Optimal Stock Prices for Small Trading Accounts

This post was contributed by a guest author, and does not necessarily reflect the views of Richard or MovetheMarkets.com

Phileo asked me if I favor $10 stocks lately. I have been favoring “cheaper” stocks for two reasons–first, I’m trying to find a low risk swing trading strategy using penny stocks. You’ve seen some results of that here on MTM.

The biggest reason, though, is related to my recent FDX trade. I found a great low risk setup, but I didn’t have enough capital to trade the number of shares I wanted.

When you are daytrading a small account, you’ve only got three chances every 5 business days to make a trade. I want to most efficiently put my capital to work, and so my spreadsheet calculates a ‘% Capital at work’ figure for each planned trade. I look at the entry, the stop, and the maximum risk in dollars that I will take. That gives me a risk-limited position size. I then look at my buying power and the entry price, and determine the maximum position size that my buying power will allow. The smaller of these sizes is the one I trade. Due to the limit on my trading frequency, my objective is to put as close to 100% of my capital to work as I can each trade. A few examples might help to illustrate.

The FDX Trade:

1% of equity ($1000) = $10 = Maximum trade risk
Long Entry: $116.35, Stop: $116.02, Spread = $0.33 per share
Risk-limited Position Size = $10/$0.33 = 30 shares (round down)

Available Buying Power = $1577, Entry: $116.35
Buying Power Position Size = $1577/$116.35 = 13 shares (round down)

Final Position Size = 13 shares; % Buying power at work = 96%; Actual Trade Risk / Max Risk = 39%

For this trade, my trade risk was only $3.96, far below my $10 target. The trade yielded 4.6R, so I made a bit over $18 of profit. If I had my full position size, I would have made $46 of profit! So while the share cost lowered my risk to a loss of 0.39% of my equity, the problem here was that I put too much of my capital to work for not enough potential reward.

Now another example–my AMNT.OB Trade:

1% of equity ($1000) = $10 = Maximum trade risk
Long Entry: $2.45, Stop: $1.45, Spread = $1.00 per share
Risk-limited Position Size = $10/$1 = 10 shares

Available Buying Power = $1685, Entry: $2.45
Buying Power Position Size = $1685/$2.45 = 687 shares (round down)

Final Position Size = 10 shares; % Buying power at work = 1%; Actual Trade Risk / Max Risk = 100%

For this trade, my trade risk was $10, but my entry-to-stop spread was huge. The trade yielded 0.87R, so I made $8.70 of profit. I only put $25 to work, and I used up a precious trading opportunity in doing so. Not an efficient use of capital. I’ve also taken some of these types of trades that didn’t work out.

Most of the setups I daytrade end up having an entry-to-stop spread of around $0.20, on average. If I assume a $10 max risk based on 1% of my equity, then a stock price of $32/share will allow my Risk-limited position size to match my Buying power-limited position size. For a spread of $0.10, that drops to $16/share. So for my capitalization level, cheaper stocks make more sense.

Naturally, all of this relates to expectancy, win/loss rates and the like. In the near future, I hope to do a more thorough study of my recent stats and come up with the ideal risk/reward/$ at work combination for my trading style(s). Which brings me to one more thought–Different trading systems and styles should have different risk parameters! The result is that I end up risking too much on setups that don’t win often, and not enough on setups that do. I got a message from Trader-X the other day, and he told me something wise:

“As I have said in the past, you can focus on just one high-quality, consistent set-up and trade it 2-3 times a week. Your account would not need to be very big, and provided they are quality set-ups you can make good consistent money. But most people are not that patient and usually end up severely overtrading and their focus is all over the map looking for 4, 5, 10 different set-ups.”

My focus has been pretty scattered. I’m going to narrow it down to 2–Trader-X style daytrades, and a swing trade system TBD. I will also have two separate risk profiles based on the respective win/loss rates and expectancy analysis. I also overtraded this month, and used up my 40 free trades from Zecco, so I’ll start new in March.

This post was contributed by a guest author, and does not necessarily reflect the views of Richard or MovetheMarkets.com