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by Jonathan AnthonyAvoiding FOMO When Investing: Position Sizing Across Your Portfolio
The equity markets have been on a tear over the last three months, moving upwards across many global indices. Looking at this upward movement, one can have the fear of missing out (FOMO) as one sees various stocks suddenly moving upward.
FOMO is one of the biggest traps laid out for market participants and needs to be avoided at all costs.
So, How Does One Avoid FOMO?
It all starts with the mindset. FOMO occurs when your favorite stock(s) in your watchlist undertake a breakout after being in a range for quite some time.
Once this happens, the intent to buy everything happens as one believes that the trend will be to move higher only.
However, this is a trap, as one would take a loss if the stock starts reversing on the entire volume bought.
When a Breakout Happens…
When the stock breakout happens, one is advised to take a small position initially.
This is because if one starts scaling in too quickly and the stock starts reversing this upward move, then the odds of failure increase; it will lead to a complete drawdown in the account.
Let us take a recent example of a metals stock that I was tracking over three months within StockMarketEye. As I was closely watching the metals index, it was due for a breakout forming a cup and handle pattern.
You can see from the chart that purchasing volumes of this stock increased, pushing the price upwards from June 7. However, as of Thursday that week, the price started to fall back within the range, forming a structure of lower high and lower low.
If you had bought 100% quantities of their capital on this, seeing this downward move within two weeks would be very difficult; hence, why you should never follow this approach.
What Can You Do To Deal With This Situation?
Simply put, enter inverse pyramiding.
Pyramiding refers to a method where one adds a particular stock after studying it for some period of time, and then it confirms the thesis that it is due for a move upward.
Always remember that the intent is to lose less money when wrong and make more money when right to grow your account.
So, you can take an initial position equivalent to 10-15% of the capital and then scale up the remaining 85-90% over time after studying the movement of the stock (again, not in one shot).
In the below chart, I scaled up 15% of my allocated free capital around June 12. I patiently waited for the stock to move – which it did.
However, you can see that around June 21, it reversed its move due to news development in the broader metal sector resulting in an overall pullback within the breakout range.
As the stock pulls back, you need to calculate the risk-reward ratio and see if it’s in one’s favor to move ahead.
If there is another wide bullish candle, then the hypothesis of the stock moving upwards is confirmed, and you can take another small 10-15% token position on it.
Sometimes prices take a breather here and don’t move much before it gives any confirmation.
Waiting Can Be An Advantage
The advantage of waiting here is that if my reading was incorrect and the stock moves continuously lower, then my loss is limited to the 15% that I used initially. Instead, if I had bought everything and the stock reversed, I would be at a 100% loss on the entire position.
Always remember that the intent is to grow the trading account and lose less money.
Using a small scaled-up approach, entry means that you have to wait for the stock to break out and then pull back before resuming its move upward to confirm your original hypothesis. In this way, you can decide whether to allocate the money and ensure that the trading account can grow over a period of time.
Limit Your Loss, Improve Your Profits
Most traders miss out on this subtle understanding of learning how not to lose money and how to make money in the market.
Think of these two elements in a sliding scale, and most will focus on one side towards making money as that is the primary intent to get into the market.
In my opinion, a better intent would be on the other end of the scale, where one doesn’t lose much money. This way allows you to lose less when wrong and make more money when right.
Position sizing allows you to limit the losses and understand where the market is trending now.
Advantages To Position Sizing
- You limit the losses on false trades. Breakout structures sometimes don’t work as expected, and any money saved is money earned for the next trade.
- A better mentality for downward movement. From a trend view, prices usually move in a higher-high and higher-low structure. When prices move lower, one is mentally prepared to handle the downward movement.
- Improve your patience, crucial when investing long-term. Always be willing to be patient and not immediately deploy all money after the initial allocation studying the movement of the stock and its volumes.
The last point is key as it involves a shift in your investor mindset when looking at the stock market. It could be in a range, and prices fluctuate up and down before breaking out.
By position sizing, one gets a significant edge over others who don’t understand this process and like to chase the momentum in the stock.
Avoid Mistakes During Pullbacks
Many traders miss and make a mistake during the pullback.
Whenever a pullback happens after the initial price spike and traders move in with large positions, they tend to exit their position quickly with the downward move.
This is why many retail participants will refuse to touch the stock, as they expect it to move down sharply.
With the knowledge of pyramid sizing, one will be waiting for the right confirmation to take more positions in the stock and see its price move higher.
This is the critical difference between a market participant who has planned well on this execution versus those who simply bought large positions blindly without studying the stock because a breakout happened.
Important Aspects Of Position Sizing
After doing position sizing, two more critical questions need to be addressed.
- How many positions to take across the overall trading account?
- How much loss can one bear across the account using this pyramiding concept?
The 2nd question is far more critical, as most people are not mentally prepared to articulate how much they are willing to lose if the markets turn south.
This is why it is really important to define how much loss you are prepared for if the markets go down.
Positions To Take Across The Overall Trading Account
Onto the first question of position sizing across accounts.
As an example, I am assuming that normal retail portfolio sizes are $1000, $3000, and $10,000; for small, medium, and large. Your sizing may vary as you may have much higher capital than these assumptions. You can change these proportions based on your own capital size.
Small Accounts
For those with a small portfolio of <$1000, consider holding a maximum of 3-4 positions at a single time in slow-growing but stable large cap stocks.
Medium Accounts
For those with a portfolio size of $3000 and less, consider doubling the positions to a maximum of 6-8 with a mix of mid-cap and large-cap stocks.
Large Accounts
For those with large accounts of over $10,000, you can look at 10-12 stock positions in total across small, mid, and large-cap stocks.
You have to give enough capital allocation to each of these amounts and manage the risk across the same to allow for the trading account to grow.
Controlling Your Losses
To the 2nd question on loss across the whole account, this is very critical.
Most retail traders hold on to their existing positions and don’t cut their losses quickly.
You can define this as a set percentage of your portfolio (usually 5-6%).
Add Position Sizing To Your Investment Strategy
Position sizing can be beneficial to long-term investors and retail traders. This strategy does require you to be more patient and shift your mindset, but I believe it can be a great tool for those looking to limit losses and increase profits.
