Specific Shares Method

Definition: The Specific Shares Method is a trading strategy that helps individuals determine how many shares to purchase based on thorough analysis, risk tolerance, and market conditions.

Understanding the Specific Shares Method

The Specific Shares Method is essential for retail traders looking to enhance their position sizing strategy. At its core, it involves determining the exact number of shares to buy or sell based on a combination of factors, including your account size, risk tolerance, and the volatility of the asset you are trading.

Why Position Sizing Matters

Position sizing is crucial because it directly affects your risk exposure. A common mistake among traders, especially those with 6–12 months of experience, is to trade the same number of shares for every position. This approach can lead to significant losses if the market moves against you.

Key Components of the Specific Shares Method

1. Account Size: The total amount of capital you have available for trading directly influences how many shares you can buy.
2. Risk Tolerance: This reflects how much of your capital you are willing to risk on a single trade.
3. Trade Setup: The specific entry and exit points, including your stop-loss and take-profit levels, will determine your potential loss and gain.
4. Volatility of the Asset: Higher volatility means a greater chance of price swings, which can affect how many shares you should buy.

Component 1: Account Size

Your account size is the foundation of your trading strategy. It’s straightforward: the larger your account, the more shares you can potentially buy. However, it’s not just about the size but how you utilize that capital.

Example:

Suppose you have a trading account of $10,000. If you decide that you are willing to risk 1% of your account on a single trade, this means you can afford to lose $100 on that trade.

Component 2: Risk Tolerance

Risk tolerance varies from trader to trader. Understanding your own risk tolerance helps to determine how many shares to buy.

Determining Risk

To calculate how many shares you should buy, you can use the formula:

Number of Shares = (Account Size * Risk Tolerance) / (Entry Price - Stop-Loss Price)
    

Example:

If you purchase a stock at $50, set your stop-loss at $48, and have a risk tolerance of 1% on a $10,000 account:

• Risk per share = $50 - $48 = $2
• Number of shares = ($10,000 * 0.01) / $2 = 50 shares

This means you can buy 50 shares of the stock while adhering to your risk tolerance.

Component 3: Trade Setup

Your trade setup includes both entry and exit points. Having a well-defined plan is crucial.

Stop-Loss and Take-Profit

• Stop-Loss: The price at which you will exit the trade to prevent further loss.
• Take-Profit: The price at which you will exit the trade to lock in profit.

Example:

If your entry price is $50, and you set your stop-loss at $48, your risk per share is $2 as calculated earlier. If you set a take-profit level at $54, your potential profit per share would be $4.

Component 4: Volatility of the Asset

Volatility is a measure of how much the price of an asset fluctuates. High volatility can mean larger price swings, which directly affects how many shares you should buy.

Adjusting Position Size

If a stock is highly volatile, it may be wise to reduce your position size to avoid larger losses. Conversely, if a stock is stable, you may increase your position size.

Putting It All Together

Now that we’ve broken down the key components, let’s integrate them into a cohesive strategy using the Specific Shares Method.

Step-by-Step Guide to Calculate Shares

1. Assess Your Account Size: Determine your total trading capital.
2. Define Your Risk Tolerance: Decide what percentage of your account you are willing to risk on a single trade.
3. Identify Entry and Exit Points: Set your entry price, stop-loss, and take-profit levels.
4. Calculate Risk per Share: Subtract your stop-loss from your entry price.
5. Apply the Formula: Use the number of shares formula provided earlier to determine how many shares to buy.

Common Pitfalls to Avoid

1. Neglecting Risk Management: Failing to set stop-loss orders can lead to significant losses.
2. Overtrading: Buying too many shares can amplify losses. Stick to your plan.
3. Ignoring Market Conditions: Adapt your strategy to changing market volatility and conditions.

Conclusion: Mastering the Specific Shares Method

By understanding and applying the Specific Shares Method, you can enhance your trading skills and make more informed decisions. This strategy not only helps you determine how many shares to buy but also instills discipline in your trading approach.