It’s not how much you have invested, but how much you have at risk

How much money should you put into one stock or investment?

Should you buy 100 shares or $5,000 worth of shares? Should you invest 5% of your portfolio or 5% of your net worth?

These are incredibly important questions. And your answers could mean the difference between making real money from your investments and losing it all.

I’m not joking here. If you don’t have a system for determining how much money to put into one investment, you’re just shooting from the hip.

That’s unacceptable especially when the answer is so simple.

So. what’s the RIGHT amount of money to put into any one investment?

If you’re not sure, you are not alone. I’d bet 99% of investors don’t have a system for determining how much is too much to invest in one idea, or how much is not enough. It’s stunning to me how willing people are to risk their life savings like this especially when there are simple answers.

Two good friends of mine, both PhDs, have spent their lives working to help individuals become better traders. They do this by zeroing in on problems like what I’ve described above.

The first is Dr. Van Tharp, who was interviewed in the excellent book Market Wizards: Interviews with Top Traders. by Jack Schwager. The second is Dr. Richard Smith. who has a PhD in applied mathematics.

Their work focuses on the same simple concept:

It’s not how much you have invested, but how much you have at risk.

Let me explain.

Let’s say you have a $100,000 portfolio. You’re willing to RISK a loss of 1% of your portfolio $1,000 on a single trade. You also use my recommended 25% trailing stop.

According to the rules Van and Richard have laid out, you could invest $4,000 in that trade. If the trade goes down 25%, you’ve lost $1,000 or 1% of your portfolio.

That’s the basics.

You can push all these numbers around, of course.

You may say, Gee, I really don’t want to lose 1% of my portfolio on any one idea. You could do a couple things.

You could invest less money. If you invest just $2,000 (0.5% of a $100,000 portfolio), you’re only risking $500 (with a 25% trailing stop) if the trade goes against you.

You could also tighten your trailing stop. If you are only willing to risk 0.5% of your portfolio on any one position, you could tighten your trailing stop to, say, 10%. Since you’re OK risking $500, you could invest $5,000 in that trade.

I know it’s a lot of numbers. But the important point to understand is.

It’s not how much you have invested, but how much you have at risk.

So how much money should you have at risk? And what is the right trailing stop?

For some strategies that will help answer those questions, I highly recommend you check out Richard’s website, TradeStops. You can learn more about it here.

I also recommend Van’s book, Trade Your Way to Financial Freedom. You can learn more about Van’s book and the other educational trading tools he offers at his website here.

These two guys are sincerely committed to making you smarter investors. Check ‘em out.