Position Sizing for Risk Management

Whenever you initiate a trade, there’s always a chance things won’t go as planned. Based on the strength of your trade setup, you determine the level of risk you’re comfortable with, essentially the amount of money you’re prepared to part with.

So, how do you determine the right number of shares to purchase?

🔥 TLDR; We’ve got a tool that does this math for you, instantly!

Imagine you’re looking to trade after spotting a significant resistance break, followed by a pullback, and now an upward trend. (As Al Brooks suggests, it’s time to “buy the failed failure.”)

Let’s say you plan to buy in at $50.10 and noticed the pullback switched directions at $49.91. Ideally, you’re hoping the stock will rise, but if it dips below $49.90, that’s your cue to bow out. This signals a probable rejection and a likely steeper decline. If you’re aiming to risk $500 on this trade, what’s the number of shares to purchase at $50.10 ensuring a maximum loss of $500 if the price drops to $49.90?

The math goes:

Number of shares = $500 / ($50.10 - $49.90)
Resulting in 2,500 shares.

Some traders prefer to discuss risk in terms of a percentage of their account balance. If this is your approach, just add an additional step. For example, if you choose to risk 1% of a $34,456 account, your risk amount would be $344.56. Plugging that into the equation gives you 1,723 shares.

Though the math might be straightforward, crunching numbers while staring at a live chart isn’t always feasible. Many traders end up guesstimating, like approximating 2,000 shares to meet their risk limit. However, this approach is flawed for a couple of reasons:

1. Your risk should be adaptive, reflecting the trade setup’s strength. For instance, speculating on a reversal shouldn’t be approached the same way as buying into a rising trend.
2. Stock value can vary significantly. The number of shares you buy for a $2 stock shouldn’t be the same as for a high-value one.

👋 To make this process seamless, we recommend using the “long position” tool (its counterpart, the “short position” tool, is used for short-selling). This ensures you size your positions accurately every time.

Example 1 “Buy the Dip”:

In the screenshot below, you think you can catch the bottom of the move because:

• There’s a descending channel, leading you to anticipate a bounce from its lower trendline.
• There’s previous resistance, marked by the dotted line at $3.88, which you believe might now serve as a support level.

Given these factors, thanks to the Long Position tool, you can:

1. Place a Limit Order: Position your order below the current price, specifically at $3.91 (highlighted with an orange line).
2. Set a Stop Loss: To safeguard against potential losses, set your stop loss below the earlier resistance with a buffer, at $3.68 (denoted by the base of the red zone).
3. Set a Profit Target: Aim for a price point of $4.32 (peak of the green zone), which aligns with the upper boundary of the descending channel.

Now, when it comes to your risk management, let’s say you want to cap your maximum loss at $500:

• Auto-Calculation: By positioning and right-clicking the tool, the system instantly computes the necessary details. For this trade, you’d be purchasing 2,170 shares, which amounts to an investment of $8,484.
• Order Execution: Once you click “buy,” the system takes over. It sets up a bracket order for you, ensuring automated trading. Should the price drop to $3.91, the system will execute the purchase of the 2,170 shares and subsequently establish two additional orders (for profit-taking and stop-loss).

🔥 Note: The number in the center of the Long Position tool is showing the risk/reward ratio. Here, it’s 1.78R, meaning for every dollar risked, there’s a potential return of $1.78. In monetary terms, you’re risking $500 with a potential profit of $890.

Example 2: ‘Buy the Breakout”:

Let’s say you want to enter on the breakout at $454.83, just above the previous high, the 9EMA, the 20EMA, and the point of control. An ascending trend line is present, and you plan to set your stop loss just below it at $451.86. Your target is yesterday’s high at $461.63, which corresponds to a 2.11R profit target.

Right-click on the Long Position tool to automate the calculations. However, in this instance, opt for a Stop order. This ensures that when the price (currently below) breaks through $454.83, an order for 168 shares will be executed, representing a trade value of $76,411.

Conclusion

There are several methods for placing orders. However, if you’re a visual person who wants to manage risk as precisely as possible, the Long Position tool is definitely for you.