Mr. Ashish Gupta

Ashish Gupta

Investing or trading is not just about what to buy or sell, position sizing, risk management, money management, time management, etc. are also equally required to become a successful trader and investor. In this article, I will cover one of the most important and yet overlooked ingredient of successful investing/trading and that is position sizing.

What is position sizing? – Position sizing tells you about how much to buy or trade in one single idea. Say you are an investor with total investment capital of 10L and you wish to buy a particular stock, position sizing would tell you out of your 10L capital, how much to allocate for this investment. More often than not, new investors don’t use any position sizing technique and end up making investments without proper allocation.

Why is position sizing important? – Consider this example, an investor with a starting capital of 10L decides to buy two stocks. Stock A which is trading at Rs 100 might be perceived as cheap and they decide to buy 1000 shares making an investment of 1 lakh in stock A. On the other hand, stock B trades at 4000 Rs and since it’s expensive, they decide to buy only 5 shares making an investment of just 20k. With this kind of position sizing, if the stock B becomes a multibagger and say it gets doubled in 1 year, it won’t make much impact on the overall portfolio because its size was very less to start with. A 100% gain in the stock means a gain of 20k which is just 2% of the overall account size. On the similar note, if stock A becomes a loser, it will have a much greater dent on the overall portfolio as it forms a good 10% of the portfolio.

Different techniques of position sizing – There are many techniques viz. fixed risk in monetary terms on each trade, fixed risk in terms of percentage of capital on each trade, equal capital allocation to each trade, Kelly criterion, position sizing based on the notional value or the leverage (applicable in case of trading in F&O). While there is no right or wrong approach, I will cover one of these in this article which can be used for investing. The method I am suggesting is fixed percentage risk on each trade with a diversified portfolio.

Position sizing for successful investing - A tool you can’t afford to overlook

Diversified vs Concentrated Portfolio – A diversified portfolio is one where you don’t put all your eggs in one basket. You take small sized trades (of the overall account value) and put it in a number of different stocks. On the other hand, a concentrated portfolio is where you invest most of your money in a lesser number of stocks. Each has its own set of advantages – while a diversified portfolio will reduce the risk of ruin and might be less volatile but it might not give exceptional returns because even if a few stocks from the portfolio do very well but since the allocation to those is not huge it might not turn into exceptional returns. Concentrated portfolios on the other hand can be very volatile but have huge potential if the view goes right. They can either make you or break you so for the investors who are starting out, it’s best to stick to diversified portfolios.

Fixed percentage risk on each trade – In this method, the overall capital is allocated to a number of stocks where the risk on each trade (or investment in this case) is fixed to a certain percentage of the overall account value. This means that even if one of your investment decisions goes wrong, you only tend to lose that fixed percentage of your overall account size. It usually is kept to be as low as 1%. Let’s say you decide to create a diversified portfolio of 20 stocks in which case you divide your entire capital in 20 stocks with 5% allocation to each stock at the beginning. You can keep a fixed stop loss at 10% price drop in each stock. This way, even if you get stopped out in that stock, the amount that you would lose is just .5% of the overall account size. Assume the worst case scenario and stop loss in each of your 20 investments gets hit, even in that case the loss would be 10% of the account size. This is just one sample calculation and based on your risk appetite, you can make your own rules about how much to own of a stock, where to keep stop loss, what % of capital are you willing to lose in one investment idea. But the key is to stick to those rules. Most people often make the mistake of keeping the losers in their portfolio forever and letting go of winners early on. For successful investing, it should be the other way round and you should let go of losers (and not try to average them out) and keep on the winners in the portfolio long enough to see those become multibaggers. I hope you pick up a few nuggets about position sizing and it helps you in your investing career, good luck.

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The Author of the article is Mr. Ashish Gupta. He comes with a rich trading experience of 10+ years and has strongly established his position as a delta-neutral volatility-based option trader. Being a full-time trader he educates people with regards to trading via his twitter account – @AshishGupta325  https://twitter.com/AshishGupta325

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One Comment

  1. ASHOK KUMAR BALAKRISHNADAS says:

    Very enlightening advice As you said I was doing everything wrongly. But as the price is going up/breakout it is causing anxiety if we don’t book profit and we regret when a massive correction occurs. Vice versa one is unable to digest the concept of STOP LOSS. But as advised by you it is worth trying position sizing which I intend to do Thank you.

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