Along with a multitude of factors to consider before properly trading the markets, correct position sizing and tranching parameters are imperative. These two aspects are within the spectrum of the Risk Management System where it is factors that a market participant can control.
It is a fact that there are matters that we cannot control in the financial markets, such as the price movement, black swan events, errors in the trader’s end (e.g. internet connection), among others. Instead, we can direct our focus to aspects that we can control, such as our management with risk, our trade plan, our trading psychology, among others.
The importance of proper position sizing and tranching is to mitigate our risk of depleting our portfolio drastically. Going all-in on one trade is as risky as jumping on a body of water without assuring whether it contains toxic chemicals, a shark, or whatnot.
A market participant must test the waters first, then scale or pyramid their position on the way up to increase their value-wise profits. This is the polar opposite to that of averaging down, where an individual would increase their position as the stock decreases. The problem with this is that there is an inevitable risk that the said name would go lower, which would decrease their value-wise losses drastically. As Jesse Livermore exclaims, thou shall not average down.
To deploy a proper position size on an individual’s trades, the trader must assess their desired number of stock positions. Initially, holding four to six names is ideal. However, there is a multitude of traders who owns ten stocks at a time. Mark Minervini would hold 20-25 positions at a time. As they say, to each their own.
The advantage of having multiple positions is that there is a high chance that you could possess a potential leader given that the scope is larger than that of a trader who wishes to acquire or maintain, for example, five positions. The problem with this approach is that you will be spread too thin.
You could apply any approach with your trades if, in the end, your winning stocks are substantially scaled on the way up. This is to fully take advantage of the direction of the trend. For example, although Mark Minervini holds that many positions, he eventually ends up with at least 10 positions as time progresses. Wherein the 20-25 positions will be cut in 10 based on the individual performances of a stock. Essentially, the laggards in his portfolio are thrown away. Mark’s leading stocks are incrementally scaled on the upside. Pluck the weeds and water the flowers, as they say.
It is best to test the waters before purchasing a said stock. If you want to hold five stock positions at a time, the trader can deploy 10% of his portfolio to a name with 1VAR. As the trade goes in your favor, the trader can add another tranche or a new trade incrementally for the said stock, so on and so forth, until their position encompasses 20% of their portfolio. This will enable the trader to maximize the movement of the said stock, wherein their value-gains will incrementally increase.
It is only applicable to scale your positions on the upside if an opportunity represents itself. Therefore, you must not force the tranche trade if there is no deemed opportunity at all. Every trade should have a basis. Always remember that patience is the key to navigate the trading landscape.
Again, you can do any approach if you apply proper risk management in all your trades. Always make sure to properly allocate our positions in a trade to maximize the opportunity at hand. Our goal as traders is to survive and prolong our journey as a market participant. Focusing on the bigger picture is of the essence to open one’s mind in this endeavor. The goal of a trader should be lifelong sustenance of the profits that they earn.
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