Position sizing

Conviction is not an input

Ask a room of beginners how they chose a position’s size and the answers are weather reports: it felt strong, I really liked the setup, I wanted it to matter. Notice that none of these can be written down before the trade, checked after it, or held constant across a losing streak. A sizing rule that depends on confidence will be largest exactly when it should not be — after a run of wins, at maximum self-belief, one trade before the streak.

The formula in this lesson takes two inputs, and neither is a feeling. The first is your risk amount from Lesson 18 — a fixed fraction of the account. The second is a distance measured off the chart, from Lesson 20’s stop: the level that proves the idea wrong. Divide the first by the second and the market, not your mood, has set your size.

The formula

Shares = risk amount ÷ (entry price − stop level). The term in brackets is the risk per share: what one share loses if the idea is wrong and the exit executes at the stop level — the plan’s assumption, not the market’s promise. A gap through the level fills worse than the level; the sizing survives that because the budget, not the fill, is what was chosen. If risking $250 and each share risks $4, the division gives 62.5 shares — and this course sizes in whole shares, so the rule is: always round down, never up. Sixty-two shares plan a loss of $248 (62 × $4) if the exit fills at the level — just under the budget, never over it. (Where a broker offers fractional shares, 62.5 shares would plan exactly $250 and require $3,125 of capital; the whole-share rule is the conservative default, and this course assumes whole shares unless a plan says otherwise.) Three different numbers come out of this one division, and they must not be confused: the planned risk ($248, assuming the exit fills at the stop level), the capital required ($3,100 — 62 shares at the $50 entry), and the actual loss, which is known only after the exit fills and can run past the plan when a gap fills worse than the level. The position’s dollar size is a consequence of the formula, never its starting point.

The site’s position-size calculator runs exactly this arithmetic — account, risk percent, direction, entry, assumed exit, and the capital the trade may use — and it separates the quantity the risk math permits from the quantity the capital funds, because the division is easy to know and surprisingly easy to skip at 9:31 in the morning. The formula is the lesson; the calculator is just the lesson with buttons.

The stop sets the size

Hold the risk amount fixed and move the stop, and watch the position breathe. A nearby invalidation level — a tight, well-defined shelf just under the entry — permits a larger position for the same $250 of risk. A distant level demands a smaller one. Same account, same risk, same trader: the chart decided. This is why two traders can own the same stock in wildly different sizes and both be disciplined — their levels differ, so their sizes do.

It also runs the other way, and this direction matters more: when the only honest stop is far away, the formula shrinks the position until the trade looks disappointingly small. That disappointment is information. A trade that only feels worthwhile at a size your risk cannot fund is a trade whose level is too far away — and the correct response is in the next section.

When the answer is ‘too big’

Sometimes the formula’s answer collides with a second limit — the maximum position your plan allows (Lesson 22 sets it; a quarter of the account is a common teaching shape). If the computed position exceeds the cap, the trade is not resized by moving the stop closer — that would be lying about where ‘wrong’ begins, and the market grades the real level, not the convenient one. The trade is simply passed. There will be another name tomorrow; the journal prints a fresh list every session.

Available capital is a second, separate constraint, and it binds just as hard. Suppose the formula permits 62 shares — $3,100 of capital — but only $2,000 of the account is actually free. Capital then caps the trade at 40 shares ($2,000 ÷ $50), and the planned risk falls with it, to $160 (40 × $4). What a tight account never licenses is the reverse: stretching to the formula’s share count with money that is not free. The size is always the smaller of what the risk math permits and what the available capital funds — and if that smaller size is too small to be worth the bother, the answer is the same as before: pass.

The same logic rides every vehicle from Folder 4. A futures contract’s size is set by its point value and the distance to the level; an option’s, by the premium you can lose in full. The instruments differ. The division does not: risk, divided by the distance to wrong, in whatever units the vehicle speaks.

Practice

Work this fictional example on paper. Planned risk $250, entry $80, stop level $76 — $4 of risk a share. (1) How many whole shares does the formula permit? (2) How much capital does that position require, and what is its planned risk at the stop level? (3) Only $3,200 of capital is free. How many shares can the capital fund, and what does the planned risk fall to?

Work it through: (1) $250 ÷ $4 = 62.5, rounded down — never up — to 62 shares. (2) Capital required is 62 × $80 = $4,960; planned risk is 62 × $4 = $248, if the exit fills at the level. (3) $3,200 ÷ $80 = 40 shares; planned risk falls to 40 × $4 = $160. Size is always the smaller of what the risk permits and what the capital funds — and the actual loss is known only after the fill.