It is usually said that picking stocks is the easiest job of trading. The hard part has always been said to be the management side. That is, managing emotions and managing positions. Today’s topic will cover managing positions.When I first started trading I always took trades with the same dollar amount. The stock could be worth $5 or $50 either way I bought enough shares to match that dollar amount. After I placed the trade I would find a ‘suitable’ area to place my stop-loss, and then sit back and watch the magic happen. Unfortunately there wasn’t much magic to be had. My gains were usually small and my losses were usually a lot bigger. I tried to make up for this by tightening up my stop-losses but that just got me stopped out to quickly.
Finally I decided I need a better system and so now I have the new and improved position calculator. I worked up an excel spreadsheet that allows me to put in my portfolio size, how much I want to risk, buy-in price, stop price, and target price. From this it tells me how many shares I need to buy, what my risk/reward is, and how much the position will cost me.
So let’s break this down.
-Portfolio size is pretty basic. This is just your account size.
-Risk % sets how much you want to risk on each position. For larger portfolios ( >$10000) you should risk no more than 1% on any single trade. Portfolios (<$10000) should risk approximately 2 – 3% when the market is in your favor. Having a risk % of only 1% means you would have to have 100 losing positions in a row to lose your portfolio. What a defined risk means is that all your positions will be equal. If you have a 40,000 portfolio and risked 1% on each trade, you would have $400 at risk on each trade. So if you had 4 positions going on, you automatically know that you have $1600 at risk.
-Buy-in price is the price I want to pay for that security.
-Stop-price should be your stop-loss. All trades should have a stop-loss. It doesn’t matter if you go ahead and place the stop-loss, but you should have one in mind on all trades. Best stop-losses come are usually built around technical support or resistance. If you are day trading then finding a stop-loss on the 5min or 30min chart is usually best. If you are swing trading a stop-loss on the daily chart or under (over) the day’s low (high) works best.
-Target Price is where you see this stock going and where you will want to take profits. This area is usually the next resistance (support) on longs (shorts).
Once you enter that information you will be rewarded with a wide variety of information. Such as:
-Position size telling you how much money this play will cost you.
-Stop-loss % which will tell you how far away your stop-loss is from the buy-in price. No longer will you have to worry about if you put your stop-loss to close or too far away as you will know the risk of each position is the same.
-Number of shares is the key data point in this spreadsheet as it tells you how many shares to buy. Basically it takes how wide you set your stop-loss and figures how many shares you can buy to match the risk % you have.
-Reward/Risk ratio lets you know if this position is worth taking. Any ratio that is under 1 shouldn’t be taken. You don’t want to have a position where you are risking more than you can earn. If you keep your ration at 1:1 then you have to be correct 50% of the time to break even. A 2:1 ratio means you only need to be right 34% of the time to break even. A 3:1 ratio allows you to be right on 25% of the time to break even. I usually shoot for ratios around 2-3, but I know traders who aim for ratios at 4:1.