Understanding Position Sizing

What is Position Sizing?

Position sizing is the cornerstone of risk management in trading. It refers to the size of a position within a particular portfolio, or the dollar amount that an investor is going to trade. Rather than arbitrarily buying a certain number of shares, professional traders use strict mathematical formulas to determine exactly how many shares to purchase based on where their stop loss is placed and how much of their total account equity they are willing to risk on a single trade. This ensures that a string of losing trades does not decimate the trading account.

The Mathematical Formula

The universal formula for calculating position size in equity trading is:

This formula first calculates your total absolute dollar risk (Account Size multiplied by your Risk Percentage). It then divides that total dollar risk by your per-share risk (the distance between your entry point and your invalidation point).

Practical Trading Scenario

Imagine you have a $10,000 trading account and follow a strict rule to never risk more than 1% per trade. Your maximum acceptable loss is therefore $100. You spot a stock breaking out at $150.00, and technical analysis dictates your stop loss should be placed below support at $145.00.

Your per-share risk is $5.00 ($150 - $145). To find out how many shares you can buy while keeping your risk capped at $100, you divide $100 by $5.00. The result is 20 shares. If the trade goes against you and hits your stop loss, you will lose exactly $100 (plus slippage/fees), keeping your portfolio perfectly safe and aligned with your risk parameters.