Position Sizing (2)

Few days ago, I posted a very simple method for position sizing. It was incorporated brokerage fees to determine the size of our trade.

In this post, we will determine our trading size using a technical stop loss method.

Let's have a look at this example:

Initial Conditions
Trading capital: $20,000
Maximum limit per position: 20 per cent or $4,000
Risk amount: 2 per cent or $400

Let’s say you consider purchasing XYZ, which is currently trading at $1.25. You have decided to place your initial stop just below its previous support level, 12¢ away.

Position Size (number of shares)= Risk amount / Distance to stop= $400 / $0.12= 3,333 shares

Now include the current share price= 3,333 shares x $1.25 = $ 4,166.25

Note, this amount is more than your maximum limit of $4,000. Therefore, you would only commit $4,000 to this position (i.e. 3,200 shares). This simple position sizing model has concluded that the level of risk in this position is tolerable and you can commit your maximum limit of $4,000.

The theory and key behind the above model is that, if the share price moves down to your exit level, you will only lose your risk amount and nothing more, because you have managed the number of shares purchased.