American Consequences - November 2018

Dr. Richard Smith has a PhD in Math and Systems Science and is the founder and CEO of TradeStops. He has spent the last 10 years researching and developing algorithms and services that give individual investors the tools they need to succeed and better manage their investments. With a rational plan and the right tools – like proper position sizing and knowing your risk tolerance – you’ll be able to confidently make the right decisions... And give yourself the financial and mental capital to successfully grow your portfolio in the face of a bear market. stop, how much money should you invest in each position? The answer is $4,000. If your $4,000 investment falls 25%, you will have lost $1,000 – or 4% of your $25,000 portfolio. That’s far less devastating than the earlier example, where a $5,000 loss would cost you 20% of your $25,000 portfolio. Again... investing isn’t a one-size-fits-all process. An experienced investor with a good track record of success and a large portfolio can afford to take larger position sizes. But if you’re just starting out, you likely can’t do that. Decide what your individual investing goals are. Then figure out the amount of risk you’re willing to take in each investment. Use that amount to determine how much money you should put into each position. Regardless of your goals, losing too much of your money when you’re just getting started in investing is a surefire way to ruin your financial future.

Losing too much when you're just getting started is a surefire way to ruin your financial future. A good rule of thumb is to risk no more than 4% or 5% of your entire portfolio on any one idea. If you’re risking 4% of a $25,000 portfolio, you’re limiting your potential loss to $1,000 on each investment. If you’re risking 4% of a $250,000 portfolio, then your potential loss would be $10,000 per investment. One common strategy uses something called “trailing stops” to limit losses. And an easy way to set those limits is with the “25% rule.” It’s simple: Sell if your investment drops 25% from its highs. Let’s go back to the $25,000 portfolio. If you’re willing to lose $1,000 on each investment and you’re using a 25% trailing amount of money into your investments relative to your total portfolio size. It’s a challenging concept to grasp because you have to think about something that most people don’t want to think about: how much you’re willing to risk losing on any single investment. Losing $5,000 in the $25,000 portfolio would be devastating. It would cost you one- fifth of your savings. But a $5,000 loss in the $250,000 portfolio would only be 2%. It’s a simple example. But it’s an important one to keep in mind. And it’s exactly why position sizing is so important to you as an investor. What is position sizing? It’s putting the right

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