One of the most crucial aspects in managing risk in your portfolio is utilizing the correct position sizing. While position sizing is simply deciding what size position to take, or how much of a specified stock to buy, how to correctly use it can be more complicated than in seems.
Because each investor is unique, investment strategies will vary widely from person to person. When looking for position sizing tips, keep in mind your individual needs and goals, your time frame for investing and your personal risk-tolerance.
There are some general rules of thumb regarding position sizing and proper money management, and these can be used along with various other strategies to mitigate potential losses and protect your hard-earned capitol.
Using Position Sizing Tips In Your Portfolio
When you use position sizing tips in your investment strategy, the main goal should be the “Big Picture”. The topic of position sizing can often be complicated, open to interpretation, and even completely overlooked, setting the stage for unnecessarily large losses.
By correctly utilizing position sizing, you can be on your way to success in the stock market. Ignoring, or using position sizing incorrectly can result in a quicker depletion of investment capitol, and a shortened trading career.
A common method of determining position sizing is to risk between 1% and 3% of a total portfolio on each trade. Taking into account trading styles, length of time positions are held, profit targets, and various other considerations, it is important to realize that there are many different formulas to determine position sizing.
In a $50,000 portfolio, and using a 2% example with an 8% stop-loss, a trader would be looking at a $1,000 risk per trade, which would then be calculated by your maximum risk trade divided by your stop-loss percent, multiplied by 100. This would be how you determine your position size, which in this example is $12,500.
That amount would then be divided by the share price of the stock you are purchasing, giving you the amount of shares to purchase. Assuming you can exit the trade at your exact stop-loss setting, you are assuming only your pre-calculated maximum risk.
By investing the $50,000 with no regard to proper position sizing tips, an investor stands to lose a greater amount of money on a single trade, and would wipe out their account more quickly.
Your entry and exit methods should also be taken into consideration, as well as your stop-loss percentage. By properly utilizing position sizing you can actually afford to make more losing trades than winning trades, and still come out ahead.
Improper Use Of Position Sizing Tips Could Wipe Out Your Portfolio
As there is no one formula for calculating position sizing in every circumstance, there are additional factors that could be working against you in the absence of position sizing tips, and proper money management.
The majority of investors fall victim to one of the biggest and most obvious obstacles to investing success – emotions. When position sizing and proper money management are not utilized, or utilized incorrectly the losses to a portfolio are exaggerated, and an investor is more likely to hold on to the losing trade in the hopes of a rebound.
This can lead to a viscous cycle of holding on to losing positions, and may lead to the dissolution of capitol, and a missed opportunity for lasting wealth.
It is important to learn as much as possible about proper position sizing, and how best to utilize it in your portfolio. Position sizing is just one of the many ways to properly manage risk, guard against financial losses, and build a secure financial future for yourself and your family.