Use Two Yardsticks for Position Size

I receive a lot of emails about position size. How big should a single position be? There is no single correct answer to this question. Position size depends purely on your trading methodology and your discipline.

Position size relative to the value of your entire portfolio is a matter of style and comfort. Some traders can effectively manage a very large number of positions, each name comprising no more than 1% or 2% of the portfolio size. The key to this approach is ensuring that such extreme diversification is not guaranteeing mediocre performance. After all, can you really control risk with 50 or more positions?

Some folks have no problem with this full-time approach. They watch their positions carefully and set hard stops that mitigate losses. If they are aggressive traders, they'll typically be in the high-beta stocks when the market is rushing higher, and they'll be scaling out of these when the market weakens. They also tend to hedge their large portfolios with positions that benefit from a market decline to lessen the damage.

Other traders manage just a handful of positions, fewer than 10. Each position might comprise no more than 10% of their portfolio. When a position becomes so profitable that it takes up an exceptionally large percentage of the portfolio -- say, 15% or 20% -- the trader will scale out of the position as a matter of discipline and look for other places to invest the profits.

This method of trimming away the fat certainly can limit gains when you are very, very right about a stock. However, remember that the market is eternally "unfigureoutable." As soon as we believe we are at the top of our game, the market reminds us how ephemeral success can be. The best traders are wrong a lot! Be confident that you are right, but certainly plan to be wrong.

Position size varies by individual. Experiment with your trading. The number of positions you can comfortably hold, while still being able to maximize potential, is completely dependent on your ability to remain disciplined. Rigid discipline allows you to be wrong more often; poor discipline gives you little margin for error. Focus on discipline, and you'll find yourself naturally gravitating to your ideal position size.

Let's look at the charts.

Marvell(MRVL Quote) is back at prior support. Notice the relatively long price-by-volume bar at the $55-$59 area, which indicates an area where a lot of stock changed hands. The crowd has a big investment in that level. If Marvell moves higher, the crowd has voted: "We buy!" And if Marvell moves below support, again, the crowd has voted: "We sell!" My bet is that the stock will test $60. To look further than that is akin to reading tea leaves.

Interest rates are destined to move higher, Thursday's strong existing-home sales numbers were due to unseasonably warm weather and the consumer is all spent out. Have I missed anything, or is this the gist of the bears' thesis that the homebuilders will continue to decline? I'm less concerned with the accuracy of this thesis than I am with the price action that's occurring in spite of it. Simply put, the last couple of weeks really smell like a tradeable rally.

I've highlighted the last couple of lows in KB Home(KBH Quote). Thursday's advance was on twice the average volume, and the intraday range was much wider than normal. With the close so close to the intraday high, I'd call Thursday a convincing sign of strength. I'd be a buyer now, or on any pullback near $65. But I'd keep my stop just beneath the last low. If that stop is hit, we'll know that the prevailing downtrend is intact.

Compare Newfield Exploration(NFX Quote) with KB Home. Different sector, same chart! Thursday's break above the most recent high was a very strong signal that the downtrend is ending. As with KB Home, I'd keep a stop beneath the most recent low, around $36.

Generex Biotechnology(GNBT Quote) was one of my "Stocks Under $5" selections a couple of weeks ago. I last looked at GB on Wednesday, noting that the stock could "scream up another $20 before pausing, or it could implode tomorrow." Sure enough, the stock didn't even wait another day, and instead made one last push to $5 before reversing on heavy volume.

Think about this for a minute. Who is left to buy? This stock has moved from below $1 to $5 in less than three months. That's a career trade for a lot of folks. Wednesday's high-volume pullback is strong evidence that the aggressive buying pressure is gone. The bulls have all piled in already. The latecomers who continue to hold the stock are regretting their buy. They are likely to sell on any advance. Therefore, I'd be really cautious here. The stock is technically (i.e., psychologically) damaged. I believe we really need to see a fundamental development for GB to resume its uptrend.

I last featured Insteel Industries(IIIN Quote) on March 14. Since then, the stock has rallied another 10% or so, and pulled back to test the breakout level. When I look at last week's high-volume, wide-ranging pullback, I see a stock that has sustained major profit-taking and continued marching higher. All those who sold last week are probably regretting it now. They are probably buying back their stock. If you're long, you probably want to remain so -- at least, unless the stock falls back into congestion. If that happens, there's really no reason to hold a stock that's caught in a trading range.

Be careful out there!

---

Please note that due to factors including low market capitalization and/or insufficient public float, we consider Generex Biotechnology and Insteel Industries to be small-cap stocks. You should be aware that such stocks are subject to more risk than stocks of larger companies, including greater volatility, lower liquidity and less publicly available information, and that postings such as this one can have an effect on their stock prices.