Why position sizing is important?

Apurva Sheth
Just think of this. You and an institutional trader both are following trading recommendations say from me or any other analyst. Both of you are entering and exiting the same stock at same price. The total amount invested by both of you is also the same. But, still your trading account ends up with no profit no loss or may be even goes slightly lower after considering the transaction costs while the institutional trader makes a descent profit.

Do you think that is possible?

How can this be possible that two people entering, exiting at same price and investing same total amount end up with different results?

Well my dear friends this is indeed possible.

Most retail traders, and maybe even you, fail to understand the importance of position size. I discussed the same point at the Equitymaster Conference 2015. And I would like to revisit it here again in my newsletter for the benefit of a larger audience.

(In case you missed the conference then don't be disappointed you can still be a part of it. The DVD for the conference is up for grabs, so don't miss it.)

So now I will show you how two traders trading the same stock can end up with different results. So here it goes.

Retail Trader
Stock Name Buy Price Qty Amt. Invested Sell Price Rs. Earned Profit/Loss
A 100 400 40,000 95 -5 -2,000
B 500 20 10,000 525 25 500
C 2,000 10 20,000 2,100 100 1,000
D 10,000 1 10,000 10,500 500 500
      80,000   Net Profit 0
Source: Profit Hunter

Institutional Trader
Stock Name Buy Price Qty Amt. Invested Sell Price Rs. Earned Profit/Loss
A 100 200 20,000 95 -5 -1,000
B 500 40 20,000 525 25 1,000
C 2,000 10 20,000 2,100 100 1,000
D 10,000 2 20,000 10,500 500 1,000
      80,000   Net Profit 2,000
Source: Profit Hunter

Most of the columns are self-explanatory. But for the sake of clarity I will explain it.

The first column is the buy/entry price. Next column is the quantity of shares bought. When you multiply both you get the amount invested per trade.  Sell price shows the rate at which the stock was sold. The Rs. Earned column shows the profit per share. The last column shows Profit or loss earned out of individual trade. The total of these profits is denoted against the Net Profit.

Now as you can see both the retail trader and the institutional trader have invested in the same shares at same price their total amount invested is also equal at Rs 80,000 but their net profit figures are different. One makes a profit of Rs 2,000 while the other ends up with a no profit no loss.

Now let me tell you what went wrong here.

You see the retail trader invested Rs 40,000 in the first trade (Stock A) which ended up as a loss. Damn! His excitement quickly turns into dejection as the first trade turns out to be a losing one. He becomes skeptical and invests only a small amount (Stock B) just to 'test' the recommendations. This trade is a profitable one and he regrets his decision of buying a small quantity. He invests more amount in (Stock C) and clocks a decent profit. Now he is eagerly waiting for the next recommendation (Stock D) which is an 'expensive' stock and so he buys only 1 share and records a profit of Rs 500 on it. The sum total of all these trades leaves him with a no profit no loss. Now he is left disappointed with the recommendation service.

On the other hand the institutional trader who is less emotional and more rational invests equal amounts in each trade. He gains a net profit of Rs 2,000 from trading the same stocks at same price the retail trader does. Unlike the retail trader he is happy with the recommendation service and looking forward for more trades.   

Has this happened to you ever before. Have you ever given a proper thought to what quantity of shares to buy across different trades?

Did you ever gave importance to proper position sizing in your trading? Share your views in the Club or share your comments here.

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11 Responses to "Why position sizing is important?"
20 Nov, 2017
Apoorva, your illustration on positioning is superb. In continuation that it is my suggestion that at the time of recommendation you select four stocks at a time, so that one can distribute amount. Please also make possible for members to see you previous recommendations, so that some time due to global event market falls down we may choose some of stocks.Like 
Renu Kalra
18 Nov, 2017
Very well explained, Apoorva. But you have assumed jump in selling prices of stocks @ 5% and decrease by 5% WHEREAS it actually does not happen like that. If we presume that the selling price of Stock-A is 108 and Stock D is 9000 with no change in selling prices of Stock-C & D as assumed by you, then with the same amount of investment and quantity as above, Retail Trader will earn Rs.3700 and the Institutional Trader will earn Rs.1600. Isn't it ? Please correct me if I am wrong. Thnx & rgrdsLike 
Varadarajan Kasturi
14 Nov, 2017
Dear Sir, Position Sizing is Important, your explanation is superb. Thanks. Also let me know whether STOP LOSS is required for this PHP recommendations, as we buy once and wait for the Target Price to profit from it, is it not ? or do the traders buy the scrips you recommended on daily basis to use the STOP LOSS. till they get another scrip recommendation from you ? Pl reply. ThanksLike 
Lakshmi narayan
14 Nov, 2017
Agree Apruva. The above is one of scenario where profit/loss is a variable. Assume if Stock A had been a profit, he would have invested more in Stock B where it is a profit and would have landed in a better position. But as you said on the safer side it would be better for the trader to invest equally across all recommendation, so that you will land up in a better position.Like 
23 Oct, 2017
We retailer always confused and unable to patience and never used stoploss. We never take long position when we are in profit and we wait longer when we are in loss.Like (1)
12 Feb, 2015
It is very true that you must be rational while trading and not emotional, and keeping track and taking decision on right time is very important to do the proper positioning of your portfolio. very good and useful example.Like 
G R Rao Subudhi
10 Feb, 2015
A good example for exercising discipline in investing. Like 
07 Feb, 2015
Good example. Does it mean that it is advantageous to it this way most of the time if not always??Like 
Gautam Rao
04 Feb, 2015
Good point! I am wondering how to put it in practice in commodity futures trading where the margin amount is different for each commodity? To make it easier for your subscribers I suggest that you can also provide the lot quantities to trade along with your recommendations.Like (1)
04 Feb, 2015
While this is right, a similar table with transaction cost included will also give a better illustration for those who were not part of the discussions on this, earlierLike (2)
04 Feb, 2015
EExcellant example. It very well explains the importance of position size as disciplined traderLike (1)
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