## What is 'Position Sizing'

Position sizing refers to the number of units invested in a particular security by an investor or trader. An investor's account size and risk tolerance should be taken into account when determining appropriate position sizing.

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## BREAKING DOWN 'Position Sizing'

Position sizing basically refers to the size of a position within a particular portfolio, or the dollar amount that an investor is going to trade. Investors use position sizing to help determine how many units of a security they can purchase, which helps them to control risk and maximize returns. (For further reading, see: Optimal Position Size Reduces Risk.)

## Position Sizing Example

Using correct position sizing involves three steps:

• Determining Account Risk: Before an investor can use appropriate position sizing for a specific trade, he must determine his account risk. This typically gets expressed as a percentage of the investorâ€™s capital. As a rule of thumb, most retail investors risk no more than 2% of their investment capital on any one trade; fund managers usually risk less than this amount. For example, if an investor has a \$25,000 account and decides to set his maximum account risk atÂ 2%, he cannot risk more than \$500 per trade (2% x \$25,000). Even if the investor loses 10 consecutive trades in a row, he hasÂ only lostÂ 20% of his investment capital.
• Determining Trade Risk: The investor must then determine where to place hisÂ stop-loss order for the specific trade. If the investor is trading stocks, the trade risk is the distance, in dollars, between theÂ intended entry price and the stop-loss price. For example, if an investor intends to purchase Apple Inc. at \$160 and place a stop-loss order at \$140, the trade risk is \$20 per share.
• Determining Proper Position Size: The investor now knows that he can risk \$500 per trade and is risking \$20 per share. To work out the correct position size from this information, the investor simply needs to divide the account risk, which is \$500, by the trade risk, which is \$20. This means 25 shares can be bought (\$500 / \$20).

## Position Sizing and GapÂ Risk

Investors should be aware that even if they use correct position sizing, they may lose more than their specified account risk limit if a stock gaps below their stop-loss order. If increased volatility is expected, such as before company earnings announcements, investors may want to halve their position size to reduce gapÂ risk. (For more, see: Do Stop or Limit Orders Protect You Against Gaps?)

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