HOW TO… DETERMINE THE SIZE OF A POSITION? Part of the Basics Series on trading- THE FOUR STEPS TO POSITION SIZING You have spotted a great stock and you want to buy. You are in front of the ideal trading set-up and you are decided to pull the trigger…but how many shares? Position sizing is one of the most overlooked subjects in trading and investing, and yet on the long run it determines a good part of the overall profitability. Why is a good position sizing method important? It gives each trade the same weight in your portfolio, or allows you controlling these weights rigorously It ensures that you do not take an outsized risk on a given trade It ensures that you won’t go in a trade with a ridiculously small stake Controlling the risk at a constant percentage of capital maximizes the odds of growing it. It is the famous “Kelly formula”. Define the size of the position in 4 simple steps. Let’s say you want to buy stock XYZ at $15: STEP 1: Take your total capital you want to use for investing or trading and decide the percentage of this capital you are ready to “bet” (to put at risk) on a given operation/trade. This percentage is typically set between 0.5% and 2%. Normally this percentage is the same for all trades. For example you have a $10,000 capital; you decide that your risk will be 2% or $200 (2% of $10,000). STEP 2: Decide where you are going to place the stop-loss order (see: How to…place a stop-loss order). You apply what you learnt and you set the stop-loss at $14.2. STEP 3: Compute the possible loss per share: if the trade goes bad, your stop-loss will be hit and you will lose 15-14.2=$0.8 per share STEP 4: The number of shares that you can buy while respecting the amount of risk equal to 2% of capital is simply derived from 200/0.8=250. That’s it. You buy 250 shares of XYZ at $15 with a stop-loss at $14.2 and you already did a good job: applying a strict methodology is the first success in trading and investing. Income trading specialist
Interesting. Thank you for the advice! Currently I am taking notes. I want to reach a level of knowledge that allows for me to invest successfully before even attempting to invest.
