FINANCIAL FOCUS

Size Matters

     In this installation of Financial Focus, we will discuss the topic of “Share Size” as part of one’s Risk Management strategy. As always, we will provide some education and commentary for the inexperienced and/or uninformed. 

     As we often mention, and have covered in our publication When to Buy and When to Sell: Combining Easy Indicators, Charts, and Financial Astrology (available on Amazon), managing risk appropriately (along with stock selection) may be more important than any indicator, chart, or astrological effect.  

     In our publication we cover many investing strategies and approaches, including Risk Management. In this blog we will focus solely on the concept of share size selection based on the type of investment or trade. Obviously, the more shares invested or traded increases the risk, but here are some basics to consider… 

     First, when choosing to invest for the longer-term, one should consider investing equivalent amounts of money, rather than equal numbers of shares. This strategy will keep your “weight” towards each investment equal, rather than distorted. For example, for those with $20,000 that they decide to invest, and have determined that these funds will be spread across 5 equities or ETFs, then $4,000 should be applied to each. This implementation will keep each investment “even,” which is suggested by most professionals. Should you decide to periodically invest in the selected equities, instead of all at once, the concept still applies. Of course, all equities increase or decrease in price at different speeds, but this approach will keep your account mainly balanced. Many fund managers will often adjust account holdings frequently when the percentage of a holding becomes deviated from an acceptable “weighting,” and one can review their account quarterly to achieve the correct balance. 

      Second, when choosing to trade shorter-term, it is wise to develop “categories” of stock or option prices to guide your risk management. When trading underlying shares of stock long or short, the same equivalency concept applies. Keeping each trade to the same amount of money, and the same accepted loss percentage, will greatly assist in safe money management. Note that the share size will be different with each trade, which is not important. If using options, it should be understood that each contract represents, and controls, 100 shares of any equity. Therefore, the amount of capital dispersed to conduct the trade will not be exact, but one could, and should, use a consistent range of risk capital. For example, if you decide to risk $2,000 per option trade, and a specific stock option is priced at $400, no more than 5 contracts should be traded. If the option is priced at $430, it would be suggested to trade 4 contracts, to keep the risk at $2,000 or less. 

      For day-traders, it is again important to pre-determine parameters concerning the amount of funds desired to “risk” before placing any order. This can be accomplished in many ways, but two common approaches are as follows; 

      One is to keep the risk amount exactly the same for each trade, similar to the longer-term investment strategy discussed earlier in this blog. The second is to categorize your trades by stock price. For example, if one wishes to use round numbered share sizes (50, 100, 200), due to the potential speed of the trade, the stock price becomes important based on the amount of liquidity in the account. If the amount available (cash or buying power) equaled $50,000, then the amount utilized would need to be below that figure for any cumulative open trade, without using margin. So, for example, for stocks under $25, trading 200 shares could be considered, stocks from $26 - $50, trading 100 shares could be considered, and stocks between $51 - $100, only 50 shares could be considered. Of course, if more than one trade is open at a time, these numbers need to be adjusted. This categorization and consistency is generally beneficial for organization.  

      For beginners and intermediates, following a strict set of consistent rules will create less headaches, and potential panic, when attempting to trade. Also, the shorter the time frame, the more important entry and exit levels become. Keep share size smaller and increase as confidence grows. 

      For additional discussions and education, please continue to visit our BLOG section here on ASTRO-FIN, where we provide periodic updates on a variety of topics.