Ask Colin

With $50,000 capital, when would it not be feasible to buy a share costing $35.00?

First, a caveat: $50,000 is a very small capital to use my methods. I generally regard $100,000 as a more reasonable minimum.

 

However, it is not impossible to use my basic method, providing that you understand that with such a small investment capital, you may have to choose your investments carefully to stay within my rules. More likely, though, it will not be possible to observe every rule and guideline and in order to work with that capital limit, you will need to clearly understand that you need to take more risk. Let me explain:

  • Capital is $50,000
  • I% maximum risk is $500
  • Buying price is $35.00
  • Assume the sell stop is at $30.00
  • Therefore the risk is $5.00 per share
  • Limiting your risk to 1% ($500) lets you buy 100 shares.
  • However, 100 shares will cost $3,500, which is 7% of your capital.
  • My rule is not to invest more than 6% of capital.
  • 6% of your capital is $3,000
  • This is the operable limit here, so you could only buy 86 shares.
  • This would be fine. You would only be risking $430 or 0.86% of capital, which would be essentially what I do most of the time.

The only thing you have not been able to do on my plan is to enter in three stages, which would be possible, but the brokerage might not be an acceptable cost.

Some options for you to consider if this is not to your liking:

The sell stop is a variable, depending on your method of setting it. In my case, if I was not happy with the size of this position, I would find another investment which had a smaller risk per share. Closing up the sell stop contrary to my investment plan rules is not an option as it destroys the entire logic of what my investment plan is about.

The percentage risked is a variable. With small capital, most investors will use a higher percentage than I do. 2% is very common as popularised by Dr Alexander Elder in his books Trading for a Living and Come into my Trading Room. There is nothing set in concrete here, so long as you realise that the higher the percentage risked, the closer you are moving to the risk of ruin threshold. Be especially careful if you are tempted to move the percentage risked towards 5%. That is like playing Russian roulette in the stock market. Be aware too, that my risk of 1% is based on the buying and sell stop prices without any allowance for slippage or brokerage. Dr Elder’s number of 2% does include both slippage and brokerage. The end result is that we are both a lot closer than the raw numbers would suggest.

The percentage invested is also a variable. I use 6%, which I regard as rather aggressive for an investor. Warren Buffett would laugh at that rule, because his portfolio is even more concentrated than mine. However, do not take comfort from that until you are as good an investor as Warren Buffett. He is close to the best living investor. Nevertheless, this is something you could vary cautiously and consciously without undue risk. What is involved here is diversification. This is the main way we deal with specific risk in our portfolios. The higher the percentage invested in each stock, the less diversified we are and the closer we come to having all our eggs in one basket.

Brokerage is a variable to some extent. You could look around for the cheapest online broker to keep control of this issue. If it is an online broker, the skill level in managing the order rests with you and is not a variable, as it would be if you use a full service broker.

I hope these thoughts are of value. What I have tried to do is outline for you the issues you need to think carefully and deeply about. Remember that they are all connected and it is the totality of the risks that you need to manage as much as each individual type of risk. 

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