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How much money should I put into a stock?

The obvious answer is never more than you can afford to lose, but the question is alot more complicated than that. A common problem newer traders have when beginning to trade is deciding how much money to put into a stock. Whether you are trading penny stocks or big boards, the amount you choose to buy is not what is important. Instead, it is the amount you choose to buy relative to your portfolio size and the daily volume of the stock you are buying.

As a rule of thumb, we recommend keeping positions to no more than 10-20% of your portfolio relative to its size (The bigger the portfolio size, the smaller this % becomes, we recommend 3-8%). For example, if one has a $10,000 portfolio, they should not be putting more than $1,000-$2,000 in any one stock at a given time.

Of course, that is just our recommendation and that is not to say that traders who go “all-in” don’t have success. However, we have found, such a strategy to be highly risky. Though it may pay off once or twice, it only takes that one time to be caught “all-in” and have a stock go south to wipe out months of gains with just one loss. Keeping a limit to no more than 10-20% keeps you protected on the downside, as even when you have to take a loss on that position, it is affecting no more than 10-20% of your portfolio.

The other factor to consider when buying a stock is the trading volume of that particular stock. It is typically not a good thing to be making up the majority of the volume on a stock. Why? Because any shares you buy are shares you are going to try to sell for a profit. So if a stock has traded 500,000 shares total for the day, and you buy 500,000 shares for yourself, you have now become 50% of the stocks trading volume. That does not bode well for your chances of being able to take profits smartly and without affecting the share price or liquidity.

We recommend never buying more than 1-3% of the days total trading volume. Let’s take our recent alert KIWB for example. After the first 1/2 hour of trading on 5/6/2011 the stock had already traded about 8 million shares. So if you would’ve been deciding how many shares to buy, by our metric, you would’ve been able to buy anywhere from 80,000-240,000 shares. We feel that is definitely a suitable position to stand to make some healthy profits off of.

Now let’s take a less liquid stock to drive home our point. HCEI, which we put on watch in our chat room @ .014 on 5/6/2011, traded a total of 2.6 million shares that day. At the time we put it “on watch,” it had traded about 1 million shares. Sticking to our rules of not buying more than 1-3% of the total trading volume, this would’ve allowed one to buy anywhere from 10,000-30,000 shares. Sure, a noticeable difference from our prior example of KIWB, but that is because HCEI was alot less more liquid. By the end of the day, HCEI had traded 2.6 million shares, and one would’ve had no problem selling those 10,000-30,000 shares for profits on the way up.

It isn’t as simple as just determining how much you want to buy. The key thing to remember is how much can I buy, that other people will then buy from me at a higher price to ensure I collect profits? We find that based on our rules, especially the second one (not being more than 1-3% of total volume), one will have much greater success taking profits on the way up. Also, relative to our first point (10-20% of your portfolio size), we don’t care how small your portfolio is. If you have $500 in your portfolio you should start practicing these methods now. Yes, we understand it will be harder to make significant profits at first, but getting into the habit of doing so now will help you later as your portfolio (hopefully) grows larger.

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