our stock picks and options picks, that’s just a reference point for the position size that was used in backtests. It’s completely your decision how many shares or contracts to buy for any given trade setup, or whether to buy any at all. The bigger position size, the more risk involved and the higher the potential reward.
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