Define the trade before the entry.

ADR describes normal movement

Average Daily Range estimates how far a stock has traveled from low to high, usually as a percentage, over a recent period. A stock with 3% ADR behaves differently from one with 12% ADR. The measure does not predict tomorrow's range; it provides a recent volatility reference.

For momentum setups, compare the planned entry-to-stop distance with ADR. If a breakout entry sits 10% above the low of day while the stock normally moves 4%, the trade asks you to absorb more than two normal daily ranges before invalidation. That may distort the intended reward and reduce position size to an impractical level.

Start with money at risk

Position sizing begins with the maximum planned account loss for the trade, not with a desired number of shares. Then divide that budget by the risk per share.

Shares = planned account risk / risk per share. The result is theoretical. Round down, account for commissions and slippage, and check that the total position value is not excessive relative to the account.

A simple worked example

Assume an educational example with a $50,000 account, a planned risk budget of 0.5%, a $40 entry and a $38.50 stop.

• Planned account risk: $50,000 x 0.005 = $250.
• Risk per share: $40.00 - $38.50 = $1.50.
• Theoretical quantity: $250 / $1.50 = 166 shares, rounded down.
• Position value: 166 x $40 = $6,640, or about 13.3% of the account.

If the same entry required a $5 stop distance, the quantity would fall to 50 shares. That is the mechanism working correctly: a wider trade receives less size. It may also reveal that the entry is too late to offer the desired payoff.

What the formula cannot solve

A stop price is an instruction, not insurance. A stock can gap through it, a market order can fill poorly and a halt can prevent any exit. Correlated positions can also create more portfolio risk than each individual calculation suggests.

• Reduce size when liquidity is poor or spreads are wide.
• Consider combined exposure to the same sector or market factor.
• Do not increase the risk budget to force a desired position size.
• Distinguish initial stop risk from overnight gap risk.
• Track actual losses against planned losses to measure execution drift.

The pre-entry check

1. Write the setup and exact failure point.
2. Measure entry-to-stop distance in dollars and percent.
3. Compare that distance with recent ADR.
4. Calculate theoretical quantity from the fixed risk budget.
5. Check total position value, liquidity and portfolio correlation.
6. Round down and decide whether the remaining trade is still worthwhile.

The calculation should make some trades smaller and reject others entirely. If position sizing never changes a decision, it is probably being performed after the emotional decision to enter.