2/12/2019 Position Sizing | Marketfy

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By Jon Boorman — Author
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Position sizing is without doubt the most important part of portfolio management. I couldn't possibly
do it justice in one post, and there are already many greater than I who have written extensively on
the subject which I feel I couldn't improve upon. To this end, I have numerous links to articles on
position sizing under my FAQ on my Resources page. CHECK OUT WHAT MY VIP MEMBERS GET

Instead, what I will do here is just show an example of how I will size positions in the Alpha Capture
portfolio.

First a brief word on trading systems.

When you break down the components of a winning system or a successful methodology, one that
has a positive expectancy, that is, makes money over the long-term, several elements become
immediately apparent to you:-

Entries merely determine frequency, how often you have a signal.

Only exits determine whether a trade is a winner or loser.

Position size determines by how much, ie the magnitude of that winner or loser, or put another way,
the impact to the portfolio.

As an aside, how important do you now think entries are? To me, they are the least important factor
in any system, but they are the one area that all of Wall Street and everyone who follows it focuses
on.

Far more important is 'where's your stop?', where are you wrong?, and most important of all is
position size.

So how do we position size?

First, before we enter a trade we have to know where we will exit. If we don't, then how can we
know what our risk is?

We need to know where we are wrong, where we will be getting out. We need to quantify the likely
distance from our entry to our stop.

Here is a typical entry setup of mine:- A stock in a longer-term uptrend, that has undergone a recent
pullback and/or period of consolidation prior to breaking out to new highs. It was also a strong trend
day today, opening near its lows and closing at its highs, and all on increased volume. It's above its
20, 50, 200-day MA's, all of which are stacked (20 above the 50, 50 above the 200 (not shown)) and
all the MA's are rising.

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That right there would trigger an entry signal for the next day's open.

Where are we wrong? For me and my timeframe, it's a return below its MA's, below the most recent
swing low. That would confirm the breakout had failed and it may consolidate (or worse) a while
longer. Basically, that's enough to know it needs more time and we're wrong.

Let's zoom in for more detail:-

By the way, know that when I talk about swing lows for finding stops, or new highs for finding
entries, everything is always on a closing basis. I don't use intraday levels for stops or to trigger
entries. Intraday levels are noise to me. The closing price is the most important price of the day.
Think of each day's price movement as a debate between numerous parties trying to come to an
agreement of what something is worth. The arguments go back and forth to various extremes, but
eventually at the end of the day all parties finally come to an agreement. That's the close. (And then
the next day they get to do it all over again!).

So back to our chart. The swing low is the 11/10 close of $33.26. A close below that price would
trigger an exit for the next day's open.

So the current price is $35.95, our stop is $33.26.

That's $2.69 away or around 7.5%.

We won't get into risk/reward specifically here, as in theory as trend followers our upside is unlimited
as we don't have price targets, but as a very rough guide, I like to feel that the potential upside is at
least 2 or 3 times the percentage distance to the stop. So, in this case, is it reasonable to expect
Intel could go up a further 15-20% from here if the uptrend continued? I don't see why not.

So how much do we buy?

To answer that we need to know how much of the portfolio we want to risk. The time honored
standard from many pros in the market wizard books and elsewhere is to risk 1%. I actually start
with just 0.5%. This is because I run a highly-concentrated portfolio and I often give my positions
plenty of room during the trade, so the risk can easily climb up to 1% during the trade before my
stop is trailed higher for the first time. I'm very comfortable with just 0.5% so let's use that for now.

We have a $100,000 portfolio.

We want to risk 0.5%. That's $500.

Our stop is $2.69 from our entry.

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$500 / $2.69 = 186 shares.

So we would buy 186 x $35.95 = $6,687.

Notice that although we are only risking 0.5% of the portfolio ($500) we are using $6,687 or 6.7% of
our capital.

You will find the capital used will differ markedly across positions. But the initial 0.5% risk will be the
same.

When managing a portfolio we don't equal-weight, we equal-risk.

Repeat this exercise across a number of stocks and what will happen? After a dozen or so you may
start to run out of capital to allocate. You can begin to see how with this kind of dynamic position
sizing you can very effectively manage a highly concentrated portfolio of just 12-15 names. If you
want to have 20-40 names you will either have to risk even less, say 0.10%-0.25%, or use much
wider stops, or use margin.

I won't be doing any of that here for the sake of the portfolio so that it continues to represent the
strategy as intended. But for those that need further names away from the portfolio I will continue to
provide you with other setups and entries and label them 'Trade Ideas'. They will be just as valid as
any position in the portfolio, they just won't be recorded as part of the portfolio.

Posted to Alpha Capture on Nov 20, 2014 — 9:11 PM

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