What is Position sizing?Position sizing is a way for traders to manage risk and keep their account balanced. It is a must for anyone who is serious about making money in the stock market.
The reason it is absolutely critical to use some sort of position sizing is because we are not going to be right all the time. We need a way to make our losses smaller so they do not affect us as much. Most people do not use proper position sizing and they are the ones that come crying when the market crashes and they lost 50% of their portfolio in a single week. So, how do we position size? Well there are 2 different ways to do this. I’ll talk about both of them and then I’ll get into what I use. Two Types of position sizing 1. Dividing up your portfolio in different trades. This strategy is simple. You simply divide your total portfolio into how many trades you want to have open at a single time. So if you want to have a maximum of 10 trades at 1 time you simply divide your portfolio by 10 and that gives you the amount you can have in 1 trade. So if you have $100,000 and are going to have a maximum of 10 positions open at once you can put $10,000 into each stock you buy. It is also important to remember that you still need to use stop losses. You aren’t simply risking $10,000 on each trade; you still should have some sort of stop loss on them. 2. Use percentage of loss. This is the other strategy you can use. It involves creating a Maximum you are willing to lose on 1 trade and that is what you are risking.
So if you have $100,000 and are willing to risk a maximum of 2% on 1 trade then the maximum you can risk is $2,000. Now, that’s not saying you can’t put more than $2,000 into 1 trade. If you want to trade a stock that is at $100 and want to put your stop at $98 you can buy 1,000 shares of that stock and put your whole account to work on that 1 trade. You just need to make sure you your stop doesn’t allow you to lose more than 2% of your account. What Do I use? I like to look at the percentage of my capital I am risking. That way I know exactly how much I can lose before I enter the trade. Normally I will only risk 2% of my account or less. But when the markets are trending strong I might risk a little more, but even then my loss per trade will never exceed 5% of my account. Here is how I figure it out. For a stock trade the most I can lose is the price of the stock minus the stop I have. So let’s say I have a $100,000 portfolio. I also want to buy a stock at $22 and have a stop at $19. The difference between $22 and $19 is $3. $3 makes up 13.6% of 22. Now I will only risk 2% of my account or $2,000 so .136/2,000 equals 14,705. $14,705 is the most money I can put into this trade. Now to find out how many shares that is I do 14,705/22 which gives me 668 shares. So 668 shares is the most I could buy and I would probably round it down to 650 shares. For options it is a little bit easier. If I have $100,000 in an account and risk $2,000 I only want to buy $2,000 worth of options. So if the option contract is $4 I only want to buy $2,000/$4 or 500 shares of stock or 5 contracts.
|
