Position Sizing

To become a successful trader one of the important thing which is required is MONEY. Yes I know that many of us have decent amount of money because undercapitalized traders will not survive for longer period of time.

However, we must understand that having sufficient amount of money is important at the same time how we are going to manage the invested money is more important.  As per my observation money management is the most important and most neglected aspect in trading.

The term position sizing is used to define ‘how much or how many shares/lots should be bought’. Let us assume that you have invested Rs.2,00,000 and your broker or some other analyst has recommended XYZ Company which is trading at Rs.1000. As per the analyst the target is Rs.1100 and stop loss is Rs.950.

Now the question is how many shares should be purchased?

Should I buy shares of worth Rs.8,00,000 by using margin money. Should I buy ‘300’ shares which is my lucky number as per my astrologer .

As we already know stock market is very dynamic but not static. So it is not NECCESARY that the target will be reached. So the primary importance should be given for protecting the capital. Please remember that a trader should not face a situation where his entire capital will be wiped out because of one wrong move. In order protect the capital we make use of an invaluable tool call position sizing where we are limiting the potential loss to X% and profit potential should be anything more than X%.

So once I get a recommendation I have to ask myself ‘How much I can afford to lose?!!’ or ‘how much lose is tolerable’?!!. Is it 5,000 or 10,000 or 1,00,000. If the answer is Rs.2000 (this differs from individual to individual) then I should buy 40 shares of XYZ Company. The formula is like this

Tolerable loss/(Current MktPrice-Stoploss).

2000/(1000-950)=40 Shares

Yes I can buy 100 shares  and if the target is achieved I can earn Rs.10,000 which appears very sexy!.

 But wait a minute what if the SL is triggered? Can I afford to lose Rs.5000 in one trade??

Please remember that stock market is not a place for easy money and we all have realized by this time(Except few great gamblers). So limit your losses to X% and stay in the market for longer period of time.