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Implementing Risk Parity in Your Portfolio

Implementing Risk Parity in Your Portfolio

Editor’s Note: In light of the market turmoil we saw on September 20, this message from the CEO of TradeSmith, Keith Kaplan, couldn’t be timelier. Today, I’ll hand the mic over to him.

Ray Dalio, billionaire hedge fund manager, uses risk parity at his quant-based hedge fund, Bridgewater Associates. That’s because it makes all the difference in the world to your investing success.

It’s the concept of investing based on allocation of risk using volatility instead of other commonly known techniques (such as market cap). You buy the same stocks, but you put LESS money into higher volatility (riskier) plays and MORE money into lower volatility (less risky) ones.

Then you sleep much better at night!

Your goal is to have your portfolio as a whole rise over time, with the least amount of fluctuation along the way.

But to make this easy, you need…

A “Position Size Calculator”

We have one in our TradeSmith system. It has three different scenarios for how to buy a stock.

You could say: “I want to risk $1,000. How much of this particular stock should I buy?”

Or if you have a $100,000 portfolio, you could say: “I’d like to risk 2% of my portfolio, how much should I buy?”

Finally, you could say: “I want to buy this stock with equal risk to the stocks in my portfolio. How much should I buy?”

This tool is VERY easy to use, and it’s set to walk you toward the perfect position sizing for you in less than a minute.

So, let’s say I want to buy Tesla (Nasdaq: TSLA).

It’s definitely what we’d call a highly volatile stock. In fact, in our system, we label it with our proprietary measurement of volatility, called the VQ, at 50%.

That’s a really risky stock.

But I’d buy it because I want risky/volatile stocks to help my portfolio move higher. I just don’t want to buy “too much” of those types of stocks.

So, in those scenarios above, here’s how much of Tesla I would buy:

If I was willing to risk $1,000, I’d buy $2,000 worth of Tesla.

If I have a $100,000 portfolio of which I’m willing to risk 2% … I’d buy $4,000 worth of Tesla.

And if I have an existing portfolio in which I want equal risk, I’d personally buy 12 shares (this number would differ for you).

The entire goal here is to buy the right amount of a stock to minimize your risk while maximizing your gains.

Size matters a LOT. Don’t get it wrong.

All the best,

Keith Kaplan
CEO, TradeSmith

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