The correct position size—how much stock you buy for a trade— is based on a formula, NOT how convinced we are a trade will work out.
In this article, I’ll discuss two methods for determining position size when trading stocks. The first is a formulaic allocation based on risk. We’ll call this the Percent Risk Method.
The second method divides up available capital among how many stocks we are willing to hold. We’ll call this the Fixed Dollar Amount Method. I use this one, but with a twist.
The Percent Risk Method for Determining How Much of a Stock to Buy
To calculate position size, we need to know the amount of capital in our trading account, our entry price for a trade, and our stop loss price.
First , determine your Account Risk. This is how much of your account you are willing to lose on one trade. I recommend 1% or less when starting out. Once you have proven yourself profitable over a long period of time, then you may choose to increase your risk to 1.5% or 2%, although if you are making money this isn’t required.
I typically risk only about 1% per stock trade.
Assume you have a $50,000 trading account. If you choose to risk 1%, then you can lose up to $500 per trade. That is your account risk.
Next, determine your Trade Risk. This is the dollar difference between your entry price and stop loss level (where you will get out if the trade doesn’t work out as expected). For example, if your entry is $125 and your stop loss is $120, then your dollar Trade Risk is $5.
Finally, divide your Account Risk (in dollars) by your Trade Risk (in dollars) to see how many shares you can buy.
If your acceptable account risk is $500, and your trade risk is $5, that means you can buy 100 shares. $500 / $5 = 100. If the stock costs $125 x 100 shares, then $12,500 is used to buy those 100 shares.
Here’s the position size formula:
Swing Trading Position Size (in shares) = Account Risk in dollars / Trade Risk in dollars
That’s it. That’s your position for the stock trade.
Here’s an example based on an explosive Cup and Handle trade that occurred in a Canadian stock I was trading. The top of the green box represents my target price. The bottom of the red box is my stop loss.
Charts from TradingView.
If you choose to risk 1.5% per trade, then multiply 0.015 by the amount of capital in your account to get the Account Risk. The same concept applies if you want to only risk 0.5% or risk 2%.
Risk Rule: To avoid putting too much capital into one trade which has a very low Trade Risk, cap all positions at 1/3 (or 1/4 or 1/5) of the trading account capital.
In other words, no matter what the position size formula says, I don’t put more than 1/3 of my capital into any single stock trade.
Stock prices can gap against us. So even though our trade risk may be very small on a particular trade, and thus the position size formula will allocate a lot of capital to that trade, we don’t want to put all our capital on the line in a single trade.
This “percent risk” approach is common among day traders. If you are a day trader, also check out How to Find Day Trading Stocks That Consistently Have Big Moves.
Fixed Dollar Method for Determining The Number of Shares to Buy
The fixed dollar method allocates a certain dollar amount to each stock trade.
Say you have a $100,000 account and want to allocate that capital between 5 different trades. That’s $20,000 per trade. Some traders will want to diversity a bit more and have up to 10 positions. Other traders may want to only focus on their best ideas, so they allocate their capital to only 3, 4 or 5 trades.
To find out how many shares you can buy, divided the dollar amount you are willing to allocate to each position by the entry price.
Assume you want to buy a stock that is currently trading at $25.25. Divide $20,000 by $25.25. You can buy 792 shares. That is your position size.
I recommend allocating at least $2,000 per position, unless you don’t pay commissions. If you pay commissions, allocate at least $2,000 per position. So if you have $6,000 in trading capital, allocate it up to three positions. If you have $10,000, you can allocate it up to 5 positions; $2,000 in each. This is because while commission costs may seem low, if you pay $5 or $10 to get in and then $5 or $10 to get out, even on $2,000 paying $20 in commissions amounts to 1% of your capital invested. Over time, that eats into your gains. Commissions negatively affect small positions much more than larger positions.
If you don’t pay commissions, and several brokers no longer charge commissions, then you don’t need to be as worried about investing a minimum amount into each stock. You could buy $100 worth of stock, for example.
Fixed Dollar Method Position Sizing for Swing Trading…With a Twist
I use the Fixed Dollar approach when swing trading, but with a bit of a twist.
I prefer to only hold about 5 or 6 trades at a time. That means I divide my account capital by 5. That is my base dollar amount I can allocate to each position. I do this because it forces me to really pick the best trades ideas. I don’t want to own 20 stocks that are average. I want to own a handful of stocks that are doing amazing and that still look great. I want to put more capital into a few great ideas, not a little bit of capital into a bunch of mediocre ones. That’s just me. You have to decide what works for you, and what you are comfortable with.
Let’s assume the account has $50,000 in it. That means I can allocate $10,000 to each position.
That is the baseline. But not all trades are equal. Some trades have more risk than others.
My average stop loss is about 6% below my entry point (for long positions). Meaning if I buy a stock at $10, my stop loss may be around $9.40. I don’t randomly put my stop loss there, my stop loss just ends up often being close to 6% based on my strategies. See How to Swing Trade Continuation Patterns for loads of trade examples.
If my risk is close to 6% on a trade then I will allocate the baseline amount of capital, $10,000 in this case.
But assume I find a volatile stock I want to trade and my stop loss needs to be placed 12% away from my entry point. That stock is twice as risky, so I will only allocate half the baseline capital, or $5,000. I then divided $5,000 by the entry price to determine how many shares to buy.
If I am trading a calmer stock and my stop loss only needs to be 3% away, my risk is half of the baseline. I will allocate double the baseline amount to that position, so $20,000 instead of $10,000. I don’t have to double the amount invested, but I do have that choice.
As the risk varies from the baseline of 6%, I adjust the amount of capital I allocate to that stock.
Here’s a chart showing how this works. I have used the same example as above, but instead of using a fixed dollar amount, I have adjusted the amount invested based on the stop loss size.
In the prior section I said I typically only risk about 1% per trade, but now I am saying I may risk 6%…or 12%! Remember though, with this method, we are dividing up our risk amoung multiple trades.
If I allocate $10,000 of my $50,000 account, and risk 6% on that single trade, there is $600 at risk (0.06 x 10,000). $600 is 1.2% of the entire account balance of $50,000. So we are still only risking about 1% of our account, just like we were with the percentage risk model discussed prior.
How Many Shares to Buy When Investing in Stocks
This method works well with swing trading, but it can also be used for investing.
Decide how many different stocks or ETFs you want to be invested in. Divide your capital by the number of stocks. Invest that amount of money in each one (make sure the fees you pay on your investments aren’t killing your nest egg).
Adjust the amount invested in each stock based on how volatile it is. You may wish to allocate more capital to some stocks or ETFs and less capital to others. Make the approach systematic though. How much you invest should not be based on opinion.
I invest in a handful of ETFs in my retirement account. I allocate capital to each one each month. Or I will allocate my contributions to one ETF this month, and then the next month another ETF gets the contribution. The same concepts apply as discussed above.
Cory Mitchell, CMT
Disclaimer: Nothing in this article is personal investment advice, or advice to buy or sell anything. Trading is risky and can result in substantial losses, even more than deposited if using leverage.