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I found this on a forum so for who are inerested .
Position Sizing
This post is intended for new traders. It's a brief FAQ on position sizing.
I hope this FAQ is of some use to you.
Q. What is position sizing?
A. It's the answer to the question "how many?" or "how much?" when you
decide to take a position. This is a critical question. How you answer it
defines the Risk of Ruin level you implicitly accept. Your position risk is
determined by your position size, entry price and stop.
Q. How is position size determined?
A. You execute these steps to determine position size.
Steps
1. Figure out where you are going to place your protective stop loss.
Calculate risk per share in dollars. This is the difference between your
entry price and your stop.
2. Figure out the dollar value of ONE PERCENT of your total equity. 'Total
equity' is the current account value.
3. Divide this dollar amount representing 1% of the account by the per-share
risk calculated in Step 2. The result is how many shares you can buy to
maintain 1% risk on the position.
Example:
You like XYZ which is at $80 and you figure it can run to $100. It may also
drop in price and you figure $74 is the price that proves you are likely
very wrong about this play at this time. The risk per share is thus $80-$74=
$6 per share.
Your current account value is $45,000. One percent is $450. $450/$6 = 75
shares. For maintaining 1% risk, you can buy 75 shares of XYZ @ $80 with a
protective stop loss at $74. You have approximately 1% of the portfolio at
risk on this play. This does not include any slippage in the fill of your
stop loss order. (Stop loss order converts to Market order when stoploss
price is touched.)
Q. Is position sizing the primary way to define risk?
A. Yes. Without the stop loss order you have no effective way to manage risk
EXCEPT to keep positions very small. Anything can happen at any time. If you
hold this belief you must and will define (and thereby limit) risk.
Q. These numbers, like risking just 1% per trade-- seem way WAY too low.
They are ridiculously small. Am I missing something?
A, Yes you are. You are missing a healthy respect for risk. IN the example
above you have a position in XYZ with 1% risk plus slippage and commissions.
Most professionals are working from anywhere from ½ or 1% to 3% risk max,
per position. 3% is actually out of line and 2% is the effective maximum
risk recommended per position used by most professionals.
Stop Placement
Stop placement is an art form. Subjective stops based on how much you are
willing to lose, or a percentage of the total position are usually inferior
to stops selected according to technical pivot points and patterns on the
chart.
Recent Google Example
A very good example is the recent bounce in Google. GOOG has very little
price history. It took a big tumble after an earnings miss that
disappointed. Lacking the price history, astute traders could have played
the 200-day moving average (200DMA) as a natural area for shorts to cover
and longs to take a stab at GOOG-- at an interesting price. At the time of
the earnings miss, GOOG's 200DMA was at around $330.
It's common for price to bounce at or near the 200DMA. Astute buyers might
scale into GOOG at price from $344 down to $325, because this range contains
the 200DMA at $330.
It is also common for price to move as much as 3% below the 200DMA intraday
when it is close to this 200DMA area of price support. However, when price
actually CLOSES 3 or more percent below the 200DMA, that is typically a
serious sell signal and high-probability proof you are "wrong" this time.
So, an astute trader with an average price of $340 for GOOG can set a stop
3.5 percent below the 200DMA to protect himself in the event he is wrong.
The stop is wide enough for normal fluctuation, but narrow enough to limit
losses.
Three percent below $330 is $320.1. This is a logical place to set the
protective stop.
Risk per share is $340-$320.1=$19.9. Note that $19.9 is 5.8 percent of $340,
your average entry price.
Quiz
How many shares can the trader buy if he has $100K in total equity and
wishes to expose 1.5% of this capital to risk on this GOOG position?
Summary
Position sizing is an essential concept not well explained in most books
that attempt to do so.
I hope this is useful to you, and spawns some questions and discussion about
position sizing in real trading. If it is well received I will draft another
FAQ on some additional trading topics and eventually post. Otherwise this
the first and last Trading101 pos
--
Regards ,
~~ Natasha !!
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