Position Sizing based on the development of an open position (gradual sizing) – Part Two
In the previous article (“ Different Risk-Based Position Sizing Techniques – Part One ”), you learned basic information about position sizing and about how sizing can influence the balance of a trader’s trading account.
For those who haven’t had the chance to read the previous article, it’s good to say again that position sizing is objective decision making about how large a new position should be.
Choosing the size of a position is purely individual; there is no universal formula.
The previous article included illustrative examples of two sizing techniques that are used by traders all around the world. The first technique mentioned was traditional sizing and the second one was sizing using the estimated probability of the risk of loss. The article also mentioned the basic differences between the two techniques and appropriate situations for the use of each of the techniques.
Gradual trade sizing
Gradual trade sizing is, without a doubt, one of the most developed and modified ways to determine the size of a position that is already open or that is being opened. The pros of this technique can make a priceless companion when trading. However, when this type of sizing is approached wrongly or carelessly, it can be a trader’s nightmare, and it can result in a trader’s trading account dropping to zero within a few short moments.
Compared to the sizing techniques mentioned before, this one is definitely the most complicated one, and that is why it requires traders to be highly professional and to make very few mistakes.
Unlike traditional sizing and sizing using the estimated probability of the risk of loss, the size of a position that is being opened isn’t determined before the position is entered, but it is adjusted as needed once the position has been entered.
The trader must, above all, protect his financial capital. That can be done by determining what maximum loss he is willing to risk per open position.
The next thing he has to do is determine how many positions at most he wants to open in one session as well as the interval in which he’ll enter them.
This method also requires the trader to set up stop-loss and profit-target orders, but unlike the previous sizing techniques, these orders do not stay unchanged the whole time. We can simply say that as the number of open positions increases and decreases, the orders change as well. What’s important is that the total stop-loss (all stop-loss orders on open positions relating to the given trade added together) is lower or, at most, equal to the highest acceptable loss per trade.
The last and most important thing is that the trader must think well about which personal analyses (values) or important reports will give him the signal to close open positions to protect what’s really important – his financial capital.
|Maximum number of open positions||Interval between the positions in points|
|Size of each open position||Maximum profit/loss ratio|
|Maximum loss in percent||3|
Example: To make the explanation as easy as possible, we have chosen the same volume per open position and the same maximum percentage loss (the highest acceptable loss per trade => one trade is usually made up of more open positions).
In our example, the maximum number of open positions is set at 3. We also have some financial resources (the exact number is not important), and if we want to trade 1 lot, we know that we can set the stop-loss order at 1000 (100 pips) at most to make our maximum loss 1%.
After performing personal analyses and doing research, we open the first position, and if it moves against us, we get to a 1% loss in 1000 points. On the other hand, if it goes the way we predicted, we open another position the size of 1 lot after 1000 points and set the stop-loss for both positions to make 1% loss if it is reached (in this case, it depends on the value at which we entered the first position). If the market keeps on following the trend we chose, we open a third position after another 1000 points and adjust the stop-loss orders again to make the total potential loss 1% again. And if the market moves another 1000 points in our direction, we close all positions that we opened for this trade either manually or using a profit-target order.
So, what is the strength of this type of sizing?
Throughout the whole trade, we were willing to risk only 1%, which meant a loss of 1000 points. However, when we reached profit-target, the maximum total profit was 6%. How is that possible, you ask? The first opened position reached a profit of 3000 points when profit-target was reached, the second position, the second had a profit of 2000 points and the third 1000 points; that is 6000 points in total (600 pips), which is 6% (the maximum profit/loss ratio is 6:1)
Now we’ve demonstrated the basic principles of gradual sizing. But why is this type of sizing complicated? Because the example above would only work under perfect conditions, which does not happen very often, and what is why to get the maximum profit and capital protection possible, it is also necessary to create new analyses, watch various fundamentals and react to them appropriately while trading (after you’ve opened your positions).
One good example is this: we’ve opened our third (last) position and we know that we have only 500 points left to reach our profit-target, but we suddenly find out that in approximately an hour, a representative of a country (the country the currency of which we are currently trading) will go on TV and speak about the issue of whether or not the country will send its troops to a foreign territory. In this situation, you need to react quickly and decide whether or not to close your profitable positions and protect your capital and risk not getting the maximum profit possible.
The basic sizing technique is not that complicated. What is complicated is following the rules strictly and precisely, constantly monitoring the development of the trade and keeping an eye out for any new relevant reports. If a trader trades on five different levels, all it takes is a small distraction and the trader can suffer a significant loss that leaves a financial as well as a psychological mark. And that is the worst thing that can happen to a Forex trader.
We have introduced the basic principles of gradual sizing, but it is only up to the trader and his skills to make this type of sizing helpful in his trading.
You can try various position sizing techniques without risk and for free on the Purple Trading demo account, which you can open on our website: https://www.purpletrading.com
About the Author
Team Purple Trading
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