How many shares to buy is one of the most important things to consider when investing or trading in the stock market. To large of a trade, YOU WILL BUST. Too Small of a trade, you won’t make any money. Position size is all dependent on factors like the size of your trading account, where you are placing your stops, and what kind of stop loss strategy. This is an essential part of risk management and prevents the trader from losing too much money on a single trade which eventually will bust your account.
Position Sizing Is Based off Entry and Exit points using Technical Analysis
What will be shown here is an example of risk management using stops, and estimating how much money you will commit on a single trade.
At this point you have done your charting, set up breakout points using technical analysis, and have received an alert to buy a certain security.
Below is a chart that we will work with. On 10/18/2007 First Solar Broke out of a Cup & Handle pattern. We received and alert of the breakout, and we need to execute a buy order to enter the trade. We must calculate how many shares we will buy.
We have decided that we will buy the breakout at $123. It is currently quoting at $126.38 which is above the breakout. So, $126 is the price we will be buying at
-We have decided from our choices of stop loss strategies, to use a price level stop. The breakout price is a support/resistance line, at $123. Now that we are above that $123, it is now a support level. We will place our stop just below support/breakout level. Our stop is $118
-We know that we will risk no more that 2% of our trading accout. And our trading account’s total value is $10,000.
-So, if we enter the trade, we know that our looses cannot exceed $200. Thus we calculate 2% bythe following calculation: 0.02 x $10,000 = $200. This is your risk value. If we get stopped out, we want our losses to be exactly $200.
-Calculate % Loss on trade: $126-$118, then divide answer by $126, we get 0.063 or 6.3% >> Equation form: (126-118)/126=0.063=6.3%
-Calculate postion size: $200 our risk value divided by % loss on trade of .063, we get $3174.60. Thus we can buy as many shares that $3174 can buy.
-Calculate how many shares to buy: $3174 divided by our entry price of $126, we get 25 shares. Our position sizing will be to buy 25 shares.
Test: Calculate Losses Based on Position Sizing
Now let’s check our work, in a failed trade scenario.
We bet $3174, and we take our losses at the stop which is a 6.3% loss.
Calculate loss: 3174 x 0.063= $199.92
Remember we don’t want to risk more than 2% of our total trading account value, which is $200. We are within the 2% risk threshold.
The 2% Rule
2% risk is the standard risk parameter for trading and investing in breakouts. Traders have been know to go as high as 5%. I would say 5% is pushing it and you make likely eventually “blow out” your account.
For those of you that are trading very small accounts, like $2000 may have to completely waive the 2% risk parameter because your trade would be so small that any profits would be so small, it would also be eaten up by commision charges. For smaller accounts I recommend going with a broker like Zecco, when starting out with low amounts of capital.
Also for smaller accounts, you may want to study the precision entry methods to screen out failed breakouts, and ensure that the breakout you enter has a higher probability of success.