Learn/ Risk/ Lesson 01

Risk · Lesson 01 9 min read Beginner

Sizing a position properly

Size is not a judgement call. It is the output of three numbers you already know, and computing it takes about twenty seconds. Almost every account that fails does so because this step was replaced by a feeling.

The whole calculation

Three inputs, two lines of arithmetic.

  1. Risk budget = capital × risk percentage.
    ₹5,00,000 × 1% = ₹5,000.
  2. Risk per unit = entry price − stop price.
    ₹1,000 − ₹975 = ₹25.
  3. Quantity = risk budget ÷ risk per unit, rounded down.
    ₹5,000 ÷ ₹25 = 200 units.

That is the entire method. Notice what is absent: any view on how good the trade is, how much you expect to make, or how much capital you would like to deploy. None of those belong in the calculation, and letting them in is precisely how it gets corrupted.

The position sizer does this arithmetic for you, but do it by hand a few times first. The relationship between stop distance and size is worth feeling rather than reading.

The stop comes first

This is the part people get backwards. The stop is not derived from the size — the size is derived from the stop.

Your stop belongs at the price where the reason you entered is no longer true. On most charts that is a structural point: below the last higher low, outside the zone, back inside the range. It is a property of the chart, and it exists whether or not you are in the trade.

The stop is on the chart before you arriveIllustrative
The last higher low is the structure holding this trend up. Below it, the sequence is broken and the reason for being long has gone. That price — not a round number, not a percentage — is where the stop belongs.

The consequence is that a wider stop means a smaller position, automatically. That is the mechanism doing its job. A volatile instrument requiring a distant stop should be traded in smaller size, and the formula delivers that without you having to remember it.

Two defensible stops, two different sizesIllustrative
Both lines are reasonable places to be wrong. With a ₹5,000 budget the tight stop allows 1,666 units and the structural one allows 961 — the same risk, expressed differently. Neither is correct in the abstract; what is not allowed is choosing the tight stop because it permits a bigger position.

Moving a stop closer to afford more size is not risk management. It is the same bet with a worse chance of surviving the noise.

Choosing the risk budget

One to two per cent per trade is the conventional answer, and the convention is sound. The reasoning is in the drawdown arithmetic: at 1%, a run of ten losses costs about 10% and is a bad fortnight. At 5% the same streak costs 40% and is an existential event.

Two adjustments worth making:

  • Lower it while you are learning. Half a per cent while you have no verified expectancy. You are paying for information, not for returns.
  • Cap your total open risk. Five positions at 1% each is 5% at risk, and correlated positions can all fail together. A ceiling of 3–5% across everything open is the sensible second rule.

Sizing when lots get in the way

In Indian derivatives you cannot buy 200 units of an index — you buy lots of a fixed size. That makes the arithmetic lumpy in a way that matters.

Suppose the calculation says 90 units and the lot is 75. One lot is 75 — under-risked, and fine. Two lots is 150, which is 67% more risk than you budgeted. The temptation to round up is enormous and must be refused every time.

When one lot is already more than your budget allows, the position is simply too large for your account. That is information, not an obstacle to be argued around. The honest responses are a closer stop that is still structurally valid, a different instrument with a smaller lot, or not taking the trade.

Common mistake

Sizing on margin rather than on risk. "I have ₹5,00,000 and one lot needs ₹1,20,000 of margin, so I can take four lots" is a statement about what your broker permits, not about what you can survive. Margin tells you the maximum the system allows. Risk tells you the maximum you should use. They are rarely the same number and the gap between them is where accounts die.

Read it yourself

Capital ₹4,00,000, risk budget 1%.

Practice
  1. Where does the stop belong on this chart, and why there?
  2. Entering at 219.8, how many units does the calculation allow?
  3. If the lot size were 250, what should you do?
Show answers

1. Below the last higher low at 213.6 — call it 213. Beneath that the sequence of higher lows is broken and the reason for being long has gone.

2. Budget ₹4,000. Risk per unit = 219.8 − 213 = 6.8. Quantity = 4,000 ÷ 6.8 = 588 units, rounded down.

3. Take two lots — 500 units, comfortably inside the budget at ₹3,400 of risk. Three lots would be 750 units and ₹5,100 of risk, which is 27% over budget. Rounding down leaves you slightly under-risked; rounding up quietly rewrites the rule you set before you looked at the chart.

Terms used

Risk budget
The rupee amount you are prepared to lose on one trade.
Risk per unit
Distance from entry to stop, in price.
Position size
Budget divided by risk per unit, rounded down.
Structural stop
A stop placed where the chart says the idea has failed.
Open risk
Total amount at risk across all positions at once.

Practise this on your own charts

The Risk track works through 5 lessons like this one, each built around a drawn example and an exercise you complete yourself.

See the Risk track