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.
