Thursday, February 10, 2005

Microsoft Part Deux (Diminish the Risk)

Earlier this week I recommended Microsoft as a purchase for the long-term security holder. As a secondary part of the Microsoft recommendation, I will go through an exercise that will help you figure out the correct position size for your portfolio.

Here is my actual summary from my last report "...I would purchase a half position at this point and wait to purchase the other half once MSFT breaks above the upper trendline. Microsoft is in good shape financially and has now started to shape up technically. At these levels Microsoft is a good candidate for a long-term portfolio position."

Once again, I will assume I currently have a $10,000 portfolio. MSFT's current share price is around $26/share. Since I am a long-term investor, I am willing to risk 5% of my entire portfolio on my MSFT purchase.

Here are the calculations:

$10,000 * .05 = $500
$500/$26 = 19.23 = Round Up to 20 shares

If we are willing to sacrifice our entire position, we are allowed to purchase 20 shares of MSFT. Most of us would not be willing to watch our Microsoft position erode to $0. So, we would establish a stop (real or mental). I would place my stop right below the uptrend line around $24.50. If MSFT gets to $24.50, we will sell our position.

Here are the new calculations:

$10,000 * .05 = $500
$25.32 (Purchase Price) - $24.50 (Stop Price) = $0.82 of Risk per Share
$500/$0.82 = 609 = Round down to 600 shares

But, remember that in my summary I suggested that you work your way into this position with just a 1/2 position right now and the other 1/2 on the complete breakout from the triangle. In that case you would just divide 600 by 2, which would give you an answer of 300 shares. The next purchase would be smaller than 300 shares since the per share price will be higher. All you have to do is follow the above steps and you should be okay.

This is very simplistic and there are many ways to figure out what your position size should be. There are many places to look for more sophisticated methods. You just have to look. The above method might be simplistic, but it will help you in keeping your risk down. I hope this helps you understand that being a good investor is not just about picking "winning" stocks.

Best Regards,

The Soothsayer of Omaha

2 Comments:

Anonymous Anonymous said...

Levi,

Great post on position sizing! Position sizing and risk management have been saving my butt lately.

Tom @ SW

4:51 PM  
Anonymous Anonymous said...

600 shares will cost you more than $10000. Are we in a margin account or buying up the $10000 and stop?

Also, any special thoughts on margin account?

6:44 PM  

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