The Importance of Position Sizing

Editor’s Note: We’re ready to bring in 2022 with a bang!

That’s why today, on the eve of 2022, we’re bringing you an article by our dear friend and CEO of TradeSmith Keith Kaplan.

Wealthy Retirement‘s publisher, The Oxford Club, has worked with TradeSmith for decades now. And if you’ve attended any of the Club’s events, you’ve likely heard Keith speak and visited the TradeSmith booth.

But if you haven’t had the privilege of meeting Keith yet and learning about his valuable investor resources, you’ll soon have a chance to…

Keith recently sat down with Wealthy Retirement‘s very own Chief Income Strategist Marc Lichtenfeld to discuss how to boost your stock returns by as much as six times in 2022.

Click here to check out their conversation. (It’s entirely free to watch!)

– Rachel Gearhart, Associate Publisher

Perfect position sizing makes all the difference in the world.

I’ll tell you exactly how NOT to buy a stock… just like younger me!

Look, this happened to me a lot: I’d read a great story and get excited. And then I’d make an emotional, in-the-moment decision to buy every single time. Then I’d get cold feet minutes, hours or days later, and I’d sell.

But on the flip side of the coin, when I bought a stock that was rising slowly, I’d get impatient and sell early.

It happened with Advanced Micro Devices (Nasdaq: AMD) and many other times. I read a story that made it clear to me that Advanced Micro Devices was about to soar to new heights. That meant I had to buy it right then and there. At that time, Advanced Micro Devices was trading under $10 a share. As I’m writing this, Advanced Micro Devices is up more than 1,200% in the five years that have passed.

So, I was right in buying. But I did it all wrong. And that caused me to sell pretty quickly, losing 3.5% instead of gaining a whopping 1,200%.

Sheesh.

The roller coaster of the market, or the individual stock, used to throw me for a loop every single time. So, what does that tell you about younger me?

I was impulsive and expected 100% gains in no time. BUT I had no tolerance for risk. I wanted the reward, not the risk of owning a stock.

And that’s really because I didn’t understand how to buy a stock. I didn’t understand how to blend it into a robust portfolio primed for gains and minimal losses. I was putting way too much money into risky stocks and not enough into low-risk stocks.

We’re talking about “position size” here – the number of shares of a stock you buy, establishing a “position” in that stock.

We want to establish a portfolio of stocks (or other instruments) that gains over time and minimizes losses.

I told you about trailing stops and how important they are to minimize risk and maximize gains. That gives you a logical plan for when to sell a stock and when to ride a stock for major upside.

But here’s the thing – the real geniuses use risk parity.

Ray Dalio, a billionaire hedge fund manager, uses risk parity at his quant-based hedge fund, Bridgewater Associates. This guy is a genius and inspired me many years ago with his “All Weather Portfolio,” designed to weather storms by minimizing losses and maximizing gains. Of course, he’s crushed the market with his returns, and most importantly, he’s done so in a lower-risk manner.

Risk parity is the concept of investing based on allocation of risk using volatility instead of other commonly used metrics (such as market cap). You essentially wind up buying the same stocks, but you put LESS money into higher-volatility (riskier) stocks and MORE money into lower-volatility (less risky) stocks. And you sleep much better at night because you did so!

Your goal is to have your portfolio as a whole rise over time with the least amount of fluctuation to get you there. Risk parity is the answer.

In our system, we offer something called a Position Size Calculator. It has three different scenarios for how to buy a stock.

1. You could say, “I want to risk $1,000; how much of this stock should I buy?”
2. Or let’s say you have a $100,000 portfolio. You could say, “I’d like to risk 2% of my portfolio; how much should I buy?”
3. And finally, you could say, “I want to buy this stock with equal risk to the stocks in my portfolio; how much should I buy?”

This tool is VERY user-friendly, and it’s set to walk you through the perfect position sizing for your portfolio in less than a minute.

So, let’s say I want to buy Tesla (Nasdaq: TSLA) using the examples above. We classify Tesla as a highly volatile stock. In fact, in our system, we label it with our proprietary measurement of volatility, called the Volatility Quotient (VQ), at around 50%. That’s a really risky stock.

And I recommend buying it if you love it because you want risky/volatile stocks to help your portfolio move higher, but you just don’t want to buy too much of those types of stocks.

So, in our scenarios above, here’s how much Tesla you’d buy:

1. You’re willing to risk $1,000… Buy about $2,000 worth of Tesla.
2. You have a $100,000 portfolio that you’re willing to risk 2%… Buy about $4,000 worth of Tesla.
3. You have an existing portfolio in which you want equal risk among your positions… This will depend on your portfolio, but in my portfolio, it says to buy 12 shares in this scenario.

The goal here is to buy the right amount of a stock to minimize your risk while maximizing your gains.

Your position size matters a LOT. Don’t get it wrong. Don’t buy too much of a risky stock and not enough of a low-risk stock. You must find (and keep!) the right blend to maximize your potential gains while lowering your risk.

I never realized until I had these tools that I had it all wrong. I was buying just a little bit of the low-risk stocks and a lot of the high-risk stocks and then overtrading because I couldn’t sleep at night!

It’s time to get better sleep, so discover how you can lower your risk on the same stocks you own today and maximize your reward…

Click here to watch my recent conversation with Chief Income Strategist Marc Lichtenfeld.

Happy New Year,

Keith