Risk Per Trade: Turning a Percentage Into Dollars and Shares

$200.

That is 1% of a $20,000 account, and it is the whole of what one trade is allowed to cost if it goes wrong. Every other number in the trade, from the share count to the dollar value of the position, gets worked out backwards from that figure and the distance to the stop, which is why the budget comes first and the order ticket comes last.

Start with the dollars

A risk rule is usually stated as a percentage of the account. Percentages are easy to agree with. Convert it before anything else.

Risk budget = account balance x risk percentage

On $20,000 at 1% that’s $200. At 0.5% it’s $100. Neither figure says anything yet about how many shares to buy.

Divide by the distance to the stop

The stop tells you what each share can lose. Subtract the stop price from the entry, and divide the budget by the result.

Shares = risk budget / (entry - stop)

Compare the two dollar figures. The position is $3,600, 18% of the account, while the risk is $200, 1% of it. Those are separate numbers, and mixing them up is how a trader who “only put 18% into it” ends up losing far more than planned after moving the stop, or how another who “only risks 1%” ends up with most of the account in a single name because the stop happened to be tight.

The position size calculator does this division for any account, risk and stop.

When the stop is very wide or very tight

Extremes give odd answers.

A wide stop makes a small position. Enter at $80 with a stop at $72 and each share can lose $8, so the $200 budget buys 25 shares, a $2,000 position. That is the rule doing its job.

A tight stop can make a huge one. Enter at $50 with a stop at $49.75 and each share risks only 25 cents, so the same $200 buys 800 shares, a $40,000 position on a $20,000 account, which would need margin and would put twice your money into one stock on the strength of a stop a quarter away. Add a second cap on position value for that case. With a hypothetical limit of 25% of the account, or $5,000, the trade gets 100 shares and risks $25.

Pad the stop for costs

The formula above assumes you get out at exactly the stop price, for free. Neither is guaranteed.

Commissions come off both ends of the trade. Slippage is the gap between the stop price and the price the order actually fills at, and in a fast market a stop order becomes a market order that can fill well below the level you set. So add an allowance to the stop distance before dividing.

Round down, always.

The allowance is a guess, and yours depends on the broker’s commission schedule and how thinly the stock trades. A gap through the stop overnight can cost far more than any allowance covers.

Recalculate from today’s balance

Use the balance you have now, not the one you started with.

After a run of losses takes the account from $20,000 to $18,000, 1% is $180, and the same $2 stop buys 90 shares. After a good run to $22,000, 1% is $220 and the trade gets 110 shares. The size shrinks while you are losing and grows while you are winning, without a single decision on your part, and that automatic braking is most of what keeps a string of losses from turning into a hole the account cannot climb out of.

Sizing from the old high does the opposite. It keeps betting money that is no longer there.

If several trades are open at once, their risks add up, and the answer on adding up the risk on all your open trades shows how to cap the total. For the argument against sizing up when you feel certain, read conviction makes a terrible position size.

Everything here depends on the stop being in the right place. The next lesson deals with where that is, and it’s rarely where the budget would like it to be.