One Position Sizing Technique For Long Term Success – ValueWalk Premium
Institutional Investors

One Position Sizing Technique For Long Term Success

Thought I'll share this short interview with Brian Hunt, a successful private investor and trader, and the Editor in Chief of Stansberry & Associates Investment Research. Happens to be one of the largest independent financial publishing firms.

Q1 hedge fund letters, conference, scoops etc, Also read Lear Capital: Financial Products You Should Avoid?

Institutional Investors

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It's about position sizing, which is often ignored as most articles only talk about what to buy and sell. Not how much to buy and sell, which is crucial to succeed.

Ignoring this idea is responsible for more losses than any other investment mistake.

Remember, that these are thoughts from one person. If it makes sense to you and is something you were looking for, great. If you have your own position sizing techniques, even better. Take it as a framework and work from there.

Why is Position Sizing so Important?

  • The successful investor thinks in terms of what percentage of their total account is in a particular stock.
  • It's the best way for investors to protect themselves from catastrophic loss
  • The catastrophic loss is the kind of loss that erases a large chunk of your investment account.
  • Worse than losing money is the mental trauma

So clearly, you want to avoid the catastrophic loss at all costs… And your first line of defense is to size your positions correctly.

Guidelines for Position Sizing

  • For example, when buying a safe, cheap dividend stock, a position size of up to 5% may be suitable.
  • Some managers who have done a ton of homework on an idea and believe the risk of a significant drop is nearly non-existent will even go as high as 10% or 20% – but that's more risk than the “average” investor should take on.
  • For volatile stocks? Position sizes should be much smaller… like a half a percent… or 1%.

As pupils of Graham and Buffett, you're taught to believe that spreading your bets wide is a stupid idea. But unless investing is your full time job, or you live and breathe investing, holding 10 positions at 10% is a tough ask for most people. There is nothing wrong with holding 20 or even 30 positions. The best ideas can often be wrong. Look at Ackman or even Lampert who went all in and have under-performed the market by over 100%.

Position Sizing Math – Protective Stop Losses

  • A protective stop loss is a predetermined price at which you will exit a position if it moves against you. It's your “uncle” point where you say, “Well, I'm wrong about this one, time to cut my losses and move on.”
  • Most people use stop losses that are a certain percentage of their purchase price.

e. For example, if a trader purchases a stock at $10 per share, he could consider using a 10% stop loss. If the stock goes against him, he would exit the position at $9 per share… or 10% lower than his purchase price.

  • Tight stop is a stop loss of 5%
  • Wide stop is a stop loss of 50%

Combining intelligent position sizing with stop losses will ensure the trader or investor a lifetime of success. To do this, you need to understand the concept many people call “R.”

An Explanation fo “R”

  • R is the foundation of all position sizing
  • R is the value will risk in any given investment
  • R is calculated using two numbers – total account size and percentage of the total account you'll risk on any given position.

Let's say Joe decides to risk 1% of his $100,000 account on the position. In this case his R is $1,000. If he decided to dial-up his risk to 2% of his entire account, his R would be $2,000. If he was a novice or extremely conservative, he might go with 0.5%, or an R of $500.

Joe is going to place a 25% protective stop loss on his ABC position. With these two pieces of information, he can now work backwards and determine how many shares he should buy.

Remember… Joe's R is $1,000, and he's using a 25% stop loss. To calculate how large the position will be, the first step is to always divide 100 by his stop loss. In Joe's case, 100 divided by 25 results in four.

Now, he performs the next step in figuring his position size. He then takes that number – four – and multiplies it by his R of $1,000. Four times $1,000 is $4,000, which means Joe can buy $4,000 worth of ABC stock… or 200 shares at $20 per share. If ABC declines 25%, he'll lose $1,000 – 25% of his $4,000 – and exit the position.

  • 100 divided by your stop loss equals “A.”
  • “A” multiplied by “R” equals position size.
  • Finally, position size divided by share price equals the number of shares to buy.
  • A tighter stop loss means you can buy even more shares.
  • If you're trading a riskier, more volatile asset, the stop-loss percentage should typically increase and the position size should decrease
  • If you're investing in a safer, less volatile asset, the stop-loss percentage should decrease and the position size should increase.

…a good, “middle of the road” R that will work for anyone is 1% of your total account. Folks new to the trading game would be smart to start with half of one percent of their account. This way, you can be wrong 10 times in a row and lose just 5% of your account.


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