What Is Position Sizing?
💡 Definition
Position sizing converts your risk plan into the actual number of shares/contracts to trade. It aligns per-trade risk, stop distance, and volatility with account size so winners matter and losers don’t cripple you.
It’s not just “how big?” — it’s “how big given my stop, volatility, and portfolio heat?” Size right and even a modest edge compounds; size wrong and even great setups sink you.
Visual Representation
From Risk Budget → Stop Distance → Position Size
Decide how much you’re willing to lose (risk per trade), define a stop, then compute size = risk ÷ stop distance. Track portfolio heat and results in R-multiples.
Core Formulas
Single Trade
Risk = Equity × r% (e.g., r=0.5–1.5%)Stop = |Entry − Invalidation| or k × ATRSize = Risk / StopContracts = (Risk / StopValuePerContract)Expectancy & Risk of Ruin
E(R) = p×AvgWinR − (1−p)×AvgLossRr% and heat decrease; keep E(R)>0 and drawdown limits.f* = Edge/Var ≈ p − (1−p)/b → use fractional Kelly (¼–½) if at all.Popular Position Sizing Methods
📏 Fixed % Risk
Risk a constant fraction of equity (e.g., 1%) on each trade. Simple, scales with account, easy to automate.
🎚️ Volatility (ATR) Based
Set stop as k×ATR (e.g., 1.5–3.0×). More volatile assets get smaller sizes automatically.
🧱 Unit / Vol Parity
Allocate equal volatility-weighted risk across symbols so each contributes similar P&L variability.
📈 Fractional Kelly
Size using a fraction of Kelly based on tested edge; reduces over-betting risk. Needs robust stats.
🪜 Scaling & Pyramiding
Add in tranches as price confirms (e.g., +0.5R, +1R), keeping total open risk <= heat cap (e.g., 3–5%).
🧯 Max Heat & Caps
Limit portfolio heat (sum of open risks), per-name exposure, sector exposure, and leverage.
Why Position Sizing Works
- Asymmetric Math: Controlled losses + occasional multi-R wins compound.
- Volatility Fit: ATR-linked stops/size adapt to changing markets.
- Drawdown Control: Heat caps keep sequences of losers survivable.
- Process Clarity: Precomputed size removes emotion at entry time.
Practical Playbook
Step-by-Step
1) Set Risk Budget: Choose r% (0.5–1.0% for most swing/position traders; 0.25–0.5% for intraday).
2) Choose Stop Logic: Structure (below swing/above high) or k×ATR. No stop → no size.
3) Compute Size: Size = (Equity × r%) ÷ Stop. Round to nearest lot/contract.
4) Cap Heat: Sum of all open risks ≤ heat limit (e.g., 3%). Reduce new size if cap would be exceeded.
5) Manage Winners: Convert risk to R. Scale partials at +1R/+2R; trail by structure or ATR.
6) Review Stats: Track expectancy, win rate, average R, max drawdown; adjust r%/heat accordingly.
Common Mistakes
⚠️ Avoid These Errors
- Entering without a defined stop (size has no anchor).
- Betting a fixed quantity instead of fixed risk across volatile names.
- Letting portfolio heat balloon (too many correlated trades at once).
- Using full Kelly or backtest-only edges — highly fragile.
- Ignoring slippage, tick size, and contract specs when sizing futures/FX.
Advanced Concepts
📊 Dynamic r%
Reduce r% during drawdowns (e.g., −50% at DD>8%); restore gradually as equity recovers.
🧭 Correlation-Aware Heat
Down-weight size when positions are highly correlated; cap sector/theme exposure.
🧮 Volatility Targeting
Target portfolio volatility (e.g., 10% ann.) by scaling gross exposure with realized vol.
🧰 Discrete Instruments
For futures/options, convert stop to $/contract using tick value; size by contracts, not shares.
The Bottom Line
Position sizing is the bridge between strategy and survival. Fix a small, repeatable risk per trade, anchor it to a real stop, cap portfolio heat, and let R-multiples measure progress. With sizing discipline, edges can breathe — and accounts can compound.