Portfolio Sizing - How much of your account should you be trading?

Throughout my journey in stocks investing and trading, one of the most important aspects to me has been portfolio sizing. Knowing how to manage your portfolio well is one of the key foundations to grow your account consistently. So I'm going to show you how I manage my portfolio sizing.

Before I go into the details, I just want to set some background scenarios for illustration purposes. Let's assume we have $100,000 cash in the account, we will be buying stocks for long term (1-5 years) investment and trading options for short term (<1 year).

Cash Allocation

First we start with cash allocation. With $100k, mostly be buying strong fundamental stocks or ETFs. Occasionally, also buying some long term debit call options (or you can call them LEAPS).

So one of the simple guidelines to start with, is to only spend up to 80-90k of the $100k doing the above. The remaining 10-20% is a contingency fund for a continuous bear market.

The reason is because in the event the market keeps going down, you have some cash on hand to continue dollar cost averaging. Since it's long term investing, you only want to be doing dollar cost averaging at a slightly longer interval, about every 1-3 months.

Long term investing should be simple to manage, do not chase the stock every day or week. One of the biggest mistakes many people make is every few days the stock drops by a bit, they immediately want to average down.  I have to admit I was in that position before too.

So cash allocation wise,  let's keep it simple to manage.

Margin Allocation

Since I set the background that there will be options trading for some term, margin is often required when trading options. So the very important question that many people never really think about is how much of your account should you trade?

I'm not going to go in depth in margin explanation, this is a complicated topic by itself. I'm just going to share trading what amount of your portfolio is more efficient and consistent. The range is around 40-50% of your NLV.

So let's continue the example for illustration. The $100k account, you've bought about $80k worth of stocks shares. Even though you spend 80% of the cash buying shares, you will still have margin for trading.

So the $80k you use to buy shares will also take up 25% of stock value as margin (this 25% as margin depends on your account's margin type whether is it RegT or Portfolio margin, and also different country may have different regulation), which is $20k of margin used. This is just to let you understand that buying stocks also takes up some margin requirement.

Since you only bought shares, there's no profit/loss yet. Your NLV will still be $100k. So you should only trade up to 40% of your NLV, which is $40k worth of margin requirement in normal times.

The layman rationale for this 40-50% to get efficient and consistent trading is such that if you always trade too huge, for example 80% of NLV, one big crash can wipe you out and you won't have enough funds to recover.

When the market goes bearish, VIX goes up, then you could trade up to 50%. This is because statistically when VIX goes up, there are often better opportunities to trade. Hence, you can go slightly more aggressive in such times.

There are also various backtests done on trading different percentages of your NLV over the past decades and these backtest results show 40-50% actually delivers the best consistent long term profit growth. Trading more than that or trading less actually won't get you better.

Per Trade Sizing

Now you know that with $100k, you should only trade $40k. The next question is then, how much margin per trade and how many concurrent trades. The answer to this can vary depending on what strategy you are trading and how consistent you have been performing.

A simple guideline would be for each trade, try to stay between 1-5% of NLV  for and manage around 10-20 concurrent trades.

So to continue the example, we got $40k to trade. You can do 2% of NLV per trade which is $2k and manage about 20 concurrent trades at max.

This is just a simple example to illustrate how you can manage your sizing, which in terms manage your overall risk at the portfolio level. There are more complex components that depend on your account margin type, the derivatives you trade (futures are SPAN margin).

Importance

Overall the important message is not to over trade, manage your portfolio sizing well so you can have a consistent and efficient growth in profit over a long term.

And to better manage your allocation, you should always journal all your trades. I do all that in Google Sheets and it gives me a clear view of my entire portfolio sizing management. I'll share more on how to do that another day.