This note includes the following topics:

Position sizing

• How many stocks to buy?
• Professionals focus on maximum drawdowns, not maximum returns
  

The 1 percent Rule

• Never risk more than 1 percent per trade
• Even if you are wrong 10 times in a row, your account will be down only 10%
• 1% risk does NOT mean to buy stocks worth 1% only of your total account

Trading Account: $100,000
Max Risk per trade: 1% = $1,000
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Stock Price: $100/share
Initial stop loss (1R): 5% = $5
How many stocks to buy = $1,000 / $5 = 200 shares
Total cost: 200 shares x $100/share = $20,000
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Position size = $20,000 / $100,000 = 20%
Hence 1% risk != 20% Position size

Dangers of tight stop losses

• With the max risk per trade being the same at 1%, a tighter stop loss is riskier
  • A 3% stop loss: 33% position size
  • A 5% stop loss: 20% position size
  • Inverse relation
• If your stock is gapped down 20%, the account will face a 6.66% loss in a single trade

Trading Account: $100,000
Max Risk per trade: 1% = $1,000
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Stock Price: $100/share
Initial stop loss (1R): 3% = $3
How many stocks to buy = $1,000 / $3 = 333.3 shares
Total cost: 333.3shares x $100/share = $33,333
Position size = $33,333 / $100,000 = 33%
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5% stop loss: 20% position size
3% stop loss: 33% position size
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# Imagine a 33% position size account having a 20% gap down
33 x .20 = 6.66% loss in a single trade