This is a presentation we put together to explain importance of "Portfolio Position Sizing" which will enable you to become a disciplined trader/investor. We hope it provides with you with enough knowledge and tools to become a successful trader/investor. Also DO NOT forget to download Position Sizing Spreadsheet under Members Area.
What is Position Sizing?
In simple words, it is how much capital we invest in one chosen financial instrument (stocks/ etf/ mutual fund/ options contract/ etc). OR in other words it tells us, How many option contracts/ stock/ etf/ etc we should BUY with respect to our total account size? Correct position sizing is one of the most important parts of a successful trading approach.
Why is Position Sizing important?
- Appropriate position size is often the difference between long-term success and short-term failure
- When you are using a position size consistent with your preferred level of risk, your fear level drops
- Leads to improvements in your trading system, a higher reward to risk ratio and more profits
What is an appropriate Position Size?
- We will never invest more than 20% of our total account value into any one financial instrument (stock/ etf/ options contract/ etc). Anything below 20% is fine. Some people use 10% some uses 15%, so choose your "%". Let's call this chunk of less than 20% investment as our "LOT".
- We will always have a HARD STOP LOSS at 10% for each LOT. This will limit our losses. If you are not comfortable with 10% loss per LOT then you can set stop loss at anything less than 10% but make sure your trade have some room to move otherwise you will get stopped out frequently.
- We will always have a target (price at which we would SELL) once our investment LOT gains in value.
- Once the target price is reached typically it's recommended to SELL half position in that LOT and put a trailing STOP loss for remaining position at 10% (you can change this to 5% as per your comfort level). This will enable you to lock in partial profits as well as provides you with an opportunity to profit from further gains if the investment moves further past the target price as well as it will also protect your investment if it falls more than 10% from your target price.
- I have a total investment capital of $10,000/-
- No more than 20% in single financial instrument = $10,000 * 0.20 = $2,000. I should not invest more than $2000/- in any single stock. My LOT size is $2000/-
- HARD STOP LOSS at 10% per LOT = $2000 * 0.10 = $200. I am ready to take a loss of $200/- on each LOT.
- Lets say we buy a stock priced at $25, hence I can ONLY buy $2000 / 25 = 80 shares and immediately we add a HARD STOP LOSS at (2000 - 200)/80 = $22.5/-
- Our target price is $40/-
- If for any reason the share prices fall below $22.5/- then our stop loss will be triggered and we will incur ONLY $200/- in losses.
- If our investment appreciates in price and goes to $40, we SELL half of our investment, in this case 40 shares at $40 = $1600. We locked in partial profits = $1600 - $1000 = $600/-
- Immediately we will place 10% trailing stop on remaining 40 shares. If shares fall our stop will be executed at $36 and we will lock in our remaining profit of 40 x $36 = $1440 - $1000 = $440/- If shares rise to new high price then our trailing stop will also move higher thereby providing us an opportunity to lock in more profits.
- Decide how much you want to risk losing from your total investment capital, lets say we consider 10% maximum loss.
- Before you invest into any financial instrument (stock/ etf/ options contract/ etc), you need to know your entry price, know your stop loss price or loss which you are ready to accept in % terms. Lets say we want to take 20% risk so that we do not get stopped out.
- Lets say we want to buy stock at $25, that means we are ready to take 20% risk = $25 x 0.20 = $5/- loss.
- So now how many shares can we buy?
- Lets say we have total investment capital = $10,000/- and we are ready to risk ONLY 10% = $1000/-
- Total # of shares we can buy = $1000/ 5 = 200
- This approach is commonly used by frequent traders but if you like this approach then use it by all means.
FREE Portfolio Position Sizing Spreadsheet is available under Download area in Members Club here.