Using a range of proven methodologies, CFD traders can adjust their position size based on volatility levels to trade effectively within the market. As an integral part of leveraged CFD trading, volatility can be used to traders’ advantage using volatility-based position sizing to align risk exposure and distribute risk appropriately in line with real-time market conditions.
What Is Volatility-Based Position Sizing?
Volatility position sizing refers to the practice of adjusting trade sizes and capital allocation according to market volatility. Traders manage risk using a dynamic approach and protect their trades in line with market conditions in order to optimise performance.
Traders take small positions during times of high volatility and larger positions in times of low volatility. This allows for stringent risk management and maximises returns, allowing the portfolio to effectively adapt to changing volatility levels for long-term trading success.
This concept uses a variety of methods such as the Average True Range and/or Fixed Percentage Approach along with a commitment to consistent market monitoring. It is widely used in CFD trading because the markets can experience sharp, sudden price movements and this approach supports traders in managing risk with a structured approach and tangible methodology.
CFDs also often involve leverage and this approach helps to control risk in a measured way in the fast-moving markets. It helps traders manage exposure across different assets as well as avoid adopting large positions during volatile times.
Volatility-based position sizing differs from other position sizing methods because it is focused entirely on adjusting position size based on volatility. With the fixed fractional sizing approach, position size is based on account size where traders risk a fixed percentage of their account balance on every trade, regardless of market volatility. Fixed lot sizing means trading the same lot size every time, regardless of either account size or volatility.
Why CFD Traders Use Volatility-Adjusted Position Sizing
CFD trading by nature involves fast-moving markets and a high degree of volatility (depending on your chosen trades). Adjusting position size based on volatility therefore offers several key benefits including better, more transparent control using a method that automatically reduces position size during price swings and turbulent market conditions.
This also means that traders avoid the risk of holding large leveraged positions in highly volatile markets, which is one of the most common causes of major losses. Volatility-based position sizing allows for smoother risk exposure meaning the portfolio is not at risk of sudden major losses or gains.
With emotional control and discipline essential skills for CFD traders, this concept also supports a stable, strategic and informed approach, minimising the risk of impulsive decision-making. Platforms such as TradingView support CFD trading using specialised volatility-based sizing tools.
ATR-Based Position Sizing - How Volatility Is Measured
Understanding how to effectively count volatility underpins the most successful trading strategies. ATR (Average True Range) is one of the most widely used volatility metrics and works by looking at the degree of price movements over specific periods. The default period is usually 14 days but this can be adjusted (e.g. per hour, per day) based on personal trading preferences, approaches and timeframes.
The ATR is calculated in pips as a moving average of the true range values. A high ATR equals high volatility, while a low ART means smooth price movements/low volatility.
The ATR value is then used with the chosen multiplier (based on personal risk tolerance) to create volatility-adjusted stops. The multiplier is typically between 1.5-3x with lower multipliers creating tighter stops and higher creating wider stops, with the method adjusting stops in line with current market volatility.
Once the ATR-based stop distance is established, this can then be used to establish appropriate position sizing levels and maintain consistent risk per trade. A simple way to do so is using the following formula:
- Position size = (Account risk per trade) ÷ (Stop distance in pips × pip value)
For a $100 dollar account risk per trade, it would be calculated as follows:
- Position size = $100 ÷ (75 × $1) = 0.013 lots
ATR supports traders in providing a number of risk models to inform strategic decisions. It acts as a barometer to show the speed of the markets and how smooth/bumpy they are, it supports the establishment of stop-loss levels using logical, real data, it adjusts position size automatically based on your chosen ATR stop, and it reduces emotion-led trading by setting clear stop and size levels.
ATR is highly valuable even for beginner traders because it supports a steady, stable approach and makes risk per trade uniform across difference instruments and volatility levels. Traders should note that it only measures movement, not trend and to therefore employ ATR within a wider context to avoid false confidence in unsteady markets.
How to Build a Volatility-Based Position Sizing Model Step-by-Step
The first stage to building a personalised volatility-based position sizing model is to select a volatility indicator. The most popular is the Average True Range and traders can then choose the desired timeframe/period to match personal trading style.
You can then define preferred risk per trade – a common range is 0.5-2% but this will depend on trading style, risk appetite, chosen markets and ideal outcomes.
The next step entails choosing your stopping distances – common choices are between 1x and 2x ATR but this will again depend on the individual. The next step is to convert volatility values into position sizes – position sizes should be adjusted as market volatility changes but this should always be calculated in relation to risk tolerance and market conditions.
Above all, traders should ensure consistent discipline in execution of this strategy. This means a commitment to revisiting position size regularly to ensure it remains optimal and doing so with a clear head without being impacted by adverse market conditions or other emotional impulses. It also means keeping a trading diary with a view to consistently improving strategy and approach in line with evolving trading ambitions.
Common Mistakes When Using Volatility-Based Position Sizing
While volatility-based position sizing can prove highly effective, traders should be aware of some common mistakes when utilising this concept.
Relying on volatile indicators without context is one such risk. ATR and other volatility indicators should always be considered within the appropriate context, including the structure of the individual market, and any news or events that may be impacting volatility and trend direction.
Relying on ATR alone will not replace a clear strategy, understanding of trend bias and personal entry/exit rules – all of these work together to create a disciplined, smart trading environment.
Using too much leverage is also a common mistake, especially because CFDs allow for high leverage which can confuse traders - overleveraging can magnify losses during volatile periods.
Placing stops too close when volatility is high is another mistake many traders make, often out of fear, but this can lead to unnecessary losses. Traders must also remember to adjust position size as volatility changes to ensure balanced exposure to risk.
How Volatility-Based Position Sizing Compares to Other Models
Volatility-based sizing offers the flexibility to rapidly adapt to changing market conditions. In comparison, the fixed fractional method sees the trader choose a fixed percentage of their account balance to risk per trade regardless of market volatility. The position size grows/decreases with the account size entirely independent of market conditions.
The Kelly Criterion is a trading formula that determines optimal position size based on your win rate and reward-to-risk ratio. It aims to maximize long-term growth but traders may use half- or quarter-Kelly and/or combine with volatility adjustments to manage risk more strictly.
Traders might also utilise simple percentage models, such as the fixed fractional method, which are easier to understand and implement than volatility-based sizing. These models risk a fixed percentage of account per trade but do not account for volatility which can increase risk and restrict reward as traders may overtrade in volatile markets or under trade in quieter markets.
Learn more from the ActivTrades guide Position Sizing Models Explained.
Volatility-Based Position Sizing – FAQs
How Can I Use ATR-Based Based Position Sizing for Forex Risk Management?
By allowing traders to adjust position size in line with market volatility, ATR based position sizing keeps risk consistent and protects the portfolio in the fast-paced, unpredictable forex markets.
What are the Benefits of Volatility Adjusted Position Sizing for CFD Traders?
It reduces emotional biases in trading decisions, helping traders to manage exposure and control risk more accurately as well as learn discipline in position sizing. This method calculates position size based on quantifiable data, leading to more rational and informed decisions, and optimal risk-reward profiles.
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