By User Request - Choosing Your Position Size

Before I start, I would like to note.  Risk management is by far the most effective tool in a trader's portfolio.  As you will notice, I am an "okay" stock picker, but I never let my losing trades run away.  That is what makes me successful.

In yesterday's post, one viewer asked,

"What percent of your portfolio are you weighting to each of these trades?"

Well, we're here to all make money, so I would gladly share my go-to method.  Now, I'll warn you in advance, there is math, so don't let your eyes glaze over. 

Here we go!  This is the method pioneered by Edwards & Magee, who published Technical Analysis of Stock Trends over sixty years ago, still considered to be the "bible" of technical analysis.

A trader has a general "rule" that they are not willing to risk more than a certain amount of their total capital on a single trade.  Depending on your personal risk appetite, this percentage of total cash may vary.  Most traders set this percentage between 1-3% per trade.  Of course, if your trading capital is so low that you need to take large relative position sizes to offset commission costs, you may risk up to 5% per trade.

I tend to risk about $45 per trade (keeping my trading capital private).  Of course after slippage, this may be slightly greater, but usually not enough to make a significant difference in your final loss.


So here's what I did for my Novagold Resources (NG) trade yesterday

1. I will enter at 12.88
2. I will keep my stop at 13.25 in case the trade goes wrong
3. That gives me a $0.37 risk per share bought
4. I am willing to risk about $40
5. I have a personal preference to buy 100 share lots rather than an "odd" number of shares
6. I'll buy 100 shares
7. 100* 0.37= $37 Risk

Easy enough, right?

Flaws
Inherently, with a fixed absolute risk, percentage risk increases as you buy cheaper stocks.  I only lost, for instance, about 15 cents on XING, but that was over a 5% loss.  For this reason, you may want to make a subjective judgement on position sizes when trading low priced stocks.  Or, you could be like me, and avoid low priced stocks all together.

Also, on high probability trades, one should be willing to risk more for a higher return.  Therefore, a fixed amount of risk may not be suitable.

Slippage
As we learned on BVN, our mental stop level can sometimes be blasted through and our actual "emergency" stop be triggered.  While, at the beginning of the trade, we may have thought we were only risking $40, we may end up losing over $100

And even in normal situations, you must accept that you will rarely enter at the price you want to.

Finally, there are many other methods of position sizing that are probably better (whatever that means), but this is simple and effective enough for my needs.  I hope this helps everyone!  Of course, if you have a question, post it in the comment box.

Happy trading
~Christopher Diodato