How Many Shares Do You Buy?

Jan 21, 2015 -

How many shares of a stock you can buy is largely dependent on how much capital you have. Evidently, the more money you have the more shares you can buy. But does that mean you should buy more shares of a company?


The general rule to how many shares you should buy is largely a function of how much you are willing to lose or risk. Not only are you looking at how much money you could lose, but also the opportunity cost foregone. Ask yourself what else could you be doing with the money? You could be saving it for a down payment on a house or a car. Alternatively, that money could be going into bonds or certificate of deposits (CDs).

Furthermore, investments take time to appreciate in value. Even if you are looking to trade stocks in the short-term, you may need to wait days or even weeks for their value to increase. In other words, when you buy a stock you will have to be prepared to have that money "locked" up for a certain period of time. Of course, unlike a CD there is no set time limit, but you can't exactly withdraw money out of your brokerage like a checking account either. 

The general rule to how many shares you should buy is largely a function of how much are you willing to lose or risk.

When you've figured out how much money you are willing to set aside for stocks and understand that you may not be able to use that money for a while that's when you can start to determine how many shares of a company you should buy.

Determine your Trading Time Frame

Are you looking to trade stocks in the short-term (less than a year) and engage in speculation? Or are you looking to hold stocks for the long-term (more than a year)?

Long-Term Position Sizing

If you are looking to hold stocks for the long-term then the answer is easy. The cheaper the stock and the stronger the belief you have in the business itself, then the more of it you should buy. For example, if you have $30,000 then maybe allocate $15,000, $10,000 and $5,000 to three different stocks. Put $15,000 in the stock you have the strongest belief in and $10,000 in the next and then $5,000 in the stock you are not as confident in. Alternatively, you could allocate it evenly between three. It is better to own a lot of three of the best stocks than some shares of twenty different stocks. Why do you ask? The reason is because you will be more selective and only pick the best of the best

Short-Term Position Sizing

Should you decide to trade in the short-term and engage in stock speculation then you'll have to determine how many shares you buy based on how much you are willing to lose on every trade. 

For example, let's say you have $10,000 of trading capital. The rule of thumb is to risk no more than 1% of your portfolio in any one trade. That means the most you can stand to lose on one trade is $100 including trading commissions. This doesn't mean that you can only buy $100 dollars worth of stock in any one trade. In fact, you can buy $10,000 in stock and still only risk $100. 


What do you mean by buying $10,000 worth of shares and still only risk $100?

Suppose you buy Clean Energy (CLNE) at $12 a share. You put your STOP LOSS at $10 dollars per share. The stop loss is the point at which you admit defeat and for whatever reason your trading plan no longer works. In other words, time to get out of the position.

In the above situation, you are buying at $12 and because your strategy is to play the $12-$14 trading range you sell when it breaks $10. You do this because you want to protect your capital and limit your losses to $2 per share. Yes, the stock could rebound and go back to $12, but you don't want to take that risk because it could just as easily go down to $8. When your trading strategy stops working it is time to get out because you can no longer with high probability predict where the stock will go next. When you first entered the position at $12, you had a good idea that it could go up to $14 and trade within that trading range. The moment it breaks the trading range, the strategy is to exit immediately. Cut your losses right then and there.

Should you decide to trade in the short-term and engage in stock speculation then you'll have to determine how many shares you buy based on how much you are willing to lose on every trade.

If you are looking to risk $2 per share and based on $10,000 portfolio, you should buy 50 shares of CLNE or at $12 a share that is a total of $600 dollars. If the stock dips to $10 you exit and come out with a controlled loss of $100 (before commissions). Should the stock go to $14, you come out with a $100 gain (before commissions). That is how you can trade with more money, but put less money at risk.
 
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