TRADING / PRACTICAL GUIDE
Position Sizing: Decide the Risk Before the Trade
Use account risk, entry and invalidation distance to calculate a position size before entering.
The short answer: Position sizing converts a risk limit into a quantity. A simple educational formula is: maximum planned loss divided by the distance between entry and stop. Real losses may be larger because prices can gap and orders may fill away from the intended level.
Begin with the loss you can tolerate
Choose a maximum planned loss that fits the account and strategy. Avoid selecting the quantity first and inventing a stop afterward.
Calculate with consistent units
For a long stock trade, subtract the stop price from the entry price to estimate risk per share. Divide the planned account risk by that number, then round down. Fees and slippage need their own allowance.
Example for learning
If the planned risk is $50 and the entry-to-stop distance is $1.25, the calculation gives 40 shares before costs. This is an illustration, not a recommended risk amount.
Know what the formula cannot do
A stop is an instruction, not insurance. Fast markets, gaps, halts and illiquidity can produce a larger loss. Position size should leave room for that uncertainty.
Put it into practice
Try this: Choose three hypothetical entry and invalidation pairs. Calculate the quantity for the same fixed risk limit, then add an allowance for costs and slippage.
Sources and further reading
Continue learning
Educational purpose: This guide provides general education. It does not provide personalised financial, investment, legal or tax advice.