Money Management

Position Sizing as an Approach to Risk Management

Many beginning and intermediate level traders may benefit from learning a new approach to risk management which I intend to discuss in this article. There are two types of trader that this may apply to and the first, (Trader A), is the one who enters a trade with a stop set at a fixed distance away from their entry and it is always the same distance regardless of the market or instrument being traded. Trader A places a stop entirely based on a fixed monetary risk and when the amount of money that they have set aside for the trade has departed their account they close the trade.
The second trader, (Trader B), places a stop that can vary in distance from their entry and is based on “Technical” reasons as to why the trade is no longer valid. In both cases the traders use a fixed amount of money per pip or per point of price movement and can be anything from 50p to £100 or more depending on their account size.

This simplistic approach has problems in both cases. For Trader A there is no accounting for the volatility of the market. Markets rarely go straight up or straight down and they fluctuate along their path whether trending or range bound. As such if the volatility of the market is greater than the distance that Trader A has set their stop then there is a high probability that they will be stopped out before the market reaches their profit target.
Trader B has the problem that their losses can vary quite a lot because Technical stops can be large or small depending on the approach being used to determine that the trade is no longer valid.

Let’s look at an example of how this may happen:

Trader A is looking to go Short and has just seen that the market has made a  lower high so enters on the break of the most recent low setting a stop 10 pips away as can be seen in Image # 1. Unfortunately they get stopped out for a 10 pips loss as the market retraces slightly and then carries on down and would have made a nice profit.

A better approach may have been to take into consideration the market volatility at the time of entering the trade. There are several ways in which this can be done and for the purposes of this example we will use “Average True Range” (ATR). This is an indicator that most charting packages have as standard and the favoured number of bars to measure it over is 14 so you will often see it stated as ATR(14). This can be changed to suit the average time that a trade is expected to last in numbers of bars but for our purposes ATR(14) is fine. We now see the same trade but with the ATR(14) at point of entry which in this case is 24 pips added to the entry price to become the stop level. This can be seen in image # 2 and in this case the stop level is not touched and the price then moves down to give a profit.

Please note that some traders prefer to multiply the ATR by an additional factor (often 1.5 or 2) and use that as the distance away from entry to set a stop. The idea being that at a distance of 1.5 x ATR or 2 x ATR away from entry price the trade is definitely no longer valid but for our purposes we will use 1 x ATR(14).

The above example is only half of the story because in this case Trader A would now be concerned that his stop is more than twice the distance than it used to be but before we move on to how this can be addressed let’s return to Trader B who places stops based on “Technical” reasons. Trader B is more likely to have variable losses because stop prices often vary considerably from where trade entry is taken. This may prevent Trader B from even considering good set ups if they think that the risk is too great. As such they can either miss out on good trading opportunities or have hugely different losses incurred when a trade fails. To address this issue both Trader A and Trader B could use different position sizing to reduce their losses based on where they wish to set their stop.

For example let’s look at a trading scenario for Trader A
Account Size = $50,000
Risk per trade = 1% = (0.01 x 50,000) = $500
ATR(14) = 24 pips
Position Size = Risk per trade / ATR(14) = 500 / 24 = $20.83 per pip of movement
We would round this down to $20 per pip and so if the market moves against the entry by 24 pips the loss is 24 x $20 = $480 (nearly the $500).

Trader B will set a Technical stop and all they need to know is what the difference in price is from their entry, for example it may 12 pips or cents away from entry. Both these scenarios are shown in an Excel spreadsheet as shown in image # 3 The spreadsheet can also be downloaded and used as the calculations are all automatic. Here is the link:

The above approach can be used for both intra-day and EOD trading as well but there is one more factor to consider in all of this and that is account size. Many new, intermediate and even advanced traders can have an account size that is too small for the risk that they wish to take. Often new traders ask about whether a $1000 account is large enough to trade with. This will depend on whether the broker being used will allow a small enough monetary value per pip / point / cent of movement to justify the risk. For example, if you have a $1000 account and wish to only risk 1% of that then that allows you to only risk $10 per trade. If the distance of the stop from entry is 24 pips then the amount per pip that you can risk is only 41c. The problem for many is that the broker may have a minimum amount that they will allow to be risked. If this is the case then you have three choices.

  1. Risk more than 1% of your account on any given trade
  2. Increase your capital to a level where more can be risked but keeps within the percentage you are comfortable risking
  3. Don’t take trades where the risk is above your comfort level

Hopefully this article has given those who have not considered an approach like this before some food for thought and comments are welcome.

Paul has been involved in trading since 1998 and an active member of Trade2Win since January 2003. He has traded futures, bonds, stocks and forex on an intra-day as well as End of Day basis with consistent annual returns and has previously coached others to do the same. He has a number of business interests including property, web based marketing, business consultancy and publishing. He is a graduate of Sheffield Hallam University with an MBA as well as being awarded a Management Fellowship from Cranfield University. He is known for having a logical approach to trading and is happy to pass this on to others and always believes that there is more to learn.

Paul has been involved in trading since 1998 and an active member of Trade2Win since January 2003. He has traded futures, bonds, stocks and forex on a...


Established member
Lets look at trader X

He has a maximum risk tollerance per trade of lets say $100 of capital and a fixed position size.
The fixed position size is based on the maximum risk tollerance.
If the maximum tollerance for 100 shares is $10, trader X will always trade 1000 shares.

One boundary condition to enter a trade is that the stop can vary in distance from the entry, based on “Technical” reasons as to why the trade is no longer valid, but this desired stop is always less or equal to the defined maximum tollerance for risk.

Trader X knows his:
-maximal risk = $100 (excl. slippage and transaction costs);
-size = 1000 shares;

And he enables himself to outperforme his maximum risk by also selecting technical valid trades that have less risk than the $100.
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Mr. Charts

Legendary member
Excellent article, pitched at the right segment and expressed clearly and concisely.
A good example of the standard that should be on Knowledge Lab., or whatever it's called these days.


I thought it was an interesting article.

Very much what I do when I position size. Newbs should take note.

I'd like to see more on risk management though.
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Experienced member
Good article which goes into more depth than most of the articles normally delve in the Knowledge Lab. I think it will help newbies start to consider different approaches to both stops and, perhaps, to really consider position sizing for the first time


Great article, that's is one of the better explinations of the use of ATR that I have seen. Kind of finny that two of the trades I placed today were examples of Trader A and Trader B. One was stopped out to early and the other made money and is still going.

foroom lluzers

Veteren member
What if extreme volatility breaks out , comes to your stops ,takes it out and goes in your intended direction without the trader?It happens quite often!

What if the market makes a monkey out of tight stop scared money traders?