Does Size Matter? (Position Sizing 101)

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Position sizing! I talk about it all the time.

But… how do you implement it?

I have shared ideas on how to use it before. But during such a volatile period, I think those ideas bear repeating.

Position sizing is meant to prevent a massive blowup in your portfolio by limiting how much you invest in any one position or with any one strategy. It also covers how to use stop losses to avoid further damage.

Some parts of position sizing – the parts that relate to buying and owning stocks – are one-size-fits-all.

But the guidance for other areas – such as short-term options, LEAPS or put sells – will vary from person to person. Don’t worry – you will get a general idea.

Large and Small Cap

For large cap stocks, you should invest no more than 4% of your investable portfolio in any one position. Plus, you should set a 25% stop loss on large cap positions. This means the MOST you can lose if the stop loss is hit, theoretically, is 1% of your portfolio.

On small cap and midcap stocks, you should invest no more than 2% of your investable portfolio in any one position and set a 25% to 35% stop loss (to account for smaller stocks’ greater volatility). This will ensure that you lose no more than 0.5% to 0.66% of your portfolio if your stop loss is hit.

LEAPS, Short-Term Options and Put Sells

On long-term equity anticipation securities (LEAPS), you should invest no more than 10% to 15% of the underlying share price on a one-year LEAP option. And no more than 20% to 25% of the underlying share price on a two-year LEAP option.

The actual dollar amount should be less than 1% of your investable portfolio, and you should set a very wide stop loss, such as 50%, or use NO stop loss. This means you are limited to losing 0.5% to 1% of your investable portfolio.

On short-term options, you should be investing no more than 0.5% of your portfolio in any single position and using a very wide (50%) stop loss or no stop loss. This is because short-term options can move very fast. Your maximum loss is limited to 0.25% to 0.5% of your investable portfolio.

On put sells, the objective is to own the underlying shares. The amount you allocate should be determined by the company’s market cap, in accordance with the guidance above. The stop loss should be the same after you are put the shares.

Obviously, you can adjust depending on your portfolio size, risk tolerance and investing experience. The objective of position sizing is to not let one or two – or a dozen – bad trades blow up your entire portfolio so you can survive a bear market.

During stock market corrections, like the one we are in right now, you can adjust your stop to account for more volatility if you like the company. But your position size should remain the same.

Action Plan: Position sizing may be the most important investment technique you will ever employ. It could save you from blowing up your financial dreams. If you want to see how position sizing is done in real time, I invite you to sign up for our FREE War Room Open House. The War Room is our highest-level trading service, and we’re giving readers like you the chance to see why it’s so special – at no cost. Click here to sign up today.