Facts: 1. The equity market consists of stock certificate equity shares in electronic format sometimes known as paper assets.
2. Paper assets in its most basic form is just paper, during good times paper assets can be chased to multiples of real underlying asset prices, during bad times paper assets are sold for pennies on the dollar.
3. Since risk is most adverse during bad markets, the wide swings of market equity prices can swing it down to 1/2, 1/3rd or even 1/5th of actual underlying asset prices.
4.Position Sizing is a way to consistently reduce market exposure by limiting the amount of equity purchased against the size of the account.
5. Valid Position sizes for day trading would sometimes be OVER>100% Using Margin, which is very high dangerous and not recommended.
6. Valid Position sizes for investing would most likely not involve borrowing of funds LOWER<100% unless it is leveraged against hard assets.
Safe Position sizes include 10% and up to 30% for single equities, 50-70% for whole market ETFs. Whole market ETFs reduce risk due to the spread of risk against multiple companies, industries and sectors. Every company within the ETF have different debt levels, earning power and future market share.
Single equities have a concentrated single point of failure, where any one of the three attributes (debt levels, earning power and future market share) can cause the paper equity to plummet into oblivion.
10% would be one of the safest initial position sizes for a single equity depending on the size of the fund and also the Goal of the fund. For performance seeking funds which isn't correlated with the S&P500 markets, 10% will affect the fund while not adversely harming the portfolio.
An example with a Single equity position sizing using 10% as initial position sizing and its benefits:
Acme Inc, a highly sought out brand of Beer with a #1 or #2 market position, 0 debt trading at $100usd per share. We also value the company @ $150 USD per share, which is 50$ above market value. Let's also consider we are highly motivated to be invested in this top company. Beer company with a #1 market position is a great buy.
Fund Total Amount: $1,000,000
Invested in Acme Inc: 10% for a position size: $100,000 @ $100 per share.
Initial drawdown for Acme Inc: 25%
Initial drawdown for Acme Inc: $25,000 @ $75 per share.
Total portfolio drawdown for Acme Inc: -2.5%
Fact: -2.5% drop won't affect our thinking or nerves too much, and a 25% drawdown is a large drop for such a stable company. We can add to our positions here, since our initial position size is only 10%.
Increased Position size +5% @ $75 per Acme Inc. share using $50,000 USD
Current Position Size: 15% : ($100,000 @ $100 @ 1000 shares ) + ($50,000@ $75 @ 666 share) = 1666 shares (Average Acme Inc : $90 USD per share)
Current Portfolio Funds: $850,000 + $125,000 in equity shares = $975,000
With our Current 15% position size in Acme Inc. and -2.5% drop in Portfolio Funds, we have acquired a sizable position size while maintained our nerves with low drawdowns even after a 25% drop in stock price. We have a $90USD average entry price with the calculated intrinsic value @ $150US, The Initial 10% position size will allow a sizable drop with the options of adding to your investment at a lower price AND only a -2.5% drop in Total Funds.