Many years ago, I received a frantic call from a gentleman that had "bet the farm" on a speculative stock that was mentioned on CNBC. He was losing his shirt on the position and wanted to know what to do with it. Even though I felt very bad for him because he had been paralyzed in an auto accident and bet his entire injury award, $360,000 on the stock, I refused to offer him any advice. But I wondered, "How could he be so stupid?"

This incident led to my classic essay, dated 05/24/96, "Where's the Beef?" More recently, 05/11/07, I wrote about a guy who lost $500,000 on the quiz show, "Are You Smarter than a Fifth Grader? Two weeks later, I wrote another essay called, "The Risk of Ruin." It was about position sizing, actually.

Position sizing is a very important part of portfolio management and, in fact, it is the first thing one should consider when putting money at risk. Before making any investment, whether it be for the purchase of a car, house or stock, one must ask, "How much can I afford, or am I willing, to lose on this investment?"

The answer to this question has several parts, the first being that of asset allocation, i.e., "What percent of my net worth can I risk in this particular asset class?" Once this has been translated into dollars, you know how much money you have to work with. Let's suppose the amount is $10,000. The next question becomes one of, "How should I invest it?"

It is generally believed that one should not risk any more than two percent of their stake in any single stock position. Even that seemingly small amount is too much for me. I believe that one should not risk any more than one percent of their stake in any single stock position. (See my 02/06/09 essay on Risk Management). What? One percent of $10,000 is only $100. How can I make any serious money investing only $100 at a time?

Hold on, silly boy. There's a big difference between what you invest and what you risk. For example, you may invest $1,000 of your $10,000 stake in any single stock position and still limit your risk to $100 by using a 10% Stop-Loss order. Or you can invest $500 in any single position and use a 20% Stop-Loss order. In fact, there are an infinite variety of investment and Stop-Loss combinations you can use to limit your risk to one percent of your stake. My essay, "How to Set the Right Stop-Loss Percent," dated 02/20/09, explains exactly how investment decisions and Stop-Loss percentages are tied together in Position Sizing.

In regard to managing the Model Portfolio, we start with a stake of $100,000 at the beginning of the year and normally elect to have 10 positions with a 5% or 10% intraday Stop-Loss, depending on how we feel. At the end of each day we calculate new Stop-Loss Prices from the higher of our purchase price or the highest closing price since purchase. Our goal is to get the Stop Price above the purchase price as soon as possible.

In the current campaign, which started on Monday, June 22nd, we used 50% of our available funds to establish 10 positions. Therefore, we are effectively risking only 5% of our stake even though we're using a 10% Stop. Moreover, we have not been replenishing vacated positions since the downturn has appeared to fizzle-out.

One of the errors many investors make is they think that making money in the stock market is only about picking the right stocks. It could be if you're right all the time. But nobody is right all the time. So the secret to success is that of making money in spite of your losers. In fact, many of the most successful money managers say that of even greater importance than stock selection, is Position Sizing and Portfolio Management.