🎯 In 30 seconds: A trade plan answers five questions before you act: where the idea is proven wrong, where you get in, where you expect to take profit, how many shares keep the loss to a fixed amount, and how long you will wait. The stop comes first because everything else depends on it. Size comes from the stop distance and your risk budget, never from how sure you feel. Write the plan down and check that the reward is worth the risk before anything else happens.
Start from where the idea is wrong
Most beginners start with the entry. A plan built from a chart works better in reverse.
First ask: what would price have to do to show my reading was wrong? That price is the invalidation level. For a pullback in an uptrend, it is usually just beyond the pullback’s low. For a breakout, it is back inside the old range.
The stop goes a little beyond invalidation, because price often pokes through a level by a small amount before turning. A volatility measure such as ATR helps decide how far is “a little”.
The five numbers
| Number | Question it answers | Usually taken from |
|---|---|---|
| Stop | Where am I wrong? | Swing low or high on the setup chart, plus an ATR buffer |
| Entry | What has to happen first? | A trigger: a close above a prior bar’s high, a break of a small line |
| Target | Where is the next likely obstacle? | The near edge of the next resistance or support zone |
| Size | How many shares keep the loss to my budget? | Risk budget divided by the distance from entry to stop |
| Time limit | How long before I give up on it? | A set number of bars that fits the setup chart |
R: measuring everything in units of risk
R is the amount you plan to lose if the stop is hit. If you plan to lose $200, then 1R is $200.
Every outcome can then be written as a multiple of R. A $400 gain is +2R. A $300 loss is −1.5R. This lets you compare trades of different sizes and stocks of different prices on one scale.
Worked example: one full hypothetical plan
Hypothetical stock KLMN on a daily chart. All numbers are invented and rounded for practice. This is an exercise, not a suggestion to trade anything.
The chart read. KLMN has made higher highs and higher lows for six months. It peaked at $57.00, then pulled back for eight sessions to a low of $47.70, near an old breakout area. Yesterday it closed at $49.20. Yesterday’s high was $49.80.
Step 1: the account and the risk budget. The account is $20,000. The rule is to risk 1% per trade, so 1R = $200.
Step 2: the trigger and entry. The plan waits for a close above yesterday’s high of $49.80. Today closes at $50.00, so the entry is $50.00.
Step 3: the stop. The 14-day ATR is $1.60. The plan uses a stop of 2 ATR below entry: 2 × $1.60 = $3.20, so the stop is $50.00 − $3.20 = $46.80. Check it against the chart. The pullback low is $47.70, so the stop sits $0.90 below the level that would prove the idea wrong. If the ATR stop had landed above $47.70, the plan would move the stop below the low instead and size down to match.
Step 4: the size. Shares = risk budget ÷ risk per share = $200 ÷ $3.20 = 62.5. Always round down, so 62 shares. The position costs 62 × $50.00 = $3,100, which is 15.5% of the account. The planned loss is 62 × $3.20 = $198.40.
Step 5: the target. The next obstacle is the old peak. Sellers who bought near the top may be glad to get out there. The plan aims for the near edge of that zone at $57.00. Reward per share is $57.00 − $50.00 = $7.00. In R terms, $7.00 ÷ $3.20 ≈ 2.19R.
Step 6: the time limit. A daily pullback setup should start working within about three weeks. If neither stop nor target is hit after 15 sessions, the plan exits at the close.
Step 7: the break-even check. With a 2.19R reward and a 1R risk, the trade needs to win more than 1 ÷ (1 + 2.19) ≈ 31% of the time to break even before costs. Whether this setup clears that bar is a question only testing can answer. See Testing an idea.
The plan card
| Item | Value | Where it came from |
|---|---|---|
| Account and 1R | $20,000 and $200 | 1% risk rule |
| Entry | $50.00 | Close above yesterday’s $49.80 high |
| Stop | $46.80 | 2 × ATR of $1.60, below the $47.70 low |
| Shares | 62 | $200 ÷ $3.20, rounded down |
| Position value | $3,100 (15.5%) | 62 × $50.00 |
| Target | $57.00 (+2.19R, +$434) | Near edge of the old peak |
| Time limit | 15 sessions | Fits a daily setup |
| Break-even win rate | About 31% | 1 ÷ (1 + 2.19) |
What could actually happen
The plan fixes the size of a normal loss. It does not fix every outcome. Here are four ways this hypothetical trade could end.
The gap case matters. A stop order becomes a market order once its price is reached, and if the stock opens below the stop, the fill comes at that lower price. Earnings reports are the most common cause. Checking the report date before entry is part of the plan.
Three checks before the plan is done
- Minimum reward. Many traders skip any plan below about 2R to the first target. Small rewards leave no room for costs and the trades that go nowhere.
- Position cap. On a very calm stock, the stop is close and the formula asks for a huge position. A cap, such as no more than 25% of the account in one name, stops a tiny ATR from creating a large gap risk.
- Liquidity. The share count should be a tiny fraction of the stock’s normal daily volume, and the bid-ask spread should be a small fraction of the stop distance.
The course chapters on position sizing and stop losses in Stock Market Trading cover the formulas in more depth. For choosing the setup chart, see Multiple time frames.
- Why is the stop set before the entry and size? Answer: The size is calculated from the distance between entry and stop, so the stop has to exist first.
- An account is $30,000 with a 1% risk rule. Entry is $40 and the stop is $37.50. How many shares? Answer: $300 ÷ $2.50 = 120 shares.
- The target is $9 above entry and the stop is $3 below. What is the reward in R? Answer: 3R.
- Why can a real loss be bigger than 1R? Answer: A gap can open beyond the stop, and the stop order then fills at the next available price.
Sources
- J. Welles Wilder Jr., New Concepts in Technical Trading Systems (1978), average true range.
- Perry J. Kaufman, Trading Systems and Methods, material on risk and position sizing.
- U.S. Securities and Exchange Commission, Investor.gov, investor education on stop orders and how they can fill.
- FINRA, investor education on day trading and margin.
- Moneydesks Technical Analysis tool: ATR, the horizontal level tool and the measure tool.