Position Sizing: Decide the Risk Before the Shares
Today’s skill is turning a trade idea, stop level, and fixed risk budget into the correct number of shares.
The core idea
Position sizing answers one question: how many shares can you buy while keeping the loss at your planned amount if your stop is hit? Many traders use a small fixed fraction of account equity as a risk ceiling. Schwab notes that some traders use roughly 1%–2% of the account as a per-trade risk guideline. This is a risk-control convention, not a guarantee or a recommendation.
Risk per share = Entry price − Stop price
Shares = Risk dollars ÷ Risk per share
Worked example
Suppose a hypothetical account is $25,000 and the trader chooses a 1% maximum planned loss. That gives a $250 risk budget. A setup has an entry at $50 and a technically chosen stop at $48, so risk per share is $2.
$50 − $48 = $2 risk/share
$250 ÷ $2 = 125 shares
The position’s market value is $6,250, but the planned trade risk is $250 if the stop executes at $48. Real losses can be larger because prices can gap through stops and execution can slip.
Why the stop comes first
A common mistake is deciding “I want 500 shares” and then squeezing the stop close enough to make the risk look acceptable. Reverse that process: identify where the trade thesis would be invalidated, calculate the dollar distance to that stop, then let the risk formula determine the share count.
A wider logical stop therefore produces a smaller position. A tighter logical stop produces a larger position. The amount at risk can remain approximately constant even though the share count changes.
Portfolio risk matters too
Five individually small trades can behave like one large trade if they are highly correlated. For example, positions in several semiconductor stocks may all react to the same industry news. Track both risk per trade and total open risk, and remember that diversification is about different risk exposures—not merely different ticker symbols.
Practical exercise
Paper-trade this setup: account = $40,000; chosen risk = 0.75%; entry = $72; stop = $69. First calculate risk dollars, then risk per share, then maximum whole shares. Finally, calculate the position’s market value at entry.
Check: Risk budget = $300; risk/share = $3; size = 100 shares; entry value = $7,200.
Quick quiz
1. What should determine share count: buying power or planned trade risk?
Planned trade risk, together with the distance between entry and the logically selected stop.
2. A $30,000 account risks 1% and the stop is $1.50 from entry. How many shares?
$300 ÷ $1.50 = 200 shares.
3. If the stop distance doubles but the risk budget stays constant, what happens to share count?
It is cut in half.
4. Does a stop guarantee your maximum loss?
No. Gaps, fast markets, liquidity and slippage can produce a worse fill.
Sources & further reading
Charles Schwab — Elements of a Smart Trade Plan
Options Academy — Position Sizing