POSITION SIZING: SIZE FROM THE RISK

Size is not a feeling and not whatever cash is left over. It is a division done before entry: the dollars you may lose, divided by the dollars one share or contract can lose. Sizing is dosing. The same medicine cures at one dose and poisons at another, and the dose is never chosen by enthusiasm — it is computed from the patient’s weight. A trade is the same: the idea can be sound and the dose still lethal. Nobody asks a pharmacist how much they ‘feel like’ taking; the chart says what the body can absorb. Your account is the body, the risk budget is its weight, and this lesson is the chart on the wall: budget first, division second, order last.

POSITION SIZING · STAGE 4 · LESSON 2

THE TAKEAWAYS

• The budget comes from the account, never from the trade. Course default for paper work: 0.5–1% of the account per trade. On $10,000 that is $50–$100; on $25,000, $125–$250. The budget is chosen in a calm moment, in advance, and it does not grow because a setup ‘looks perfect’ — Lesson 3 shows what ten straight losses do at each setting of this dial, and boring is the point.
• Risk per share = entry price − invalidation price, where invalidation is the level that proves the idea wrong — Stage 3’s shelves and trend breaks are where it lives. No invalidation means no denominator, no division, no trade. Lesson 4 turns this into paperwork; here it is arithmetic: if you cannot point at the price that proves you wrong, you are not sizing a trade, you are buying a hope of a particular weight.
• Rounding is always down, and the remainder is not spendable. $100 ÷ $12 = 8.33 shares is 8 shares (planned risk $96, not $99.96). The ‘just this once’ round-up is how budgets become suggestions — and it always happens on the trade that ‘can’t lose', which is the one position sizing exists for.
• Two dials that are not the same dial: risk-per-trade (this lesson’s 0.5–1% — the slice of the account one trade may cost you) versus a position’s maximum loss as a share of the account (some published house rules for defined-risk spreads run 1–3%). Conflating them is a real beginner error with real bills attached: sizing a spread by its max-loss percentage while believing you followed the per-trade rule can quietly triple your risk. This course’s exercises use the 0.5–1% default; the other dial gets its own treatment in Stage 7.

WORKED EXAMPLE — STEP BY STEP

1. The shares case, on the lesson’s labeled example numbers: the example account is $10,000; the risk setting is 1%, so the budget is $100. A share idea enters at $600 with its invalidation at $588 — the level that proves it wrong. Risk per share: $600 − $588 = $12.
2. Do the division: $100 ÷ $12 = 8.33. Round DOWN: 8 shares. Planned risk: 8 × $12 = $96 — inside the budget, with $4 of slack that stays slack. Position value: 8 × $600 = $4,800. Read those two numbers side by side until they stop feeling related: $4,800 is what the position is worth; $96 is what the plan risks. The second number is the one that can hurt you.
3. The defined-risk case: a structure whose ticket prints its maximum loss — $250 per contract, known before entry, the Stage 7 shape. Size = $100 ÷ $250 = 0.4 contracts. Rounded down, that is ZERO contracts. The trade does not fit a $10,000 account at a 1% setting. That is not a shameful outcome; it is the system working exactly as designed, before money is involved.
4. Watch the answer change with the account, not with desire: the same $250-max-loss structure on a $25,000 account at 1% has a $250 budget — exactly 1 contract, planned risk $250. Same trade, same market: one account may take it, the other may not. Size is a property of the account-and-trade pair, never of the trade alone, and never of how the trade ‘looks’.
5. The wrong way round, for contrast: ‘ten contracts — they’re cheap’ — and the risk is discovered afterwards: 10 × $250 = $2,500, a quarter of the $10,000 account riding on one idea. One ordinary loss is now a 25% drawdown, which Lesson 3’s recovery table prices at needing +33.3% just to get home. Nothing about the trade changed; only the order of the thinking did.

THE ACCOUNT-LEVEL BRAKES — DAILY, WEEKLY, AND THE DRAWDOWN LADDER

Per-trade sizing has account-level companions, adopted by this course as conventions (frameworks, chosen conservatively — not laws of markets): a daily max loss of 2% of the account — two full-risk losses and the day is over, because a third decision made angry is the expensive one; a weekly max loss of 4% — the week closes early and gets reviewed instead of re-fought; and a drawdown ladder measured from your account’s peak — at −10%, size halves until the peak is recovered; at −20%, trading returns to paper until a written review says otherwise. Stage 8 builds the full bad-day protocol on these three brakes. They exist because the per-trade rule alone cannot stop a determined person having a bad week — the brakes are the rule, applied to the person.

COMMON BEGINNER MISTAKES

• Sizing from the cash available (‘I have $10,000, so…’) instead of from the risk budget. The account balance is not a position size.
• Rounding 8.33 up to 9 ‘just this once’. The rounding rule is the budget rule; breaking it on the confident trades breaks it exactly where it matters.
• Moving the invalidation after entry to ‘give it room’. That is resizing mid-trade without admitting it — the denominator changed, the size should have changed with it, and the journal (Lesson 6) will grade it as what it is.
• Counting five SPY positions as five separate risks. Five trades on one ticker are one idea wearing five hats — size them as a portfolio (Stage 8), not as strangers.

CHECK YOURSELF

DO IT — RUN THE DIVISION THREE WAYS

In your journal, run the division cold on three cases, showing the budget, the denominator and the rounding each time: (a) shares — entry $250, invalidation $241, the $10,000 example account at 1% (answer: $100 ÷ $9 = 11 shares, planned risk $99); (b) a defined-risk structure with a $180 printed max loss on the same budget (answer: zero contracts — it doesn’t fit); (c) that same structure on a $25,000 account at 1% (answer: a $250 budget buys exactly 1 contract, planned risk $180). Three divisions, in writing — the second half of Stage 4’s arithmetic gate.