Position Sizing

Two traders both have ₹5,00,000 accounts. They take the same setup — entry at ₹500, stop at ₹482. Trader A sizes based on conviction: the setup looks excellent, so they put in ₹1.5 lakhs. Trader B sizes based on risk: the stop is ₹18 away, so they calculate how many shares keep them within 1% of capital.

The trade loses. Trader A is down ₹30,000 — 6% of their account — on a single trade. Trader B is down ₹5,000, which is 1%. Trader A needs to make 6.4% just to break even. Trader B needs 1.05%. Both made the same mistake. One can recover easily. The other has a serious problem.

By the end of this chapter, you will be able to:

• Calculate position size using the fixed percentage risk model.
• Apply the formula to any setup where the entry price and stop loss level are known.
• Explain why sizing based on conviction rather than risk is the primary cause of account blow-ups.

The Fixed Percentage Risk Model

The formula has two steps:

First: Maximum Risk Amount = Account Size x Risk Percentage. For ₹5,00,000 at 1% risk: Maximum Risk = ₹5,000.

Second: Position Size = Maximum Risk Amount / Stop Distance. With entry at ₹500 and stop at ₹482: Stop Distance = ₹18. Position Size = ₹5,000 / ₹18 = 277 shares.

This formula ensures that every trade risks the same predetermined fraction of capital.

At 1% risk per trade, a trader can lose 20 consecutive trades and still have 82% of their capital intact.

Best example to understand this: A municipal water board supplies a city's water based on reservoir capacity, not on how thirsty each neighbourhood feels. Each area gets its allocation based on a calculated formula. One area demanding more does not get it at the expense of the others. Position sizing is that allocation formula for your trading capital.

All three setups below use an account of ₹5,00,000 with 1% risk (₹5,000 maximum loss per trade) and the same entry level of ₹500:

Common Mistakes

Mistake 1: Increasing position size on trades that feel more certain

There are no certain trades. Sizing up on conviction inflates exposure precisely when overconfidence is most likely to cause oversized risk.

Mistake 2: Using a wider stop to justify a larger position

If the stop distance is too wide for the desired position size at 1% risk, the correct response is to take a smaller position — not to tighten the stop artificially.

Key Takeaways

• Position size = maximum risk (1% of ₹5,00,000 = ₹5,000) divided by stop distance. This formula is applied to every trade without exception.
  
• Sizing based on conviction rather than risk is the primary mechanical cause of account blow-ups. Confidence in a setup is not a relevant input to position sizing.
  
• A wider structural stop reduces position size automatically. The stop protects the thesis. The position size protects the account.
  

Assignment

For the next five trades you evaluate — whether you take them or not — calculate the position size using the formula: maximum risk divided by the stop distance in rupees.

Write down: the entry price, the structural stop level, the stop distance, and the calculated position size. Compare the calculated size to what your gut would have told you to buy. Are you typically over-sizing or under-sizing relative to the formula?

With risk management fundamentals covered, the next module moves into volume analysis — the tool that tells you whether the market's price moves have genuine conviction behind them.