Online Stockmarket Trading Update

When markets are volatile having the desired level of exposure in the market relevant to be both your risk profile and available capital is critical. Its importance is further magnified when dealing with leveraged products such as CFDs.

In this post we ll put forward a position sizing model that can be applied when trading CFDs to manage risk and exposure in the market. In coming weeks we ll outline alternative strategies that can also be considered.

Key principals

1. Have a predetermined level of risk that you are comfortable taking whereby a string of losing trades is not going to be fatal to your account. This can be a % of total equity or alternatively a $ amount.

2. Determine the position size of each trade based on this predetermined level of risk.

3. Place a cap on your total exposure considering the balance between margin to equity.

Taking a risk based approach to position sizing

This means setting a specific level of risk prior to entering the trade and molding a position around this figure.

To determine the level of risk per trade, you would take your entry level minus your stop level and multiply it by the number of CFDs. The desired risk level is the constant, the entry price and stop price are fixed so the variable is the position size.

The position size (and hence your exposure) is determined largely by the difference between your stop loss and your entry price. You can of course use a tighter stop level and gain a larger exposure for the same amount of risk which will make you wins larger however you will experience a higher number of losses than if you employed a wider stop.

The opposite is also true. If you widen the stop and want to maintain a set level of risk, you will have a smaller position or a reduced exposure to the underlying instrument and the potential return will be reduced however you are likely to have a greater number of winning trades.

All things being equal, a tighter stop will result in a shorter trade duration whilst a wider stop will allow you to stay in the position longer.

Stay tuned for further updates on position sizing incorporating volatility based approaches. For more general information on CFDs, sign up for our free mini course.