In this scenario, you have one winning stock and one losing stock. And the less volatile stock wins an amount equal to its stop amount. So it’s easy to see that for stocks with widely varying stops, an equal dollar portfolio can take on too much risk – especially if stocks are lower priced and volatile.Īnother scenario is when the more volatile stock hits its trailing stop.
Let’s look at what happens if we encounter a little bit of market weakness and we hit the trailing stops on both stocks: For Stock B, we buy 250 shares ($1,000 risk per trade divided by $4 risk per share = 250 shares). For Stock A, we buy 1,000 shares ($1,000 risk per trade divided by $1 risk per share). Equal Risk Portfolio: We determine how many shares to buy, based on risking 1% – or $1,000 per trade.We simply buy $50,000 dollars worth of each stock, or 1,000 shares. Equal Dollar Portfolio: This one is easy.But Stock B has a very high volatility, so we set the stop-loss $4 below the entry price. However, Stock A is a slow-mover with very low volatility, so we set our stop-loss/trailing stop just $1 below the entry price. To make this even easier, we’ll say both stocks are $50 each. To do this comparison, we’ll look at two portfolios that contain the same two stocks. Why the Equal Risk Position Sizing Strategy Beats Equal Dollar Investing $1,000 (risk per trade) divided by $2.00 (risk per share) = 500 shares to purchase.Īnd when you compare this risk-based method with just allocating equal dollar amounts across trades, you have an advantage.Since you’re only risking $1,000 total on the trade, here’s the math for how many shares to buy: When the first trade comes along, your strategy dictates that you’ll get out if the stock moves $2.00 against your position. Let’s say you’re willing to invest $100,000 and are okay with a 1% downside risk per trade. So let’s do a quick calculation to see how it works… And that should be based on how much of your overall portfolio you would be willing to risk for each trade.Īnd it’s this risk-based part of the equation that I’ll talk about here. That’s to determine the risk per share that you’re taking for a given trade (you are using stop losses, aren’t you?) Once you know your risk amount for each trade, you can use the position size calculator to find how many shares to buy. Equalizing Risk Across All Your Trades: Instead of buying the same dollar amount in each stock, you use your stop-loss level for each position.So if you’re taking a position in a $100 stock, you’d buy 200 shares for a $50 stock, you’d buy 400 shares, etc. If you want to distribute it in five equal parts, you’d simply buy $20,000 worth of each stock. For example, let’s say you have $100,000 to invest. Equal Dollar Weighting: Splitting your money into equal parts has always been an easy way to allocate money across trades.For simplicity, I’ll talk about stocks, but the same concepts can be applied to futures, options and currencies. To compare the two, let’s look at how each is done. When investing, you have a couple of choices when position sizing: Equal dollar weighting, versus equal risk. Stock Position Size Calculator Strategies Learn more about how you can maximize your returns and limit your risk with these investment tools. Of course, there is more to risk management than just position sizing (including proper stock selection and asset allocation). That way if you take a maximum loss of 25% on your maximum position size of 4%, the value of your portfolio has fallen only 1%. On top of that, we recommend a 25% trailing stop. And its policy is to never let a stock fall more than 25% below the purchase price without selling it. The Oxford Club (the publisher of Investment U) recommends putting no more than 4% of your equity portfolio in any single stock. Our position size calculator will help you figure out the proper number of shares to buy or sell in to maximize your return and limit your risk. Position sizing is vital to managing risk and avoiding the destruction of your portfolio with a single trade. And it all starts with proper position sizing. Risk management is a crucial concept every successful investor should champion.
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