How to Set Stop-Loss Distance and Position Size: Start With How Much You Risk per Trade

Decide in reverse order

Many people first decide how much to buy and think about the stop later. The order commonly used in risk management is the reverse. First decide how much you can afford to lose on this trade, next pick the stop level on the chart where you would consider your idea proven wrong, and finally calculate the quantity from those two. That way, whether the stop is wide or tight, the amount you lose if it is hit equals the amount you set in advance.

• ① How much you can afford to lose on one trade
• ② The stop level (from chart structure or volatility)
• ③ Quantity = ① ÷ (entry price − stop price)

Worked example: a $10,000 account

If your account holds $10,000 and you decide to lose no more than 1% of it on any one trade, the loss you can absorb is $100. The 1% is only a commonly cited example, not a recommended rate. If, as in the figure, you enter at $100 and stop out at $95, the risk per unit is $5, so the quantity is $100 ÷ $5 = 20 units and the position is worth $2,000. If you place the stop at $90 instead, the risk per unit is $10, so the quantity drops to 10 units and the position to $1,000. The farther away the stop, the smaller the position.

Stop placement: structure or volatility

There are two broad ways to choose a stop level. One is structure: for a trade that expects a rise, place it where the reason for that expectation disappears if price breaks it, such as below the latest swing low. The other is volatility: place it some multiple of the ATR (average true range, how far a single bar typically moves) away from the entry. A stop tighter than the usual fluctuation is easily hit by meaningless noise. Using 2 to 3 times the ATR is a common example, but it is only an example; details are in the ATR article. Raising the stop along a Supertrend line, which is built from ATR, follows the same idea.

R multiples: recording profit and loss in units of risk

R is a unit in which the amount you decided to risk at the start of a trade counts as 1. In the example above 1R is $100 ($5 in price terms), so selling at $105 is +1R, selling at $110 is +2R, and being stopped out is −1R. Recording results in R lets you compare trades of different sizes and work out the expected value of a whole set of rules. For example, with a 40% win rate, an average win of +2R and an average loss of −1R, the expected value per trade is 0.4 × 2 − 0.6 × 1 = +0.2R. But win rate and payoff ratio are linked (the farther away the target, the less often it is reached), so changing only one of them in the calculation gives the wrong answer.

Leverage does not change the size of the loss

If you close the same quantity at the same stop price, the loss is the same regardless of leverage. A $2,000 position needs $1,000 of margin at 2x and $200 at 10x, but if it is stopped out at $95 you lose $100 either way. What leverage changes is the margin required and the distance to the liquidation price. For an isolated-margin long, the liquidation price is roughly entry price × (1 − 1/leverage + maintenance margin rate), so at 25x in a tier with a 0.4% maintenance margin rate it sits about 3.6% below the entry. Liquidation comes before a stop placed 5% below. The Futures Liquidation Calculator lets you check which one would be reached first.

The arithmetic of losing streaks

Even with a 50% win rate, losses do not arrive evenly spread out. If you simplify trades to coin flips, the chance of at least 5 losses in a row within 10 trades is about 11%, and within 100 trades about 81%. In other words, if you trade long enough, you are likely to go through a streak such as five straight losses at least once. This is where the size of the risk per trade makes the difference. If you lose a fixed percentage of your balance each time and lose 10 times in a row, the balance left is as shown below. From about 60% you need a gain of about 67% to get back to even, and from about 35% a gain of about 187%.

• 1% each time: about 90.4%
• 2% each time: about 81.7%
• 5% each time: about 59.9%
• 10% each time: about 34.9%

Actual losses can be larger than planned

The calculated loss assumes a fill exactly at the stop price. In reality, entry and exit fees are added, and when price moves fast there is slippage, where the stop order fills at a worse price than the stop. Crypto trades 24 hours a day, but when mass liquidations cluster the order book can empty out in a short time and price can slip a long way. So a common approach is to leave room for these gaps when setting the loss you can absorb. A backtest also has to include the same costs for the plan and the result to match (see the backtesting article).

What this article does not tell you

This article shows how to calculate the quantity once the amount at risk has been set; it is not advice on how much to risk. Numbers such as 1%, 2 to 3 times the ATR and +2R are examples chosen to show the calculation. The right size differs from person to person, depending on whether the money is needed to live on and how large a loss you can bear. How leverage and liquidation magnify losses is covered separately in the coin topic's article "What happens when you trade with borrowed money".