Editor's note: Limited downside, unlimited potential upside…
In today's Weekend Edition, Palm Beach Letter editor Teeka Tiwari explains exactly how you can achieve this in your trading… As you'll see, with this strategy, you'll never have to worry about devastating losses again…
Most people don’t know this. But you can buy $5,000 worth of stock and only risk $1,000 doing it.
It’s all based on a simple, powerful concept…
I’ve spent years studying this strategy. And I believe it will help you make massive profits in the markets—without losing another night of sleep worrying about your investments.
In a moment, I’ll show you exactly how it works.
But first, let's look at the four major components to this strategy…
The Four Most Important Terms You Should Know Before You Invest
To be a more successful and disciplined investor, you need to master these key concepts:
Stop loss. This means you set an order with your broker to sell a position when it reaches a certain price. There are two types of stops.
Trailing stop: The stop-loss price can be set as a percentage away from the current market price.
Hard stop: The stop-loss can be set as a constant price. This mitigates risk by limiting the dollar amount you are willing to put into a position.
Stop-loss size. This is the difference between the buy price and the stop-loss price. So, for example, if you buy a stock for $50 and have a stop set at $40, the stop-loss size is $10 (the amount you would lose per share if you sold at the stop).
Position size. This means you designate a dollar amount you are willing to put in a given position within a portfolio. This limits risk by managing our exposure to a position that we are in. I generally recommend that you risk no more than 1% of your investing capital in any single position.
Position risk standardization. This means you should keep the position size of your portfolio investments uniform. In other words, don’t put 1% into one trade and 6% in another trade. Instead, all of your trades should be 1% of your portfolio. That way, you won’t over-own a losing position or under-own a winning position. I’ll explain this in more detail in a moment.
Altogether, these make up the foundation to any robust risk-management plan.
Now let's look at a hypothetical trade and company to see how it works…
How to Invest $5,000 and Only Risk $1,000
Let’s say you have a $100,000 portfolio. And you want to buy a small-cap called ABC Company. You really like ABC and believe it will be a big winner. So, you want to leverage your position while minimizing your risk.
I’ll show you how you can buy $5,000 worth of ABC shares but only risk $1,000 (or 1%) of your $100,000 portfolio.
First, we need to set up the trade. For this example, we’ll be using a hard stop.
Buy Signal: ABC Co. (ABC)
Buy-up-to Price: $50
Stop Loss: $40
Stop-loss Size: $10
Position size: 1% of portfolio ($1,000)
• The buy signal is the name and ticker of the company
• The buy-up-to price is the maximum you will pay for the stock
• The stop loss is the bottom price at which we’ll sell
• The stop-loss size is the difference between the buy-up-to price and stop loss
• The position size is the percentage of your portfolio you’re willing to risk on a given position
Now that we have the trade setup, we can use a simple formula to determine how many shares you can buy: position size divided by stop-loss size.
Here’s the step-by-step method to calculating the number of shares you can buy.
Step 1: Calculate the position size.
The position size is $1,000 (1% of your $100,000 portfolio).
Step 2: Calculate the stop-loss size.
The stop-loss size is $10 ($50 buy price minus $40 stop-loss price).
Step 3: Calculate the number of shares you can buy.
The number of shares you can buy is 100 ($1,000 divided by $10).
That’s all there is to it.
Now, here’s the kicker…
We’ve determined you can buy 100 shares of ABC. That will cost you $5,000 (100 times $50). But remember, you’re only risking $1,000 on this trade.
Let me show you why…
Our stop-loss price is set at $40. If ABC hits that price, we’ll sell.
We have 100 shares of ABC. If we sell them at $40 each, we’ll recoup $4,000.
Our initial purchase was $5,000. The most we could lose on this trade is $1,000.
So, our downside is capped.
But what about the upside? What if ABC goes up 10 times in value?
That $5,000 will be worth $50,000. But you still only risked $1,000!
That’s the beauty of having a robust risk-management strategy. Your downside is limited, but your potential upside is limitless.
Each trade becomes a $500 (if you risk only a half-percent) or a $1,000 bet (if you risk the full 1%). You can easily recoup those losses. One bad trade won’t wipe you out. (In tomorrow’s essay, I’ll show you how you can lose more trades than you win and still come out on top.)
It’s the major losses that we want to avoid… 20% or 30% of your portfolio in a single trade that result from poor position sizing. Those are hard to overcome. And they can ruin entire portfolios.
But with a sound risk-management strategy, you won't have to worry about these devastating losses…
You'll sleep well at night knowing you can profit in today's market… without risking your entire life savings.
Editor, The Palm Beach Letter
Editor's note: Teeka and Palm Beach Research Group co-founder Tom Dyson will be using this same strategy in their brand-new service, Palm Beach Confidential. In Palm Beach Confidential, you’ll be able to access the exclusive picks Teeka and Tom come across in their meetings and discussions with the most “hyper-connected” elites in the world.
These are often small hidden gems with the potential to make you a lot of money—like the tiny gold recommendation Teeka believes will explode up to 838% from today’s prices. To learn why they've withheld these profitable trades from you until now, click here.