Introduction
Suppose you have decided to enter into the cryptocurrency market, but you do not know how to manage your wallet. You cannot afford to allocate all your assets for futures trading as it is too risky. Similarly, going all in for spot trading may be too time-consuming as you might be required to hold coins literally for years to get the desired yield. Keeping all this in view, you need to learn how to manage your trades and the position size within a trade.
Why You Need to Calculate Position Size?
Calculating the size of your trading position helps you manage risks. Risk management is key to good trading. If you ignore this point, the progress you have made in months and years can be wiped out in single trade. It is rightly said that you must not try as hard to win as to not lose. Before relishing the idea of big profits, try to imagine the potential loss. The probability of a loss in crypto trading is so high that it is almost certainty. There is no trader in the world who can claim to have never incurred a loss. In fact, majority of traders lose more than to win. Yet expert traders end up being on the profitable side sheerly due to proper risk management.
Position Size and Trade Management
Making a system of trading by calculating your trade position for yourselves is also important so that you may keep emotions at bay. Elevated volatility in the crypto market has potential to catch you off guard. Loss can clutch you from the edge of a victory. In such a situation, if you do not have any backup plan, you get nervous, get liquidated, and open a revenge trade, only to lose again. In short, your personal trading system saves you from taking harmful impulsive decisions.
There are a few important things to consider when you intend to devise a trading system leading to the calculation of position size. The most important of them all are two things: what is your startup size and how much risk you can afford to take.
What is the Account Size?
The size of the position in crypto trading is easy to determine if you know how to find out the actual size of your account. You cannot risk all your assets in futures trading, which poses a very high risk of liquidation. Your long-term portfolio is not counted when the size of your account is considered. This long-term portfolio may be on any exchange or even on a cold wallet. Only buy-and-hodl strategy applies to the long-term bags. You cannot use it for scalping, day trading, swing trading or trend trading.
Account Risk
After determining the actual size that really matters for a position size, it is necessary to decide the risk you can take on that trading account. In the world of finance other than cryptocurrency, 2% rule is followed. It means only 2% of your trading account is used in one trade. Since the cryptocurrency market is far more volatile than an ordinary stock market, it is better to limit the rule to a more conservative approach by halving it to 1%. It is a truth universally acknowledged that almost every trader has a success ratio of 50% or less in the crypto market, so you should play safe. The 1% rule dictates that you must put a stop-loss order where your loss is no more than 1%.
Trade Idea Invalidation
No matter how immaculate your analysis is prior to entering a trade, there can come a point where you admit that your study was not enough, and then you get out of the trade. You generally base your trading idea on some support or resistance, trend reversal, break of structure, etc. If you are taking a swing trade or a trend trade, you can also take help from the indicators of fundamental analysis or macroeconomic factors. However, the level of uncertainty in the crypto market has got the potential to turn your analysis topsy-turvy. That’s why, putting an SL is very important.
How to Calculate Your Position Size
When you have learned how to calculate your real account size, how to determine the risk factors and amount of risk you can afford to take, and finally how to get out of a trade if it turns out to be a disaster, you have come to the stage where you can easily calculate your position size.
Suppose you have $10,000 in your trading account. The 1% rule dictates that you cannot afford to lose more than $100 in one trade. The next point is that you have to find out at what point of the trade your $100 will be lost, or in other words, at what point you must put an SL order. Let’s imagine that the point exists 15% away from your trade. You can easily calculate your position size by using the following formula:
position size = account size x account risk / invalidation point
Now, let’s put the values in the formula to find out the position size.
position size = 10,000 x 0.01/0.15
666.67 = 10,000 x 0.01/0.15
The calculation shows that you need to open the trade with $667. From the calculation, it is evident that the farther your SL is, the smaller the position size. It means you can take the same trade by risking less of your account size. For example, suppose that your SL is 25% away from your entry point, the calculation is as follows:
333.34=10,000 x 0.01/0.30
Movin SL away from your entry point 2X will cut your position size in half.
Conclusion
Calculating the position size of your trade is very important when you take into account risk management and return on investment. Unless you know how much you can risk in a trade, you are prone to open a very risky position that can destroy your trading account. Also, not knowing the exact position size of your trade can drive you to emotional disturbance, leading you to even more flawed decisions.
