Risk first: sizing, stops and R multiples
Every earlier lesson ended up in the same place: leverage, spreads, gaps and fast markets can turn a small mistake into a large loss. Experienced traders tend to think about how much they could lose before they think about how much they could make. This lesson covers the basic tools for doing that.
Start from the loss you can accept
A common way to size a trade works backwards. Instead of asking "how many shares can I afford?", it asks "if this trade goes wrong, how much am I prepared to lose?", and then works out the size from there.
Three numbers are needed:
- The amount of money you are prepared to lose on the trade. Some traders set this as a small fixed percentage of their account.
- The distance from your entry price to the price at which you'd accept you were wrong, your stop.
- What each point of that distance is worth per share or per contract.
Position size = money at risk ÷ (stop distance × value per point).
Suppose a hypothetical account holds $10,000, and the trader decides to risk 1%, or $100, on a trade. They want to buy a stock at $50 with a stop at $48, a $2 distance. $100 ÷ $2 = 50 shares.
The same method works for futures. Suppose the trader wants to trade Micro E-mini S&P 500 (MES) futures, worth $5 a point, with a 10-point stop. Each contract risks 10 × $5 = $50, so $100 allows 2 contracts. On the full-size E-mini (ES), at $50 a point, the same 10-point stop would risk $500 for a single contract, five times the planned amount. Lesson 5's point values matter here.
These numbers illustrate the arithmetic, not a recommended amount to risk. The point is that the stop decides the size, not the other way round.
Stops are a plan, not a guarantee
A stop order becomes an order to trade at market once the price reaches your stop level. It doesn't guarantee that price. If the market gaps past your stop, for example when a stock opens far lower after overnight news, or moves very fast, your order fills at the next available price, which can be much worse. This is slippage again, from Lesson 1. Your real worst case is your planned loss plus whatever a gap or fast market adds. Products and times with frequent gaps, such as single stocks around earnings, deserve extra care.
R multiples
R is the amount you planned to risk on a trade: the distance from entry to stop. Measuring results in multiples of R lets you compare trades of different sizes, in different markets, on the same scale.
In the stock example, 1R is $2 per share. If the trader exits at $54, the gain is $4, which is +2R. If the stop is hit at $48, the result is −1R. If a gap fills the stop at $47, the result is −1.5R.
R makes one important idea easy to see. Suppose a trader's winning trades average +2R and their losers average −1R. If they win 40% of the time, over 10 trades they'd expect about 4 × 2R − 6 × 1R = +2R. If they win only 30% of the time, it would be 3 × 2R − 7 × 1R = −1R. The average result per trade, combining win rate and the size of wins and losses, is called expectancy. A high win rate alone tells you little; small wins and occasional large losses can still add up to a loss.
Leverage cuts both ways
Leverage means controlling a position worth more than the money you've put up. It multiplies results in both directions, by the same amount.
Suppose you put up $1,000 and control a $10,000 position, which is 10 times leverage. A 5% rise in the price gains $500, which is 50% of your money. A 5% fall loses $500, which is also 50%. A 10% fall loses everything you put up.
Losses are also harder to recover from than they look, because the recovery is measured from a smaller base. After a 10% loss you need an 11.1% gain to get back to where you started. After a 50% loss you need a 100% gain. That arithmetic is the main reason careful traders treat avoiding large losses as their first job.
A track record needs enough trades
A handful of good trades can come from luck. Results only start to say something about a method when there are many trades, taken under the same rules, recorded honestly, including the losers. Most traders' own records fail that test, because it's tempting to forget the bad trades.
How PYE Markets scores setups
That is why PYE Markets scores community trade setups automatically. When a member publishes a setup with an instrument, entry, stop and target, it is locked. Our system then checks it against delayed market prices every 15 minutes. The setup counts as entered when price first trades at the entry, and it closes at the stop (−1R) or the target, whichever is reached first. If both are touched in the same 15-minute bar, it counts as stopped. Limits on stop and target distances stop tiny-stop setups from distorting records, and deleting a post doesn't remove its setup from the record.
The full rules are on How setup scoring works. When reading anyone's record, here or elsewhere, look at the number of closed setups as well as the average R. Past results don't predict future results.
Where to go from here
You've finished the series. The Markets page shows delayed prices and volatility with their sources, Rates and Positioning show the forces behind them, and the community is where members publish setups that are scored in public.
Key terms
- Position size
- How many shares or contracts to trade; set from money at risk divided by stop distance times value per point.
- Stop order
- An order that becomes a market order when price reaches a set level; not a guaranteed exit price.
- R
- The amount planned to be risked on a trade, from entry to stop; results are measured in multiples of it.
- Expectancy
- The average result per trade, combining win rate with the size of wins and losses.
- Leverage
- Controlling a position worth more than the money put up; multiplies gains and losses alike.
Next: that's the end of the series. Back to all lessons
General education, not investment advice.