I made the following video for 12631 members last summer. I believe that position sizing is one of the most important yet overlooked/not-often-discussed aspects of trading. I will look into doing a follow-up video soon.
7 Responses to POSITION SIZING: Your First and Last Line of Defense in Risking Your Capital
Thanks for this great reminder. I’m guessing you want someone to come along and say something “contrary”, so here goes… while position sizing is important, it’s also important to only enter fully researched positions. Maybe technical traders have an edge as they’ve got a better chance to do their analyses on a greater number of issues than people trying to cover fundamentals, but still… it’s tough to cover 10+ issues that are in the zone on any given day. So, most of the time, if you pay attention to your position sizing you’ll find yourself making poor use of your capital – which over time (assuming you’re making money trading) will have a negative effect on your results.
If you’re managing money for clients it’s tough to say that you’re in cash… after all, they’re not paying you to be in cash (that’s something they can manage to do all by themselves). If it’s just your own money you’re managing then it’s better to allocate your funds in such a way that trading capital is always at risk, always trading – that way “cash” gets the right treatment too. This is challenging, but it’s a challenge that should be met, even at the cost of conservative position sizing (and maybe decreasing the allocation to the trading account).
All good points and thank you for mentioning them. I suppose if that video can help one hyper aggressive type from going broke it is worth it, though.
Was playing a bit of a devil’s advocate, and a foil for your additional commentary – thank you for your insights and timely reminders!
I think your position size should be more related to risk proportioning. This assumes that you adhere to your stops or place them at the same time your enter your trade.
For instance if you have a $100K account and are willing to risk 1K (1% of your account) on the trade. If you identify an entry at $50 and a stop at $48 for stock XYZ, you would need to buy 1,000/(50-48) = 500 shares * $50 => $25,000 or a quarter of your account, would be in use for this. However, since you placed your stops early, you should only have $1,000 at risk even though a quarter of your capital is tied up.
While this should help maximize the use of your capital, you may want to dial back the risk exposure if the stock is illiquid and there is a chance your stop will be blown through resulting in skyrocketing risk exposure. You might also want to decrease your at risk capital if you need more capital for multiple trades that you wish to enter.
That’s how I operate at least. Thoughts?
Tight stops are problematic for just the reason you mention, and you’ve got to consider opening gaps. Don’t think it’s possible to model tight stops as a replacement for position sizing.
Oh I definitely agree for that. The method is useful for longer time frames. Using that methodology for tight stops would lead you to want to leverage your account. That’s when a percentage of your overall account makes more sense. Or you could scale back and run the methodology off of say 5-10% of your account for a tight stop, which could lead to a more realistic capital allocation.