What's Your Risk?

So you decide your going to swing trade Wellcare Health Plans (WCG). It's got a decent trend, had a little pullback...looks like a decent trade. How much will you risk? Lots of traders will suggest you should decide where to put your stop and determine your position size from there. So let's say you're conservative and put a stop 5 points down at 110. Let's also say you have a $100,000 portfolio and you're willing to risk 2% of your account. So you buy 400 shares for $46,000 or $23,000 on margin. But you're only risking $2,000 because you have a stop...right?

Then, the next day, WCG opens 60 points below your stop. Assuming your order was a market stop, your $2,000 "risk" just resulted in a $26,000 loss. 26% of your account...gone...overnight.

Now, some will say "That just doesn't happen very often". And you're right, it doesn't. But it just takes once to put a serious dent in your account. Too often traders let greed control their position size. I think a better method of position sizing is to just have a system of slots. Say you want to have a maximum of 10 positions. In our hypothetical account we would allocate $10,000 to each position. So instead of 400 shares, we could buy about 87. And instead of a 26% hit, we would have had around a 6% loss. Still not something you really want, but it's not nearly as daunting.