November 8, 2025

Risk Management in Trading — Position Sizing, Stop Losses, and Risk-Reward Ratios

By HorizonAI Team

Here's the uncomfortable truth: Your trading strategy doesn't matter if your risk management is broken.

You can have a 70% win rate and still blow up your account with one overleveraged trade. Professional traders don't focus on picking winners—they focus on not losing.

This guide covers the three pillars of trading risk management that separate profitable traders from gamblers:

Position Sizing — How much to risk per trade
Stop Losses — Where to exit losing trades
Risk-Reward Ratios — How to ensure wins outweigh losses

By the end, you'll know exactly how to protect your capital while maximizing long-term returns.

Why Most Traders Lose Money (It's Not What You Think)

Studies show 80-90% of retail traders lose money. But it's rarely because of bad strategy—it's because of bad risk management.

Common ways traders blow up:

Risking 10% per trade (one bad streak = account gone)
No stop losses ("I'll wait for it to come back")
Taking profits too early, letting losses run
Revenge trading after a loss (doubling position size)

The solution? Follow systematic risk rules every single trade, no exceptions.

The Golden Rule: Never Risk More Than 1-2% Per Trade

This is the most important rule in trading. Period.

The 1-2% Rule:

Risk maximum 1-2% of your account on any single trade
If you have $10,000, risk $100-$200 per trade
This means your stop loss distance dictates your position size

Why this works:

You Can Survive Losing Streaks

Even great strategies have 5-10 losing trades in a row. Let's compare:

Risking 10% per trade:

Lose 5 trades in a row = -41% account balance
Need 69% return just to break even

Risking 2% per trade:

Lose 5 trades in a row = -9.6% account balance
Need 10.6% return to break even

Risking 1% per trade:

Lose 10 trades in a row = -9.6% account balance
You're still in the game

Position Sizing: How to Calculate Trade Size

Position size depends on:

Account size
Risk percentage (1-2%)
Stop loss distance

Formula:

Position Size = (Account Size × Risk %) ÷ Stop Loss Distance

Example 1: Stock Trading

Account: $10,000
Risk per trade: 1% = $100
Entry: $50
Stop loss: $48 (distance = $2)

Calculation:

Position Size = $100 ÷ $2 = 50 shares

Verification:

Buy 50 shares at $50 = $2,500 position
Stop loss at $48 = lose $2 per share × 50 shares = $100 loss (1% of account) ✅

Example 2: Forex Trading (EUR/USD)

Account: $10,000
Risk: 2% = $200
Entry: 1.1000
Stop loss: 1.0950 (50 pips)
Pip value: $10 per pip (standard lot)

Calculation:

Position Size = $200 ÷ (50 pips × $10/pip) = 0.4 lots

Example 3: Crypto (Bitcoin)

Account: $10,000
Risk: 1% = $100
Entry: $50,000
Stop loss: $48,500 (3% away = $1,500 per BTC)

Calculation:

Position Size = $100 ÷ $1,500 = 0.0667 BTC

Position value: 0.0667 BTC × $50,000 = $3,335

Notice: Even though BTC position is $3,335, you're only risking $100 (1% of account).

Pine Script: Auto-Calculate Position Size

//@version=5
strategy("Position Sizing Example", overlay=true, default_qty_type=strategy.cash)

// Inputs
riskPercent = input.float(1.0, "Risk Per Trade (%)", minval=0.1, maxval=5.0)
stopLossPercent = input.float(2.0, "Stop Loss (%)", minval=0.1)

// Calculate position size based on risk
accountSize = strategy.equity
riskAmount = accountSize * (riskPercent / 100)
stopLossDistance = close * (stopLossPercent / 100)
positionSize = riskAmount / stopLossDistance

// Entry condition (example: 50 SMA crossover)
sma50 = ta.sma(close, 50)
sma200 = ta.sma(close, 200)
longCondition = ta.crossover(sma50, sma200)

if longCondition
    stopLoss = close * (1 - stopLossPercent / 100)
    strategy.entry("Long", strategy.long, qty=positionSize)
    strategy.exit("Stop", "Long", stop=stopLoss)

plot(sma50, "50 SMA", color.blue)
plot(sma200, "200 SMA", color.red)

This automatically adjusts position size to risk exactly 1% per trade, regardless of stop loss distance!

Stop Loss Strategies: Where to Place Stops

Stop losses protect you from catastrophic losses. Here are the most effective methods:

1. Percentage-Based Stops (Simplest)

Set stop loss at fixed percentage below entry.

Example:

Entry: $100
Stop: 2% below = $98

Pros: Simple, consistent
Cons: Ignores market structure (support/resistance)

Best for: Beginners, trend-following systems

2. ATR-Based Stops (Volatility-Adjusted)

Use Average True Range (ATR) to set stops based on market volatility.

Formula: Stop = Entry - (ATR × Multiplier)

Pine Script Example:

//@version=5
strategy("ATR Stop Loss", overlay=true)

// Calculate ATR
atrLength = input.int(14, "ATR Length")
atrMultiplier = input.float(2.0, "ATR Multiplier")
atrValue = ta.atr(atrLength)

// Entry condition (example)
longCondition = ta.crossover(ta.ema(close, 9), ta.ema(close, 21))

if longCondition
    stopLoss = close - (atrValue * atrMultiplier)
    strategy.entry("Long", strategy.long)
    strategy.exit("Stop", "Long", stop=stopLoss)

// Visualize ATR stop level
plot(close - (atrValue * atrMultiplier), "ATR Stop", color.red, 2, plot.style_circles)

Pros: Adapts to volatility (tighter stops in calm markets, wider in volatile)
Cons: More complex to calculate
Best for: Swing trading, crypto, forex

3. Support/Resistance Stops (Technical)

Place stop below support (for longs) or above resistance (for shorts).

Example:

Price breaks above resistance at $100
Support level below = $98
Stop: $97.50 (slightly below support)

Pros: Based on market structure
Cons: Requires technical analysis skill
Best for: Breakout strategies, price action traders

4. Time-Based Stops

Exit after N bars regardless of profit/loss.

Example: Close position after 5 days if it hasn't hit stop or target.

//@version=5
strategy("Time-Based Exit", overlay=true)

maxBarsInTrade = input.int(10, "Max Bars in Trade")

var int entryBar = na

longCondition = ta.crossover(ta.rsi(close, 14), 30)

if longCondition
    strategy.entry("Long", strategy.long)
    entryBar := bar_index

// Exit after N bars
if not na(entryBar) and (bar_index - entryBar) &gt;= maxBarsInTrade
    strategy.close("Long", comment="Time Stop")
    entryBar := na

Pros: Prevents capital from being tied up
Cons: May exit profitable trades early
Best for: Mean reversion strategies

Risk-Reward Ratios: The Math of Winning

Risk-Reward Ratio (RR) = Potential Profit ÷ Potential Loss

Example:

Entry: $100
Stop loss: $98 (risk $2)
Take profit: $106 (gain $6)
RR = $6 ÷ $2 = 3:1

Why RR Matters: You Can Lose More Often and Still Profit

Let's compare two traders:

Trader A: 60% win rate, 1:1 RR

10 trades: 6 wins × $100 + 4 losses × $100 = +$200

Trader B: 40% win rate, 3:1 RR

10 trades: 4 wins × $300 + 6 losses × $100 = +$600

Trader B makes 3x more profit with a worse win rate because of better RR.

Minimum RR for Profitability

Formula: Minimum RR = (1 ÷ Win Rate) - 1

Win Rate	Minimum RR to Break Even
30%	2.33:1
40%	1.5:1
50%	1:1
60%	0.67:1
70%	0.43:1

Rule of thumb: Aim for minimum 2:1 RR on every trade. This means:

If you risk $100, target $200+ profit
If stop is 50 pips, target is 100+ pips
If stop is 2%, target is 4%+

The Kelly Criterion: Optimal Position Sizing (Advanced)

The Kelly Criterion calculates the optimal percentage of your account to risk per trade based on edge.

Formula:

Kelly % = (Win Rate × Avg Win - Loss Rate × Avg Loss) ÷ Avg Win

Or simplified:

Kelly % = Win Rate - [(1 - Win Rate) ÷ RR]

Example Calculation

Your strategy stats:

Win rate: 55%
Average RR: 2:1

Calculation:

Kelly % = 0.55 - [(1 - 0.55) ÷ 2]
Kelly % = 0.55 - 0.225
Kelly % = 0.325 = 32.5%

Warning: Full Kelly is way too aggressive. Most traders use 1/4 Kelly or 1/2 Kelly.

1/4 Kelly = 32.5% ÷ 4 = 8.125%

Even this is aggressive for most retail traders. Stick to 1-2% unless you have years of proven results.

The Martingale Trap (Never Do This)

Martingale: Double your position size after every loss to "make it back."

Example:

Trade 1: Lose $100
Trade 2: Risk $200 (to make back $100 + profit)
Trade 3: Risk $400
Trade 4: Risk $800
Trade 5: Risk $1,600

After 5 losses: You've lost $3,100 total and need a $1,600 win to break even.

Why it fails:

You'll eventually hit a losing streak that blows up your account
You reach max account size before recovering
Emotional devastation

Never use Martingale. Stick to fixed risk per trade.

Creating a Risk Management Plan

Write down your rules before trading:

Example Risk Management Plan

1. Position Sizing

Risk 1% per trade
Maximum 3 open positions (3% total risk)
No new trades if down 5% on the week

2. Stop Losses

Use ATR-based stops (2× ATR)
Never move stop loss further away
Honor all stops (no exceptions)

3. Take Profits

Minimum 2:1 RR on all trades
Exit 50% at 2:1, trail remaining 50%
Maximum hold time: 10 days

4. Daily Limits

Max 3 trades per day
Stop trading after 2 consecutive losses
Max daily loss: 3% of account

5. Psychology Rules

No trading after 8pm (tired)
No revenge trading after losses
Journal every trade (entry, exit, reasoning)

Pine Script: Complete Risk Management Template

//@version=5
strategy("Risk Management Template", overlay=true, 
         default_qty_type=strategy.cash,
         initial_capital=10000)

// ===== Risk Parameters =====
riskPercent = input.float(1.0, "Risk Per Trade (%)", minval=0.1, maxval=5.0)
minRR = input.float(2.0, "Minimum Risk-Reward Ratio", minval=1.0)
useATRStop = input.bool(true, "Use ATR-Based Stop Loss")
atrLength = input.int(14, "ATR Length")
atrMultiplier = input.float(2.0, "ATR Stop Multiplier")
fixedStopPercent = input.float(2.0, "Fixed Stop Loss %")

// ===== Calculate Position Size =====
accountSize = strategy.equity
riskAmount = accountSize * (riskPercent / 100)

// Calculate stop loss distance
atrValue = ta.atr(atrLength)
stopDistance = useATRStop ? (atrValue * atrMultiplier) : (close * fixedStopPercent / 100)

// Position size based on risk
positionSize = riskAmount / stopDistance

// ===== Entry Logic (Example: EMA Crossover) =====
ema9 = ta.ema(close, 9)
ema21 = ta.ema(close, 21)
longCondition = ta.crossover(ema9, ema21)

if longCondition and barstate.isconfirmed
    stopLoss = close - stopDistance
    takeProfit = close + (stopDistance * minRR)  // Enforce minimum RR
    
    strategy.entry("Long", strategy.long, qty=positionSize)
    strategy.exit("Exit", "Long", stop=stopLoss, limit=takeProfit)

// ===== Visualize Levels =====
plot(ema9, "9 EMA", color.blue)
plot(ema21, "21 EMA", color.red)

// Show stop and target levels when in trade
var float entryPrice = na
var float stopLevel = na
var float targetLevel = na

if strategy.position_size &gt; 0 and na(entryPrice)
    entryPrice := close
    stopLevel := close - stopDistance
    targetLevel := close + (stopDistance * minRR)

if strategy.position_size == 0
    entryPrice := na
    stopLevel := na
    targetLevel := na

plot(stopLevel, "Stop Loss", color.red, 2, plot.style_circles)
plot(targetLevel, "Take Profit", color.green, 2, plot.style_circles)
plot(entryPrice, "Entry", color.white, 1, plot.style_cross)

This template automatically:

Calculates position size to risk exactly 1%
Sets stops based on ATR or fixed %
Enforces minimum risk-reward ratio
Visualizes entry, stop, and target levels

Risk Management Checklist

Before every trade, ask:

✅ Am I risking 1-2% or less?
✅ Is my stop loss placed?
✅ Is my RR at least 2:1?
✅ Do I have less than 3 open positions?
✅ Am I within my daily/weekly loss limit?
✅ Is this trade part of my plan (not emotional)?

If any answer is NO, don't take the trade.

Build Risk-Managed Strategies with HorizonAI

Tired of manually calculating position sizes and stop losses? HorizonAI generates strategies with built-in risk management:

Example prompt:

"Create a Pine Script strategy with 1% risk per trade, ATR-based stops, and minimum 2:1 risk-reward ratio. Use EMA crossover for entries."

HorizonAI automatically includes:

✅ Position sizing calculations
✅ ATR or fixed percentage stops
✅ Risk-reward enforcement
✅ Maximum open position limits

Generate risk-managed strategies →

Final Thoughts

Risk management isn't optional—it's the difference between professional trading and gambling.

The best strategy in the world means nothing if you blow up your account before it shows results. Follow these rules:

Risk 1-2% per trade (never more)
Always use stop losses (no exceptions)
Target minimum 2:1 RR (preferably 3:1)
Position size based on stop distance (not arbitrary)
Have written rules (and follow them every time)

Master risk management first. Optimize strategy second.

Questions about implementing risk management in your strategies? Join our Discord community to discuss with experienced traders.