Implementing Risk Parity in Your Portfolio
By Keith Kaplan CEO, TradeSmith
Risk parity will make all the difference in the world to your investing success.
Ray Dalio, billionaire hedge fund manager, uses it at his quant-based hedge fund — Bridgewater Associates. It’s the concept of investing based on allocation of risk using volatility instead of other commonly known techniques (such as using market cap).
What essentially happens is you wind up buying the same stocks, but you put LESS money into higher volatility (riskier) stocks and MORE money into stocks that have lower volatility (less risky).
And you sleep much better at night because you did so!
Your goal is to have your portfolio as a whole rise over time, with the least amount of fluctuation to get you there.
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 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 through the perfect position sizing for you in less than a minute.
So, let’s say I want to buy Tesla (Nasdaq: TSLA) and we’re using the examples above.
Tesla is 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 our scenarios above, here’s how much of Tesla I’d buy:
- Willing to risk $1,000 … buy $2,000 worth of Tesla.
- I have a $100,000 portfolio of which I’m willing to risk 2% … buy $4,000 worth of Tesla.
- I have an existing portfolio in which I want equal risk? That would be 12 shares for me.
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
P.S. Please join me and Ted tomorrow night to hear how you can juice your investment returns by 18 times. It’s simpler than you realize. Register HERE now.