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Thursday, May 21, 2009

Must READ on Position Sizing

Position Sizing: The Golden Rule of Successful Trading

There’s one investing rule more important than all others. It has nothing to do with stock picking or market timing. Although about 95% of all investment commentary in the mainstream media deals with these two aspects of investing, you’d be surprised how little these actually matter.

Position sizing is what matters, says Brian Hunt, editor in chief of Stansberry Research in yesterday’s Growth Stock Wire. Trading psychologist Dr Van Tharp says its how “great traders manage their money.”

Smart position sizing is easy: never risk more than 2% of your capital on any one trade.

That’s it. We told you it wasn’t complicated. But would be surprised how few traders and investors actually follow this rule.

Here’s how it works. Take it away, Brian…

Let’s say you’re a trader with a $50,000 “grubstake.” And you’re thinking about buying Intel at $20 per share.

How many shares should you buy? Buy too much and you could suffer catastrophic damage if, say, an accounting scandal strikes Intel. Buy too little and you’re not capitalizing on your great idea.

Here’s where intelligent position sizing comes in. Here’s where the concept of “R” comes into play.

“R” is the amount of money you’re willing to risk on any one position. You can easily calculate R from two other numbers: 1) your total account size and 2) the percent of your account you’ll risk on any given position.

Let’s say you want to go “middle of the road” with your risk tolerance. You’re going to risk 1% of your $50,000 account on each idea. Your R is $500. (If you wanted to dial up your risk to 2% of your account, R would be $1,000.)

OK, so you’ve already decided you want to put a 25% protective stop loss on your Intel position. Now you can work backward and determine how many shares to buy.

Your first step is always to divide 100 by your stop loss number: 100/25 = 4.

Now, take that number and multiply it by your R: 4 x $500 = $2,000.

So you should buy $2,000 worth of Intel… At $20 per share, that’s 100 shares. If Intel declines 25%, you’ll lose $500 and exit the position.

If you really want to become a successful investor and stay that way, you should read Dr Van Tharp’s Trade Your Way to Financial Freedom and Jack Schwager’s Market Wizards, if you haven’t already. Both hammer home the importance of proper position sizing.

These books are to trading what the Bible is to Christianity. Make them your friends. We guarantee you’ll be a better investor as a result. We’ll leave the last word on position sizing to Tharp…

Perhaps the greatest secret to top trading and investing success is appropriate money management or what we now call position sizing. I call it a “secret” because few people seem to understand it, including people who’ve written books on the topic. Some people call it risk control; others call it diversification. Money managers call it managing other people’s money and still others call it how to “wisely” invest or spend your money.

Of course, it helps if your trades make gains. Even with proper position sizing, you still need to be right more than you are wrong. Otherwise, you will eventually be forced out of the game.

One Wall Street insider’s “secret formula” produced 438% gains in January 2009. The man behind this strategy hit the markets head on with his brand new formula. It’s based on three ultra-timely criteria. These include a new way to profit from extreme volatility and a signal that Forbes calls “one of our favorite bullish indicators.”

Notes readers can get full access to this formula right now by claiming two free months of his specialized research. But you have to act fast. Once the doors are closed on this offer, you’ll have to pay full price to get in.

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