Why Position Sizing Matters
Even a great strategy fails if one large loss wipes out months of gains. Position sizing is the discipline of deciding how much of your capital to risk on each trade — the cornerstone of portfolio survival.
The 1–2% Rule
A widely used rule: never risk more than 1–2% of your total portfolio on a single trade.
Formula:
Dollar risk = Portfolio value × Risk % (e.g. 2%)
Example:
- Portfolio: $50,000
- Risk per trade: 2% → $1,000 max loss
- Entry: $100/share, Stop-loss: $95/share
- Risk per share: $5
- Maximum shares: $1,000 ÷ $5 = 200 shares
This means a single bad trade loses $1,000 — painful but recoverable. Without this discipline, one large loss could require a much bigger gain just to break even.
Position Size ≠ Portfolio Weight
Risking 2% does not mean allocating 2% of your portfolio to a position. If your stop is tight (e.g., 1% below entry), you can buy more shares while still only risking 2% in dollar terms.
| Entry | Stop | Risk/share | Dollar risk | Shares |
|---|---|---|---|---|
| $100 | $99 | $1 | $1,000 | 1,000 |
| $100 | $95 | $5 | $1,000 | 200 |
| $100 | $80 | $20 | $1,000 | 50 |
The tighter your stop, the larger your position can be — but tighter stops are also hit more easily.
Concentration Limits
Beyond per-trade risk, limit concentration in any single stock or sector:
- Single position: typically ≤ 10–20% of total portfolio value
- Single sector: typically ≤ 30–40% of total portfolio value
Concentration amplifies both gains and losses. Diversification smooths the ride.
Kelly Criterion (Advanced)
The Kelly Criterion calculates the mathematically optimal bet size:
f* = (bp − q) / b
Where:
b= ratio of win/loss sizep= probability of winningq= 1 − p
In practice, most traders use half-Kelly or less to avoid volatility. This is an advanced concept — the 1–2% rule is sufficient for most beginners.
Applying This in PaperTrade Academy
When placing a simulated order, our platform enforces a maximum position size relative to your portfolio to protect you from accidental over-concentration. Use this as a learning guide: if the system flags your order, recalculate using the formula above.