I used to fall in love with a stock story and make a split-second decision to buy.
It happened with Advanced Micro Devices Inc. (Nasdaq: AMD) … and many other times.
I read a story that made it clear AMD was about to soar to new heights … and that meant I had to buy AMD right then and there!
At that time, five years ago, AMD was trading under $10 a share.
As I’m writing this, AMD is up over 1,000% since then.
So, I was right to buy. But I did it all wrong.
And that caused me to sell pretty quickly, losing 3.5% instead of making a whopping 1,000% gain.
Look, this used to happen to me a lot.
There was a great story about a stock. I got excited and made an emotional, in-the-moment decision to buy.
Then I’d get cold feet minutes, hours or days later, and I’d sell.
The roller coaster of the market, or even an individual stock, used to throw me for a loop every single time.
I bought AMD. It dropped, came back and dropped again. I sold for a 3.5% loss.
And at the same time, when I bought a stock that would rise slowly, I got impatient and would sell early.
So, what does that tell you about younger me?
I was impulsive and expected 100% gains in no time, but I had no tolerance for risk.
I wanted the reward, but not the risk of owning a stock.
And that’s really because I didn’t understand how to buy stocks.
Risk Parity Is the Answer
When I was younger, I didn’t understand how to blend a stock into a robust portfolio primed for gains and minimal losses.
I was putting way too much money into risky stocks and not enough into low-risk stocks.
I’m talking about position size here, which is the number of shares of a stock you buy.
We want to establish a portfolio of stocks (or other instruments) that gains over time and minimizes losses.
On Monday, I told you about trailing stops and how important they are to minimize risk and maximize gains.
That’s because you now have an appropriate plan for when to sell a stock and when to ride a stock for major upside.
But here’s the thing — the best investors use risk parity.
Ray Dalio, a billionaire hedge fund manager, utilizes risk parity at his quant-based hedge fund, Bridgewater Associates.
This guy is a genius. He inspired me many years ago with his “All Weather Portfolio” designed to weather storms by minimizing losses and maximizing gains.
Of course, he’s crushed the market with his returns. And most importantly, he’s done so in a lower-risk manner.
Risk parity is the concept of investing based on allocation of risk using volatility instead of other commonly known techniques (such as basing investment decisions on 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 are less risky (lower volatility).
And you sleep much better at night because you did so!
Your goal is to have your whole portfolio rise over time, with the least amount of fluctuation to get you there.
Risk parity is the answer.
The Position Size Calculator
We have something called a Position Size Calculator in our system at TradeSmith.
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 let’s say 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 user-friendly, 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 Inc. (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 Volatility Quotient (VQ), at around 50%.
That’s a really risky stock. But I recommend buying it if you love it.
That’s because you want risky stocks to help your portfolio move higher. You just don’t want to buy too much of those types of stocks.
So, in our scenarios above, here’s how much of Tesla you’d buy:
- If you’re willing to risk $1,000: Buy $2,000 worth of Tesla.
- If you have a $100,000 portfolio and you’re willing to risk 2%: Buy $4,000 worth of Tesla.
- If you have an existing portfolio and you want equal risk: In my personal portfolio, it says to buy 12 shares in this scenario.
The entire goal here is to buy the right amount of a stock to minimize your risk while maximizing your gains.
It’s Time to Get Better Sleep at Night
Size matters a lot. Don’t get it wrong.
Don’t buy too much of a risky stock and not enough of a low-risk stock. You have to have the right blend.
I never realized I had it all wrong until I had tools such as the Position Size Calculator.
I was buying just a little bit of the low-risk stocks and a lot of the high-risk stocks, and then overtrading because I couldn’t sleep at night.
It’s time to get better sleep. So, I hope you join Ian King and me on February 25 at The 4X Stock Accelerator Summit.
At this exclusive event, you’ll discover how you can lower your risk and maximize your reward on the same stocks you own today.
In fact, with one small change, your returns could go up to 4X higher.
You can reserve your spot for this free event now by clicking here.
All the Best,