Day Trade Stocks Successfully Using Odds Based Position Sizing

Position Sizing is the process of determining how many shares of stock that you must trade in order to risk a certain dollar amount or percentage of your account. You must consider the size of your exit stop and the amount of money you are willing to risk when making this calculation. For example, if you are day trading a $50 stock, and you place your exit stop 50 cents away from your entry price and you do not want to risk more than $100 on a particular trade, you would have to purchase exactly 196 shares in order to avoid losing more than $100 if your exit stop is executed.

After you have performed enough position size calculations, you will quickly see that the ability to vary your position size with stocks gives you a tremendous tactical advantage because no matter how large your stop, you will almost always be able to adjust the number of shares to an amount that will fit your desired level of risk. In other words, you can maintain the same amount of money at risk, regardless of whether your stop is 50 cents or 5 dollars from your entry price, by simply adjusting the number of stock shares. This flexibility allows you to take day trades using various strategies and chart time-frames without enabling the size of your stop to dictate whether or not you can take the trade.

What is odds-based position sizing and why is it important? Odds-based position sizing means varying the amount of risk (i.e., money you are willing to lose) for a particular trade if certain risk factors develop. This type of position sizing is important for day traders because every trade should not be treated equally. Certain trades have a higher probability of success than others based on the risk factors that you have defined for your trade setups.

Risk factors are conditions that you have identified by reviewing past trades that tend to degrade the quality of the trade. For instance, if a trade setup has historically lost money 60% of the time whenever a certain condition existed, you should classify the condition as a risk factor for the trade. Some examples of questions you should ask to determine risk-factors for day trades are:

1. Does the trade have enough time to reach it's profit objective before the market close?

2. Are you trading in the same direction as the stock's intermediate or short-term trend?

3. Are the market indices (S&P, Dow, Nasdaq) going in the same direction as the trade?

Answering "No" to any of the above questions may create a risk-factor depending on your analysis of past trades. However, the above considerations are only a small sample of potential risk factors that could affect a trade when day trading. You should perform a thorough review of past trades to identify additional risk factors with respect to your trade setups.

Once you have developed your list of risk factors, odds-based position sizing entails decreasing your position size a predetermined percentage whenever a risk factor exists. For example, you may decide to reduce your position size by 10% for each risk factor that exists in order to carry a smaller position when the odds are not entirely in your favor. Therefore, if three risk factors exist, you would reduce your intended position by 30%. The result of this process will be that you only carry your largest position size on your highest probability trades and your smallest position size on your lowest probability trades.

A good way to begin this procedure is to develop your list of risk factors. Before you enter a trade, count the number of risk-factors that exist against your trade, and then reduce your position size accordingly. Over time, you will be able to quickly and intuitively perform this process in your head.

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