Do you clench the mouse when you enter a position? Cannot leave the computer to go to the bathroom when you’re in a trade? Do you watch every tick when you’re in a position?
If you do any of these, you are trading with too much size. Trading with too much size not only makes trading way more stressful than it needs to be, but it also costs you money. It affects your ability to see the markets objectively without emotion. It also affects your risk management, can result in you taking massive losses, and cutting your winners short.
Here is how you should size your positions correctly, and what you need to understand about position sizing to become a more consistent and profitable trader:
Smaller Positions Can Make You More Money
This doesn't make sense to most newer traders. How does buying or shorting fewer shares make you more money? Doesn’t doubling your size means doubling your profits?
This is one of the biggest misconceptions traders have. Trading with too much size will cause you to stop out prematurely because you are afraid of losing too much money. It also causes you to get greedy and take profits to early.
Essentially, incorrect position sizing causes you to focus on your PNL, and not on what the price action of the market is telling you. We talked a lot about risk management in yesterday’s article. Trading too much size completely screws up your risk vs reward ratio, as it makes your winners smaller and your losers larger.
You have to find the sweet spot of trading enough size to make the time you put into trading worthwhile, but small enough that it doesn't cause you to trade emotionally. You should size according to your account size and your net worth. Less emotional attachment to your positions will make it easier to let your winners ride and cut your losses short.
Risk Proportionally To Your Net Worth and Account Size
Some people say to not risk more than 1% of your account, but if you have $2000 account (which many people reading this probably do) risking $20 is pointless. That being said, when you are a new trader you should not be putting all of your savings into a trading account when you have not proven yourself to be profitable.
If you only have 5 grand to your name and you are risking $500 on a trade in a $2000 account, you are going to panic if that trade starts to against you. Whatever you decide to risk on a trade, that outcome of that trade should not change the financial decisions you make in everyday life. Risk only what you can afford to lose.
Better Risk Management
Have you ever frozen up when you were holding a big position? When you trade with too much size, you may not cut your loss when you are supposed to. When you are all-in on a trade and it goes against you, realizing the loss is painful. For some traders, it becomes too painful, and play the avoidance game until it gets too big to ignore.
The other thing to consider when trading too much size is what happens in the worst-case scenario. Anything can happen once you are in the trade. Bad news could come out when you are in a position. If the stock tanks fast when you are overleveraged, you could lose everything, and even go into debt with your broker.
Free Workshop on Risk Management and Consistency 2/25
Because risk management is so integral to your trading success, we are doing a free webinar on 2/25 to show you our proven risk management strategies and tips for finding and maintaining consistency in your trading.