How Position Sizing Can Reduce Emotional Trading

If you have ever entered a trade and immediately felt your heart racing, you are in good company. Many traders will feel various emotions (excitement, fear, panic, greed) immediately after money is on the line. The greater the position, the stronger ALL of those emotions. This is why position sizing isn't just numbers and risk management; position sizing also happens to be one of the most effective ways to calm your mind and approach a logical thought process when it is your money on the line.

Risk and Emotion

When you risk too much per position, every tick feels like a life or death decision. A small amount against you creates anxiety, while a small amount in your favor creates greed. When you become emotional, then you will opt to close trades early, chase losses, or break your own rules.

On the other hand, when your position size is managed at a reasonable amount (say 1% of your account), you can then settle down and just trade. One loss won't derail your trading plan. Your emotions don't take over in the same manner because you can absorb the loss.

Why Emotion in Trading is Dangerous

Many emotional trading results create some common trading mistakes:

Revenge trading: re-entering and then putting on another trade immediately after a loss because you need to win it back. Small move against you creates anxiety, small move in your favor, creates greed.

Overconfidence: when someone increases their size after winning, thereby believing they cannot lose.

Both of these examples exist because you allowed your feelings to dictate actions rather than sticking to a plan. Position size creates a natural barrier against that spiral.

An Easy Example

Let’s say that there are two traders with accounts of $10,000.

Trader A, is probably panicking, stressed; questioning their whole trading strategy. Trader B, feel good because they have most of the account left and also feel good that they can keep trading according to plan. Both are down the same amount, but Trader A feels defeated while Trader B is much less stressed, just because of position sizing.

Position Sizing Lets You Stay Objective

When the risk is small and predefined (prior to entering the trade), you look at trades more like probabilities instead of battles. Essentially you are not involved in winning or losing one single trade. As you make this shift in how you look at trading, you will focus on successfully executing your strategy rather than reacting emotionally to the wins or losses.

Think of it like a professional poker player for example. They don’t go all in on every hand. They manage their chip stack so that regardless of the outcome of a single round, they are not put out of a once-in-a-lifetime game. Traders should remain aware of these same principles when approaching the markets.

Discipline Through Size

Position sizing does not only help you to limit your loss; it helps you cultivate discipline. Simply put, every time you put on a trade with limited risk, you have practiced consistency. Over time, this consistency lessens stress and builds trust in your own system. You become generally less focused on wins and losses, and more about executing your trading process.

The "Sweet Spot" from a Psychological Perspective

The correct position size will be balanced between:

Small enough that you do not panic whether you’re right or wrong.

Big enough that you still feel it, and it engages you.

If a loss is negligible, you may carelessly take the next trade. If the loss, on the other hand, affects you too much, you will be indecisive or react too drastically. The comfort 'middle ground' that I’ve found is typically at 1 - 2 % of account risk.

A Trader’s Perspective

I once knew a trader who went "big" on every trade and doubled his account in one month! It was extremely exciting; and then came the week of terrible trades that wiped him out. In contrast, there was another trader I knew who slowly and methodically grew their account, while risking only 1% on their trades. Their growth is not flashy, and they are still trading years later. The difference was not in the trading skill of either trader - it was position sizing and the ability to maintain emotional control.

Conclusion

Although emotions will always be involved with trading, it does not need to be a controlling force in your decision-making. By using the appropriate position sizing, you will change the wild swings of fear and greed into manageable changes good and bad. This steadfast position gives you a better chance at being disciplined and remain focused on the long haul.