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Position Sizing Tharp's book, "Trade your way to financial freedom", devotes a chapter to position sizing, and he even wrote a whole (other) book about it. By the way, I recommend his "Trade your way to financial freedom" book, but I haven't read the other one. The most important aspect of position sizing is that you understand what it means if you trade 100, 200, or 500 shares of a stock. Many people think that position sizing is important because it tells you how much you can profit, the more shares you trade, the higher the profit. This is true, but an even more important aspect of position sizing is how much you could lose, and afford to lose. The first question you want to ask yourself is how much maximum you want to lose on a trade. Say you have $50,000 in your account, and you're willing to lose up to 1% per trade, so $500. Next you need to know where you're planning to place your first stop loss (see the trade exits page). Say you're planning to place your stop loss one dollar below the price you're planning to buy. Now you know exactly how many shares to buy, $500 (total max loss) divided by $1 (max loss per share), tells you that you can trade up to 500 shares. The number of dollars in your account will also limit your shares. If you're buying $125 shares, you won't be able to buy 500 shares. You might have mis-figured your stop loss in this case. In the case of a $50,000 account, I would plan to spend around $7,000 to $12,000 per trade, and take that into account as well when you calculate your position size. Tharp has another more refined scheme that takes volatility of the stock into account. Feel free to read his books and come up with your own position sizing algorithm. All I insist upon is that you have an understanding of how many shares you should buy each trade, and why. |