What is Margin of Safety?
Benjamin Graham’s earliest teachings and the most vital is Margin of Safety. Most of the time margin of safety is always related to only stock investing. Rarely it is considered for Stock Trading.
The wonderful thing about the margin of safety is its simplicity and how much effective it is. It protects investors from making mistakes.
In stock investing when you make a big mistake and even if you have your investment is 90% down still you have the stock in your demant account. That is not the case in stock trading if you lose 90% of your capital in a single trade or in few trades, ultimately you are left with nothing.
A margin of safety gives you the cushion or buffer to absorb your big mistakes and still make money in long term. According to a margin of safety principle only those stock should be purchased who’s market value is much lesser than its intrinsic value. Importantly margin of safety is a precaution and it should not be considered as a guarantee of returns.
Margin of Safety for Stock Trading
The margin is to ensure that you keep learning and don’t quit. You get the vantage point when your next 10 trades you lose and still you continue to trade and earn a reasonable return at the end of the year.
Now margin of trading for stock trading is to choose the right amount to block for each trade and not to overburden any one trade for reward or risk.
Contemporary stock brokers give excessive leverage for stock trading and this most of the time exploited for their own loss. A margin of safety should consider and survive market crashes, falls, and corrections.
What is the Optimal Position Size for Me?
There is no mathematical rule to calculate the position size for any particular person. The reason being that from person to person the financial intelligence and behavior differs. The ideal way to calculate your position size is if you can have a very good sleep after 10 continuous trading losses and still continue to trade. Not that you go bankrupt with all your money and keep adding capital for the purpose of trading.
Most people keep giving importance to the system or strategy for stock trading whereas the key role is played by Risk Management and Money Management. System relatively matters less than risk and money management.
Most of the time after few consistent profit people add their capital which is the scariest thing one can do. Other people stop trading after few losses. Hence they lack the discipline of trading.
This would be an interesting article An Interview with Van K. Tharp, Ph.D.
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