Ask Colin

I am thinking of trading smaller stocks starting with a $50,000 portfolio. Which is wiser: twenty $2500 parcels or ten $5000 parcels?

You know trading is as much about asking the right questions as it is about knowing the right answers. There are no absolutely right answers for every person in every situation. However, if they have asked the right questions, they will have had a chance to think through the problems to what might be right for them.

Portfolio management theory suggests that eight uncorrelated positions is all the diversification you need to remove the greater part of specific risk. However the trap is that all shares are correlated to the market, interest rates, economic conditions etc to some extent. This being the case, twenty parcels would be much closer to the mark than ten. The way I would put this is that you should not put more than 5% of your capital into any trade.

By the way, small companies are far more risky than large companies for many reasons. If you are thinking of accepting this risk, it is vital that you take off some risk in other parts of your investment plan. I strongly suggest you subscribe to my website and read my book The Aggressive Investor and study what has to be in a trading plan and why. That way you will give yourself a chance to take all the risks types into account and balance them sensibly.

The Aggressive Investor may be purchased from my web site. Go to the home page and click on one of the links to the book page.