﻿ Stock Position sizing guide using Percent Risk

Stock Position Sizing Guide Using Percent Risk

Employ stock position sizing to enhance your profits in the stock market. When investing in the stock market, how much should you be willing to lose before selling your stock? Known as risk or capital management, controlling how much you are willing to lose on each stock investment goes a long way to increasing your overall return.

One method used by many investors is to establish the size of each stock position based on their tolerance for risk. Dr. Van K. Tharp performed an experiment on position sizing in his book Trade Your Way to Financial Freedom. He tested five position-sizing methods where the only variable was how the size of the position was established. Starting with an initial equity of \$1,000,000, he simulated 595 trades over a five and a half year period. The results from Van Tharp's stock position sizing study are enlightening:

1. To establish baseline he simulated the purchase of 100 shares of stock whenever a buy signal was encountered. The baseline delivered \$32,567 or 0.58% annualized return.
2. The next method invested a fixed amount when a signal was given to buy. Dr. Tharp bought 100 shares per \$100,000 in equity. This approach returned \$237,457 or 5.75% annualized return.
3. The third approach invested 3% of account equity. The return for this approach was \$321,121.
4. The fourth approach used the percent risk model. All positions were sized with the risk at 1% of the account equity. This method returned \$1,840,493 or 20.92% annualized.
5. The fifth method was based on the volatility of the stock as measured by the average true range indicator. The more volatile the stock the fewer shares are traded. This method returned \$2,109,266 or 22.93% annualized.

As you can see, stock position sizing is a proven technique that investors can use to align their share purchases with their risk strategy. Since the percent approach to risk management provides a proven way to improve your return, we will look at this method in a little more detail. The percent risk method gives investors an objective way to determine the size of the risk they should assume for each of their stock or ETF positions.