Importance of Position-Sizing

The Importance of Position-Sizing

How much should I allocate to each trade?

This frequently asked question lacks definitive answers. Why? The answer is quite simple; as investors, we all have a different set of goals. There are just too many variables out there (age, income, retirement goals, spending habits, etc.) to give a universal answer to the question.

Options brokers allow you, the investor, the flexibility to allocate your account by specified dollar amount, specified quantity of contracts, percentage of available buying power, etc. It is your responsibility to figure out what works with your risk tolerance and investment goals.

This brings me to the important and rarely covered topic of Position-Sizing. Too many investor, especially options investor, have a casual attitude towards the risk-management of their investment portfolios. In the constant race for profit, risk management and money management seem to be secondary. The almighty return, the “we want a lot of return, we do not want any risk, and we want it by Monday” mentality, seems to override the importance of position-sizing.

This is particularly true in the options arena. How many websites have you come across that tout outlandish gains with minimal risk with great consistency. All that needs to be said is “think about it”.

This, of course, does not mean that the typical options investor can’t beat the market by a decent percentage annually. It just means that “shooting for the moon” is not sustainable.

The Gallup organization and UBS conducted a survey a few years back that found 39% of respondents believed stocks would deliver at least a 15% annual return over the next ten years. This goes to show how wishful thinking consumes a large portion of the investing publics’ attitude towards investment returns. Historically the notion of such investment returns is unreasonable.

“Whenever I enter a position, I have a predetermined stop. That is the only way I can sleep. I know where I’m getting out before I get in. The position size on a trade is determined by the stop and the stop is determined on a technical basis.” -Bruce Kovner

Position-sizing is possibly the most important aspect of any options portfolio and options trading system. As an investor you must always be aware of risk-management (how much you are comfortable losing per trade) and money management (the size of the position per trade).

So, as far as “how much you should allocate to each strategy”, trade, etc., the answers are ambiguous. I can only speak to the strategies I use. One thing is certain, position-sizing is an integral part of the strategies I follow.