Risk management and position sizing
Position size follows from the risk you accept per trade and the distance to invalidation. It is arithmetic, not intuition.
The sizing formula
Decide the fraction of your portfolio you are willing to lose if a single idea is wrong — many disciplined participants use something in the region of 0.5% to 2%. Convert it to a currency amount. Divide that by the per-share distance from your entry to your invalidation price. The result is the number of shares.
Shares = (portfolio x risk %) / (entry - stop). Notice that a wider stop mechanically means a smaller position. Conviction does not change the arithmetic; it is not an input.
Why drawdown maths is unforgiving
Losses and the gains needed to recover them are asymmetric. Down 10% needs +11.1%. Down 50% needs +100%. Down 80% needs +400%. Capital preservation is not timidity; it is the precondition for compounding.
Expectancy over accuracy
A strategy can be right 40% of the time and still profit if winners are meaningfully larger than losers. Expectancy = (win rate x average win) - (loss rate x average loss). Chasing a high hit rate by cutting winners short is one of the most common ways to destroy a workable approach.
Worked example
Sizing a trade, then checking reward-to-risk
- Portfolio: $20,000. Risk per trade: 1% = $200.
- Entry $52.10; invalidation below the retested breakout zone at $51.30. Risk per share = $0.80.
- Position size = $200 / $0.80 = 250 shares, costing 250 x $52.10 = $13,025.
- That is 65% of the portfolio in one name — too concentrated, so cap exposure (say 20% = $4,000, about 76 shares) and accept risking less than $200.
- Target at the next resistance zone, $56.00: reward per share $3.90 versus $0.80 risk, roughly 4.9:1.
Run both checks: the risk-based share count and a maximum exposure cap. Tight stops can imply absurdly large positions, and only the second check catches it.
Common misconceptions
“High conviction justifies a bigger position.”
Conviction is unmeasurable and often highest just before surprises. Size from portfolio risk and stop distance.
“I just need to win more often than I lose.”
Expectancy depends on the size of wins and losses, not only the hit rate. A 40% win rate with large winners can beat 70% with tiny ones.
Checkpoint