If we want to establish a portfolio of stocks or other instruments that gains over time and minimizes losses than we have to understand the importance of position sizing. We have to determine the number of shares of a stock to buy, establishing a position in that stock.
You should focus to use risk parity. Risk parity is the concept of investing based on allocation of risk using volatility instead of other commonly used metrics. You essentially wind up buying the same stocks, but you put less money into higher-volatility stocks and more money into lower-volatility stocks. Your goal is to have your portfolio as a whole rise over time with the least amount of fluctuation to get you there.
You can ask yourself 3 different questions to find out how much of a stock you want to add to your portfolio:
1. I want to risk $1,000; how much of this stock should I buy?
2. I am prepared to risk 2% of my portfolio; how much should I buy?”
3. I want to buy this stock with equal risk to the stocks in my portfolio; how much should I buy?
Example: If you are considering buying a highly volatile stock with our proprietary measurement of volatility, called the Volatility Quotient (VQ), at around 50% than you would come tom the following results:
1. You’re willing to risk $1,000 and at a VQ of 50%, this means you should buy $ 2,000 worth of the stock.
2. If you have a $100,000 portfolio that you’re willing to risk 2%, then you should buy $4,000 worth of the stock.
3. You have an existing portfolio in which you want equal risk among your positions then it will depend on your portfolio. E.g. you would have to buy half of the amount of stocks with a VQ of 25%.
Your position size matters. Don’t get it wrong. You must find and keep the right blend to maximize your potential gains while lowering your risk.
Sven Franssen