FAZ position size / Risk management example

I had been asked about Risk management for some positions and decided that it' been a long time since I've posted anything like this as it is an exceptionally important part of long term success.

I prefer a 2% rule (for equity positions), for options I think risk management is better achieved through some more complex option trades than our typical long calls or puts so we'll just deal with equities for now.

Lets assume a $10k portfolio size (calculations don't include any margin) for a nice round number. I wouldn't want to trade any more than 4 to maybe 5 positions tops (you can diversify enough with 4-5 positions and any more diversification is killing performance) and I'd prefer no more than 15% allocated to any 1 position, but since transactions costs represent a much greater cost than say someone with a $100k portfolio using the same strategy where transactions costs are negligible, I could see going to 20% per position and ideally you'd have some dry powder still left over.

 For FAZ long...

This is a rough calculation and I typically use different metrics for gauging risk, but I chose to use a risk metric based on gaps as they are the hardest to protect against and I came up with about $1.20 risk per share.

So if we are using a $10k portfolio and the maximum 2% loss is $200, then divide $200 by $1.20 and you come up with 166 shares, multiplied by the current price you have about a $2,000 position size which is about 20% of a 10k portfolio which is a little on the high side, but you have to still cover  higher percentage of transaction costs, so it would be ok with me.

So approx. 165 shares at a 10k portfolio with 2% risk on a closing basis and a stop of $1.20 or approx. $10.93 which isn't near any psychological stop area so that's ok with me too.

I prefer a wider stop on initial trades, especially when looking for a turn around or in heavier volatility, you can always add to a trade moving in your direction, but to have too tight a stop to get more shares is just greed and you'll generally find the transaction costs of getting booted out of numerous trades because the stop was too tight  add up pretty quick between slippage and commissions, etc.

By the way, it's mathematically impossible (for practical purposes)  to go broke if you stick to a 2% rule.