I'm trying to wrap my head around understanding buying power, position size and how it's relative to how much I can risk in any single given trade depending on my initial total capital.
For example, say the total amount of capital is $100,000. The general rule from what I understand is that a trader should only take a maximum of 2% risk of total capital on any single trade to mitigate losses. So, 2% of $100,000 is $2,000 which will be my risk for any single trade. My risk-to-reward ratio is 1:2.
Say, the XYZ stock's entry price I entered was filled at $70.59. My protective stop loss is 69.99 based on my strategy using ATR (average true range) for stop losses. The take profit will be two times the risk at 71.79. The number of shares would be 3,333 to meet the 1:2 risk-to-reward ratio criteria based on the stop loss and take profit price.
Now, when I calculate the position size (seen in screenshot for reference), the value became $235,297.65 which greatly exceeds my buying power of total amount of capital ($100,000). This order trade would be invalid due to insufficient buying power in order to execute it.
I'm a bit puzzled and confused as to why that would be the position size value, if I'm only risking 2% of my total capital given a 1:2 risk-to-reward ratio? What am I missing and how can I better calculate it to fit within the confines of my total capital available to purchase shares on a stock?
Total capital: $100,000 Buying Power: $100,000 Entry Price: $70.59 Stop Loss Price: $69.99 Take Profit: $71.79 # of Shares: 3,333 Risk-to-Reward Ratio: 1:2 Position Size: $235,297.65 (puzzled at this number)
Position Size Calculator showing the position size calculation: