Size Matters: Position Sizing Strategy

When trading in markets, “how much” you buy makes a big difference.

If you're going to buy shares of Facebook, how many shares do you buy? Do you buy an arbitrary 100 shares? Or as much as $5000 will get you?

Everyone wants to pick the big winner, but it's more important to focus on keeping losses contained to specific parameters.

In a quantified system, there is no room for “hope.” Nobody knows what the future looks like; FB shares could be trading at $1 next year.

Here is how I would trade FB in a $100,000 trading account:

FBs current price is $99.75

First, I would risk 1% net assets per trade, so $1000 risk per trade.  

Next, I would determine when I would sell FB. I like to use the bottom range of a 20-period Donchian Channel on a 5-year chart on Barchart.com, which is $85.72 (if you want to know this process in depth, I can walk you through it).

Then, I would find my initial position size by dividing my risk($1000) by the difference between the entry price and the exit price($99.75-$85.72=$14.03).

Position size=$1000/$14.03

=71.27

Position size=71 shares@$99.75/share equaling $7082. Although this one FB trade takes up 7.08% of equity, I’m only willing to lose 1% of equity.

Its not as if I’m buying $1000 of FB stock, or 10 shares, and leaving the trade alone. I know when I'm exiting the trade before I even enter, and I know how much I’m willing to lose per trade. Position sizing is just a function of how much I’m willing to let a stock move relative to how much I’m willing to allow my account to move.

The 20-period Donchian Channel used to determine the initial exit price also acts as a trailing stop-loss. As FB moves up far enough, so does the exit price--to ensure a profit.

*This is not an endorsement to buy FB.