Risk Management & Position Sizing
The 1-2% rule, risk/reward, and the diversification trap that isn't really diversified.
The 1-2% Rule
A widely used guideline is to never risk more than 1-2% of your total account on a single trade — where "risk" means the distance between your entry price and your stop-loss, not the total dollar amount invested.
This matters because it protects you from ruin: even a brutal losing streak of 10 trades in a row only costs you 10-20% of your account, not your entire portfolio.
Risk/Reward Ratio
Before entering a trade, compare how much you stand to lose (entry to stop-loss) against how much you stand to gain (entry to target). A common minimum bar is a 1:2 risk/reward ratio — risking $1 to potentially make $2 — which means you can be profitable even with a win rate below 50%.
Rare but important
Owning 10 different stocks feels diversified, but if all 10 are semiconductor companies, they will likely rise and fall together during a sector-wide shock — you effectively hold one large, concentrated position dressed up as ten small ones. Real diversification is about correlation, not headcount: assets that don't move together (e.g., different sectors, asset classes, or geographies) provide real risk reduction. Two "different" stocks with 0.9+ correlation offer almost none.
Worked Example
Problem: You have a $10,000 account and want to risk no more than 1% ($100) on this trade. You plan to buy at $50 with a stop-loss at $47. How many shares should you buy, and what does that mean for your total capital at risk?
- Risk per share = entry − stop = $50 − $47 = $3.00.
- Position size = risk budget ÷ risk per share = $100 ÷ $3.00 = 33.3, rounded down to 33 shares.
- Total capital deployed = 33 × $50 = $1,650 — only 16.5% of the account — while the maximum loss if the stop is hit is capped at 33 × $3 = $99, right at your 1% budget.
- Notice position size is driven by the stop distance, not by "how much money you feel like putting in." A tighter stop lets you buy more shares for the same dollar risk; a wider stop means fewer shares.