Bet sizing is a crucial aspect of successful trading and investing. It involves setting the correct size while buying or selling an instrument or calculating the money amount that a trader will open a new trade with. One of the key principles of bet sizing is maintaining a consistent percentage of the total trading capital for each trade. Proper bet sizing helps prevent capital loss on a single trade, controls risk-taking, and maximizes performance.
Every trader wants to capture big winning trades and 5x, 10x, or even 20x their trading capital. This is easier said than done. Such changes do come along once in a while, but the probability of the entire trading capital getting wiped out, if all of it is put in one trading, is always there. Hence, instead of investing in one trade, it is better to utilise effective bet sizing techniques. Let us delve deeper into what bet sizing is all about.
A position is the total amount of currency, or any other financial instruments, that a trader holds. Positions can be either long or short. The former means that the trader speculates that there will be a rise in the price of a particular trading instrument, whereas the latter implies that the investor speculates about falling prices. What is important to know here is that when there is speculation on falling prices, it could be for an asset that the investor actually does not hold.
Defining Bet Sizing
Bet sizing is an important aspect of successful trading and investing. To put it very simply, the setting of the correct size while buying or selling an instrument or the calculation of the money amount that a trader will open a new trade with is known as bet sizing. One of the key principles of bet sizing is maintaining a consistent percentage of the total trading capital for each trade.
It might sound simple, but the process can be complex. For instance, the correct bet sizing is possible only with prior knowledge of how much risk a trader is willing to take while entering a trade and what impact it will have on this trading account. Additionally, it needs constant monitoring – after all, markets are dynamic!
Importance of Bet Sizing
Proper Risk Management
Opening positions with random position sizes that are based on gut instinct can lead to huge losses for an investor. bet sizing is about preventing such losses. It is all about having a well-thought-out risk management strategy. Hence, bet sizing’s primary importance lies in the fact that it helps to prevent capital loss on a single trade.
Controls Risk Taking
Bet sizing also helps the trader to focus on his account as a whole and see how all the open positions are working. This is especially useful for short-term traders who must react quickly to new developments and, thus, often tend to forget how much risk they are already juggling and land up opening more positions.
The correct bet sizing also helps the investor to maximise his performance. For example, a very risk-averse investor will get to know via bet sizing that the returns that will accrue to him will never be huge. In other words, it shows investors how to get the right balance – allowing them the chance to maximise profits while preventing excessive losses.
Bet Sizing Strategies
This is one of the simplest bet sizing strategies wherein one must allocate a fixed amount to every trade undertaken.
For example, if a trader has a trading capital of ₹10,000 and decides to allocate ₹1,000 to each trade, then he has the option of making ten trades instead of putting all his money into one trade.
Allocation of the money into more than one trade automatically brings down the risk being taken and, hence, helps to preserve the capital even if there are some trades which result in losses. Those who are just entering the trading arena find this to be quite useful as they operate with a limited amount of capital.
In this strategy, the investor risks a small percentage of his total capital on each trade. This is usually found while trading in forex, metals, oil, indices and others. In general, the rule of thumb that is used is a one to two per cent per trade risk.
For example, as per this method, if an investor has a total amount of ₹10,000, he should risk only ₹100 to ₹200 per trade.
The fixed percentage strategy is anti-Martingale. This means that every time there is a loss, the risk is halved thereafter, and every time there is a profit, the risk gets doubled. This strategy, hence, focuses on the per cent risk instead of the monetary value.
This method helps the trader to get exposure to a fast-moving market while controlling his risk. It is usually employed by index and commodity traders who want to limit their risk. Most trading providers offer contracts – standard, mini or micro. The investor can choose from amongst these based on the trading capital that he has and also his trading experience. Usually, one starts with a smaller-sized contract and then moves up the ladder.
Leverage can bring in large profits, but it can magnify losses as well. Hence, it should be used with some caution. Traders usually provide leverages from 20:1, 50:1, 100:1 and others. The best way forward for a trader using this method is not to begin from the highest level of leverage, as that comes with the greatest risk exposure.
The formula that operates in this strategy is:
Kelly% = W – [(1-W)/R]
W = Historical win percentage of the trading strategy
R = Profit/loss ratio.
This value (K%) indicates the percentage of the total that one should risk.
Factors that Determine the Right Bet Sizing
Several factors need to be considered when determining the right bet sizing for a particular trade or investment. These are as follows:
Volatility of the Underlying Asset
An important factor to consider when determining bet sizing is the volatility of the underlying asset. If an asset is highly volatile, it may be necessary to reduce the position size to manage risk effectively. Conversely, if an asset is less volatile, a larger position size may be appropriate. This is because the risk of a large loss is reduced in a less volatile market.
Time Horizon of the Trade
The time horizon of trade is also an important factor to consider when determining bet sizing. If the time horizon is short, such as a day trade, a smaller position size may be appropriate to minimise the risk of a large loss. If the time horizon is longer, such as a long-term investment, a larger position size may be appropriate as the risk of a large loss is reduced over time.
Stop Loss Level
Another aspect of bet sizing is determining the appropriate stop loss level. A stop loss is a predetermined level at which the trader will close the trade if the market moves against them. The stop loss level should be set at a level that will minimise the risk of a large loss but also allow for some breathing room in the event of normal market volatility. A commonly used stop-loss level is one to two per cent of the total trading capital.
Investor’s Risk Tolerance
It is important to consider the individual’s risk tolerance when determining bet sizing. Some traders and investors are more comfortable taking on larger amounts of risk, while others prefer to be more conservative. Understanding one’s risk tolerance and adjusting the bet sizing accordingly is important.
Bet sizing is an important aspect of successful trading and investing. It helps investors maximise profits and minimise losses while managing risk effectively. It is important to remember that bet sizing is a dynamic process, so strategies need to be adjusted as market conditions change. Traders should regularly review their bet sizing strategies and make adjustments to ensure that their trading capital is protected from unnecessary losses.
Bet sizing is an important aspect of successful trading and investing.
It involves setting the correct size while buying or selling an instrument or calculating the money amount that a trader will open a new trade with.
One of the key principles of bet sizing is maintaining a consistent percentage of the total trading capital for each trade.
Bet sizing helps in proper risk management, controls risk-taking, and maximizes performance.
There are different strategies for bet sizing, including fixed value, fixed percentage, contract size, leverage, and the Kelly Criterion