A couple of weeks ago, we looked at some of the year-end issues that investors should consider before the calendar turns to the new year. You can find that article here.

One of the topics we covered was potentially rebalancing your portfolios. For those new to the TradeStops methodology, when we talk about rebalancing, we’re specifically talking about rebalancing the positions in your portfolio so that you’re taking an equal amount of risk in each position.

What this means is that for a stock like Apple (AAPL), that has a Volatility Quotient (VQ) of 18.4%, if we want to take $1,000 of normal risk, it means we can buy $5,429 (or 20 shares) of AAPL. If we want to take $1,000 of normal risk in Yamana Gold (AUY), we can only buy $2,792 of AUY because the VQ is 35.8%.

The Risk Rebalancer tool in TradeStops automatically does the calculations for you. For instance, in this portfolio of stocks, you can see that the current values are dramatically different. We know intuitively that we’re taking more risk in some of the positions and less risk in others, but just looking at the portfolio, it’s almost impossible to quantify.

sample portfolio

We can run the portfolio through the Risk Rebalancer tool to see what changes could be made to bring the portfolio back to an equal risk position. Keep in mind that for this example, we’re not considering the Stock State Indicator (SSI) condition — or health — of each stock.

Here are the changes we can make to bring the portfolio into a position of risk parity.

rebalancing the sample portfolio

Making these changes would bring the risk per position to 1.28% of the portfolio, or about $1,546 of risk per position.
There are instances when your portfolio can be out of balance, but you’re doing it purposely. Here’s a portfolio that has been following the TradeStops Sector ETF strategy, but also has a few other holdings.

sample portfolio with sector ETFs and other positions

Aside from the 10 sector ETFs, this portfolio holds the junior gold miners ETF (GDXJ), an ETF for Europe (IEV), and a closed-end fund that specializes in preferred stocks (JPS). Here’s what happens if we run this through the Risk Rebalancer.

second sample portfolio risk balanced

The Risk Rebalancer is suggesting that we reduce the number of shares of GDXJ and JPS while making very small changes to the Sector Select ETFs. In this case, let’s say the current allocation is exactly what this portfolio’s owner wants. She wants to receive a small amount of monthly cash flow that the JPS closed-end fund generates and she’s content to hold onto a little larger position of GDXJ with its VQ of 25.6%.

Even though the VQ of GDXJ is almost double the other VQs, the Portfolio Volatility Quotient (PVQ) is actually lowered by holding the GDXJ. Here’s a look at the PVQ without the GDXJ position. It’s a low PVQ of just 8.45%.

PVQ of sample portfolio 2 without GDXJ

And here’s the PVQ with the GDXJ position. Even though GDXJ has a VQ of more than 25%, the PVQ with GDXJ is only 8.13%. This portfolio’s owner can actually lower her overall volatility by holding the GDXJ position.

PVQ of sample portfolio 2 with GDXJ

She has decided not to make any changes to her portfolio at this time and her rationale is solid.

We’ll be talking more about rebalancing this coming Friday at 1 p.m. ET. As you know, our usual webinars are on Wednesday afternoons, but for some reason, we don’t think we’d get too many people to attend on Christmas or New Year’s Day (and we want the time with our families and friends, as well). Click here to register for this educational presentation. As always, we will be recording this webinar, so even if you can’t attend the live broadcast, be sure to register and we’ll send you the recording to watch at your convenience.


Thomas Meyer
Research and Education Specialist, TradeSmith