Position sizing strategies (bonds, broker, mutual fund, trading)
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Position sizing has to be one of the most important aspects of investing, but it's haphazard.
Generally, I put on larger positions for larger cap stocks (such as S&P stocks) that I like. Essentially, I perceive larger cap stocks to be less risky, so I'm more likely to buy more than smaller cap ideas. Even if my small cap ideas are a whole lot better.
However, I'm beginning to shift away from this strategy. Rather than ordering position size by perceived riskiness of the stock pick, I'm ordering by quality of investment idea. So what I think is my best investment idea is the largest position, even if it's a riskier seeming small cap stock.
So far it's been working, and my account is at all time highs despite the recent downturn. I just wonder what others think of this strategy.
I do it based a variety things, but the main one is risk. I never buy a stock without establishing my exit. If my exit is 2%, then I don't mind buying a large amount all at once even if it's something speculative like TSLA. Likewise, if my exit is 6%, then I might start with a half position even if it's something solid like MSFT.
"So far it's been working, and my account is at all time highs despite the recent downturn"
Wow! Just Wow! Impressive! You should be managing a mutual fund or something.
Whatever you do must be working for you. Congrats again on such an amazing performance.
Anyway, for the uninitiated, position sizing is a technique used to reduce drastic loss by not putting too much of your money in one stock. For example, if you have 70% of your account in one stock, you would lose a good amount when it goes down significantly. The loss would be much less if you only have 20% of your account in this stock.
Catastrophic losses happen all the times and often can not be anticipated. Position sizing together with stop loss can help reduce losses.
Position sizing has to be one of the most important aspects of investing, but it's haphazard.
Generally, I put on larger positions for larger cap stocks (such as S&P stocks) that I like. Essentially, I perceive larger cap stocks to be less risky, so I'm more likely to buy more than smaller cap ideas. Even if my small cap ideas are a whole lot better.
However, I'm beginning to shift away from this strategy. Rather than ordering position size by perceived riskiness of the stock pick, I'm ordering by quality of investment idea. So what I think is my best investment idea is the largest position, even if it's a riskier seeming small cap stock.
So far it's been working, and my account is at all time highs despite the recent downturn. I just wonder what others think of this strategy.
My initial position size is based entirely upon not losing more than 1.5% of my total portfolio if I sell at the stop loss.
If say I have 100k in my account and I am looking at a stock at $10. I set a stop loss at $9.30 for it.
1.5% of 100k is 1500. If I sell at the stop loss I lose 0.70 a share so the total number of shares I could purchase is 2100 (round down) shares for $21,000.
I may increase that by buying more shares if I see more potential entry points but not until I have some gains to show for it.
This would be a purely risk based way to size positions.
I do not like the idea of a "quality" based way, especially in this market. Too many "quality" stocks are nothing more than cash furnaces. This probably looks like a great idea in a bull market but would fair worse outside that.
"So far it's been working, and my account is at all time highs despite the recent downturn"
Wow! Just Wow! Impressive! You should be managing a mutual fund or something.
Whatever you do must be working for you. Congrats again on such an amazing performance.
Anyway, for the uninitiated, position sizing is a technique used to reduce drastic loss by not putting too much of your money in one stock. For example, if you have 70% of your account in one stock, you would lose a good amount when it goes down significantly. The loss would be much less if you only have 20% of your account in this stock.
Catastrophic losses happen all the times and often can not be anticipated. Position sizing together with stop loss can help reduce losses.
Well, it's entirely due to 1 stock. All my other positions are actually down slightly. One is up over 100% from initial entry. I wouldn't go more than 40% of account in one stock, absolute maximum. 70% is asking for trouble, unless you're a director of a company and know for a fact that the shares are undervalued.
I wouldn't go more than 40% of account in one stock, absolute maximum. 70% is asking for trouble, unless you're a director of a company and know for a fact that the shares are undervalued.
I think what you're really getting into is tail-risk. bmw335xi, myself, and justanokie are spot on with position sizing, but it isn't that simple. If you take 1.5% risk, as justanokie does, ideally that is all you lose. If you take that risk, but you have 40% of your money tied up in the stock and overnight something catastrophic for the stock price is announced you'll lose way more than the 1.5% you initially committed. I don't think there is a great answer to this problem which is a major reason why I don't like stocks. If that is a situation you're concerned about you might consider hedging with options, but that may or may not be a practical solution.
I think what you're really getting into is tail-risk. bmw335xi, myself, and justanokie are spot on with position sizing, but it isn't that simple. If you take 1.5% risk, as justanokie does, ideally that is all you lose. If you take that risk, but you have 40% of your money tied up in the stock and overnight something catastrophic for the stock price is announced you'll lose way more than the 1.5% you initially committed. I don't think there is a great answer to this problem which is a major reason why I don't like stocks. If that is a situation you're concerned about you might consider hedging with options, but that may or may not be a practical solution.
I probably wouldn't have 40% unless I started with say 20% and the stock doubled. Then I wouldn't necessarily sell, even if it has grown to a larger portion of the account. 40% to start would require tremendous conviction, I've never sized that large to start but might if I run into something I really like. I'm well aware of gamblers ruin, as such I believe 40% is asking for trouble.
This whole thing about stop-losses isn't my cup of tea. It's a trading strategy. I'm not good at trading. And even if you are, you're using market orders in stop losses. The fills could be bad. Markets could gap as you mentioned. Last thing I would want is a flash-crash, and getting filled at $0.01, and then having to complain to broker to bust the trade. I never use stops investing in stocks, and would only use for futures trades (where that's probably a good idea).
Position sizing has to be one of the most important aspects of investing, but it's haphazard.
Generally, I put on larger positions for larger cap stocks (such as S&P stocks) that I like. Essentially, I perceive larger cap stocks to be less risky, so I'm more likely to buy more than smaller cap ideas. Even if my small cap ideas are a whole lot better.
However, I'm beginning to shift away from this strategy. Rather than ordering position size by perceived riskiness of the stock pick, I'm ordering by quality of investment idea. So what I think is my best investment idea is the largest position, even if it's a riskier seeming small cap stock.
So far it's been working, and my account is at all time highs despite the recent downturn. I just wonder what others think of this strategy.
It'll probably work great until it doesn't. Seriously. Being overweight in a risky stock just because you "think" it is a good investment is a recipe for losing a lot of money fast. One time I had way too much money in a risky biotech stock that had a drug that I thought was a slam dunk for FDA approval. I was wrong and one morning the stock opened down over 50%.
Anyway, if you like to gamble, fine. Las Vegas might be more fun, though.
Position sizing has to be one of the most important aspects of investing, but it's haphazard.
Generally, I put on larger positions for larger cap stocks (such as S&P stocks) that I like. Essentially, I perceive larger cap stocks to be less risky, so I'm more likely to buy more than smaller cap ideas. Even if my small cap ideas are a whole lot better.
However, I'm beginning to shift away from this strategy. Rather than ordering position size by perceived riskiness of the stock pick, I'm ordering by quality of investment idea. So what I think is my best investment idea is the largest position, even if it's a riskier seeming small cap stock.
So far it's been working, and my account is at all time highs despite the recent downturn. I just wonder what others think of this strategy.
Sorry, but my reply is going to be a bit long, because I need to make my case.
The Total Market Return is the weighted average of every investible asset in the world including stocks, bonds, sovereign debt, real estate, commodities, exotic financial instruments, rare art, expensive race horses, vintage race cars, etc. It is a market basket of the Economy of Earth.
This points out that "beating the market" is a zero-sum game. Let’s say averaging all the investible assets together gives a Market Return of, say, 5%. In order for you to “beat the market” of the Market Return by earning more than 5%, someone else MUST under-perform by earning less than the Market Return of 5% because it all adds up to the Market Return of 5%. This isn’t the fictional Lake Wobegon where everyone is above average.
Academic finance has led to well-accepted Fama-French 3 Factor Model, which extends the Capital Asset Pricing Model's traditional Beta (a measure of volatility with respect to the total market) to include other factors. See https://en.wikipedia.org/wiki/Fama%E...e-factor_model. The model indicates over time there is a premium ("beat the market") available to tilting your portfolio towards smaller companies (which means away from large cap companies) and towards companies with a low price-to-book ratio (that is, value stocks -- which means tilting away from so-called growth stocks).
Cliff Asness, then a doctoral student studying under Fama, found quantitative evidence to support including a 4th factor -- momentum (that is, stocks that are going up for the past month compared to the overall market tend to continue to go up, and stocks that are going down for the past month compared to the overall market tend to continue to go down). This finding was a key piece of his PhD dissertation.
So... what does it all mean?
Well, as an investor, you either (a) invest in an index of the weighted average of the entire economy, or (b) you are consciuosly or by accident "tilting" your portfolio away from the market index based on some set of rules.
You can only "beat the market" if your rules are better than the rules of someone else who is going to "lose to the market" by the same amount.
It seems your tilt is towards large cap. That's fine, but evidence suggests that you would be better off just owning the overall market.
Now, there are several ETFs and MFs out there that attempt to implement the above strategy. Cliff Asness now runs Applied Quantitative Research, and has numerous ETFs available that implement his published research. Several other companies do as well -- for example the ETF that goes under the ticker TILT is one that "tilts" the overall market basket it invests in towards the factors that have historically been shown to produce better risk adjusted returns (small companies, value companies).
Remember, in a world of efficient markets, you only get some extra return by taking on a risk that someone else has declined to incur. Think about that for a second. In the real world that includes some irrationality, you can also get some extra return by capitalizing on someone else's mistake (or, conversely, you could make the mistake yourself).
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