Risk Management for Algo Traders: Position Sizing and Stop-Loss Guide

Why Risk Management Matters More Than Strategy

A mediocre strategy with excellent risk management will outperform a great strategy with poor risk management. Risk management determines how much capital you retain to compound future gains. Without it, a single bad trade can wipe out months of profits.

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Position Sizing Methods

Fixed Percentage Method

Risk a fixed percentage of account capital per trade, typically 1-2%. For a ₹100,000 account risking 1% per trade:

Risk per trade = 100,000 × 0.01 = ₹1,000
Position size = Risk / Stop-loss distance

ATR-Based Position Sizing

Adjust position size based on current volatility using Average True Range:

ATR = ta.atr(14)
Risk_Distance = ATR × 2
Position_Size = Risk_Amount / Risk_Distance

During high volatility (large ATR), reduce position size. During low volatility (small ATR), increase it.

Kelly Criterion

The Kelly Criterion calculates optimal position sizing based on win rate and risk/reward ratio:

Kelly % = (Win Rate × Avg Win) - (Loss Rate × Avg Loss) / Avg Win
f = (bp - q) / b
where b = win/loss ratio, p = win probability, q = loss probability

Example: 55% win rate, 1:1.5 risk/reward = ~6% optimal position size.

Stop-Loss Types

Technical Stop-Loss

Place stops below support levels for long trades, above resistance for short trades:

//@version=5
strategy("Technical Stop", overlay=true)
support = ta.lowest(low, 20)
entry_price = close
stop_loss = support - (entry_price - support) * 0.05

ATR-Based Stop-Loss

Exit when price moves against you by a multiple of ATR:

atr = ta.atr(14)
long_stop = entry - atr * 2
short_stop = entry + atr * 2

Chandelier Stop

Trailing stop based on high/low over a period, adjusted by ATR:

chandelier = ta.highest(high, 22) - ta.atr(22) * 3

Implementing Risk Management in Pine Script v5

//@version=5
strategy("Risk Management System", overlay=true)

risk_pct = input(1.0, "Risk %")
account_size = input(100000, "Account Size (INR)")
rr_ratio = input(1.5, "Risk:Reward")

atr = ta.atr(14)
entry = close
risk_amount = account_size * (risk_pct / 100)
stop_distance = atr * 2
position_size = risk_amount / stop_distance
stop_loss = entry - stop_distance
take_profit = entry + (stop_distance * rr_ratio)

if ta.crossover(ta.sma(close, 20), ta.sma(close, 50))
    strategy.entry("Long", strategy.long)

strategy.exit("Exit", "Long", stop=stop_loss, limit=take_profit)

Maximum Drawdown Limits

Set maximum monthly/quarterly drawdown limits. If reached, stop trading and reassess:

• Daily Loss Limit: Stop if down 2% on the day
• Weekly Loss Limit: Stop if down 5% in the week
• Monthly Drawdown: Maximum 10% portfolio drawdown acceptable

Portfolio-Level Risk Management

Don’t risk more than 5-10% of total portfolio on single trade. Diversify across multiple setups, timeframes, and assets to reduce correlation risk.

Practical Examples with Indian Stock Prices

Example: Trading RELIANCE (NSE:RELIANCE) at current price ₹2,750

• Account Size: ₹500,000
• Risk Per Trade: 1% = ₹5,000
• Stop-Loss Distance: ₹50 (ATR × 2)
• Position Size: ₹5,000 ÷ ₹50 = 100 shares
• Entry: ₹2,750
• Stop Loss: ₹2,700
• Take Profit (1:1.5 RR): ₹2,825

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