Ask a new trader how a trade went and they will tell you whether the price went up. Ask an experienced one and they will tell you how much they risked. The second answer decides whether a run of bad trades is a lesson — or the end of your account.
Start with the risk, not the price
Before you think about how many shares to buy, decide how much you are willing to lose if the trade goes wrong. A common rule of thumb is to risk no more than one percent of your trading account on a single trade. With $10,000, that is $100.
One percent sounds small. That is the point: a run of ten losing trades — which happens to everyone sooner or later — costs you about a tenth of your account, not most of it.
Then set the stop
Your stop-loss is the price at which the idea behind the trade is proven wrong — below a recent low, under a support level, beyond the normal daily swings. Put it where the chart says, not where your budget would like it to be.
The formula
Position size = amount at risk ÷ (entry price − stop price)
- Account
- $10,000
- Risk per trade (1%)
- $100
- Entry price
- $50
- Stop-loss
- $46
- Risk per share
- $4
- Position size
- 25 shares = $1,250
If the stop is hit, you lose about $100 — the amount you decided on — plus costs. The position is worth $1,250, but the risk is $100. Keeping those two numbers apart is what position sizing is about.
The size of the position follows from the stop — never the other way round.
Common mistakes
- Moving the stop further away once the trade goes against you.
- Sizing by conviction: a trade you “really believe in” gets the same risk as any other.
- Forgetting gaps: a price can open below your stop, and the loss can then be larger than planned.
- Counting similar trades as separate: three bank stocks behave more like one big position than three small ones.
