Ask Colin

Why do you use total capital for your position sizing calculation?

The detailed question was:

With your emphasis on controlling risk, I note that you make your position sizing calculations based on your capital, when your capital minus capital at risk is the only amount you can be reasonably certain of (ignoring slippage).  I'd like to know if there is any reason you use your portfolio capital (which unfortunately is not what you would sell the positions for if they went pear shaped tomorrow) rather than the capital minus capital at risk for your position sizing calculations, as it would appear that this would also minimise risk?  I'm sure you have a thorough reason for this, and when you have a moment, i'd appreciate if you would help me understand this?

 

 

All my reading on the subject is that one would use total capital for the position sizing calculation. Yes, all stops could be hit tomorrow as you seem to have experienced, but this has only happened to me once in 51 years – in 1987. I only had 25% of capital invested at that time. So, trying to mould a method around a unique occurrence does not make sense to me. The normality of investing is that only some investments will hit their stops in any month/quarter/year.  

 

However, there is nothing to stop you using capital minus capital at risk if that accords with your trading experience. Bear in mind that I am an investor, not a trader, which may be why far fewer of my stops are all hit at once, which has clearly been your experience from your question. In controlling risk, having any process is better than having none.

Keywords: