In partnership with

When I first started trading, I made every rookie mistake you could imagine. One of the most dangerous was not understanding the importance of position sizing and risk management. I’d throw a large chunk of my portfolio into a single stock or trade, only to see my account balance take a major hit when the market didn’t move in my favor. Let me tell you, watching a 20% drawdown in a single trade is a harsh wake-up call.

I quickly learned that if I wanted to succeed in the long run, I had to master these critical aspects of investing. Fast forward to today, and I'm still following a strict set of rules that have not only protected my capital but have also led to consistent and sustainable growth. Now, I want to share with you the five golden rules that completely changed my approach to investing—and they could just as easily change yours too.

1. Never Risk More Than 1-2% of Your Portfolio on a Single Trade

One of the most common mistakes traders make is going all-in on a single stock or trade, hoping for a big win. I’ve been there, thinking, "This is going to be my ticket!" But when the market turns against you, it’s a fast track to wiping out your account. That’s why I adhere to the rule: never risk more than 1-2% of your total portfolio on a single trade.

Let’s break it down with some numbers. If you have a $50,000 portfolio, risking 1% means you're putting $500 on the line in each trade. If you take a loss—and trust me, losses happen even to the best of us—it will be a manageable $500, which is only a small portion of your overall portfolio. Even a series of bad trades won’t wipe you out. Consider this: a study by BarclayHedge shows that successful hedge funds typically lose less than 1.5% on a bad trade, which helps them remain profitable over the long term.

Now, I know what you’re thinking—if I’m only risking 1%, how am I supposed to make significant returns? Here’s where consistency comes into play. When you follow this rule over hundreds of trades, you minimize devastating losses and maximize the potential for steady gains. This is why legendary traders like Paul Tudor Jones are so adamant about protecting capital first. Jones famously said, “Don’t focus on making money; focus on protecting what you have.”

2. Calculate Your Position Size Based on Risk

Position sizing is not about throwing random amounts of money into a trade and hoping for the best. It’s a calculated decision, and understanding how to do it correctly can be the difference between winning consistently and blowing up your account.

Here’s my process for determining position size: First, I identify my entry and exit points, which typically means calculating where I’ll place my stop-loss. Then, I figure out how much I’m willing to lose on the trade. For example, if I’m risking $500 on a trade and I know my stop-loss will be set at $5 below my entry price, I know that I can buy no more than 100 shares (because 100 shares x $5 = $500).

To put this in perspective, professional traders almost always use this approach. The best funds in the world, including the likes of Renaissance Technologies and D.E. Shaw, employ rigorous risk management protocols based on calculating potential losses. According to a report from Morningstar, the most successful funds in 2023 maintained an average position size that reflected less than 2% portfolio risk per trade, ensuring that no single trade could catastrophically impact their returns.

You can also use online position sizing calculators, which will help you make the math easy. Tools like these are crucial for sticking to a disciplined approach, particularly when you're managing multiple trades simultaneously.

3. Use a Stop-Loss, Always

If there’s one rule you should never break, it’s using a stop-loss. I’ve learned this lesson the hard way. Early in my career, I’d hold onto losing trades thinking, “The stock will bounce back.” Sometimes it did. More often than not, it didn’t, and I was left holding a position that eroded my capital.

A stop-loss is like an airbag—it’s there to protect you when things go wrong. Let’s say you bought a stock at $100 and set your stop-loss at $95. If the price drops to $95, your stop-loss order will sell the stock automatically, protecting you from further downside. While it might be tempting to “give the trade more room,” I’ve found that discipline here is what separates the winners from the losers.

Take the example of Lehman Brothers in 2008. Investors who didn’t have stop-losses in place saw the stock collapse from $85 to $0 in just a matter of months. By the time many retail investors decided to sell, they had already lost everything. A simple stop-loss could have mitigated those losses.

Research backs this up too: According to a 2023 study by JP Morgan Asset Management, traders who consistently use stop-losses average a 10% higher annual return compared to those who don’t. It’s a small action that can have a massive impact on your portfolio over time.

For long-term investments, I prefer to use a trailing stop-loss, which adjusts upward as the stock price increases. This way, I protect my gains as the stock moves in my favor but get out automatically if the stock starts to decline.

4. Diversify, But Don’t Over-Diversify

Let’s be real—everyone tells you to diversify, but few people explain how much diversification is too much. When I first started, I thought the key to success was owning as many different stocks and assets as possible. I had dozens of stocks in my portfolio, thinking I was being “safe.” The result? My returns were mediocre at best.

While diversification is essential, over-diversification can dilute your returns. Studies suggest that owning between 10-20 different stocks can provide optimal risk mitigation without overly diluting your portfolio. A 2021 Vanguard study showed that once you own more than 20 stocks, the benefits of additional diversification are minimal. Beyond that, you’re not spreading your risk—you’re spreading your capital too thin.

Take a cue from Warren Buffett. Buffett has said that "diversification is protection against ignorance. It makes little sense if you know what you are doing." His portfolios with Berkshire Hathaway often hold concentrated positions in just a handful of high-quality companies. His belief? If you truly understand and believe in a business, it deserves a larger allocation.

Your portfolio should be a team of your best ideas. Each stock or asset class should play a specific role in balancing risk and return. This approach allows you to focus on quality over quantity, which ultimately leads to better performance.

5. Regularly Review and Adjust Your Risk Parameters

Markets evolve, and so should your risk management strategies. One of the most important things I’ve learned is that the work doesn’t end once you’ve set your position size and placed your stop-loss. Every few months, I review my portfolio to ensure that my position sizes, risk exposure, and overall strategy still align with my goals.

In 2022, a study from BlackRock showed that traders who regularly adjusted their risk management strategies based on market conditions saw better long-term performance than those who stuck rigidly to a static strategy. In particular, traders who rebalanced their portfolios quarterly outperformed those who didn’t by 3% on average per year.

For example, you might find that a stock has grown to become a large portion of your portfolio due to strong performance. While this is a good problem to have, it can expose you to outsized risk if the stock faces a downturn. In these cases, I often trim my position to lock in profits and maintain balance in my portfolio.

The same principle applies if you find that market volatility has increased. In those times, you may want to reduce the amount of risk you're taking per trade, perhaps tightening your stop-losses or reducing position sizes.

Conclusion

Mastering position sizing and risk management is the cornerstone of long-term investing success. The markets are unpredictable, and no one—not even the best investors—can avoid losses entirely. But by following these five golden rules, you can minimize your losses, protect your portfolio, and set yourself up for consistent gains.

When I first began, I wish I had known these principles. They could have saved me a lot of heartache and financial loss. But now that I’ve learned these lessons, my portfolio is built to weather storms, and yours can be too.

Take control of your risk, make disciplined decisions, and watch as the rewards follow. It’s a slow and steady process, but in the world of investing, that’s exactly what you want. Remember, the goal is to be in the game for the long haul—and position sizing and risk management are your ticket to that longevity.

Found these insights valuable? Elevate your investing game by subscribing to our blog for more in-depth analysis, strategies, and market trends. Stay ahead with expert tips and refine your portfolio. Share this post with friends interested in the stock market and let's build a smarter investing community together!

Disclaimer: The content on this blog is for educational and informational purposes only and is not intended as financial, investment, tax, or legal advice. Investing in the stock market involves risks, including the loss of principal. The views expressed here are solely those of the author and do not represent any company or organization. Readers should conduct their own research and due diligence before making any financial decisions. The author and publisher are not responsible for any losses or damages resulting from the use of this information.