Position sizing is the single most important factor in determining your long-term trading success. You can have a winning strategy, but if you size your positions incorrectly, you will eventually blow up your account. This guide covers the essential position sizing formulas every trader needs to know.
Why Position Sizing Matters More Than Your Strategy
Many traders spend all their time looking for the perfect entry and exit signals. But here is the truth: position sizing determines whether you survive long enough for your edge to play out. A trader with a 60% win rate can still go broke with poor position sizing, while a trader with a 45% win rate can be profitable with proper sizing and good risk-reward ratios.
Key insight: Position sizing is not about maximizing profits on any single trade. It is about maximizing your long-term growth while ensuring you survive the inevitable losing streaks.
The Basic Position Sizing Formula
The foundation of all position sizing is this simple formula:
Core Formula
Position Size = Account Risk / Trade Risk
- Account Risk = Account Size x Risk Percentage
- Trade Risk = Entry Price - Stop Loss Price
Step-by-Step Calculation
Let us walk through a complete example:
Example: Stock Trade
You have a $50,000 account and want to risk 2% per trade.
- Account Size: $50,000
- Risk Percentage: 2%
- Account Risk: $50,000 x 0.02 = $1,000
- Entry Price: $100
- Stop Loss: $95
- Trade Risk per Share: $100 - $95 = $5
- Position Size: $1,000 / $5 = 200 shares
Percentage Risk Model
The percentage risk model is the most popular approach among professional traders. You risk a fixed percentage of your account on every trade, regardless of the setup.
Common Risk Percentages
- Conservative: 0.5% to 1% per trade
- Moderate: 1% to 2% per trade
- Aggressive: 2% to 3% per trade
- Very Aggressive: 3% to 5% per trade (not recommended)
Most professional traders stay in the 1-2% range. This allows for inevitable losing streaks without significant account damage.
Dollar Risk Model
Some traders prefer to risk a fixed dollar amount rather than a percentage. This is simpler but has drawbacks as your account grows or shrinks.
Dollar Risk Example
You decide to risk $500 per trade, regardless of account size.
- Fixed Risk Amount: $500
- Entry Price: $50
- Stop Loss: $48
- Risk per Share: $2
- Position Size: $500 / $2 = 250 shares
The problem with dollar risk: if your account grows to $100,000, you are only risking 0.5%. If it drops to $20,000, you are risking 2.5%. The percentage model automatically adjusts.
Volatility-Adjusted Position Sizing
Smart traders adjust their position size based on market volatility. When volatility is high, you reduce position size. When it is low, you can increase it.
ATR-Based Formula
Position Size = (Account x Risk%) / (ATR x ATR Multiplier)
- Account: $50,000
- Risk: 2% = $1,000
- Stock ATR (14-day): $3.50
- ATR Multiplier: 2
- Stop Distance: $3.50 x 2 = $7.00
- Position Size: $1,000 / $7.00 = 142 shares
Position Sizing for Options
Options require a different approach because your maximum loss is often the premium paid (for long options) or the spread width minus credit (for spreads).
Options Position Sizing
For a credit spread where max loss is $350 per contract:
- Account Risk: $1,000 (2% of $50,000)
- Max Loss per Contract: $350
- Number of Contracts: $1,000 / $350 = 2.85 (round down to 2)
The Anti-Martingale Approach
Anti-martingale means increasing your position size when winning and decreasing when losing. Since you use a percentage of your account, this happens automatically:
- Account grows to $55,000: 2% risk = $1,100 per trade
- Account drops to $45,000: 2% risk = $900 per trade
This is the opposite of the gambling martingale system and is mathematically sound for trading.
Maximum Position Limits
Beyond per-trade risk, you should set maximum limits:
- Maximum single position: 10-20% of account
- Maximum correlated exposure: 20-30% in similar assets
- Maximum total exposure: Depends on leverage and strategy
Common Position Sizing Mistakes
- Sizing based on conviction: "This is a sure thing" leads to oversized positions and blown accounts
- Ignoring correlation: Five 2% positions in tech stocks is really one 10% position
- Not adjusting for volatility: Same dollar size in a calm market vs. volatile market is not equal risk
- Rounding up: Always round down your position size, not up
- Forgetting about gaps: Your stop loss might not protect you from overnight gaps
Calculate Position Sizes Automatically
Pro Trader Dashboard tracks your account size and calculates proper position sizes based on your risk parameters. Never manually calculate position size again.
Building a Position Sizing System
Create rules for yourself and follow them strictly:
- Set your standard risk percentage (start with 1%)
- Define your maximum position size
- Create rules for when to reduce risk (losing streak, high volatility)
- Never override your rules based on emotion or conviction
- Review and adjust quarterly based on performance
Summary
Position sizing is not glamorous, but it is what separates successful traders from failed ones. Master these formulas, create your rules, and stick to them. Your future self will thank you when you survive the inevitable drawdowns that every trader faces.
Ready to dive deeper? Learn about the Kelly Criterion for optimal position sizing or explore volatility-based sizing with ATR.