1) Determine Stop Loss (trailing) and Profit Target. [LINKS]
- Base stop loss and profit target on key support and resistance levels (if history allows): trend lines, moving averages, pivots, recent H&L, historical H&L, measured moves, etc.
- Profit Target can be raised depending on the ongoing situation, but stop loss must remain as it did at the initiation of the trade.
2) Determine Total Tolerable Loss based on a percentage of Total Portfolio Value (2% is a fairly risk-averse percentage, and will be my default for now)
3) Divide Total Tolerable Loss ($) by Loss Per Share (difference between Purchase Price and Stop Loss Level) to get Total Position Size* (round as appropriate)
4) At this point, one should calculate the Profit Target : Total Tolerable Loss ratio. [LINK] This is a last-minute filter to determine the potential best performers at a given time.
- A value of 2 would be considered great, 1.5 mediocre, and anything below 1.25 not worth investing in.
- Remember that Profit Targets can/should be adjusted upward or downward as the situation progresses, meaning the initial ratio can be skewed by conservative or aggressive expectations.
*Total Position Size is a risk-limited quantity. The Actual Position Size may be lower due to a shortage of Cash in the account, due to the fact that we are calculating Total Tolerable Loss from our portfolio as a whole, which may be comprised of any proportion of cash and other investments.
