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Exactly How Much You Should Invest in a Single StockBy
Wednesday, October 31, 2012
How much money should you put into one stock or investment?
Should you buy 100 shares or $5,000 worth of shares? Should you invest 5% of your portfolio or 5% of your net worth?
These are incredibly important questions... And your answers could mean the difference between making real money from your investments and losing it all.
I'm not joking here. If you don't have a system for determining how much money to put into one investment, you're just shooting from the hip.
That's unacceptable – especially when the answer is so simple...
So... what's the RIGHT amount of money to put into any one investment?
If you're not sure, you are not alone. I'd bet 99% of investors don't have a system for determining how much is too much to invest in one idea, or how much is not enough. It's stunning to me how willing people are to risk their life savings like this – especially when there are simple answers.
Two good friends of mine, both PhDs, have spent their lives working to help individuals become better traders. They do this by zeroing in on problems like what I've described above...
The first is Dr. Van Tharp, who was interviewed in the excellent book Market Wizards: Interviews with Top Traders, by Jack Schwager. The second is Dr. Richard Smith, who has a PhD in applied mathematics.
Their work focuses on the same simple concept:
It's not how much you have invested, but how much you have at risk.
Let me explain...
Let's say you have a $100,000 portfolio. You're willing to RISK a loss of 1% of your portfolio – $1,000 – on a single trade. You also use my recommended 25% trailing stop.
According to the rules Van and Richard have laid out, you could invest $4,000 in that trade. If the trade goes down 25%, you've lost $1,000 – or 1% of your portfolio.
That's the basics.
You can push all these numbers around, of course.
You may say, "Gee, I really don't want to lose 1% of my portfolio on any one idea." You could do a couple things...
You could invest less money... If you invest just $2,000 (0.5% of a $100,000 portfolio), you're only risking $500 (with a 25% trailing stop) if the trade goes against you.
You could also tighten your trailing stop... If you are only willing to risk 0.5% of your portfolio on any one position, you could tighten your trailing stop to, say, 10%. Since you're OK risking $500, you could invest $5,000 in that trade.
I know it's a lot of numbers. The important point to understand is this:
It's not how much you have invested, but how much you have at risk.
So how much money should you have "at risk"? And what is the "right" trailing stop?
Richard is actually holding a free online, interactive webinar on these exact strategies – and how to use them – on Thursday.
If you are curious about them – and you should be – I highly recommend you check out Richard's webinar tomorrow. You can register here. (As always, I don't get any compensation for mentioning Richard or his services.)
I also recommend Van's book, Trade Your Way to Financial Freedom. You can learn more about Van's book and the other educational trading tools he offers at his website here.
These two guys are sincerely committed to making you smarter investors. Check 'em out.
Good investing,
Steve
Further Reading:
Stansberry & Associates Editor in Chief Brian Hunt says Market Wizards changed his life. "It's the first trading book I recommend when anyone asks. And I think every DailyWealth subscriber should read it." Get the full story here.
DailyWealth classic: Following your trailing stops is one of the foundations of successful investing. See how the strategy helped Matt Badiali's subscribers book 542% gains in just 10 months here.
Market NotesSMALL TECHNOLOGY, BUT GIANT INVESTMENT LOSSES Yesterday, we noted how our warnings against clean energy are well-founded. The popular clean energy fund, PBW, is at the bottom of our fund-tracking list, with a two-year return of -59%.
Close to PBW in the losers section is the PowerShares Lux Nanotech Fund (NYSE: PXN). The fund provides investors a diversified, "one click" way to invest in nanotechnology.
Nanotechnology is the science of manipulating matter on an extremely small scale... as small as an atom. It holds the extraordinary promise of turning lumps of coal into diamonds... building tiny machines that can clear out blood vessels ... and turning toxic waste spills into pristine lakes. As investment "stories" go, nanotech is as good as it gets.
We reckon within five years, nanotech stocks will be a huge story. They will capture the public's attention and investment dollars like Internet stocks did in 1998. But like all fantastic investment "stories," this one has boom-and-bust periods.
As you can see from PXN's -39% return over the past two years, the nanotech story is more bust than boom right now. We'll alert you when the trend changes... it will be worth it to know.
– Brian Hunt
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