How to think about Position Sizing?
Most investors obsess over what to buy, but far fewer think deeply about how much to buy. The latter is equally important because it's not just about being right or wrong on a particular stock; it’s about how much you make when you’re right and how much you lose when you’re wrong. This is where position sizing becomes critical— It's the difference between a winning idea and a winning portfolio.
A simple way to think about position sizing is by weighing two variables— 1. Your conviction and 2. Potential upside
Your conviction - Conviction is basically a function of how well you understand the business. Simple things like how does the company make money? What is the underlying industry structure look like? How will the company defend its market position over time? How is the competitive landscape evolving? What is the long-term vision of the management? How does their track record of execution look like? And most importantly, what are the 2-3 key risks involved and what is the company doing to solve them?— These are some of the important questions required to build strong conviction.
Potential upside - Judging the potential upside is about asking questions like how big are the markets the company is targeting? At what rate are these markets growing? And what is the current market cap./ revenue of the company? What kind of market share can company realistically achieve? Is it a winner-takes-most market? etc.
Eg: A company like Apple, this is a business I understand fairly well. So my conviction is very high. However, at $3 trillion market cap today, the question to ask is how much potential upside does it have? I am not aware of any product roadmap disclosed by the company that justifies a 10x from today’s price in 10 years. On the other hand, a hot biotech company aiming to cure cancer, if successful, has a lot of potential upside. However it is very difficult, at least for me, to build conviction. Hence, I look for companies where I can have a balance of both.
Tesla is a business I understand— They make cars, battery packs, self-driving systems and robots. I also understand the market potential of each of these products. Today at $1T market cap (though fairly a big company), I see the potential roadmap ahead, that it can become a $10T company in 10 years. Tesla has the balance of both— High conviction combined with high potential upside.
When I do find such an opportunity (like Tesla) I bet heavily— even allocating ~50-60% of the portfolio. I know allocating ~50%+ of your portfolio in a single company is high and some might consider it risky. Even the conventional wisdom says to diversify your investments. However, I believe if you have done your work and you have conviction then you should be asking— Why am I not betting more? To quote Charlie Munger, “The goal of investment is to find situations where it is safe not to diversify.”
What’s strange is how normalized the opposite has become. Portfolio construction today often starts from a mindset of small increments—1%, then 2%, then 3%—until a position is “full.” That kind of thinking anchors all positions at small sizes by default, with only the rare outlier exceeding 10%. But there’s another way to construct a portfolio: invert the process. Start at 100% and work your way down. Ask yourself: what would have to be true for this to deserve 100% of my capital? And then deduct based on uncertainty, lack of clarity, or opportunity cost. It’s a completely different mindset—one that forces clarity and conviction instead of defaulting to cautious mediocrity.
This is why I find it hard to understand people who hold 30 or 40 stocks. Why put your capital in your 20th-best idea when you could double down on your top three? Or when someone tells me they’ve found the best business they’ve ever come across, done weeks of research, and deeply believe in it—only to discover they’ve allocated 2-3% of their portfolio— Such a small position won’t have any significant impact on your portfolio.
Hence I believe rethinking position sizing through this lens of judging your conviction vs potential upside is a much better way. Because if you truly believe in the quality of your ideas, your portfolio should reflect that belief.