Position sizing is arguably the most important concept in trading. It determines how much capital you put into each trade and directly impacts your long-term survival as a trader. Get it wrong, and even a great strategy will fail. Get it right, and you can weather losing streaks while letting winners compound.
What is Position Sizing?
Position sizing is the process of determining how many shares, contracts, or units to buy or sell in a trade. It is not about picking the right stock or timing the market perfectly. It is about managing risk so that no single trade can significantly damage your account.
Most new traders focus on entry signals and ignore position sizing. They might buy 100 shares of a $50 stock without considering whether that $5,000 position is appropriate for their account size or risk tolerance.
Key Principle: Professional traders typically risk between 0.5% and 2% of their account on any single trade. This ensures survival through inevitable losing streaks.
Why Position Sizing Matters
Survive Losing Streaks
Even profitable traders experience losing streaks. A strategy with 60% win rate can easily have 5-10 consecutive losses. If you risk 10% per trade, 5 losses puts you down 50%. You would need a 100% return just to break even.
Consistent Returns
Proper position sizing creates smoother equity curves. Instead of wild swings from oversized bets, your account grows steadily as your edge plays out over many trades.
Emotional Control
When position sizes are appropriate, losses feel manageable. You can follow your strategy objectively without panic or greed taking over.
The Position Sizing Formula
The basic formula for calculating position size is:
Position Size = (Account Risk / Trade Risk) x Entry Price
Where:
- Account Risk = Account Size x Risk Percentage (e.g., 1%)
- Trade Risk = Entry Price - Stop Loss Price
Example Calculation
Let us work through a concrete example:
- Account size: $50,000
- Risk per trade: 1% ($500)
- Stock entry price: $100
- Stop loss: $95 (risk of $5 per share)
Position Size = $500 / $5 = 100 shares
Position Value = 100 x $100 = $10,000
In this example, you would buy 100 shares for a total position of $10,000. If the stock hits your $95 stop loss, you lose exactly $500, or 1% of your account.
Position Sizing Methods
Fixed Dollar Amount
Always risk the same dollar amount per trade regardless of the setup. Simple and easy to calculate, but does not adjust as your account grows or shrinks.
- Pros: Simple, consistent, easy to track
- Cons: Does not compound, risk percentage changes with account size
Fixed Percentage
Risk a fixed percentage of your current account on each trade. This is the most common approach among professional traders.
- Pros: Automatically adjusts with account size, compounds gains, protects during drawdowns
- Cons: Position size varies, harder to calculate quickly
Volatility-Based
Adjust position size based on the stock's volatility (often using ATR). More volatile stocks get smaller positions to keep dollar risk consistent.
- Pros: Equalizes risk across different volatility stocks
- Cons: More complex, requires ATR calculations
Position Sizing for Options
Options require special consideration because they can expire worthless:
- Long options: Your maximum risk is the premium paid. Size so that losing 100% of the position equals your risk tolerance (e.g., 1% of account).
- Spreads: Risk is the debit paid or maximum loss on the spread.
- Naked options: Risk can be substantial or undefined. Most traders avoid these or use very small sizes.
Common Position Sizing Mistakes
1. Sizing Based on Conviction
Do not take larger positions just because you feel confident about a trade. The market does not care about your confidence. Stick to consistent sizing.
2. Ignoring Correlated Positions
Three tech stocks each sized at 2% risk equals 6% total risk if they all move together. Consider total portfolio exposure.
3. Not Adjusting for Account Changes
If your account drops 20%, continue calculating risk from the new balance. Otherwise, you are over-risking relative to remaining capital.
4. Chasing Losses with Larger Sizes
After losses, some traders increase size to recover faster. This is the opposite of what you should do and accelerates account destruction.
Track Your Position Sizes Automatically
Pro Trader Dashboard calculates your position sizes and risk metrics for every trade, helping you maintain consistent risk management.
Building a Position Sizing System
Step 1: Determine Your Risk Tolerance
Start conservatively. Most beginners should risk 0.5% to 1% per trade until they have proven consistency.
Step 2: Define Stop Loss Before Entry
Always know where you will exit before entering. Use technical levels, not arbitrary dollar amounts.
Step 3: Calculate Position Size
Use the formula above or a position sizing calculator. Do this before every trade.
Step 4: Check Portfolio Exposure
Verify that the new position does not create excessive concentration in one sector or correlated assets.
Summary
Position sizing determines your long-term success more than any other factor. Risk a small, consistent percentage of your account on each trade. Calculate position size based on your stop loss distance. Avoid the temptation to size up on high-conviction trades or after losses. Implement a systematic approach and your account will be able to survive the inevitable losing streaks while compounding during winning periods.
Learn more: the 1% rule in trading and step-by-step position size calculation.