To determine my trade size I am using the formula:
Risk - Commission / Difference between entry and stop
I have a 50,000$ account and using a 1% risk so my formula (when trading JNJ) looks like this:
$500 - 4.95 / 0.47 (based on average ranges I use). This gives me a trade size greater than 1,000 shares which would be $60-$70k. It is a margin account but this seems a strange. How do you deal with this?
Forexcalc.com has an easy to use calculator for position size and risk assessment, great for forex traders. As far as position size, professional traders recommend 1-4% of your total account size. This way you can take a few losses without blowing up your account, live to fight another day.
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.
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 :-/
Last edited by bnichols; September 18th, 2012 at 11:15 PM.