Position sizing is the calculation methodology that you use to determine how many shares you will buy or sell to open each new trade. Your risk management strategy must include a method of calculating how many shares to buy. This alone is the single greatest contributor to your profitability in the market place. An effective position sizing strategy can have a dramatic influence on the profit and loss outcome of any trading system.

When you close a trade, you will have made a certain dollar profit on every share you bought or sold when entering the trade. Therefore your gross profit on the trade in absolute terms is:

$ profit per share * Number of shares in the trade = Gross $ profit for the trade

For example, if you had a trade where you opened a long position at $1.00 and closed it at $1.50, you have made a $0.50 profit for every share you had in the trade (50% gross profit).

Scenario 1: If you only had one share in the trade your gross profit is ($1.50 - $1.00) x 1 = $0.50

Scenario 2: Contrast this with the exact same trade, where your position sizing methodology allowed you to enter this trade with 10,000 shares then your gross profit is ($1.50 - $1.00) x 10,000 = $5,000.

The only difference between scenario 1 and 2 is the size of the position that you took initially to open the trade.

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When is a trade too small?

Brokerage has a large impact on the profitability of traders who have small floats.

The above example is only partly complete as your net profit per trade, the amount that enters your bank account, can only be calculated after you subtract the effect of brokerage from your gross profit.

Net Profit per trade = Gross Profit – Brokerage (Both in and out)

For example, assuming $27.45 brokerage to enter the trade and $27.45 to exit the trade the Net Profit from the above 2 scenarios would be:

Scenario 1: $0.50 (Gross Profit) – ($27.45 x 2) (Brokerage in and out) = $54.40 (NET LOSS) OR to put it another way, your broker made money today while you didn't.

Scenario 2: $5,000 (Gross Profit) – ($27.45 x 2) (Brokerage in and out) = $4,945.10 (NET PROFIT) OR to put it another way, both you and your broker made money today.

In order to avoid this scenario, of entering trades where your best case scenario is that you lose money after brokerage you should consider having a minimum trade size.

Minimum trade size

Your minimum trade size is the smallest dollar value for a trade that you will take and should be greater than your break-even dollar trade size.

Average brokerage per trade / Average % profit per trade = Break-even dollar trade size.

For example, assuming that the average brokerage rate is $27.45 per side (or $54.90 for a completed trade) and the average % profit per trade is 10% (from your backtesting results), the break-even dollar trade size would be $54.90 / 10% = $549.00.

Therefore if you were to enter a trade with $549.00 and you made your average profit of 10%, you will have a gross profit of $54.90 ($549.00 x 10%). Subtracting your brokerage of $54.90 leaves you with a net profit of $0 (i.e. a break- even trade).

Hence your minimum trade size is a dollar amount that is greater than $549.00 (your break-even trade size). As long as you enter positions equal to or greater than your minimum dollar trade size you will be able to close trades and have a profit both before and after brokerage.

Your minimum dollar trade size is used when your trade size calculation gives you a dollar trade size that is smaller than your minimum or when the amount of cash you have available to enter a trade is less than your minimum dollar trade size. In both cases you would not take the trades.

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