The process of determining how large a trade to take based on your risk tolerance and stop loss distance.
Position sizing calculates the number of units, shares, or lots you should trade so that if your stop loss is hit, you lose only a predetermined amount. It combines your account risk (the dollar amount you’re willing to lose) with your stop loss distance to determine trade size.
Position sizing is the single most important risk management tool. It ensures that no single trade can cause catastrophic damage to your account. Without proper position sizing, even a good strategy can lead to ruin through oversized losses.
You have a $10,000 account and risk 1% per trade ($100). Your stop loss is 5% below your entry. Position size = $100 / 0.05 = $2,000. The size of the trade should be $2,000 worth of the asset.
Risking 1% of a $10,000 account ($100) with a 5% stop loss gives a position size of $2,000.