Trading Basics: Evolution of a Trader

POSITION SIZING BY MARKET CONDITION: BULL OR BEAR?

Table 2.1 illustrates an interesting idea, which is this: When a bear market begins, for every 10-percentage-point drop in the S&P 500 index, cut the position size in half. That way, as the general market searches for a bottom, you will still be buying stocks, but in smaller and smaller amounts.

Table 2.2 Position Size According to Market Index

Market Drop	Amount per Trade	Discussion
0% to 19%	$20,000	Do nothing. Drops of this magnitude are routine.
20% to 29%	$10,000	Bear market begins. Position size cut in half.
30% to 39%	$5,000	Position size cut in half.
40% to 99%	$2,500	Position size cut in half.

The technique allows for increased diversity among holdings (small positions in many stocks, some bucking the bearish trend and rising) and a diminished chance of being seriously hurt (smaller amounts invested per position) on new positions. The idea is not to put $5,000 into one stock five times, but to buy five different stocks, each worth $5,000. Multiple positions in one stock should be the exception, not the rule.

Table 2.2 shows how this idea works. Suppose I have a portfolio valued at $200,000 and I want to own 10 stocks. I would allocate $20,000 for each of the 10 positions.

If the market dropped 20 percent from the bull market peak (entering a bear market, by definition), then I would cut the position size in half to $10,000. Instead of spending $20k for a new stock, I would spend only half that.

For each ...