Position size management

Well, football doesn't start for a little while yet and I mentioned it in another thread so I guess it's a good time to talk about how I manage position sizes and the impacts of account size on trading strategies.

First I'll state that the assumptions in this post are for the beginner/novice trader and aren't intended for experienced traders who I assume already have a position management plan that works for them. It is also aimed at day/swing traders and not long term investors (though I think some of it could/does apply to investing).

Secondly I'm going to make those assumptions and I'll tell you why I'm making them:
1. I'm assuming total cash balance of at least 10k. -This is based on my belief that 10k is the minimum needed to ensure commission impact and psychological impact is not pushing us into high risk low cost stocks. (I'll be making a post on "How much money is really needed to trade" at a later time to expand my thoughts on this btw)

2. I'm assuming total cash balance of no more than 40k. -This is based on ensuring that we are not risking too much while learning so that losses don't have a devastating psychological (or financial) impact which could lead to ignoring rules and increasing risk.

3. I'm assuming trading in a margin account to alleviate the T+3 rule but not using margin to minimize risk while developing as a trader.

So how big or small do I think positions should be? In general I'd go with
an average position (trade value at entry) should be no less than 10% total account cash balance (how much you would get if you closed the account out today). -I make this assumption because this ensures that we're not trying to monitor an excessive number of positions at any given time and focuses our concentration on the trades we have active/planned.

I also believe that an average position should be no more than 30% total account cash balance- This is based on ensuring that no one position undermines too much of our overall risk:reward (which I will note is different than trade r:r but I'll discuss that some other time) or has too high of an impact on our account.

Next I'll state that the middle of the road there is probably where most positions should fall. I use 10% for trades initiated on short term or weak support/resistance levels. I use 20% for standard trades, and in general only go to a 30% position if it's because I'm adding to a strongly moving position.

Now let's analyze how those sizes and commissions impact what we are trading. I'll work with an average 20% position size and a 10k account so each position will be ~2k. I'll also look at what movement we need to get a 5% gain arbitrarily picked for no particular reason.

Let's look at stocks at the 5, 10, 20 and 50 dollar price areas.

For a $5 stock we get 400 shares, $10 gives us 200, $20 gets 100 shares and $50 gets 40 shares.

$5 stock needs a .25 increase to get our goal.
$10 stock needs a .5 increase to get our goal.
$20 stock needs a $1 increase to get our goal.
$50 stock needs a $2.50 increase to get our goal.

Now lets add in commissions one of the platforms I use Thinkorswims $10 roundtrip (using per share pricing minimum price as it is the cheapest for all of the above trades).

With Thinkorswim our numbers are:
$5 stock needs a .275 increase to get our goal.
$10 stock needs a .55 increase to get our goal.
$20 stock needs a $1.1 increase to get our goal.
$50 stock needs a $2.75 increase to get our goal.

So obviously we need less price change for the lower priced stocks to lock in our $100 gain after commissions. Let's now look at the change in % that it represents across the different price levels.

$5 stock needs an additional .5% gain.
$10 stock needs an additional .5% gain.
$20 stock needs an additional .5% gain.
$50 stock needs an additional, yep, you guessed it, .5% gain.

Moral is, trade the percentage, not the price. Making money in the stock market is about percentages, not dollars. Win % > loss % is a win.

If you only get 5% out of the trade then commission is going to cost you .5% each time in this scenario. If "only" getting 95% of your expected gains is insufficient then you may have an over-optimistic view of trading.

As some of you may have noticed I'm making each of these threads basic. When I'm done putting up my "basics" posts, I'll move onto my "integrated" posts on how to intermix the different basics and I plan to continue to add some of my trading methods as I go as well.

Good Stuff here JCLNUKE...keep up the good work this stuff is imperative for the new guys to know.

Size managment using this technique would result in your stops and goals being set at arbitrary levels, that may or may not match with support, resistance or other technical levels that may be important. For example, if you have a 400 share trade, with a .25 goal, and you want to maintain a 1:2 risk reward, then your stop would need to be .125 below your entry point on a long trade. This is all fine and good, but if the true support level is .15 or .20 away, you are going to get stopped out prematurely should the trade pull back to the support level before taking off for a lost chance at a big gain.

I set my position size based on the stop and potential goals, using a risk level that I am comfortable with. If you were to use $50 as a maximum loss that you would be willing to take, (based on a 1:2 risk reward basis, and your 5% goal on a $2K trade), and the support was .20 below my entry, then I would enter a 250 share position. If it was not reasonable to expect a .40 gain on the trade without hitting strong resistance, then I would not take the trade at all, but would move on to another trade. You need to factor into your risk the commissions as you stated in your post, so the example above would actually have a support at .18 below my entry, and .01 per share commission each way to total the .20 risk shown.

Many times on a day trade, I will have risks of .05 to .10 per share, including the commissions, which may allow you take a position of 1000 shares, even on a stock that may be trading $40 or $50 per share, or higher.

Regarding the underlined portion I disagree. Position size management is not related to risk:reward ratio as far as entry points for a trade as that is determined separately. Necessity for support/resistance levels to have a large enough spread to allow for commissions to be relatively inconsequential is.

Based on the assumptions I made regarding experience level and capital available I didn't discuss adjustments of position size for scalping trades because even if a person took all of their 10k account and bought a $50 stock looking for a 10 cent gain they would only get $20 out of the trade minus commissions, so $10 in this example, and the losses at a .05 stop including commission would be -$15. That is not an acceptable risk:reward scenario in my opinion.

Do you disagree with that? Keep in mind, this is a beginner method of position management and is aimed at newer traders with limited capital.