Position Sizing in Investments
Assuming account of Rs. 10 Lac
Risk per trade - Variable or based on historical volatility
Maximum positions - 20
No brokerage is assumed for simplicity
Initial Strategy
Now it is widely known that position sizing can vastly increase one's trading performance. In this post, I am going to highlight a simple technique which I use for positioning my trades. Please remember, position sizing is different for the kind of trade one undertakes. Here, I am going to explain position sizing for long term investments. Hence don't follow these techniques when you trade.
Now, lets say I identify Stock ABC as a potential investment candidate. Initially, I put in 1% of the account size, which in this case would be Rs. 10,000. If I have identified something as investment trade, I would definitely expect before hand what sort of levels that stock can attain. Usually, if everything remains normal, it is fine to assume that a good investment will double in 2-3 years. Hence, our motive should be to capture bulk of the move with the correct position size.
The maximum I invest in any one trade is 5% (in current market conditions) or 10% (if market conditions are extremely robust). At the moment, I would commit only 5% of my account size in one trade. So this means we need to start with investment of Rs. 10,000 and scale in positions till our investment reaches limit of Rs. 50,000.
TO start with, lets assume ABC is currently trading at Rs. 100. With an initial investment of Rs. 10,000, I would be in a position to buy 100 shares. I would then, scale in another Rs. 10,000 when ABC appreciates by 10% that is, Rs 110. Going forward, I will keep increasing my position at every 10% gain till my investment reaches value of Rs 50,000. When I do so, I would get an average price of Rs. 119.9 and number of shares equivalent to 417.
What if trades begin to fail
I will just mention two scenarios here and I would leave the rest for you to figure out.
Scenario 1: Stock Moves down from 100
In this case, we would incur a loss on 100 shares. That is, loss on Rs. 10,000. The amount of loss occurred is determined by the kind of exit strategy one uses. I have observed most traders keep stop losses in the wrong manner. They keep a fixed % stop losses for all stocks. Well this should not be done because every stock has different volatility levels and hence each stock must have a different stop level in % terms. Else, one simple way to limit large losses is to not incur loss of more than 20% of investment. Which in this case would be Rs. 2000 on investment of Rs. 10000.
Scenario 2: Stock Moves up to 110 and then collapses to 100 and then probably further.
In this case the average price would be 104.7 and we would get 191 shares. Well, the exit in this case is very simple. If the stock reaches Rs. 110, you would be in profit of Rs. 1000 (100 shares * 10 Rs gain) and it is here where you would add another Rs. 10,000. You would get roughly 91 shares at 110 level on investment of Rs. 10,000. SO, if the stock collapses and reaches Rs 100 again, you would be incurring a loss of Rs 910 (91 shares * Rs 10 loss). Once Rs 100 is reached, I would square off the add on position with a loss of Rs 910 and would have the basic 100 share position open which I took when I bought the first time. With this position, I would exit the same way like I did in scenario 1. Remember, our main motive is to ride a possible trend of 100 - 300 % and hence we should be prepared to take a loss of 20-30% on our investments. Since this percentage seems high, we diversify and position size to take loss at small quantity and gain at higher position size.
Isn't investing Rs. 50000 at one stroke better?
Well, lets work the math here. Typically, before getting on to the real trend, we would get whipsawed a great deal. Hence we need to ensure our losses are small. Now lets assume, I buy Rs. 50,000 worth shares when ABC was at 100. I would get 500 shares. If I take 20% loss on investment as stop loss, then I would roughly loose Rs 10,000 on one trade. Now imagine what if I have 5 such losses in a row. I would incur a total loss of Rs. 50,000, which by the way is 5% of my account size.
Now, going by our original plan of investing just Rs.10,000, we would have a loss of Rs.2000 on each trade. Even if we take 5 losses in a row, we would get a loss of Rs. 10,000 in total. This is only 1% of our account size and is totally acceptable. Remember, our main aim is to preserve capital. And once we learn how to do this, we will be far better money managers than we were earlier.
I hope this post helped many of you who wanted to position size properly. This is not exhaustive. Infact this is something I have worked on my own as it suits my style of investing. At times I scale in quickly if I find a stock moving at great pace. Hence, position sizing is also subjective and discretionary. If one wants advanced strategies, then one can refer to many writings by Van Tharpe.
Tc
Assuming account of Rs. 10 Lac
Risk per trade - Variable or based on historical volatility
Maximum positions - 20
No brokerage is assumed for simplicity
Initial Strategy
Now it is widely known that position sizing can vastly increase one's trading performance. In this post, I am going to highlight a simple technique which I use for positioning my trades. Please remember, position sizing is different for the kind of trade one undertakes. Here, I am going to explain position sizing for long term investments. Hence don't follow these techniques when you trade.
Now, lets say I identify Stock ABC as a potential investment candidate. Initially, I put in 1% of the account size, which in this case would be Rs. 10,000. If I have identified something as investment trade, I would definitely expect before hand what sort of levels that stock can attain. Usually, if everything remains normal, it is fine to assume that a good investment will double in 2-3 years. Hence, our motive should be to capture bulk of the move with the correct position size.
The maximum I invest in any one trade is 5% (in current market conditions) or 10% (if market conditions are extremely robust). At the moment, I would commit only 5% of my account size in one trade. So this means we need to start with investment of Rs. 10,000 and scale in positions till our investment reaches limit of Rs. 50,000.
TO start with, lets assume ABC is currently trading at Rs. 100. With an initial investment of Rs. 10,000, I would be in a position to buy 100 shares. I would then, scale in another Rs. 10,000 when ABC appreciates by 10% that is, Rs 110. Going forward, I will keep increasing my position at every 10% gain till my investment reaches value of Rs 50,000. When I do so, I would get an average price of Rs. 119.9 and number of shares equivalent to 417.
What if trades begin to fail
I will just mention two scenarios here and I would leave the rest for you to figure out.
Scenario 1: Stock Moves down from 100
In this case, we would incur a loss on 100 shares. That is, loss on Rs. 10,000. The amount of loss occurred is determined by the kind of exit strategy one uses. I have observed most traders keep stop losses in the wrong manner. They keep a fixed % stop losses for all stocks. Well this should not be done because every stock has different volatility levels and hence each stock must have a different stop level in % terms. Else, one simple way to limit large losses is to not incur loss of more than 20% of investment. Which in this case would be Rs. 2000 on investment of Rs. 10000.
Scenario 2: Stock Moves up to 110 and then collapses to 100 and then probably further.
In this case the average price would be 104.7 and we would get 191 shares. Well, the exit in this case is very simple. If the stock reaches Rs. 110, you would be in profit of Rs. 1000 (100 shares * 10 Rs gain) and it is here where you would add another Rs. 10,000. You would get roughly 91 shares at 110 level on investment of Rs. 10,000. SO, if the stock collapses and reaches Rs 100 again, you would be incurring a loss of Rs 910 (91 shares * Rs 10 loss). Once Rs 100 is reached, I would square off the add on position with a loss of Rs 910 and would have the basic 100 share position open which I took when I bought the first time. With this position, I would exit the same way like I did in scenario 1. Remember, our main motive is to ride a possible trend of 100 - 300 % and hence we should be prepared to take a loss of 20-30% on our investments. Since this percentage seems high, we diversify and position size to take loss at small quantity and gain at higher position size.
Isn't investing Rs. 50000 at one stroke better?
Well, lets work the math here. Typically, before getting on to the real trend, we would get whipsawed a great deal. Hence we need to ensure our losses are small. Now lets assume, I buy Rs. 50,000 worth shares when ABC was at 100. I would get 500 shares. If I take 20% loss on investment as stop loss, then I would roughly loose Rs 10,000 on one trade. Now imagine what if I have 5 such losses in a row. I would incur a total loss of Rs. 50,000, which by the way is 5% of my account size.
Now, going by our original plan of investing just Rs.10,000, we would have a loss of Rs.2000 on each trade. Even if we take 5 losses in a row, we would get a loss of Rs. 10,000 in total. This is only 1% of our account size and is totally acceptable. Remember, our main aim is to preserve capital. And once we learn how to do this, we will be far better money managers than we were earlier.
I hope this post helped many of you who wanted to position size properly. This is not exhaustive. Infact this is something I have worked on my own as it suits my style of investing. At times I scale in quickly if I find a stock moving at great pace. Hence, position sizing is also subjective and discretionary. If one wants advanced strategies, then one can refer to many writings by Van Tharpe.
Tc
