Position Sizing With Limited Capital

A question related to Adaptive Analysis for Stocks about position sizing:

Let’s say I have a system where I want to size my capital the same way I do with the Growth Portfolio. That is I divide my capital into 20 equal parts.

Let’s say I have $100,000 and therefore each size is $5,000.

I have a lovely trending stock that’s appeared on my buy signal list. I want to enter the trade at $5.50, and put a stop at $5.00, so a risk of $0.50. I want to risk no more than 1.5% on any trade; therefore my risk is $1500.

This means 1500/0.5=3000.

So I can buy 3000 shares.

However, 3000 shares at $5.50 puts me at $16,500 for the whole 3000 shares. I only want to use $5000. Buying $5000 worth at $5.50 gives me 909 shares, but then with 909 shares my risk goes down to about $500 and 0.5% risk.

Is there a way to keep the 1.5% risk but only use $5000? Or is it totally fine to just drop the risk% in such cases?

In this situation, pyramiding may help.

The position sizing model you are wanting to use is Fixed Fractional and it’s very normal to use vast amounts of capital when low risk entries come around on higher priced stocks.

In our ASX Power Setups® we use this model, but you will note that the underlying share prices are low, not high. Indeed, should you find low risk setups in stocks > $20 you can use up to 50% of your capital. Should you wish to use Fixed Fractional in this way, you will need to go beyond your $5000 threshold. If not you have unequal risk.

You could use a portfolio heat mechanism whereby any single position is limited to n% of the portfolio, say 10% or a little more, but at 5% it may be too restricting in balancing risk. Alternately cap the universe to shares below $3 or so.

Another question: If you’re using up to 50% of your capital on one trade, doesn’t it mean you’re giving up a lot in terms of opportunity risk?

Answer: It’s a shortfall of using that type of position sizing with equities.