Money management principle - Position Sizing

Most of the investors and soon to be a trader have one common goal

" To make money in the stock market"

Well, that is a legitimate goal. But it is not always true. Me being in the stock market for the last few years, I have came across many professional traders. Most of them (with high probability point), follows two rules

• Rule no 1 : Never lose money in the stock market
• Rule no 2 : Do not forget Rule no 1

But it is impossible not to lose money in the stock market but it is possible to control how much we loose per stock in our portfolio. Here comes the are of "Position Sizing".

Normally, investors follows two kinds of methodology when putting their money into the market.

1. Bought no of shares ending with zeros at the end (bought 200 HCC)
2. Invested rupees ending with BIG zeros (Invested 1 lakh rupees in HCC stock)

So far, I never encountered an investor (to my knowledge) who have bought or shorted random no of shares. i.e bought 37 no of HCC.

Well, this may be related to our thinking. Have you heard anyone schedule a meeting at 11:12 am or 1:17 pm? It would be either 11 am or 1:3o pm.

Art of "Position Sizing" helps to rewire our thinking. Here is my approach to position sizing.

1. Allocate not more than 10% of my net worth in the investment or trading account. If your networth is 10 lakh rupees, I would set aside 1 lakh for my stock account
2. Do not hold more than 5 stocks at a time.
3. Limit your losses to 2% of your trading account per stock. With 1 lakh is your trading capitol, this should be around Rs 2000 per position.

Now let us calculate how many no of shares that you need to buy with your working capitol.

You found RPL (Reliance Petroleum) is trading around Rs 220 and heard the news that they are in the process expanding their global presence. You came to the conclusion that RPL would go up in values in future and decided to buy the stock.

Let me add a pinch of technical analysis. Let us assume that you are a long term investor. You found that price of the stock is above 200 day moving average (i.e mvg) and 200 day mvg is around Rs 140 (you can get this values from any financial website like moneycontrol.com, rediff finance etc).

Now you decided to hold this stock till it price drop below 140. That is Rs 80 per share (Rs 220-Rs 140). Maximum allowed money to loose per position is Rs 2000. Now get the number of shares of RPL to purchase. It is simple. It is 2000/80 = 25 shares.

This is something different from buying 100 shares of RPL or investing Rs 1 lakh on RPL.

Good trader or investor always decide about how much money they planned to loose. Amateurs go with how much money they can make. Who wins at the end? You know the answer.

What do you think?

Mahadevan.L

RPL Breaking with Good volume

Looks like RPL is breaking with good volume. Technically looks like a good pattern for the following reason

• Price Closes above 50,21 and 8 EMA.
  
• Average daily volume is more than 100%
• Prices bounces nicely above 50% Fib retracements

Take a look at the chart pattern. Good time to entry. Either I will buy at the market price (Rs 220) Or pull back to 8 EMA price (Rs 210). My stop would be below 50 EMA (Rs 190). Here my rules for number of shares to buy.

1. Assume that I am buying it at market price for Rs 220 and my stop is Rs 190.
2. Assume that my account value is 1 lakh rupees
3. My maximum loss per stock position is 2% of my account size. i.e Rs 2000
4. Maximum loss per share of RPL is Rs 30 (220-190)
5. No of shares of RPL to go for is 2000/30 = 66 shares

Please post your comments on this blog. This will help me to refine my future postings. Happy trading and investing.

- Maha