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Position Size – Why Losing Isn’t Everything!

A “so-called” investor questioned my trading methods and claimed that he would lose 76% if he suffered 8 consecutive 8% losses. Knowing me, I had to take a deep breath, release the anger of a person who knows nothing about position sizing, and teach him a simple math lesson. The following example is simplified to allow you to understand what is happening. In the real world, things are a bit more complicated with commissions, emotions, slippage and the like.

What is position sizing?

Position size tells you “how much” to risk on any given trade.

Here I’ll show you how position sizing can allow you to lose 80% of the time while risking a worst case scenario of 3% equity (I typically risk 1% equity); however, a slight winner still comes out.

If I start with $100,000 and lose 8 trades in a row at 8% (only risking 3% of equity with an 8% stop loss), this is what it looks like:

$100,000 portfolio

3% risk per trade (I’m being extreme here to prove a valid point)

8% loss limit

1st Trade:

The risk will be $3000 = ($100,000*3%)

Amount to trade at the 8% cap: $37,500 = ($3,000 / 8%)

An 8% stop loss will cost me $3000

2nd trade:

The risk will be $2,910 = ($97,000*3%)

Amount to trade at the 8% stop: $36,375 = ($2,910 / 8%)

An 8% stop loss will cost me $2910

3rd Trade:

The risk will be $2,822 = ($94,090*3%)

Amount to trade at the 8% stop: $35,283 = ($2,822 / 8%)

An 8% stop loss will cost me $2,822

4th Trade:

The risk will be $2,738 = ($91,267*3%)

Amount to trade at the 8% stop: $34,225 = ($2,738 / 8%)

An 8% stop loss will cost me $2,738

5th Trade:

The risk will be $2,655 = ($88,525*3%)

Amount to trade at the 8% stop: $33,198 = ($2,655 / 8%)

An 8% stop loss will cost me $2,655

6th Trade:

The risk will be $2,576 = ($85,873*3%)

Amount to trade at the 8% stop: $32,202 = ($2,576 / 8%)

An 8% stop loss will cost me $2,576

7th Trade:

The risk will be $2,498 = ($83,297*3%)

Amount to trade at the 8% stop: $31,236 = ($2,498 / 8%)

An 8% stop loss will cost me $2498

Eighth trade:

The risk will be $2,423 = ($80,798*3%)

Amount to trade at the 8% stop: $30,299 = ($2,423 / 8%)

An 8% stop loss will cost me $2423

Total loss after 8 trades: $19,201

This loss amounts to 19% (less commissions, etc…)

TRADE #9:

The risk will be $2,351 = ($78,374*3%)

Amount to trade at the 8% stop: $29,390 = ($2,351 / 8%)

An 8% stop loss will cost me $2,351

**This trade ends with a 40% profit: $11,756 = ($29,390*40%)**

Original amount: $78,374 + $11,756 = $90,130

TRADE #10:

The risk will be $2,703 = ($90,130*3%)

Amount to trade at the 8% cap: $33,787 = ($2,703 / 8%)

An 8% stop loss will cost me $2,703

**This trade ends with a 30% profit: $10,136 = ($33,787*30%)**

Total Portfolio Value: $100,266

WOW – a win with 8 consecutive losing trades and 2 winning trades!

That’s a 20% winning percentage but it gave me an end result of a small win!

This is how money management works! Note that I was using extreme examples to emphasize the important point of position sizing.

Now imagine having a win rate of 40% or more and cutting some of those losses down to less than 8%, your portfolio could easily earn 50% or more in a year with a win rate of 40% based on the size of your portfolio. the simple position.

This is how REAL investors and traders get money off Wall Street.

What does the position size do when you alter the sell stop?

Here are several examples of buying the same stock with a 7%, 15% and 25% sell stop with two different sized portfolios. The number of shares changes but the risk remains the same.

In the first set of examples, I’ll use $10,000 and then $5,000 for the second set of examples. In these examples, I’ll be using the simplified approach discussed by Brian Hunt in my first post. Please note that these examples do not consider other variables such as slippage, expectation, fees, capitalization, etc. Read Van K. Tharp’s book to study detailed models of position size. I will also point out that it is very difficult to employ this position sizing strategy with only a $5,000 stake. In my own experience, I only bought a stock or two when my portfolio started with less than $10,000. Also, I didn’t know about position size ten years ago!

Example 1:

XYZ stock is trading at $25 per share

$10,000 portfolio size

3% risk model per trade (due to a small account)

The stop loss is 7%

The risk will be $300 = ($10,000*3%)

Amount to trade at the 7% stop: $4,285 = ($300 / 7%)

Shares to buy: 171

Example #2:

XYZ stock is trading at $25 per share

$10,000 portfolio size

3% risk model per trade (due to a small account)

The stop loss is 15%

The risk will be $300 = ($10,000*3%)

Amount to trade capped at 15%: $2,000 = ($300 / 15%)

Shares to buy: 80

Example #3:

XYZ stock is trading at $25 per share

$10,000 portfolio size

3% risk model per trade (due to a small account)

The stop loss is 25%

The risk will be $300 = ($10,000*3%)

Amount to trade capped at 25%: $1,200 = ($300 / 25%)

Shares to buy: 48

I will now change the parameters to a 2% risk model with $5,000 in the account:

Example 1:

XYZ stock is trading at $25 per share

$5,000 portfolio size

2% Risk Model per trade

The stop loss is 7%

The risk will be $100 = ($5,000*2%)

Amount to trade at the 7% stop: $1,428 = ($100 / 7%)

Shares to buy: 57

Example #2:

XYZ stock is trading at $25 per share

$5,000 portfolio size

2% Risk Model per trade

The stop loss is 15%

The risk will be $100 = ($5,000*2%)

Amount to trade capped at 15%: $667 = ($100 / 15%)

Shares to buy: 26

Example #3:

XYZ stock is trading at $25 per share

$5,000 portfolio size

2% Risk Model per trade

The stop loss is 25%

The risk will be $100 = ($5,000*2%)

Amount to trade at 25% stop: $400 = ($100 / 25%)

Shares to buy: 16

Using simple math, position size will keep you in the game by telling you “how much” to risk on each trade. Be sure to read my other article on expectation as it goes hand in hand with position sizing.

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