Why size matters a lot in trading
It’s reality check time: Do you find yourself focusing almost entirely on the entry price, ending up underestimating the entry size? You are not alone in this. In the frenzy of finding the perfect entry point, entry size is often neglected with the majority of traders ending up trading too big.
The problem with that is that the larger the size, the more likely you are to exit a good trade on a meaningless adverse price move, as fear (rather than judgement and experience) takes the decision.
Considering that we don’t know if the next trade is a winner or a looser, it is a useful rule of thumb to risk no more than 1% or 2% of the capital on each individual trade, in order to be able to easily make up losses in case the market moves in an unfavorable way.
Defining the amount one can afford to lose and the price level that invalidates the trading strategy allows a trader to calculate the right position size. Let’s take an example: If you are willing to risk £1000 per trading idea and your stop is £2 below/above entry, you can afford 500 shares.
And to put it in the words of the Sage of Omaha:
“Risk comes from not knowing what you are doing”, Warren Buffet
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