Position Sizing

Position sizing refers to deciding how many units of an asset you should trade based on the amount of capital you are willing to risk.

Its main purpose is to manage the potential loss from a trade while allowing you to participate in possible price movements. Position sizing is therefore an important part of trading risk management.

For example, instead of choosing to buy an arbitrary number of shares, you can first decide how much money you are prepared to lose if the trade moves against you. You can then use that amount and your stop-loss level to calculate the position size.

A suitable position size can also help you avoid putting too much of your trading capital into a single trade. If the position is too large, even a small adverse price movement may lead to a bigger loss. If the position is smaller, the possible loss may also be lower.

Position sizing does not guarantee profits or prevent losses. It simply gives you a structured way to decide how much capital to expose to a trade. The final position size depends on factors such as your available trading capital, chosen risk level, entry price, and stop-loss price.

To understand position sizing, you first need to understand two concepts: account risk and trade risk.

Account risk

Account risk refers to the maximum amount or percentage of your trading capital that you are willing to risk on one trade.

The percentage you choose may depend on your risk tolerance and trading strategy. For example, a trader may decide to risk 2% of their total trading capital on one trade, while another trader may choose a different level.

The purpose of setting account risk is to limit how much one unsuccessful trade can affect your overall trading capital. This can help you avoid putting a large portion of your capital at risk in a single position.

Trade risk

Trade risk refers to the amount you could lose per unit between your entry price and your stop-loss price.

For example, suppose you are involved in share trading and plan to enter a stock trade at ₹1,500 per share. You place a stop loss at ₹1,450 per share.

Your trade risk per share would be:

Trade risk = ₹1,500 − ₹1,450 = ₹50 per share

This means that the planned risk is ₹50 for every share traded, assuming the position exits at the stop-loss price.

Also read: What is a block trade?

Once you know your account risk and trade risk per unit, you can calculate your position size using the following formula:

This calculation helps you decide how many shares or units you can trade while keeping the possible loss within your chosen risk limit.

Consider a simple example. Your total trading capital is ₹5,00,000, and you decide that your maximum account risk on one trade will be 1%.

Account risk = ₹5,00,000 × 1% = ₹5,000

This means you are willing to risk up to ₹5,000 on that particular trade.

Now suppose the stock is trading at ₹780 per share, which is also your planned entry price. You set the stop loss at ₹730 per share to limit the loss if the price moves against you.

Trade risk = ₹780 − ₹730 = ₹50 per share

This means the planned risk on each share is ₹50.

Using the position sizing formula:

Position size = ₹5,000 ÷ ₹50 = 100 shares

Therefore, based on these assumptions, the calculated position size is 100 shares. If you buy more than 100 shares, the amount of capital at risk would rise above your chosen 1% limit. If you buy fewer shares, the amount at risk would be lower.

The calculation can also change when you adjust your stop-loss level. For example, if the stop loss is placed farther from the entry price, the trade risk per share becomes higher. To keep the same overall account risk of ₹5,000, you would then need to reduce the number of shares traded.