The Golden Rule of Position Sizing

Asad Dossani
By now you understand why position sizing is important. So how do you go about it in practice? When I'm deciding on a position sizing rule, I keep the following factors in mind. First, the rule should be simple and easy to implement. And second, it should adequately manage our risk.

Simple is important because everyone should be able to implement it. You shouldn't need any fancy mathematics or programs. Just simple calculations and straightforward logic. Risk management is important because that's the goal of position sizing in the first place. To manage risk. Risk management is critical to success in trading. The best trading ideas are useless without risk management.

So here is the golden rule: Place 1% of your portfolio at risk for each trade. How would this work in practice? Suppose you are trading a futures contract. The initial margin requirement is Rs. 5,000 per contract. Now Imagine your portfolio is worth 10 lakhs. 1% of 10 lakhs is Rs. 10,000. So you should trade two contracts. Trading two contracts means you place Rs. 10,000 at risk for that trade.

Now keep in mind that the portfolio I'm referring to is not your long term portfolio. It is not your total wealth. It is the amount you have allocated to trading. It is an amount you can afford to lose, because trading is a high return and high risk endeavor.

We've worked out that for a portfolio size of 10 lakhs, you should risk Rs. 10,000 per trade. This means that you should risk an equal amount of money on each trade. This risk of each trade should be as close to Rs. 10,000 as possible. Obviously, contract sizes mean that you can't risk exactly Rs. 10,000. But trade however many contracts you need to get as close to Rs. 10,000 as you can. It is fine to risk slightly less or more, just be close.

Why risk an equal amount on each trade? Doing this means that any one trade won't dominate your portfolio. Imagine you make three trades, one large and two small. You don't want losses from one large trade to dominate the gains from two small ones. Risking an equal amount on each trade means you benefit from diversification.

What if Rs. 10,000 is not enough to invest in certain contracts? For example, if you wanted to trade one lot of Natural Gas on the MCX, Rs. 10,000 is nowhere near enough. What should you do then? In this scenario, just avoid trading Natural Gas.

It is better to avoid trades that are too large for your portfolio. Remember any trade can lose money, even when you use an excellent trading strategy. So don't put yourself at mercy of a single trade.

The worst thing that can happen to your portfolio is a large loss. It is very difficult to recover from large losses, because you need larger subsequent gains to break even. For example, a 50% loss on your portfolio requires a subsequent 100% gain to break even. This is why risk management is so important. This is why correct position sizing can be the difference between success and failure.

So remember: Stick to the 1% golden rule. Do this, and your portfolio will be protected.

Do you have comments or questions about implementing the 1% rule? Share your views in the Club or share your comments here.

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9 Responses to "The Golden Rule of Position Sizing"
s n keshari
09 May, 2015
Dear Sir. You have open my mind. It is too fool to get more in rising market also.Like 
Ajay Kumar Gupta
10 Feb, 2015
Dear Assad, I could not follow it up, please explain in some other way?Like 
S Anantharam
08 Feb, 2015
Hi Assad, This makes ample sense. I just wished you had sent this advise at the beginning of the programme.... Hope you are not holding back other such basic nuggets for future elaboration.. Rgds AnantLike 
08 Feb, 2015
very well said. It looks me as very good strategy to manage a risk. Like 
Altaf Husen
07 Feb, 2015
Hi, it's well informative, I Appriciate.Like 
dinesh shah
06 Feb, 2015
very important & well said.Like 
06 Feb, 2015
Does this 1% mean a single trade at one time or all open trades at that moment / period of time. Please clarify. Thanks Nikhil.Like 
06 Feb, 2015
Completely sensible and i am with you all the way. You and Apurva had elucidated this principle on trading strategy very well during the conference as well.Like (1)
06 Feb, 2015
Hi, Thank you for the very informative article.I always thought at risk value in a futures trade was the amount of potential loss based on your stop loss and not on the actual margin figure.For the same contract the margin is very different for a carry over trade and intraday trade.It is also affected by the type of order like cover order or bracket order while potential loss from the trade will remain the same if your stop loss range is same.Can you please clarify?Like 
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