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Position Size Calculation – Part 4

May 8, 2013
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The facts about managing your portfolio to beat the market

A few weeks back, an avid reader of the Gary Stone Journal posted a number of questions that, in essence, needed to be answered by all active investors. So over the past 3 weeks I have done just that. This fourth post brings an end to this series.

The final question that I posed last week was “How do we know that the edge combined with its position sizing even works in a portfolio at all, and if it does, what the life journey of that portfolio would be?”

You see, in trading circles and with technical analysis there is so much emphasis put into individual technical set ups, indicators, trading instruments or trading patterns that very little emphasis is put on how all these would perform at the portfolio level in different market conditions.

The moment ‘portfolio’ is mentioned, position sizing and money management is implied. Most just divide the portfolio into 5, 10, 15 or 20 equal positions, depending on portfolio size. I have dealt with position sizing in some detail over the past 3 weeks but there is still a big unknown, as posed by the question above, which, if left unanswered, can cause so much psychological angst that the active investor might just be frozen into inaction.

Most don’t even try to answer the question because it is perceived to be unanswerable, or take some presenter’s word for how their portfolio’s life journey might look because it sounds plausible and the investor has no way of qualifying it anyway.

I have attended and been briefed about so many different seminars (attended by existing customers) that show investors how to trade options, CFDs, FX and even futures where the strategies are recommended to be traded with less than $20,000 or even less than $10,000, in single positions or just 2 – 3 positions. Or ‘story writers’ that are one of only a handful of researchers to have caught a plane, a helicopter, a dugout canoe and machete’ed their way to commodity discoveries in deepest darkest Africa or South America for the investor to take just half a dozen positions a year!! Ok, so you made 56% and 38% on those two $10,000 positions in 2012 and the ego’s feeling good.

My question begs: “What about the other multiple 10’s or even 100’s of thousands of dollars that the investor needs to manage on an ongoing basis?”

This is where a portfolio comes in and this is the domain of DIY unleveraged stock investing. Otherwise, and unfortunately, the investor will end up investing the bulk of their investment capital with the main alternative, managed funds. We at Share Wealth Systems, and other educators, present a far better alternative to managed funds for portfolio bases from $20,000 to $800,000 for those willing to learn how to do it themselves.

But before they do they should answer the question above. We have done just this. Readers this year of this Journal or of my ebooklet The Trading Manifesto would have seen some of my writings about exploratory simulation.

Exploratory simulation is a powerful investment research tool that allows investment strategies that comprise entry and exit criteria and risk & money management criteria to be stress-tested on many different portfolio scenarios in varying and different historical market conditions.

Exploratory simulation is used to determine the boundaries of risk per trade, as shown in my Journal posting Busting the Myth of the 2% Rule, to use depending on particular portfolio scenarios as determined by:

  • Portfolio size, from as little as $25,000 to multiple 100’s or thousands of dollars.
  • Exchange being traded, e.g. NASDAQ or ASX. The stocks traded on different exchanges show different characteristics and different levels of volatility.
  • Brokerage rate used, from $4.95 to $9.95 for the NASDAQ and from $9.90 to $27.50 for the ASX and the effect that it has on portfolios of different sizes.
  • Market and sector risk criteria. To remain invested through all market conditions or only some and, if so, which ones and how are they determined?
  • Risk tolerance as measured by Maximum Drawdown from -15% to -30%.

I published two White Papers to our customers, one each for the NASDAQ and the ASX, that provided the detailed outcomes of conducting exploratory simulation on the scenarios mentioned above. We ran over a million portfolio simulations so we know the upper and lower boundaries of our approach and how it compares to the market benchmarks.

These White Papers show these risk and performance boundaries in detail and answer the question posed at the beginning of this Journal post.

The Trading Manifesto is a summarised version of these White Papers and is available for the public to read.

I might summarise, in answer to the question posed above, that the life journey of a SPA3 portfolio looks very good, especially compared to the market benchmarks and other investment avenues over the last 12+ years for managing decent sized portfolios.

You owe it to yourself to do this sort of preparation before just willy-nilly handing your investment capital over to somebody else to manage it with a strategy that it is unknown to you. Or you could embark on the journey yourself……

To best way to see SPA3 in action is to register for a demonstration. – CLICK HERE

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