Risk

You are mixing up position size and initial risk. The 1% you are referring to is the initial risk amount. That’s the amount of money you are willing to risk or lose on a trade often expressed in terms of percent of equity. Position sizing is the total dollar amount of a trade or total shares, which is also often stated as a percent of equity. Additionally, your risk amount or 1R should generally not exceed 1% of your equity and any single position size should generally not exceed 20% of your equity.

Use the CPR Method written about in the book and calculate your risk first to determine your position size for a trade. If you had a $100,000 account and were willing to lose $1,000 on a trade, you would risk 1% of your equity. $1,000 is your 1R. Say you liked a stock at $10 with an $8 stop price. You would buy 500 shares ($1,000/$2 per share risk = 500 shares). In this case your position size would be $5,000 which in equity terms is a 5% position. Now say you wanted to buy another stock at $10 because you believe it just hit a major bottom at $9.80. You set your stop price for the trade at $9.75 and you would calculate a 4,000 share position ($1,000/$.25=4,000 shares). This $40,000 position is 40% of your equity. Even though your 1R is at an acceptable 1% of equity, this big of a position exposes an unacceptable share of your equity to market risk or price shocks. Imagine if you had taken on a position this big on the afternoon of Monday, September 10, 2001 or on the eve of some other market moving event. With that much equity exposed in the market in a single position, you could take a hit from which it would be hard to recover. You need to manage both the initial risk amount and the position size.