Position sizing

The step between deciding to deal and entering a volume. Nothing in the market sets it: it is a rule the trader chooses, and the version described most widely fixes an amount of equity to be put at risk, then derives the size that makes the distance from entry to the protective level cost exactly that amount. Stated that way, size is an output of the stop rather than an input to it, which is what distinguishes the method from choosing a round volume and placing a stop wherever it happens to fit.

The arithmetic needs three inputs, and two of them come from the instrument rather than from the trader: the money value of one unit of price movement, which follows from the contract size and the pip value or tick value in the specification, and the conversion into the account currency where the instrument is not quoted in it. The third is the distance to the protective level. Amount at risk divided by the product of the other two gives the size, and the result is then rounded down to a volume the instrument accepts, which is a real constraint on small accounts and on instruments with large minimum increments.

The figure that comes out is planned risk, not maximum risk, and that is the most consequential misreading. The calculation assumes the protective level fills at the level named, so a gap or a fast market can produce a realised loss larger than the amount that was sized for. The conventions on top of the arithmetic are also less settled than they appear: fixed fractional sizing is one, sizing by volatility so that the stop is measured in units of average range is another, and formulas such as the Kelly criterion are derived under assumptions that trading results rarely satisfy. Practitioners disagree about the level of the fraction, and no evidence base establishes a correct one.