Position Sizing
Success in trading isn’t just about finding the right stocks – it’s about protecting your capital through robust risk management practices. In this article, I’ll share essential principles that every trader should implement to build a sustainable trading career.
Understanding Position Sizing
Position sizing is a crucial concept that determines how many shares you should trade to maintain your predetermined risk tolerance. Let’s break this down with a practical example to help you implement this strategy in your own trading.
Step 1: Establish Your Risk Parameters
Consider a trading account with $10,000. A day trading risk management approach suggests limiting your potential loss to 2.5% per trade, which equals $250 in this case.
Formula:
Account Size × Maximum Risk Percentage = Maximum Risk per Trade:
$10,000 × 2.5% = $250
Step 2: Identify Trading Opportunities
Let’s say your MomentumDetector stock scanner has identified a stock matching your explosive stock criteria, and you’ve validated the candidate through your analysis. After observing a pullback, you decide to enter the position when the price moves just above the previous pullback bar.
Step 3: Calculate Your Position Size
Looking at our chart example: Entry point: $2.53 (one tick above previous bar’s high) Stop loss: $2.36 (one tick below the bar preceding entry) Risk per share: $2.53 – $2.36 = $0.17
Formula:
Position Size = Maximum Risk per Trade ÷ Risk per Share: $250 ÷ $0.17 = 96 shares
With this position size of 96 shares, even if the trade moves against you and hits your stop loss at $2.36, your loss would be limited to $250 – exactly 2.5% of your account (excluding potential slippage). This systematic approach ensures that no single trade can significantly damage your trading capital.
Remember, consistent success in trading isn’t about hitting home runs – it’s about staying in the game long enough to let your edge work in your favor. Position sizing is your first line of defense in achieving this goal.
Let’s calculate position sizing for a more conservative 1% risk approach:
Calculate Maximum Risk Amount:
Formula: Account Size × Risk Percentage
$10,000 × 1% = $100 maximum risk per trade
Calculate Position Size:
Formula:
Maximum Risk Amount ÷ Risk per Share Risk per Share = Entry ($2.53) – Stop Loss ($2.36) = $0.17
Position Size = $100 ÷ $0.17 = 37.17 shares (round down to 37 shares)
With this 1% risk approach, you’d trade 37 shares instead of 96 shares (2.5% risk). When combining this with a 2:1 reward-to-risk ratio on explosive stocks, you create a robust system based on sound mathematical principles.
Implementing the calculation in your trading flow
Let’s explore two efficient methods to streamline your position sizing calculations for daily trading:
Excel/Google Sheets Implementation
I’ve created a ready-to-use spreadsheet to automate your position sizing calculations. Access it here. To utilize this tool:
- Create your own copy by selecting File > Make a copy
- Input your specific parameters in the designated cells
- Customize the calculations according to your risk preferences
The spreadsheet eliminates manual calculations, reducing potential errors and saving valuable time during market hours.
Trading Software Integration
For a more sophisticated approach, consider integrating position sizing calculations directly into your trading platform. While detailed coding instructions are beyond our current scope, you can explore our recommended trading software options on our dedicated software page.
Choose the method that best aligns with your trading workflow – whether it’s the straightforward spreadsheet approach or the more advanced coding software integration. The key is to have a systematic, reliable way to calculate position sizes before entering trades.
Maximum Daily Loss
Setting a daily loss limit is a critical rule in trading. This is your maximum acceptable loss for a single day, and once reached, you must stop trading – no exceptions. This rule becomes most valuable precisely when it’s hardest to follow: when you’re tempted to trade more to recover losses.
Calculating Your Daily Risk Limit: Formula:
Daily Profit Target × (2 or 3) = Daily Risk Limit
Example: If your daily profit target is $200, set your loss limit between:
- Conservative: $200 × 2 = $400 maximum daily loss
- Aggressive: $200 × 3 = $600 maximum daily loss
Adjust these numbers based on your personal risk tolerance and account size.
Professional Protection Strategy
By combining position sizing with daily risk limits, you’re adopting professional-grade risk management practices. These methods will protect your trading capital – but only if you enforce them with absolute discipline.