Position Sizing — Read This Chapter Twice
"It is not strategy that kills you. It is _size. It is always size."_
A Story: The Same Trade, Two Traders
Two traders, on the same morning, open the same trade: a long AAPL 30-DTE 175-strike call at $2.50. The market is calm. The thesis is reasonable.
Trader A has a $50,000 account. They buy one contract ($250 risk). That is 0.5% of the account. They sleep that night.
Trader B has the same $50,000 account. They buy fifty contracts ($12,500 risk). That is 25% of the account. They check the app at midnight.
Two weeks later, AAPL has not moved. The call is now worth $1.20.
-
Trader A is down $130. They are annoyed. They put on another trade.
-
Trader B is down $6,500. They are not annoyed. They are awake at 4 AM trying to decide whether to "average down" or take the loss. Either choice will worsen things.
Same trade. Same direction. Same wrong thesis. Different sizes. One trader continues. The other ruins their year.
This is the chapter where you decide which trader you want to be.
The Single Rule
|
Do not risk more than 1-2% of the account on a single trade. This is not a tip. This is not a guideline. This is a survival condition. Every trader who breaks this rule consistently is eventually eliminated. The rule is older than options trading. It is repeated in every credible trading text — Schwager’s Market Wizards interviews, Douglas (2000), the position-sizing chapter in nearly every reputable risk management book. The reason they all say the same thing is not coincidence. |
What Does "Risk" Actually Mean?
"Risk" in this rule is the maximum loss of the trade — the number from the matrix in Chapter 5 — not the capital outlay.
For a $5,000 cash-secured put with a $0.50 premium, your capital outlay is $5,000 but your risk is closer to $4,950 (the strike minus premium, in the worst case). Do not confuse the two.
Example 1: Long Call
-
Account: $20,000
-
Max risk per trade: 1% = $200
-
AAPL 30-DTE $175 call premium: $2.50 → contract cost $250
-
Result: Even one contract exceeds the 1% limit. Either pick a cheaper strike/expiry, or pass.
The Kelly Intuition, Without the Math
The Kelly criterion (Kelly, 1956; popularized for trading by Thorp) gives an "optimal" fraction of capital to risk per bet, given an edge and a probability of winning:
-
If you have a positive edge (expected value > 0), Kelly says: bet more.
-
The "more" is precisely calculable, but for trading the answer is always smaller than you think.
Two practical takeaways from Kelly (synthesized — math omitted):
-
Most retail traders overestimate their edge.
-
Even with a real edge, Kelly suggests sizing well below the "obvious" maximum.
The widely-used adaptation is fractional Kelly — risk half or even a quarter of what Kelly would suggest. The 1-2% per-trade rule is, in essence, a heavy fractional-Kelly approximation for an edge you have not actually proven yet. As Sinclair (2010, Ch 9) notes, the appropriate sizing factor in a retail context is closer to 0.1 of Kelly than to 1.
The Monthly Risk Budget
The per-trade rule is necessary, not sufficient. Twenty trades each at 2% risk, all going wrong in the same month, would be a 40% drawdown — fatal.
Set a monthly risk budget as well. A reasonable starting point: a 5% account drawdown caps the month.
Account Size and What You Should Trade
| Account Size | Recommended Posture | Reason |
|---|---|---|
< $5,000 |
Options trading not advised (education only) |
Any meaningful position exceeds the 1% rule; risk of ruin is high |
$5,000 – $25,000 |
Long calls/puts (small), defined-risk spreads |
Risk-defined is required; no naked positions |
$25,000 – $100,000 |
All spreads, modest CSP/CC, condors |
PDT (pattern day trader) constraint is cleared; more flexibility |
$100,000+ |
Portfolio hedging, LEAPS, advanced structures |
Flexibility increases; the 1-2% rule still applies |
The PDT rule (US-specific) restricts cash accounts under $25,000 from making more than three day trades in a five-day rolling period. For options traders, this is a real constraint — if you cannot close a position the same day you opened it, you may be forced to hold overnight gamma.
A Common Trap: "All Eggs in One Trade"
This asymmetry is the entire reason small position sizes matter. Drawdowns compound against you geometrically. Recovery is linear. You cannot out-skill a position-sizing error.
Position Sizing for Correlated Trades
A subtle trap: ten "small" trades on related underlyings are one big trade.
If you have 1% in an AAPL spread, 1% in MSFT, 1% in GOOGL, 1% in QQQ, 1% in NVDA, and 1% in SPY — you have 6% in long-tech beta, not six independent 1% bets. When the tech sector sells off, all six move together.
The cure is correlation awareness:
-
Group positions by sector and underlying type.
-
Treat a group as a single risk unit for budgeting purposes.
-
If your tech exposure is at 4%, count it as having spent more than four 1% slots.
This is the discipline that distinguishes a retail trader from a portfolio manager.