“How can I invest in 10 to 15 stocks if I’m only risking 1 to 2 percent per stock? Wouldn’t I have to buy 50 to 100 stocks if I take such small risks?”
This is a question we get from many of our members. At TradeStops, when we’re talking about risk, we’re not looking at the total amount we’re investing in each stock. We’re looking at the amount of normal risk we’re taking in each of our stocks.
Assume we have a $100,000 portfolio. Let’s look at two different stocks, one stock is low risk and the other stock is high risk. We’re looking at taking 1% risk in each position. In other words, we want to take $1,000 of risk in each stock.
We’ll start with the low-risk stock. Coca Cola (KO) has a Volatility Quotient of 10.19%. This is how it shows up on the TradeStops site:
There are two ways we can determine how much we can invest in order to take $1,000 risk in each of these. The hard way is to pull out a calculator and do the following calculation: 1000/VQ = Amount to Invest.
Don’t forget that the VQ is a percentage so for KO, the calculation is 1000/.1019 = 9813.54. Of course, then we have to divide by the share price to show the actual investment.
Or We Can Do It The Easy Way
We can go to the Position Size calculator in TradeStops and determine how much we can invest to take the $1000 risk in each position. We’ll enter the information for KO first.
When we hit the “Calculate” button, we see that we can invest almost $9,800 in KO for us to take $1000 of risk.
If you were to take 10 stocks, from different sectors and industries, you could build a very nice portfolio this way. Here’s an example of that.
Risk parity – taking the same amount of risk in each position – is one of the tenets of TradeStops portfolio management. TradeSmith has written about this on several occasions, the most recent time was here.
Plus, using the Volatility Quotient to assist with determining the right amount to invest based on your personal risk tolerance is one more way to optimize your portfolio.
By limiting yourself to only 1%-2% of risk per position, you can sleep easily at night knowing that one position can’t crush your entire portfolio.