Any of our customers who have been with us for any time at all know that — in addition to a solid exit strategy — one of the risk management tools we most advocate for is proper position sizing in your portfolio.
Without proper position sizing, you could be risking more than you’re comfortable with on an extremely risky stock, while not risking enough on the less volatile stocks in your portfolio.
We’ve already introduced the updated Position Size Calculator. This tool makes it easier to know the right amount to invest in any and every position. (In case you missed it, you can find this tool from your dashboard and under the Tools tab in the menu).
Let’s use Apple Inc. (AAPL) as our example today.
Once you’ve searched for Apple, there are three different boxes, based on how you want to view the results.
In the first box, you can enter the amount you want to spend and the tool will tell you how many shares you can buy based on the Volatility Quotient (VQ) of the underlying stock. The default amount is $10,000, but you can change that amount to whatever you want.
You can use the pencil icon next to “Your Amount at Risk” to change the percentage amount. The VQ percentage is the default, but you can change it based on your preferences.
We have received some questions asking why we use the Volatility Quotient as the default amount of risk rather than using the distance to the Stock State Indicator (SSI) Stop Loss. It’s a good question. It makes sense for us to use the VQ as our default because that’s what we use in the Risk Rebalancer. The Risk Rebalancer can be used for stocks in any SSI state, not just stocks in the SSI Green Zone. Since the Risk Rebalancer can be used for stocks in all SSI states, we decided to do the same for the Position Size Calculator and stick with the VQ as the default.
And our research confirms that was the best decision. We studied the portfolios from our Billionaires’ Club using both SSI and VQ exit strategies; the results were similar, but as you can see, the VQ results were ultimately better.
When you think about it, it makes sense. As stocks move higher and make new highs, the SSI stop loss and the VQ stop loss become the same. Even if a stock doesn’t make a new high, but trades close to the high, the stop losses are close to each other. Holding stocks that are moving higher is the key to profitability.
Many of the newsletter publishers we partner with advocate risking 1% of your portfolio on any new positions. As we’ve written in the past, this is not the same as investing 1% of your portfolio in any given position. The amount at risk is based on the amount invested and the position’s VQ.
The middle box of the Position Sizing Tool will help you follow this strategy. First, select the portfolio where you’ll be adding the new position from the dropdown menu at the top of the screen. Then, based on the ticker you’ve entered, the calculator will show you how many positions to buy.
Note, if you have especially high conviction about a position and want to risk a little more, you can click the pencil icon in the middle of the page to adjust the percentage of risk you want to use in the calculation.
The third box assumes you’ve recently rebalanced your portfolio, and you’re now looking to add a position. It will allow you to risk-balance the new position so that you’re taking roughly the same amount of risk as you are on the other positions in your portfolio. This calculation only works if the rest of your portfolio is equally risk-balanced, so make sure you’ve rebalanced recently, or your calculation may be inaccurate.
We’ll show you different examples of how best to use this tool to your advantage and discuss how to change the default amounts if you want to use something different than the VQ percentage during our upcoming educational webinar on Wednesday, Oct. 2 at 1 p.m. ET. To register for the presentation, click here.
Research and Education Specialist, TradeSmith