Risk & execution
Position sizing, stop losses, and risk-to-reward
Calculate planned position risk, understand reward-to-risk and expectancy, and account for contract size, slippage, and correlated exposure.
By atradeaday · Published
Position sizing translates a trade idea into an amount of exposure. A direction and target are incomplete without an invalidation price and a maximum planned loss. Choosing a percentage of capital is a personal risk decision; the examples here only illustrate the arithmetic.
Calculate planned risk per unit
For a simple spot instrument, a first approximation is:
planned risk per unit = absolute(entry - stop) + estimated costs per unit
position units = risk budget / planned risk per unit
Round down to the venue's permitted lot size. For futures and other derivatives, include the contract multiplier, tick value, settlement convention, and currency conversion. The spot formula must not be copied unchanged into an inverse contract or an options position.
CME Group's position-sizing lesson connects the stop location and acceptable account risk to position size.
Work through a hypothetical example
Assume a risk budget of 50, entry at 100, stop at 98, and estimated round-trip costs of 0.50 per unit. Planned risk is 2.50 per unit, allowing 20 units before lot-size constraints. If the stop distance increases to 4 with costs unchanged, the size drops to about 11.11 units before rounding.
This is a plan, not a loss guarantee. A gap or illiquid market can produce a worse exit. A stop-limit order introduces non-execution risk; a stop-market order introduces uncertain fill price. Review the order's actual venue rules.
Reward-to-risk is not expectancy
With a target at 104 and stop at 98 from an entry of 100, gross reward-to-risk is 2:1. Costs reduce that ratio. A high target does not make the setup valuable unless the probability and distribution of outcomes support it.
For a hypothetical strategy winning 40% of trades at an average 2R and losing 60% at 1R, gross expectancy is 0.4 × 2 - 0.6 × 1 = 0.2R. Subtract costs if they are not already included in the measured outcomes. Real losses may exceed 1R.
Manage the portfolio, not only the next trade
Three similar long positions can behave like one larger directional bet. Track total open risk, concentration, and the effect of a common market shock. Decide how new positions affect an existing exposure before submitting an order.
Keep planned and realized risk separately in the journal. Their difference reveals whether fill assumptions, fees, or stop behavior need revision. See execution costs and signal evaluation for the next steps.