Position Sizing Examples (Simplified)

Question on Blog:

Hey Chris,

This post is great. It has really helped me to comprehend the concepts of risk management. I had one question though. Do you advocate holding relatively few investments (5-8) or more? I noticed that in the example with the $100,000 portfolio, the amount of capital used on a single position was $4,000. This would equate to roughly 25 positions in all. Do you think it would be smarter to invest more capital in fewer positions if you are only starting out with, say, $5,000-10,000?

My Answer:
What the reader is saying is only true to a certain degree. Let me show you several examples of buying the same stock with a 7%, 15% and 25% sell stop in place with two different size portfolios. The number of shares change but the risk stays the same.

In the first set of examples I will use $10,000 and then $5,000 for the second set of examples. In these examples, I will use the simplified approach discussed by Brian Hunt from my first post. Please note that these examples don’t consider other variables such as slippage, etc. Please read the book by Van K. Tharp to study the detailed models of position sizing. I will also note that it is very difficult to employ this position sizing strategy with only a $5,000 stake. In my own experiences, I only bought one or two stocks when my portfolio was starting out with less than $10,000. Besides, I didn’t know about position sizing ten years ago!

Example #1:
Stock XYZ is trading at $25 per share
Portfolio size of $10,000
Risk Model of 3% per trade (due to a small account)
The stop loss is 7%

Risk will be $300 = ($10,000*3%)
Amount to Trade at 7% stop: $4,285 = ($300 / 7%)
Shares to be bought: 171


Example #2:
Stock XYZ is trading at $25 per share
Portfolio size of $10,000
Risk Model of 3% per trade (due to a small account)
The stop loss is 15%

Risk will be $300 = ($10,000*3%)
Amount to Trade at 15% stop: $2,000 = ($300 / 15%)
Shares to be bought: 80


Example #3:
Stock XYZ is trading at $25 per share
Portfolio size of $10,000
Risk Model of 3% per trade (due to a small account)
The stop loss is 25%

Risk will be $300 = ($10,000*3%)
Amount to Trade at 25% stop: $1,200 = ($300 / 25%)
Shares to be bought: 48



Now I will change the parameters to a 2% risk model with $5000 in the account:

Example #1:
Stock XYZ is trading at $25 per share
Portfolio size of $5,000
Risk Model of 2% per trade
The stop loss is 7%

Risk will be $100 = ($5,000*2%)
Amount to Trade at 7% stop: $1,428 = ($100 / 7%)
Shares to be bought: 57

Example #2:
Stock XYZ is trading at $25 per share
Portfolio size of $5,000
Risk Model of 2% per trade
The stop loss is 15%

Risk will be $100 = ($5,000*2%)
Amount to Trade at 15% stop: $667 = ($100 / 15%)
Shares to be bought: 26

Example #3:
Stock XYZ is trading at $25 per share
Portfolio size of $5,000
Risk Model of 2% per trade
The stop loss is 25%

Risk will be $100 = ($5,000*2%)
Amount to Trade at 25% stop: $400 = ($100 / 25%)
Shares to be bought: 16

Piranha