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Dartmouth NS
Experience: Intermediate
Platform: MC, MC.Net, NT, TWS
Broker: IB / IQFeed / Kids
Trading: Forex, stocks
Posts: 637 since Feb 2010
Thanks Given: 64
Thanks Received: 460
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The formula says nothing about share price since it uses price difference, hence all it tells you that if ca. 1000 shares of anything move $0.47 against you then the loss is $500--it does not say whether you can afford to own those 1000 shares.
For example, you could easily afford 1000 $5 shares, for which a movement of 47 cents amounts to a huge 9% change in share price, but not 1000 $500 shares for which a 47 cent change amounts to change of 0.09%, even though in both cases you would be down $500 if share price moved $0.47 in the wrong direction.
On the face of it, given a $50,000 account, an arbitrary 1% risk & the 47 cent stop constraint the costliest stock you can afford is $50 / share.
One solution is to assign a perhaps equally arbitrary account risk based on the stop expressed as a percentage of stock price. I.e., 47 cents is about 0.68% of 68.55 (JNJ closing price), so using 0.68% rather than 1% as the risk the formula becomes
N = (S*A - commission) / (S * P) = A/P - commission / S / P.
where
S = stop as a percentage of share price expressed as a decimal (i.e., 0.68% = 0.0068)
A = account size = 50000
P = share price
so that for JNJ and a $50,000 account
N = (0.0068 * 50000 - 4.95) / .47 = ca. 700 shares (total cost 700 * 68.55 = $47985).
In other words, when the stop as a percentage of price approximates the account risk percentage, simply divide your account size by the price per share to determine the number of shares :-/
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