Position Sizing: Fixed Dollar Model
In the Fixed dollar model we have a pre determined $ value we are prepared to enter the market with along with the percentage of capital we are willing to risk. With the fixed dollar model the trader has pre determined trade sizes they take and this does not change based on capital available. If the trader is aware of the trade size they want to take and how much they are willing to risk then a distance till the stop loss should be calculated first.
In the example to below consider:
- Trader is willing to risk 2% of capital.
- Always trades $1,000 positions
- Has $5,000 trading capital
- The trader wants to purchase 1000 XYZ CFDs and its currently trading at $1.00
Here we can see the difference in determining trading risk. We can see in this example position size is not of that much importance as the same amount of risk is taken no matter what size the trade is. The variation is in the distance to market the exit point will be based on the position size taken.
So far throughout the risk management CFD Tutorial we have discussed basing a lot of our risk management on the Equity that as a trader we bring to the markets. This is vital as without equity there simply is no trading. To take everything one step further I wanted to walk through the concept of using Core Equity and not just an initial equity when assessing risk parameters. This model is ideal for am much more risk adverse person.
Core equity is the equity you have left when you subtract the total value at risk in all open positions from your total equity. In this case core equity then factors in a worse case scenario that every current position you have open at the point of entering the new trade are considered to all be losing trades. By using core equity we help eliminate the risk that if all trades went bad at once we would not lose all available capital. Core equity can be hard to track depending on how many positions you have open.