Position Sizing: The Secret to Longevity in Trading
The Gambler's Ruin
If you bet 50% of your account on a coin flip, even if the coin is weighted in your favor (say, 60% win rate), you will eventually go broke. Mathematical certainty dictates that a streak of bad luck will wipe you out. This is known as "Gambler's Ruin."
The 1% Rule
Professional traders rarely risk more than 1-2% of their total equity on a single trade. Does that sound too small? Let's do the math.
If you have ₹1,00,000 capital and you risk 1% (₹1,000), you would need to lose 100 trades in a row to blow your account. This gives you staying power. It allows you to survive the learning curve.
Contrast this with a trader risking 10% per trade. A 5-trade losing streak triggers a 40%+ drawdown, which requires an 80% gain just to break even.
How to Calculate Quantity
Most traders ask, "How many shares or lots should I buy?" The answer isn't a fixed number; it's derived from your risk:
Quantity = (Total Capital * Risk %) / (Entry Price - Stop Loss)
Example Scenario
- Capital: ₹5,00,000
- Risk per Trade: 1% (₹5,000)
- Stock Entry: ₹500
- Stop Loss: ₹490 (₹10 risk per share)
Quantity = 5000 / 10 = 500 shares.
If the Stop Loss was ₹480 (₹20 risk), the quantity would halve to 250 shares. Your monetary risk remains exactly ₹5,000.
Adhering to this math removes the emotion of "hoping" the trade works out. You know exactly what you will lose in the worst-case scenario, and you are comfortable with it.