Technical analysisModule 5, lesson 27 of 32
Risk/reward and position size per trade
How to set risk per trade as a share of capital, calculate how many shares to buy from the entry and stop, work out risk/reward ratios, and include trading costs.
In this lesson
- Set risk per trade as a fixed fraction of capital.
- Calculate position size from the entry price, stop price and costs.
- Calculate a risk/reward ratio and explain what it does and does not tell you.
- Explain why a good risk/reward ratio does not make a trade a good trade.
Builds on
- Placing stop-lossesPosition size is calculated from the stop distance chosen there.
On this page
In simple terms
Two questions decide how much damage a failed idea can do:
- How far is the stop from the entry? The stop placement lesson covers this.
- How many shares do you hold?
Position sizing links them. You decide first how much you are willing to lose on one idea, then calculate how many shares make the loss at the stop equal to that amount.
As throughout this module, this is about understanding risk arithmetic, not a suggestion to trade.
Risk per trade
Risk per trade is the loss, in rupees, if the stop is hit. It is usually set as a small fixed fraction of capital. A fraction of 1% is often quoted in trading education; whatever the figure, the point is that it is small enough to survive a long run of losses, as the expectancy lesson shows.
Calculating position size
rupee risk = capital × risk fraction position size (shares) = rupee risk ÷ (entry price − stop price + costs per share)
Worked example: A made-up trade plan
From the plan in the entry and exit planning lesson: capital ₹5,00,000, risk 1%, entry ₹310, stop ₹298. Suppose, for this example, that round-trip costs come to about ₹0.50 a share.
| Rupee risk: 1% × 5,00,000 | ₹5,000 |
|---|---|
| Stop distance | ₹12 |
| Size ignoring costs: 5,000 ÷ 12 | 416 shares |
| Size including costs: 5,000 ÷ 12.50 | 400 shares |
| Position value: 400 × ₹310 | ₹1,24,000 |
The position uses about a quarter of capital, but risks only 1% of it if the stop works as planned. The position size calculator does this arithmetic for any plan, including short trades.
Notice that the stop distance decides the size. A wider stop means fewer shares; a tighter stop, more shares. The rupee risk stays the same. Choosing a stop to suit the size you want reverses the logic and usually puts the stop in the wrong place.
Also check that the position is not too large for the share's liquidity, and remember that gaps can make the actual loss larger than planned.
Risk/reward ratio
The risk/reward ratio compares the potential gain with the potential loss:
reward-to-risk ratio = (target − entry) ÷ (entry − stop)
For the plan above, with a target of ₹340, the ratio is (340 − 310) ÷ (310 − 298) = 30 ÷ 12 = 2.5. The target is two and a half times as far from the entry as the stop.
What risk/reward does not tell you
A ratio compares distances. It says nothing about how likely each outcome is.
Worked example: Two made-up plans
| Plan A | Plan B | |
|---|---|---|
| Reward-to-risk ratio | 4 | 1.5 |
| Estimated chance of reaching the target first | 15% | 50% |
| Expected result per ₹1 risked: chance × reward − chance of loss × 1 | 0.15 × 4 − 0.85 = −0.25 | 0.5 × 1.5 − 0.5 = +0.25 |
Plan A has the better ratio but the worse expected result, because its target is rarely reached. The probabilities here are made up; in practice they must be estimated from tested records, which is hard.
A distant target makes the ratio look attractive but may rarely be hit. That is why risk/reward must be combined with win rates in expectancy, and why both need real, tested data rather than guesses.
Including costs
Brokerage, securities transaction tax, exchange charges, stamp duty, GST and the bid-ask spread are paid on every trade, as the trading costs lesson explains. For short-term trades aiming at small moves, costs can be a large share of both the reward and the risk. Include them in both sides of the calculation.
Why it matters
Position sizing is the main tool for keeping any single failed idea from doing serious damage. Many trading losses come not from bad ideas but from positions far too large for the stop distance. Understanding risk/reward, and its limits, prevents the common error of choosing trades by an attractive ratio alone.
Limitations
Position sizing assumes the stop fills near its trigger, which gaps and thin liquidity can prevent. The right risk fraction depends on your circumstances and the strategy's losing streaks. Win probabilities are hard to estimate without large, honest samples.
Common mistakes
- Sizing by how much you want to invest instead of from the stop.
- Moving the stop to fit a desired size.
- Choosing trades by risk/reward alone.
- Ignoring costs on short-term trades.
Try it yourself
- Assume capital of ₹2,00,000 and a risk fraction of your choice.
- For a share, pick an entry, a stop from the previous lesson, and a target.
- Calculate the rupee risk, the position size with and without an assumed cost per share, and the reward-to-risk ratio.
- Estimate, honestly, the chance of reaching the target first, and calculate the expected result per ₹1 risked.
Key takeaways
- Risk per trade is the amount you would lose if the stop is hit, set as a small fixed fraction of capital.
- Position size = rupee risk ÷ (entry − stop + costs per share). The stop distance decides the size, not the other way round.
- Risk/reward compares the distance to the target with the distance to the stop. A ratio of 2 means the target is twice as far as the stop.
- Risk/reward says nothing about how likely the target is. A trade with a high ratio and a low chance of success can be worse than one with a lower ratio.
- Include brokerage, taxes and the spread. On small moves, costs change the numbers noticeably.
Check your understanding
Try the numbers yourself
- Position size and risk/reward calculatorHow many shares can I hold so a stop-loss costs only what I planned?
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Terms used in this lesson
- Position size
- The number of shares held in a trade, calculated so that the loss at the stop equals a fixed small share of capital.
- Risk/reward ratio
- The distance from entry to target divided by the distance from entry to stop, comparing a trade's possible gain with its possible loss.
- Stop-loss order
- An order that waits until the price reaches a trigger you set, then becomes a live limit order (SL) or market order (SL-M).
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This lesson is general education, not investment advice. Examples use made-up or clearly dated figures to explain ideas; they are not recommendations. Read the disclaimer.