I want to share & expand upon the answer I gave to an email about position sizing the other day. Justin wrote:
[SNIP] After reading your article on 100 R i can now see that it would benefit me to daytrade and use 1 R per trade instead of my old 2 R per trade from swing trading. My question to you is that while daytrading many people still dont believe in putting all of your portfolio into 1 trade even if it is only 1% of your portfolio at risk, because the chance of a stock getting haulted. Do you use all of your capital in one trade if your daytrading and if it doesnt go over your position sizing limit?
I don’t worry too much about maximum position size. I frequently have positions that are equal to 100% of my equity although I’d probably be hesitant to put 200% or more into one position but opportunities to do that rarely happen. Part of my hesitancy is that I like to be able to have 3 or more positions on at one time. If I sink a ton of money into one position than I’ll be stopping myself from taking other good setups.
I am careful not to trade stocks which I think could be halted. Those include stocks moving wildly on rumors or no news and stocks with pending litigation (RMBS comes to mind) and small biotechs. There are plenty of other stocks to trade so I choose to stay away from those mine fields. I’m reminded of the madness with Host America Corporation (CAFE) about a year ago. Danger Will Robinson… if it sounds too good to be true…
There are some other things I consider when I’m looking at tradings candidates. Since I’m on a a per-share commission structure the number of shares impacts my commission costs. So I’ll think twice about positions that require me to by a ton of shares. Similarly, given 2 stocks, one very low priced and one higher priced, tracing identical patterns on a percentage basis I’ll choose the higher priced stock. For example:
Let’s say I have two candidates priced at $5/share and $50/share both presenting setups that require a 1% stop loss. Let’s also assume I have $100,000 in equity and, therefore $400,000 in intraday buying power. I want to risk 1% of my equity per trade, in other words R is 1% or $1,000. Also, let’s use a commission cost of 0.5 cents per share. First, let’s look at the $5 stock:
Initial stop = 5 cents
Number of shares to trade = $1,000 / $0.05 = 20,000 shares
Commission = $100 one way or $200 round trip
For the $50 stock:
Initial stop = 50 cents
Number of shares to trade = $1,000 / $0.50 = 2,000 shares
Commission = $10 one way or $20 round trip
Each position requires $100,000 (100% of my equity) but the choice of which stock to choose is clear based on the commissions. The other consideration is that for most $5 stocks it’s going to be tough to snag 20,000 shares without moving the stock. And if it moves 1 cent away from you’ll need to drastically adjust your position size.
To be honest, I’d never even considered that a stock might be halted in the middle of the day. That would be a nightmare.
The more I thought about it, the more my concerns were eased. It’s rare to begin with, and even if you do get into a stock that halts, being a dummy trader you would probably be on the right side of such an occurrence, don’t you think?
Dave, always be on the lookout for Black Swans! It’s tough to say whether you’d be on the right side or not. It all depends on the reason for the halt. I think it’s more likely that momentum traders would be on the wrong side.
1. What about equipment, ISP failures, do you always write down your trades?
2. What kind of backup set-up do you have?
3. Brokerage problems, problems at their site or with their people making errors?
When I started active trading, I would use huge amts of margin, and did not think of possible failure scenarios? So now I am more thinking it through, prompting these questions – and using margin more cautiously of course.
For Black Swans, see the article:
http://www.gladwell.com/2002/2002_04_29_a_blowingup.htm
in which Victor Niederhoffer was one of the most successful money managers in the country, blows up twice.
Wait Mike your saying at some point you would have 100% of your equity in a position? Do you find this dangerous? What happens when you run into a bad streak of trades? How will you deal with the drawdowns? The most I ever have had on a position is 25% and the stop was at 1% of that. Can you talk more about your position sizing and why your comfortable with it.
Hi Mike,
Love your blog. I think it’s brilliant and I’ve learned a ton since I found it.
You seem to have a bias for higher priced stocks I’m not sure I understand. I see the issue being more of relative market liquidity and volatility, niether of which will necessarily be dictated by price.
Commission on the $50 stock is less expensive if you are paying per share, and I do understand they add up at the end of the year, but it is a cost of business that averages out.
Seems like the tail wagging the dog to me. If commissions are less than an acceptable percentage of your gross profit then commissions are really the least of your worries, work on gettin your expectancy up.
In your example you are assuming the $5 stock purchase of 20,000 shares would have more market impact than the 2,000 share purchase at $50. But price alone doesn’t tell the story. If the $50 stock has avg daily volume of 1 mil, and the $5 stock has avg daily volume of 10 mil, then they have the exact same daily market liquidity. Why would buying 20,000 of the $5 stock be any more likely to “move” the market?
Also, you seem to be assuming the volatility characteristics of both stocks are the same and the likelihood of having (x)R return on both stocks is equal. Something that is not likely to be true and also something that is hard to determine in the heat of battle when they both pop up on the day trade radar.
So having a bias against lower priced, but highly volatile and highly liquid stocks could be keeping you out of some trades that might be considerably more profitable than their higher priced but less volatile counter parts.
Does this make sense or am I missing something fundamental in what you were trying to get across?
Thanks again for providing such a wonderful forum. Please keep on.
Best Regards,
Steve
Hi, great blog. I must admit that I was surprised that you are still paying per share commissions. It would seem that flat rate commissions would be the way to go. That way the impact on your risk calculations would be minimal, ie, why not virtually eliminate one bad thing (large per trade commissions) that are having a disproportionate impact on your risk by going with a flat rate commission broker. The impact on risk management when one has to take a relatively large commission into account seems unacceptable to me. Why not eliminate something that impacts negatively? With a flat rate commission structure, the impact of commissions is negligible. You can then trade whatever number of shares suits you without regard to commission costs, as one trade will cost the same low price as the other. Your commission structure seems to have a disproportionately large and negative impact on your trading. If your commissions are so large as to be a consideration, I would assert that you need to find another brokerage (say, E*trade, for example) which will allow you to almost entirely forget about commissions. One less bad thing to worry about.
Hi Mike,
Your TA’s are real helpful and not to mention, you have a great site.
Question: Do you believe in having multiple brokerage accounts? For eg. TradingDirect offers:
* $9.95 for up to 1,000,000 shares
Would that not be helpful whenever one wants to trade large number of shares of a less expensive stock (say $5 or less)?
thanks
Sam
I responded to the above comments in another post — Position Sizing Q & A