Recently, I was reading a finance blog recommending investors, that it is ideal for a retail investor to have at least 40-60 open positions in their portfolio for proper diversification and wealth building. Later, that evening I was reading Mark Minervini saying that the maximum positions he has at any given point of time is roughly between 5- 7. 

What a stark contrast between a blog that recommends having a portfolio of 40-60 stocks for diversification and Mark Minervini saying that he never exceeds more than 5-7 positions at any given time. 

For those who are unaware of Mark Minervini – He is the author of “Trade Like A Stock Market Wizard” and “Think & Trade Like a Champion”. He has also won the US State investing championship twice in 1997 with 155% return and in 2021 with 334% return .You can see his recent interview done by  Mr. Vivek Bajaj in his Face to Face you tube program.

This made me think “How many open positions is ideal for a positional trader to have in his portfolio?”. When a two time winner of the US investing championship says that he has very limited open positions at any given time, it has to be taken seriously. However, I thought that it would be better to check in a mathematical way, whether the number of open positions at any given point of time has an impact on the growth of account size and profitability.

In this article, I am going to analyze how having lesser / concentrated open positions have a remarkable outcome in our stock market investing and how it helps us to grow our account quickly. I will also share my thoughts on the things to be considered while having a lesser / high concentrated position. 

The Hypothesis:

For my study, I considered three traders. Trader A, B, C.

All three traders have a capital of 6 Lakhs and this 6 lakhs is divided equally for the positions they take. 

• Trader A always trades in a very concentrated portfolio. At any given time he has only six open positions. Invests 1 Lakh  each trade.
• Trader B is a little conservative. He will have 12 open positions at any given time. Invests, 50,000 each trade.
• Trader C is very conservative and believes in diversification too much and hence has 18 open positions at any given time. Invests 33,333 approximately, each trade.

All three traders set a risk reward ratio of 1:2 or an R Multiple or 2R.

They limit their risk to 10% every trade and have a target of 20% but not limited to only 20%. They will ride the position as much as possible if the conditions are right.

Their winning probability or batting average is fixed at 50%. That is 

• Trader A – out of total 6 positions, wins three trades and loses three, 
• Trader B – out of total 12 positions, wins 6 loses 6
• Trader C- out of  total 18 positions, wins 9 and loses 9.

Now, it is considered for simplicity that the trades are carried for a period of 1 year. That means for the entire 1 year time period, they won’t take any other trades other than the ones taken already. 

Also, it is assumed that each trader is lucky enough to get one winning trade which gives them 100% return, instead of their usual profit target of 20%. We can consider this as 1X multi-bagger. Thus, each trader gets one multi-bagger from his positions and all other trades when won gives 20% profit and when lost gives them 10% loss.

Results:

Now, the results are as follows:

For Trader A with six open positions:

You can see that at the end of six trades he ends up with 7,10,000 with net profit % of 18%.

Trader B with 12 open positions ends up with a net profit % of 11.6% that is 6,70,000.

Trader C with 18 open positions ends up with a net profit % of 9.4% that is 6,56,667.

So, from the above example, it is clear that the trader with a concentrated portfolio gets a higher return than the others. Also, note that as the portfolio becomes more diversified the returns reduce to half. From 18% when the open positions are six  to just 9.4% when the open positions are 18, even though the risk reward ratio, the amount invested ( 6 Lakhs in total) remains the same.

Now, let us dive in further. Let us assume that this is continued for the next three years and each year, each trader manages to get a multi-bagger. Now, see the image below to see how the capital grows at the end of each year for these three traders.

Trader with 6 positions at the end of three years makes 9,94,192 while trader with 18 positions makes only 7,86,542.

In terms of percentage see the image below.

The annualized return percentage (CAGR) of Trader A stands at 18% and his absolute return stands at 66% while for trader C it is just 9% and 31% respectively.

Why the impact?

The impact comes from the fact that in concentrated portfolios we are buying larger quantities of stocks than the one we can buy with a diversified portfolio. For example, Trader A invests 1 Lakh in a position while Trader C invests only 33,000 approximately in a position.

By that sense, if a stock is trading at 1000 INR then Trader A will buy 100 stocks while Trader C will be buying only 33 stocks. If the trade is a multi-bagger then Trader A gets a fantastic and remarkable profit.

To understand more, we can calculate the impact of profit or loss of a individual position on portfolio level and how it varies in different open positions as follows:

Net portfolio profit or Loss = % of gain in a single trade / Number of positions

So, if Trader A, who has six positions in open, gets 100% gain in a position, then the net gain of portfolio can be calculated as follows:

Net portfolio profit = 100% / 6 (positions) = 16.66%

See the table below for more examples:

So, now it will be clear why the number of open positions is very important in deciding our trading success. So, next time when you get huge profits in a trade like 70%, 100% or more than that, before becoming too optimistic about yourself, check the total impact it had on your portfolio. You may even get a trade that gives you 1000% return, but if you have 20 positions then it is just 50% of your entire portfolio. Track this also in your trading journal. I had explained in detail how to make a perfect trading journal for free using excel and a website called trade bench. You can read it for further details.

 In a bull market, we get more opportunities to trade. But, in the race to get into all trades one may be tempted to take as many positions as possible. That’s why an active trader actually loses more money in a bull market than making it.

Finding Multi-baggers:

One may argue that, when taking many positions one can get more multi-baggers than a trader taking less positions. This seems to be a valid argument. But, even great traders and investing champions like Mark Minervini themselves claim that their batting average is not more than 45%. It is not easy to both spot and ride a multi bagger. 

Anyone of us can spot a multi-bagger in hindsight, but have we gotten ourselves a ride in that up-run is the question. 

By that logic, in our example above, Trader C has to get 3 multi-baggers giving him 100% returns to get equal with Trader A. That too he should get three multi baggers every year consistently for three years, to get equal with Trader A. 

Getting three multi-baggers by taking 18 positions may be logically easy, but the reality will be completely different.

Most successful traders had made big money by investing huge money in two to three stocks. Those 2-3 stocks only raised their portfolio to the moon. 

Have you seen any mutual fund manager beating the index by a margin more than 5-6% consistently? No, right? This is because they look for safety. They don’t want a drawdown more than the index. A large cap fund manager selects more than 80% of stocks from nifty 50 and the remaining 10-20% here and there from small caps. Even if these 20% stocks become a multi-bagger, it does not make any big impact in the investors portfolio because of this diversification. That’s why investors are becoming more interested in passive investing. After all, passive investing is not as passive as we think. It also runs by certain rules.

Other points to remember:

• Having a concentrated portfolio works well only if you are strict with risk management. If you are not following risk management properly, then concentrated positions may backfire since the loss % will also be higher. In our example, if Trader A loses 50% in a trade then it is a loss of 8.3% of the portfolio, while for Trader C it is a net loss of only 2.7%. So, make sure you know what you are doing.
• One should know how to do position sizing properly. Without position sizing, nothing will work in the market. Sooner one understands this, sooner he is nearer to the success. I had written a must-read article on “various position sizing strategies” which I keep by heart.
• Concentrated portfolio works well, if one knows how to limit drawdowns. One should exit the positions immediately when trade is not working in one’s favor. Limiting drawdowns can grow your account faster and bigger.
• In my next article, I will try to write about how batting average and position sizing is related, and how one should be adjusting the positions depending on the different market conditions.

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Thanks for reading with patience and wishing you all a successful investing journey ahead. Happy investing !!!