How The Standard Method Can Destroy Your PortfolioPosition Sizing For Optimal Results
by Bo Yoder
Position sizing is a facet of trading that is often misunderstood and has the potential to dramatically affect your returns. After all the indicators have indicated, the support or resistance levels have been established, and the signal to buy or sell has flashed, one last question remains: How many shares? A rule of thumb is to risk no more than 5% of your account on any single trade. For intraday traders, between 1% and 2% of cash equity is often recommended. For a trader with a $25,000 account, 1% would be $250, while 5% equals $1,250. Many traders use these guidelines to pick a share size with which they are comfortable. Consistently taking 200, 500, or 1,000 shares gives traders a feeling of comfort; yet with certain trading styles, this can be an insidiously destructive way to trade.
CONTROLLING POSITION SIZE
Keeping position size under control is important, as it allows a trader to stay in the game despite a losing streak without blowing out an account. But if you don't maintain a consistent dollar risk as you trade, you are doomed to follow lady luck like a dog on a chain.
Certain trading strategies work well for traders who take a fixed lot on each setup. Mr. Jones daytrades the QQQ. Most of his stops are 20 cents or so, and profits average 20 to 60 cents (one to three times the initial risk). His dollar risk is consistent due to his trading strategy, so he can trade a fixed lot of 1,000 shares each time and maintain his edge.
...Continued in the September 2002 issue of Technical Analysis of STOCKS & COMMODITIES
Excerpted from an article originally published in the September 2002 issue of Technical Analysis of STOCKS & COMMODITIES magazine. All rights reserved. © Copyright 2002, Technical Analysis, Inc.
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