How to Determine the Size of Your Position in Futures Market

Oct 7, 2021 08:02 PM ET
How to Determine the Size of Your Position in Futures Market

One of the most critical decisions you'll have to make as a futures day trader is the size of your positions. In order to control your risk and maximize your earnings, it's critical to know how big your long-term futures investment will be.

In order to successfully trade futures contracts, position sizing is critical regardless of the asset being traded. 

Below are key guidelines on how to calculate the optimal position size while integrating risk tolerance, account size, and the best market.

Determining position size

In the futures market, there is the potential for a great deal of disorder. Prior to entering the market, traders should focus on trade management and leverage to avoid subjectivity-related mistakes.

Quantifying the correct size of a futures position requires consideration of three key futures trading factors:

  • Capital: One of the essential variables of the position size is the trading capital. To trade actively in the futures market, a trader must adhere to the margin requirements imposed by the broker for each asset.

Trading positions are automatically closed by the broker if a trader fails to comply with these rules and regulations. When that happens, a trader will only be able to continue trading after they have added more collateral to their account.

  • Risk threshold:  Acceptable risk is the amount of money that a trader is willing to lose on a single trade. The widespread consensus is that traders should take on a risk of 1-3 percent of their trading capital.

  • Stop loss: In order to limit losses, stop-loss orders are used as pending entry orders. This ensures that they close automatically when the price reaches a specific price level, thus minimizing losses.  In the futures market, the stop loss size is typically expressed in ticks.

To get your best position size, multiply the amount of money you're willing to risk by the cost of the transaction.

Optimal Position Size = Maximum Capital Risk - Specific Trade Risk

Working example

For a position in a Soybean futures contract with a tick value of $100, for example, we apply the following approach to find the ideal position size. Assume that the trader has a US$100,000 account, a risk tolerance of 2%, and a 10-tick stop loss.

Do the following: 

1. Calculate the maximum capital risk:  

   $100,000 x 0.02 = $2, 000.

2. The risk associated with a particular deal can be calculated as follows: 

10 ticks x $100 per tick = $1,000

3. The optimal size of a position is calculated as follows:

$2,000 ÷ $ 1000 = 2 contracts.

Based on the example above, the best position for a Soybean futures trader is two contracts. If you take more than two contracts, it would mean taking excessive risk. Conversely, anything lower than that wouldn’t be worth the effort and would likely result in negligible or sub-optimal profit.

Determining maximum risk

As discussed above, the maximum risk is the maximum amount of money that a trader would be willing to lose in a single futures trade. 

You can set your account risk limit per trade to any proportion you wish, but beginners are generally advised to take smaller trades and not take on too much risk at once. This will ensure that you'll only be down by a few points even in the event that you suffer a losing streak. It's easier to recover your losses when the drawdown is under control.

Determining position value

Futures contract size can have a significant multiplier effect, increasing or decreasing profits or losses significantly. Any price movement or market volatility will affect the value of your open trading position. Therefore, understanding this impact is crucial before you enter the futures market. The size and amount of typical moves can be determined by looking at the contract's average price change and the accompanying tick value.

The value of your position is therefore determined by the price movement of the underlying asset at the end of the expiry period. That is to say that the value of a position fluctuates depending on the difference between the current price and the price at which you locked the contract.

In summary

Position size in the context of futures trading refers to the volume of assets you buy per contract. The size of your position is not determined by how confident you are that trade will succeed. Instead, the size of a position is determined objectively using a formula that aids in risk management and maximizes returns on the risks taken.

By being objective in a trade, you benefit by reducing emotional interference with your decision-making.  In addition, it also helps in increasing the probability of making a profit and reducing the potential losses in case the market goes against you.


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