In particular, you need to make sure that one trade doesn’t take on so much risk that it sinks your portfolio.
But what happens when a logical level for your stop loss is larger than you would like? Adjust your position size. That way the larger risk for the trade doesn’t turn into a larger risk for your portfolio.
Portfolio Management And Dollars Risked Per Trade
First, you need to have a set amount you are willing to risk per trade. Say you’re willing to risk 1% of your portfolio on each trade. For a $100,000 portfolio that works out to $1,000 of portfolio risk. Sure, an unforeseen gap down in price could make you lose more. But for the most part, being disciplined in your portfolio management means those cases will be rare.
Then, consider the risk percentage for the trade. Investor’s Business Daily often suggests a 7% or 8% automatic sell from your purchase price. It’s an easy portfolio management tool for reducing risk. If you buy a stock at 50, your stop triggers at 46 or 46.50.
Next, determine your position size with stock trading position sizing calculator. Simply divide your dollars risked by your risk percentage. That gives you a position size of $12,500 ($1,000 divided by 0.08). In terms of a weight for your portfolio, that’s 12.5% for a full position. This is our logic behind using eight positions for a fully invested portfolio and the model used for IBD Leaderboard. It’s simply the way the math works out.
Adjusting Position Size
Not all markets are created equal, nor is each trade. In a strong uptrend, you might consider getting more aggressive. You might be willing to risk more dollars per trade because the reward potential is greater. You may even use margin to juice up your returns. When things are weak, you may adopt a conservative stance. Consider reducing the portfolio risk to just half a percent per trade or less. It’s also smart to do less trading in an unfavorable environment.
There are also situations where allowing for a larger loss on the trade makes sense. What if you identify a strong stock that typically gets support at its 10-week moving average and at your entry, the 10-week line is 10% away? What do you do? You can adjust your position size.
In this case, $1,000 risked will lead to a $10,000 position size ($1000/0.10). You’re taking on a little extra risk for the trade, so you adjust your position size down from 12.5% of the entire portfolio to 10%.
Of course, as with any portfolio management decision, consider the trade-offs. If the stock is truly a big winner, you will have less invested. But that might be better than passing up the trade entirely. Or even worse, your 8% loss triggers and then you watch the stock bounce off the 10-week line and go on a winning streak without you.
Alteryx Stock Example
Let’s consider an example for practice. Alteryx (AYX) is in the computer software database field. In a world of data and the necessary analysis that comes with it, Alteryx offers platforms that ease the process. In 2019, MarketSmith pattern recognition identified a base breakout (1) on Jan. 7 at 67.50. If you got in right at the buy point your 8% stop was at 62.10. In its 119% run over the next nine months, it never triggered your stop.
But what if you bought it above that buy point? We often use a 5% buy range above the buy point. Let’s say you bought Alteryx stock at 70.88 the next week (2) right at the edge of the buy zone. That would put your 8% stop at 65.21, just 3.3% below the breakout. A little tight.
And if you wanted to use the 10-week line as your stop, that was 14% away at 60.88. Why use the 10-week line? Many of the best performing stocks will find support at that level during their moves. Taking a step back to the weekly chart, you can end up riding a big winner for the bulk of its move if you hold it as long as it closes above the line.
So if you decide to use the larger risk percentage of 14%, how do you adjust the position size? A little math ($1000/0.14) brings the position down to $7,143. Even if you take the larger percentage loss on the trade, your portfolio will only take the same hit of $1,000.