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Position Sizing in Crypto: What Is It and How to Calculate It?

Position Sizing in Crypto: What Is It and How to Calculate It?

While trading cryptocurrency can be a great investment opportunity that has the potential to bring significant gains, it is also a very volatile industry with its risks. With that in mind, those that wish to start trading should use all tools available to keep their investments as safe as possible. It’s also important to remember not to take unnecessary risks they can’t afford. Among the many ways to make crypto trading secure, there is a fundamental and easy-to-apply concept called position sizing.

This article teaches you everything you should know about position sizing in the cryptocurrency ecosystem. In addition, we’ll include essential information to make your investments more secure, from what position sizing is to how to calculate and apply it.  

What Is Position Sizing?

In short, position sizing is the number of units an investor places in a given security. In other words, position sizing is the size of a position a trader or investor holds of a specific portfolio. Investors often use position sizing to control risks and optimize returns since it facilitates the decision of how many units of particular security they should acquire.  

Even though position sizing can assess any investment, it is most commonly associated with day trading and currency trading. Thus, it is highly relevant when it comes to cryptocurrency trading.

How Does Position Sizing Works?

By thoroughly evaluating position sizing, investors will be able to measure the number of units they can acquire within the degree of risk they are willing to accept. This will allow them to earn the highest possible profits while assuming the least risk. Another benefit of position sizing is avoiding making impulsive and unnecessary decisions.

Position Sizing Formula and How to Calculate It

Now that you know what position sizing is and how it works, you are ready to put it into practice. 

To do that, you will need to get familiarized with the formula of position sizing so that you can calculate yours. But before jumping into the formula, it is crucial to understand the three factors that influence position sizing:

Account Size

As the name implies, account size is how much capital you have available to invest in a specific trading option. Unfortunately, many guides on calculating the position size don’t include this step, but it is crucial. It might seem quite simple, but in many cases, especially if you are a beginner, it is vital to make sure you are properly tracking the progress of your investment strategies.

For example, if you believe in a specific cryptocurrency in the long term and will keep these assets stored in a wallet, you probably shouldn’t include these funds as trading capital. This way, you will better organize your strategies and avoid risking too much.

Account Risk

The next value to consider when calculating your position size is account risk. This step determines the percentage of the available capital you are willing to invest in a particular trade. In other words, how much of your account size you are ready to risk. But what is the ideal percentage?

Many experts state that you shouldn’t risk more than 2% in a single trade in traditional financial markets. However, this rule might be too risky when it comes to cryptocurrency trading. That is because the crypto market is still quite volatile, and while this can bring higher earnings, it can also put your capital at higher risk. So, to be more secure, especially if you are starting, being more conservative and only risking 1% in a single trade might be wiser.

However, this does not mean that you can only invest 1% of your available capital. Instead, if you made a trade that did not work out and you achieve your stop-loss, you will only lose 1% of the account.

Remember that a stop-loss order does not ensure an exit at the specified price. Even if low, there is a chance you will lose far more than 1% in a volatile move or overnight price gap known as slippage. That is why risking only 1% is ideal since most less-than-ideal swings only result in a bit of percentage reduction in equity, which is quickly recovered.

Invalidation Point

Once you determine your account size and risk, you can finally define the invalidation point. This concept might sound more complicated than it is, but when you are trading, you must assume that you’ll make a mistake and lose money. Therefore, it is crucial to have risk management and know when to leave an investment – and that is what the invalidation point is. But let’s go in parts.

There is a tool called stop-loss that is vital when managing trade risk. A stop loss is an order that closes out a given trade if the price reaches a specific price against you. Therefore, it’s essential to set your stop-loss value to your invalidation point.

The invalidation point is understanding that the initial investment idea was wrong and knowing when to leave the position to avoid further losses. Moreover, it is learning from which point that investment is not valid anymore and you should drop it.  

It can be tricky to define what is your invalidation point since there is not one single strategy to follow. It can vary a lot depending on your investment style and preferences. Invalidation points can be based on many factors such as technical parameters, indicators, or even a break in market structure.   

Position Sizing Formula

Finally, once all these concepts are clear, you can apply them to the position sizing formula:

position size = account size x account risk / invalidation point

You will apply the values you found for each formula factor and calculate your position size. 

Ultimately, these three factors will give you an idea of how many assets you can invest in a particular trade without taking more risks than you are willing to. To better illustrate it, let’s take a look at an example.

Position Sizing Example

Now that you know all factors that influence the position size formula, it is possible to visualize it through an example.

You have a $10,000 account and wish to risk only 1% of it in one specific trade; thus, you will not risk losing more than $100. However, you also established that your trade invalidation point is 10%. So, if the market goes 10% against you, you will leave the trade with a $100 loss. Therefore, your 10% position should be the same as 1% of your account. So, these are the values you have:

Account Size: 10,000

Account Risk: 1%

Invalidation Point: 10%

Let’s put this into the formula:

position size = account size x account risk / invalidation point

position size = $10,000 x 0.01 / 0.10

$1,000 = $10,000 x 0.01 / 0.10

Using this formula, you will have a $1,000 position size for this specific trade as an example and, in theory, help manage your risk and minimize loss. 

Thus, in this example, $1,000 is how much you can place in one trade under the risk management conditions you settle (account size, account risk, and invalidation point).

Optimizing Your Position Sizing in Crypto Trading

Calculating your position sizing gives you a way to visualize how you can optimize gains and reduce risks. Thus, by changing the variants of the formula, you can find a way to enter an investment better. 

In crypto, there are some great ways you can assume greater risk and reap greater rewards through leverage. Some of them are offered by our platform, NFTperp, which stands out from other trading platforms because we give everyone the ability to gain exposure to blue chip NFTs like BAYC.

Unlike traditional AMMs, users can long or short any assets’ perpetual contracts with up to 5x leverage. This has the potential to increase your gains on a given trade since you’ll be opening up larger positions, assuming your current position size, with the help of our vAMM.  However, it’s important to remember that trading with leverage, although allows you to place bigger bets, carries increased risk.

In addition, NFTperp also offers other features such as perpetual contracts. Besides not having an expiry date, it also provides more price stability between the mark price and the index price, reducing the risk and allowing the investor to leave a trade if the invalidation point is reached.

The Bottom Line

Position sizing is critical when it comes to managing your risks in a trade. In the cryptocurrency ecosystem, this is becoming even more essential due to the industry’s volatility. 

As demonstrated, using the simple formula of position sizing will allow you to make well-planned investments that follow your strategy, goals, and preferences.

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