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Hi everyone,

In the Transocean write up (, I said at the end that I'd be opening a 2% position ($340) on the way to a 4% position. (For the record, TMF bought for my account on Tuesday 6 shares at $63.94 -- wouldn't you know it, right near the high for the day.) And I called it not a full-conviction 6%.

So why am I choosing those numbers and how big would I let a position grow if it's wildly successful?

Well, the target position sizes of 2%, 4%, and 6% are based on invested capital as a fraction of total available ($17,000). For the 4% and 6% positions, I plan on buying in 2 or 3 stages to minimize risk of going all in just before a big drop in price. The commission cost (which we are being charged) is very low, thanks to the broker (I believe we're using Interactive Brokers). That purchase cost me $1 in commissions.

So why those size allocations?

In the Fool's analyst development program which I completed late last summer, one of the (many!) readings we went through was this article from Zeke Ashton of Centaur Capital Partners (I don't know if he's still there). In it, he discusses position sizing as a function of confidence in the idea. Most confident, largest position size; less confident, smaller; and so on down to speculative, smallest.

The reasoning is that you want to have enough money in the ones you expect to be most right about to give you a good push to the portfolio's results, while if you are completely wrong on the lower confidence ones, the blow up doesn't hurt as much.

Now that makes a lot of sense to me, so I decided to apply it to this portfolio. Unfortunately (or fortunately, depending on your point of view), I don't have a large pot of money in order to finely tune the position sizes into the four categories (or more, if you subdivide them) that he outlined for the long side of the port. If I make the divisions too small, then a single share could push the size into a higher or lower category, depending. So, I settled for three target sizes, ranked by how confident I am or how risky I view the stock.

Taking this back to Transocean, I'm quite convinced that the market is pricing in too much pessimism about the company's prospects going forward. The company is the largest rig operator in the world, has the vast majority working outside the Gulf, and has three newbuilds coming on line over the next six months at respectable dayrates. The liability for damages or lawsuits is unknown and will almost certainly drag out in court for several years while Transocean and BP fight over those indemnify clauses in the contract. (I agree with management that overturning those clauses would set a horrible precedent and you would see all kinds of ripple effects in every single business-to-business transaction around.) But the risk is there.

Because of that, and because the company has a relatively high level of debt compared to its peers, I decided that, instead of a 6% position, I'd go for a 4% position. If I'm right, it will still be large enough to help the portfolio. If I'm wrong, it won't hurt as much as it would if I put too much in.

Anyway, at the end of each buy article, I'll mention the target position size and that I'm buying the first or second (or third) increment to reach that target.

How do you look at position sizes in your own portfolios?

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