Calculating position size
How big your position may be follows from the loss you allow divided by the distance to your stop loss. You calculate it instead of deciding by gut feeling.
Learning objective: After this lesson you can calculate your position size from the allowed loss and the distance to your stop instead of guessing it.
Most people do it the other way round. They think about how much money they want to put in and then set a stop loss somewhere. The right order is the reverse.
Start with the allowed loss
First you decide how many euros a failure may cost. Then you decide where you'll get out if you're wrong. The number of shares follows from both, and then there's nothing left to argue about.
The calculation
The calculation is: allowed loss divided by the distance per share. If Emre may lose €50 and his stop is €3 below the entry, that's 16 shares. 50 divided by 3 is 16.7, and you always round down.
Stop distance and size
The nice thing is: a tight stop allows a bigger position, a wide stop calls for a smaller one. Your risk stays the same either way. That's exactly what the calculation is for.
An example trade with made up numbers
Lena has €8,000 in her account and risks 1 percent per trade, so €80. She's planning two very different purchases.
A coin at €2.40: Her stop is at €2.16, a distance of €0.24. €80 divided by €0.24 gives 333 coins, so about €800 invested.
A stock at €120: Her stop is at €112, a distance of €8. €80 divided by €8 gives 10 shares, so €1,200 invested.
The amount invested is completely different, the risk isn't. If both stops are hit, Lena loses about €80 each time, plus roughly €2 in fees each. Had she simply put €1,000 into both, her loss would have been €100 on the coin and just under €67 on the stock, without her having consciously decided that beforehand.
The formula is: number of shares equals account balance times risk share, divided by the distance between entry and stop. For products traded in fixed contract sizes or with a point value, you also divide by that value. Also allow for fees and some slippage, because the actual loss is almost always a bit more than the calculated one.
Deriving the stop from the chart
Where the stop goes should follow from the chart, not from the risk you'd like. Many use a measure of the usual fluctuation such as the average daily range (ATR), so the stop sits outside the normal back and forth. If you set the stop so tight that the position size you want comes out, you'll very likely be stopped out by quite ordinary swings.
Position size with leverage
With leveraged products, the position size no longer has anything to do with the money you put down. That leads to the most common calculation error. The calculation is dutifully applied to the €500 deposited, while a position worth €5,000 is actually moving. What counts is always the full value of the position, not the collateral you put down.
Data as text
Account €5,000, risk per trade 1 percent, which is €50, distance to stop €3 per share, resulting in 16 shares.
Summary
- Set the risk first, then the stop, and the number of shares follows.
- The stop belongs at a sensible point on the chart, not where the calculation works out.
- With leveraged products the full value of the position counts, not your stake.
Did you get it?
What's the basic formula for the number of shares?
Allowed loss in euros divided by the distance between entry and stop per share.
What happens if you set the stop tight so the position gets bigger?
The position will very likely be stopped out by quite normal swings.
What is risk measured by with leveraged products?
By the full value of the position, not by the collateral deposited.
Check your understanding
Your task
Your account holds $12,000, and you risk 1 percent per trade. You want to buy a stock at $45 and set the stop at $41.50. Calculate the number of shares and round down. Check it in the position size calculator and then work out how many shares it is if your stop sits $5 below the entry.
Related
- The one-percent ruleStage 3
- Position-size calculatorCalculator
- Setting a stop-loss correctlyStage 2
- Matching questions for this stageQuestions