Explained: Position Sizing

Whether speculating or investing, position sizing is one of the utmost vital elements of success. Unfortunately, it is usually neglected and gets very little coverage when compared to trade entry/exit methods.

There are two common types of position management; one predominantly used by longer-term traders, and the other that short-term traders should adhere to. To effectively trade, control risk, and get the most “bang for their buck”, it is important for traders to understand how position sizing works and the best methods for accomplishing the ideal position size.

What Is Position Sizing?

Position sizing is how many coins or tokens of a cryptocurrency traders want to buy. Many traders just “wing it,” buying as much as their account will allow, or buying large positions if they feel very confident in the trade and small positions if they are not as confident, but these are not effective methods for determining an ideal position size.

Why Is Position Sizing So Important?

For active traders, and even investors who want to avoid the major drawdowns in their accounts that inevitably occur during crashes or price corrections, position size must be of paramount importance. Without proper position sizing, it is possible for traders to lose a substantial amount of capital on a single trade.

Assume a given trader has $5,000 with which to trade. They feel confident that the cryptocurrency ANT, currently priced at $1, is going higher. They decide to buy 3000 tokens at a price of $3,000. A new feature is delayed, and the price proceeds to decline over the following week, finally settling at $0.50. They admit they were wrong and close out the position for a loss of $1,500 in a matter of weeks, nearly a third of their trading account.

There is a major problem here. The position size, 3,000 tokens, is random and not calibrated to the account size. Risk was also not controlled in any way when the trade was placed. Defining how much they are willing to lose is something every trader should do on every trade.

The Bottom Line

Long-term investors will likely find the equal dollar method of position sizing easiest to implement. By investing a small portion of the total account capital in each cryptocurrency, some level of diversification is achieved. Stop-losses can be implemented on each position to control risk, either by using a fixed percentage risk or by applying individual stops to each position.

Short-term term traders typically use the equal risk — also called equal percentage risk — position sizing strategy. This is because diversification does not matter as much to short-term traders. The trader wishes to utilize their capital on opportunities, but keep risk controlled to a small percentage of their account while doing it. This method requires placing a stop-loss and then calculating the position based on the individual risk of the trade.
Both methods can be utilized by any trader, as can any stop-loss strategy. The ultimate goal is to make sure that no single trade creates a large drawdown in the account; this is accomplished by making sure the position size matches the goals of the trader for controlling risk.