The most critical aspect of being a successful market speculator is often neglected in trading courses and trading blogs. The aspect is position sizing. Everyone wants to focus on chart patterns, trade setups, and when they’re going to buy a lambo. But without a strong grasp of bankroll management and position sizing, all of these topics are for naught (and the lambo will likely remain a distant dream).
An investor could have a portfolio of a dozen stocks, of which 11 are losers. But if the 12th stock is 78% of the portfolio and it’s a big winner, then it can drive the total portfolio return well into the green.
Stan Druckenmiller seems to agree when he said, “Sizing is 70% to 80% of the equation. Part of the equation is seeing the investment, part of the investment is seeing myself in a good trading rhythm. It’s not whether you’re right or wrong, it’s how much you make when you’re right and how much you lose when you’re wrong.”
There are several aspects of position sizing worth considering:
- Betting larger when one has higher conviction in a favorable outcome. It’s logical to increase the size of our position the more we believe the outcome will be favorable. Likewise, our position size should be smaller when there is greater variance in the potential outcome. The trick with betting larger is being able to objectively assess whether the probability of a favorable outcome really is greater, opposed to a variety of cognitive biases that create an illusion of greater certainty for the investor.
- The investment time frame should also be considered when adjusting one’s position size. The longer the investment time horizon the greater the potential for volatility. That means the longer the time horizon for the investment to play out, the smaller the position size that one should use. The shorter the time frame, the larger the position size one can use as long as one’s risk is clearly defined.
- Risk tolerance is a critical factor in determining position size. How much of a drawdown are you willing to withstand? In the junior mining sector stocks can have absolutely breathtaking rises and falls. Take these two charts for example:
Mystery Junior Mining Chart 1
Mystery Junior Mining Chart 2
There are many other examples like these in the junior mining sector from the last few years. These stocks can rise 1,000%+ in relatively short periods of time, only to subsequently decline 80%, 90%, or even 99%!
In order to handle this sort of volatility, one should size their positions accordingly. If a stock can realistically rise 10x or more during bull market periods, or when your investment thesis proves out, then a position that equates to 10% of your portfolio at initiation can deliver a doubling of your total portfolio value.
On the flip side, a 10% portfolio position that declines 50% is not fatal, it only amounts to a 5% drag on the overall portfolio value. Even an 80% drop would still only amount to an 8% portfolio drawdown.
Too often novice investors in micro-cap stocks take positions that are far too big for the volatility that these stocks can experience. The end result is usually these positions being liquidated after big losses.
Most investors do not have the risk tolerance for the junior mining sector. While it may seem like a great idea to own these stocks when they are rising during a bull market phase, they can also experience very large declines and go through periods of being relatively illiquid during bear market phases.
Looking back, we may regret not holding a larger position in a stock that has become a big winner. But hindsight is 20/20, and we should not fool ourselves by making things seem more clear than they actually were in the moment we took a position.
If one is ever debating on how large to size a new position, I invite you to err on the side of caution and choose a smaller position size. You can always buy more later if/when your thesis is getting stronger based upon evidence.
By far, the most important skill for an investor is knowing when to size up a position and bet bigger when they have a higher level of conviction. This is a nuanced subject because there are times when certain ‘rules’ may not apply. Conventional wisdom has it that one should add to a winning position at higher prices when the fundamental story is getting stronger and being confirmed by price action. However, there are situations (particularly in the junior mining sector) where the market action is relatively quiet as the company works on advancing its project(s) to some sort of important milestone (drill program, PEA, etc.). It is this quiet period that may allow the investor to accumulate a substantial position at low share price levels. Once the company news flow is more active, the share price could jump to multiples of what it was trading at during the quiet period.
A few examples come to mind from recent history:
In October 2018, Amex Exploration (TSX-V:AMX) began a follow-up drill program at the Eastern Gold Zone (EGZ) at its Perron Project in Quebec. The stock remained relatively dormant for a few weeks before some buying pressure began to drive the share price higher. Despite the company reporting encouraging drill results on November 20th, 2018, the market remained skeptical and sold the news in the final days of November. The buying pressure came back into the market in early December and Amex reported a bonanza-grade gold intercept at the EGZ on December, 13th, 2018.
Without knowing anything about gold exploration or Amex, a technical analyst would have bought AMX shares on the breakout above $.10 (green shaded area above) in early December. The ensuing rally over the next three months led to a 15x gain in AMX shares. At a sub-$10 million market cap, AMX offered an attractive opportunity for accumulation during November/December 2018. The drill results proved to be exceptional, but certainly not something that should be expected in every junior explorer. If one can make 10x or 15x on the winners, it can make up for a lot of 50% losers that report dusters from their drill programs.
As it turned out, 2018 was a great year for Canadian gold discoveries made by junior explorers. Great Bear reported its discovery hole in August 2018 and Westhaven (TSX-V:WHN), another Canadian junior I was fortunate enough to be a shareholder of, made its discovery at the Shovelnose Project in British Columbia in the summer of 2018 (assays were reported in October 2018):
Since Westhaven’s June 2018 low near $.10, their stock nearly doubled before it staged what would prove to be a decisive breakout at the end of September. Westhaven shares eventually rose to $1.42 per share in December 2018, a more than 14x return from the levels it was trading at just six months before.
One of the best technical examples of an accumulation phase in a junior miner, followed by a powerful upside breakout occurred in Kodiak Copper (TSX-V:KDK) during the summer of 2020:
In July 2020, Kodiak announced that it had begun drilling at its MPD Copper-Gold Project in southern BC, Canada. Over the next seven weeks, KDK shares traded in a relatively tight range constrained by support near $.40 and resistance near $.60. KDK began to change its trading character at the end of August when the stock began moving higher on increasing trading volume.
KDK was in the midst of a clean technical breakout by the close on September 2nd, 2020. On September 2nd it traded well above average volume, and closed at $.75. On the morning of September 3rd, the company published a news release reporting the discovery of a significant high-grade copper-gold extension of the Gate Zone at MPD. KDK shares soared on the news of the results of hole MPD-20-004, rising more than 300% over the next few weeks.
These are three examples of virtually best case scenarios in the junior mining sector. There will be plenty of other situations where an investor accumulates a position during a quiet period and the subsequent drill results prove to not be up to market expectations. It is these situations where experience and objective analysis can help an investor to know when to cut losses and exit, or stick around for a while longer.
Some questions that can help to decide whether to size up a position in junior miner:
- Am I comfortable with the potential downside? How much can I lose in a worst-case scenario?
- Is the upside potential of whatever catalysts I’m looking for big enough to make it worthwhile?
- Is the risk/reward asymmetric? In other words, is the reward potential significantly greater than the downside risk?
- Is this a management team that I can trust to tell it like it is?
- Is there a clear time frame in which I will know whether my thesis is correct or not?
- Are all the stars aligning? Fundamentals? Technicals? Macro? Or is there a significant weakness with the thesis (i.e. stock trading poorly despite apparently strong fundamentals)?
- Will you be willing to admit you were wrong if the facts do not validate your thesis? What sort of price action would cause you to change your mind (for better or worse)?
If you can answer all these questions and you are comfortable with the answers, then you might have a trade worth taking some added risk on. The biggest positions should be the ones where you have a rare, unique insight into a company and the catalysts that could drive its share price higher in the future. These situations will usually involve a stock that few are paying any attention to. In junior mining, it can often mean being a lonely buyer of a stock for an extended period of time before the herd begins to arrive and take notice.
There is no magic cookie cutter formula for how to size positions in junior mining stocks, however, I feel confident in saying that there are very few situations that merit a greater than 10% portfolio allocation to any one stock. If you have the good fortune of watching a position grow into a big winner then it will be up to your judgment to decide how large a percentage of your overall portfolio you will let it be. And it’s also important to remember that cash is a position too. Having a healthy cash allocation (10%-20%) allows one to take advantage of new opportunities as they arise.
I would be interested to hear your thoughts on position sizing in junior mining, and even some examples of your best/worst trades.
DISCLAIMER: The work included in this article is based on current events, technical charts, company news releases, and the author’s opinions. It may contain errors, and you shouldn’t make any investment decision based solely on what you read here. This publication contains forward-looking statements, including but not limited to comments regarding predictions and projections. Forward-looking statements address future events and conditions and therefore involve inherent risks and uncertainties. Actual results may differ materially from those currently anticipated in such statements. This publication is provided for informational and entertainment purposes only and is not a recommendation to buy or sell any security. Always thoroughly do your own due diligence and talk to a licensed investment adviser prior to making any investment decisions. Junior resource companies can easily lose 100% of their value so read company profiles on www.SEDAR.com for important risk disclosures. It’s your money and your responsibility.