TheStockBandit.com

A trader named Thomas recently asked the following:

Jeff, What percentage of your trading portfolio do you put on one trade?

This was my reply:

Rather than designate x% of my funds (ex: 10% of account) to each trade or a set amount of money per trade (ex: $20,000 per stock), I take a different approach.  I will typically designate an amount that I’m willing to lose in any given trade should it happen to fail.

The difference is that I’m weighing my actual risk, not the capital required to put on a position.

That amount for me is usually in the neighborhood of .5% (1/2 of 1%) of my account.  For a round-number example, on a $100,000 account that would equate to a max loss in any trade of $500 (.5%).  That amount will change periodically based on a few factors, including:

• My confidence in the setup.  If the play looks exceptional, the risk/reward is better than usual, and the overall market conditions are particularly conducive for the play, I may be a bit more aggressive than if it were simply a clean pattern which looks to have some potential.
• The way I’ve been trading.  If I’ve been trading well, then I need to scale up my size and take advantage of that so that I’m pressing only when I’m ahead.  I want to be more aggressive when I’m trading well and back off when I’m not.  If I’ve been off my game, then I’ll put less on the line until I start to find my groove again. Therefore, my recent performance always has a direct influence on my size.
• The personality of the stock.  A wild stock with big fluctuations is going to get less of my money than one that moves slower, which is directly correlated to the width of the stop and therefore the size of the position.  How a stock behaves should always play a role in ‘how much.’
• How many other positions I’m expecting to have.  If there are quite a few plays surfacing, I want to be getting positioned in several of them.  Often that will mean I’m splitting funds a little more thinly across the larger number of plays.  But if there isn’t much happening and I can devote more of my attention to just a couple of positions, then I just stick with full-sized positions based on the % of risk I’m currently accepting.

So at times I’ll have more on the line than at others, but usually it’s between .5% and 1% of my account at risk of loss in any given trade.

Trade Like a Bandit!

Jeff White
Take a trial to my Stock Pick Service to get my trades.

Follow @TheStockBandit

Plans, if drawn up correctly, can give a man direction.
Poorly-formed plans, however, can lead to ruin.

Recently I heard from a reader who had been doing some calculating.  That potentially dangerous activity had led him to set up a plan for earning his income through trading.  No problem there, but he wanted to invest a couple hundred thousand dollars into as many as 80 active positions with a holding time of 2-5 days each.  He was having trouble getting up to that many positions.

How many positions is too many?

To start with, it would become a full-time job continually managing 80 positions.  But aside from the time commitment, let’s examine the logic here and determine if there’s any merit to this approach.  Here’s a very short list of the first items that come to mind which I see as problematic:

• Diluted position size.  Assuming $200k on full margin ($400k buying power), max size per trade is $5,000. Non-margin would be $2,500 per position.
• High rate of churn means tons of time spent entering/closing positions + considerable operating costs via commissions.
• Index correlation – any portfolio beyond around 20 positions will closely resemble an ETF

Attempting to run that many positions is essentially a small fund.  Although $200,000 is no small sum, it would certainly be so in the fund world.  Anytime your portfolio starts to resemble the broad market, just go with SPY or something reflective of whatever it is you’re holding (ex: QQQ for heavy tech exposure).  There’s no benefit to trying to spin all those plates of staying on top of earnings announcements and darting in and out when all you’re doing is trying to run a miniature fund.  Abort that plan and simplify with an ETF if you want that much diversification.

My personal style is such that I take fewer trades, but that has some big advantages.  It reduces churn on my account, which not only frees me up to seek out other plays or tend to other matters, but it also saves me a ton in transaction costs.  Additionally, limiting my activity exposes me only to the best setups, so that I focus on the prime opportunities at any given point in time.  I can maintain tight stops, but because my positions are relatively larger, I still benefit from them nicely when they make good moves.

If you’re looking to be more active in the markets, fewer trading positions will likely serve you better.  Each might entail a bit more risk, but if you’re active, then you’re keeping close tabs on them anyway and maintaining resting orders.  Managing them will be nowhere as stressful and hectic as attempting to manage several dozen at a time on an account that size.  Big funds might do that, but they’re running so much money that they essentially have to.  You and I are more nimble than they are, and we should continually embrace that advantage.  You don’t have to be hyper-active to do well trading.

One last note on number of positions.  Keep a good handle on what your risk tolerance is on a trade-by-trade basis, AND on a portfolio basis.  If at any time you have your hands too full (whether it’s an inability to manage them all or an inability to stomach the risk), it’s too many positions.

Why behave like a tanker when you’re built like a speed boat?

Trade Like a Bandit!

Jeff White
Take a trial to the Stock Pick Service to get my trades.
Follow @TheStockBandit on Twitter