Risk, Sizing and Execution
16 articles · 8 glossary terms
The part that decides whether an edge survives contact with an account: position size, stops, expectancy and the cost of getting filled.
Foundations
Start here if the subject is new.Position Sizing
Position sizing is choosing how many shares to trade so that a stopped-out trade loses a fixed, chosen amount. It is separate from what to trade, and it decides whether a losing run is survivable.
Stop Losses: Types and Placement
A stop loss is a price set in advance at which a position is closed because the reason for it no longer holds. Where it sits should follow from the chart's structure rather than a preferred dollar amount.
Risk and Reward
The risk-reward ratio is the distance to a target divided by the distance to a stop. It is useful for comparing opportunities, and meaningless without a realistic probability of reaching each.
Drawdown and the Arithmetic of Recovery
A drawdown is the fall from a peak to a later low. Recovering takes a larger gain than the loss (a 50 percent loss needs a 100 percent gain), and the asymmetry worsens quickly as losses deepen.
Writing the Plan Down
A trading plan is a written set of rules for entries, exits, position size and account limits. A plan held only in memory changes to fit whatever is tempting; writing it down makes it a constraint.
Day Trading, Swing Trading and Position Trading
Day trading opens and closes a position within one session, swing trading holds for days to weeks and position trading for months. The holding period decides which risks, costs and rules apply.
Intermediate
Assumes the foundations above.Diversification and Correlation
Diversification only works to the extent holdings move differently. Counting positions is not the measure; correlation is.
Expectancy and Win Rate
Win rate is the share of trades that make money, and on its own it says little. Expectancy combines it with the sizes of wins and losses to give the average result per trade, the number that decides everything.
Liquidity and Slippage
Slippage is the gap between the price on the screen and the price actually filled. In thinly traded stocks it is frequently larger than the edge the strategy was pursuing.
The Real Cost of Trading
Commission is usually the smallest cost and the only visible one. The spread, the slippage and the tax treatment are larger and mostly invisible.
Scaling In and Out
Building or reducing a position in pieces rather than at once. It changes the distribution of outcomes and it is frequently confused with averaging down.
Portfolio Heat
The total amount at risk across every open position at once. Individually sensible positions can add to an exposure nobody chose.
Advanced
Detail, edge cases and methodology.The Kelly Criterion
A formula for the position size that maximizes long-run growth. Mathematically clean, extremely sensitive to inputs nobody knows, and almost never used at full size.
Hedging
Taking an offsetting position to reduce an exposure. Every hedge costs something, and the cost is frequently less visible than the risk it removes.
Tail Risk
The rare, large losses that dominate long-run outcomes. Standard risk measures are built on a distribution that understates exactly these events.
Correlation Between Strategies
Running several methods at once diversifies only to the extent they fail at different times. Most methods within one style fail together.
Terms Defined in This Subject
Open one for its definition, and the article that explains it in full.
Frequently Asked Questions
What is a stop loss and where should it go?
A stop loss is the price at which the reason for a position no longer holds, decided before the position is opened. Traders commonly place it where the chart structure would be broken, such as below a support level or a pattern's low, and then size the position so that reaching it costs an acceptable amount.
Read the full article: Stop Losses: Types and PlacementHow much do traders risk per trade?
A widely cited convention is to risk about one percent of the account on a single trade, meaning the loss if the stop is hit, not the size of the position. The point of a fixed fraction is that a long losing run, which every method has, stays survivable. The right figure depends on the trader and the method.
Read the full article: Position SizingWhat is a good risk-reward ratio?
No ratio is good on its own. Risk-reward is the distance to the target divided by the distance to the stop, and it only means something alongside the probability of reaching each. A 3-to-1 trade that rarely reaches its target can be worse than a 1-to-1 trade that usually does. Expectancy combines the two.
Read the full article: Risk and RewardWhat is slippage?
Slippage is the difference between the price expected when an order is sent and the price it actually fills at. It comes from orders larger than the size quoted and from the market moving while the order travels. It is worst in thin stocks, fast markets and at the open, and it can only be measured and planned for.
Read the full article: Liquidity and Slippage