Stocks course · Section 5: Risk, Leverage and Testing
Position Sizing, Stop-Losses and Risk:Reward for Stock Traders
Calculate how many shares to buy from a fixed account risk, place stop-losses that make sense, and use risk:reward, break-even win rates and expectancy.
Advanced6 min read·6:39 video·Lesson 18 of 26·quiz: 5 questions
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Position sizing means choosing how many shares to buy so that, if your stop-loss is hit, you lose a fixed small share of your account, typically 0.5% to 1%. The formula is simple: shares = (account size x risk per trade) / (entry price - stop price). Combined with a sensible stop, a risk:reward ratio and an honest win rate, it decides whether a strategy survives its losing streaks and grows, or blows up.
Why sizing matters more than entries
Every strategy has losing streaks. What decides whether you survive one is how much each loss costs.
Example
Two traders use the same strategy and hit the same streak of 10 losses in a row. Trader A risks 1% of the account per trade and ends the streak down about 9.6%. Trader B risks 10% per trade and ends down about 65%, needing a gain of almost 190% just to get back to the start. Same entries, same exits, very different futures.
You will see the maths of these streaks in drawdowns and risk of ruin. For now, the rule: keep risk per trade small enough that a long streak hurts but does not end your trading.
The position-size formula
- Account risk = account size x risk %.
- Risk per share = entry price - stop price.
- Shares = account risk / risk per share, rounded down.
Example
Your account is $10,000 and you risk 1%, or $100. You plan to buy at $50 with a stop at $46, so the risk per share is $4. Shares = $100 / $4 = 25 shares, a position of $1,250. Note the difference between position size ($1,250, 12.5% of the account) and risk ($100, 1%). Beginners often confuse the two.
Where to put the stop
Decide the stop first, from the chart or the rules, then size the position to fit. Good places:
- Structure: just below a recent swing low or a support zone (see how to read stock charts). If the price breaks it, your idea is wrong.
- Volatility: a multiple of ATR, such as 2-3 x ATR below entry, so normal noise does not stop you out (see RSI and ATR).
- Time: exit if the trade has done nothing after a set number of days.
A bad stop is one chosen because "I can afford to lose $200 on this", placed with no regard to how the stock moves.
Risk
Never move a stop further away once the trade is open. The size was calculated from the original stop. Widening it turns a planned small loss into an unplanned large one, and this habit is behind many blown accounts.
Cap the position, because of gaps
Stops do not protect you from gaps, as shown in stock order types.
Example
You hold the 25 shares bought at $50 with a stop at $46. Bad news comes overnight and the stock opens at $40. Your stop fills near $40, a loss of 25 x $10 = $250, or 2.5% of the account instead of 1%.
Now imagine a very tight stop: entry $50, stop $49.50. The formula says $100 / $0.50 = 200 shares, a $10,000 position, the whole account. A gap to $40 would cost $2,000, 20% of the account. That is why traders add a second limit: no single position larger than a set share of the account, for example 20%. Here the cap allows at most $2,000, or 40 shares. Size for whichever limit is smaller.
Also include costs in your risk. If commission and expected slippage add $0.10 a share, treat the risk per share as $4.10, not $4.
Risk:reward and the break-even win rate
Risk:reward compares what you stand to gain with what you stand to lose.
Example
Entry $50, stop $46 (risk $4), target $58 (reward $8). The reward is twice the risk, written 1:2 risk:reward, or "2R" of reward.
The higher the reward compared with the risk, the fewer trades you need to win:
| Reward : risk | Break-even win rate (before costs) |
|---|---|
| 1 : 1 | 50% |
| 2 : 1 | 33.3% |
| 3 : 1 | 25% |
The formula is break-even win rate = 1 / (1 + reward:risk). A big reward:risk is not automatically better, because distant targets are hit less often. What matters is the combination.
Expectancy: what a strategy earns per trade
Measure every trade in R, its result divided by the amount you risked. A $150 gain on $100 risked is +1.5R; a full stop-out is -1R.
Expectancy = (win rate x average win) - (loss rate x average loss)
Example
A strategy wins 40% of trades with an average win of 2.5R and loses 60% with an average loss of 1R. Expectancy = 0.40 x 2.5 - 0.60 x 1 = +0.4R per trade. Risking $100, that is an average of $40 a trade before costs. Over 50 trades the average outcome is about +20R, or $2,000, but any real run of 50 trades can land well above or below that, and a losing streak of 6-8 trades would be quite normal along the way.
Expectancy must come from a large, honest sample of trades, from a backtest or a long journal, not from a few memorable winners.
Total open risk
If you hold five positions, each risking 1%, your total open risk is 5%. If all five are in the same sector, they may hit their stops together. Set a maximum, such as 5-6% of the account at risk across all open positions, and count highly correlated positions as one bigger bet (see sector rotation and correlation).
Sizing for long-term investors
Long-term investors often do not use stop-losses. They size by portfolio weight instead, for example no more than 5% of the portfolio in any single company at purchase. The question to ask is: "If this stock fell 60% and stayed there, could I live with the damage?" With a 5% position, the answer is a 3% hit to the portfolio.
Tip
Build a tiny spreadsheet with four inputs (account, risk %, entry, stop) and two outputs (shares and position value), plus a check against your position cap. Use it for every single trade, without exception.
Next: what happens when you borrow to trade, in margin and short selling.
Key takeaways
- Shares to buy = (account x risk per trade) / (entry price - stop price).
- Risking 0.5-1% of the account per trade lets you survive the losing streaks every strategy has.
- Place the stop where the trade idea is proven wrong, then size the position to it, never the other way round.
- Break-even win rate = 1 / (1 + reward:risk); expectancy tells you what a strategy earns per trade on average.
- Cap the size of any single position, because gaps can jump past stops.
Quiz: check what you learned
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