How to Determine the Right Position Sizing for Your Crypto Trades
Chapters
Beyond the “buy low and sell high theory”, any crypto trader should understand and learn how to determine the right position size, aka the amount of capital to allocate to a trade based on your risk tolerance.
Your position size defines both the profit you’ll potentially make and the level of risk you might be exposed to.
If your position size is too small, you might miss opportunities and get a short ROI. Conversely, if your position size is too large and you dedicate a large amount of your capital, your losses will be substantial. The crucial aspect is finding the right balance—a position size that can generate significant profits while minimizing potential losses.
Here’s how you can determine the appropriate position size for your trades so you can grow your crypto portfolio.
How to Calculate Your Position Size
The typical adage “never invest more than you can afford to lose” is directly linked with position sizing. That’s because it’s a basic risk management technique that impacts both your potential profits and potential losses.
By carefully calculating your position size based on factors like account size, risk tolerance, and market conditions, you can create a solid foundation for your trading activities.
And here are some basic calculation rules:
- Percentage risk rule
This rule recommends traders to limit the amount of their trading capital at risk on any single trade. While the specific percentage may differ among traders, a widely recommended guideline is to never risk more than 2% of your total trading capital on a single position.
Based on this rule, you shouldn’t risk more than 2% of your account on a single trade. Yet, the 2% rule is rather suitable for traditional finance that excludes highly volatile crypto markets.
In the crypto world, and especially if you’re an active trader, the 2% rule should be turned into the 1% rule instead.
Let’s take one example:
Suppose your total trading capital is $8,000 and you want to risk 1% of your capital on any single trade. Considering the percentage risk rule, you decided to trade Ethereum (let’s imagine its current price is $3,500 per coin.
You take into account this formula;
Position Size = Total Risk per Trade / Trade Risk
For this scenario:
Total Risk per Trade (1% of $8,000) = $80
Trade Risk (Difference between entry price and stop-loss price) = $40
Using the formula:
Position Size = 80 / 40 = 2
This means that you can buy or sell 2 ETH while you stick to the 1% risk tolerance for this trade.
- Fixed amount rule
The trader chooses a predetermined capital amount to risk on each trade instead of a percentage. This approach is often preferred by traders with smaller accounts who are uneasy about risking a portion of their entire trading capital.
- Volatility-based rule
Volatility-based position sizing is another effective strategy that considers market dynamics and price movements. Instead of using a fixed percentage, this approach adjusts the position size based on the volatility of the asset being traded. This way, traders can adapt their risk exposure to changing market conditions. This method allows for more flexibility in adjusting position size according to the level of risk in the market.
Position Sizing in Bearish vs. Bullish Markets
In a bullish market, investors generally feel optimistic. You might feel tempted to invest more money, expecting big returns. However, it's still wise to be cautious to protect against unexpected downturns, even in a bullish market. The safest approach would be to slightly increase your investment size while staying within your risk tolerance to ensure potential losses are manageable.
On the flip side, a bearish market doesn't necessarily mean you should avoid trading altogether. It could actually be a good time to trade smaller amounts, reducing your risk exposure while still being able to profit if prices fall as expected. Smart position sizing in bear markets means aligning your trading strategy with market conditions and taking a more conservative approach.
Rely on Position Size Calculators
Position size calculators are valuable tools that help traders accurately determine the appropriate position size based on their risk parameters. These calculators take into account factors like account balance, entry price, stop loss, and desired risk level to calculate the optimal position size for a trade.
For instance, Altrady’s risk-reward calculator determines trade size based on the specific risk-reward ratio of each trade. It takes into account both the potential profit and the associated risk of a trade, enabling you to optimize position size and achieve the desired balance between risk and reward. This method ensures that trades with higher reward potential relative to risk receive larger allocations of capital.
Steps in Implementing Position Sizing in Crypto Trading
- Assess risk tolerance
Before determining position size, it's crucial that you assess your risk tolerance and investment objectives. Factors like risk appetite, financial goals, and time horizon should inform position sizing decisions, ensuring alignment with overall trading strategy and risk management principles.
- Use Stop Loss orders
Stop Loss orders are essential tools for managing risk in crypto trading. By setting predefined exit points for each trade, you can limit potential losses and protect against adverse market movements. Incorporating Stop Loss orders into position sizing strategy helps to enforce disciplined risk management practices and mitigate the impact of unexpected market events.
- Regularly review and adjust
Market conditions and risk factors constantly evolve, requiring you to adapt your position sizing strategy accordingly. Regularly review and adjust position sizes based on changing market dynamics, volatility levels, and risk profiles, so you can maintain optimal risk management and maximize trading performance.
The Bottom Line
Key takeaways:
- position sizing is a strategic method where you allocate a portion of trading capital to each trade;
- it helps you define your entry and exit points, manage risk, and maintain a balanced trading approach;
- using Altrady risk-reward calculator and risk management tools, you can save time and enhance your overall trading performance.
More than a simple tool or technique, position sizing is a fundamental principle that underpins successful trading. The right position sizing helps you protect your capital, stay resilient during market fluctuations, and increase your chances of achieving consistent profitability over time.