How to Size Trades Properly

Key Concepts

• Net Liquidity (Net Liquidity): The value of an account after subtracting liabilities. Used as the base for calculating trade size.
• Contract Size: The standardized amount of an asset represented by a single contract in futures or options trading.
• Risk Percentage: The percentage of an account’s net liquidity risked on a single trade.
• Buying Power: The amount of capital available for trading.

Trade Size Determination: Percentage vs. Contract Size

The primary method for determining appropriate trade size should be based on a percentage of net liquidity, rather than a fixed contract size. The speaker advocates for risking between 1% and 3% of total net liquidity per trade, with a wider, but less desirable, range extending to 5%. This percentage is not static and is inversely proportional to account size. Specifically, smaller accounts will inherently utilize a larger percentage of their buying power due to their limited capital base. Conversely, accounts with substantial capital (multi-million dollar accounts) will operate at significantly lower risk percentages, well below 5%, even when initiating new trades.

The speaker emphasizes that the 1-3% range is “probably the paramount question, paramount one to look at” when assessing risk. This highlights the importance of capital preservation and avoiding potentially devastating losses from oversized trades.

The Role of Default Contract Size

While percentage-based risk management is preferred, the speaker acknowledges the practical application of defaulting to a consistent contract size. This is particularly relevant for traders who consistently operate at a specific level, such as a “one lot trader.”

This “one lot” approach means maintaining a consistent contract size across various products, regardless of the underlying asset’s price. For example, a trader might consistently trade one contract whether the asset is a stock trading at $25-$30 per share or a stock trading at $250-$300 per share. This simplifies trade management and allows for a standardized approach to position sizing.

Combining Approaches: A Hybrid Strategy

The speaker suggests a combination of both methods. While the initial calculation should be based on a percentage of net liquidity to control risk, a default contract size can be used for practical implementation and consistency. This hybrid approach allows traders to adhere to their risk parameters while streamlining their trading process.

Account Size and Risk Tolerance

The discussion clearly links account size to appropriate risk tolerance. Smaller accounts necessitate a higher percentage of buying power utilization simply due to their limited capital. Larger accounts afford the luxury of lower risk percentages, providing a greater margin for error. This underscores the need for personalized risk management strategies tailored to individual account sizes and risk profiles.

Notable Statement

“If I was going uh a little bit tighter on that with a lot more uh leeway, especially in a smaller account, you know, you're going to use more buying power just because your account size is smaller.” – This statement directly illustrates the inverse relationship between account size and the percentage of capital allocated to a single trade.

Synthesis

The core takeaway is that trade size should primarily be determined by a percentage of net liquidity (1-3% recommended), adjusted based on account size. While a default contract size can be a useful tool for consistency, it should not override the fundamental principle of risk management based on a percentage of available capital. This approach balances risk control with practical trading considerations, ultimately aiming to protect capital and promote long-term trading success.