Position sizing is a constant challenge for amateur and professional investors alike. There’s no exact science behind it (we’ll discuss a few strategies in a moment), yet how you allocate capital across your investments can have a massive impact on your returns.
Consider the following example. If you have a 1 per cent position that goes up 300 per cent, the portfolio-level contribution of that big winner is just 3 per cent. On the other hand, if you have a 300 per cent return on a 10 per cent position, it contributes a full 30 percentage points. Big difference.
Case in point, in the summer of 2010, I started researching TradeStation, an online brokerage company here in the US that I thought was significantly undervalued. For one, the company had a massive historical database of derivatives prices that I hadn’t seen elsewhere and it wasn’t mentioned in brokerage reports. I did considerable due diligence, spoke with the CFO, users of the product, etc. and thought the odds were favourable that I’d make money on the investment. It was the best idea I’d had in some time.