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. Its 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: Id 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 its set to walk you through the perfect position sizing for you in less than a minute.
So, lets say I want to buy Tesla (Nasdaq: TSLA) and were using the examples above.
Tesla is what wed call a highly volatile stock. In fact, in our system, we label it with our proprietary measurement of volatility, called the VQ, at 50%.
Thats a really risky stock.
But Id buy it because I want risky/volatile stocks to help my portfolio move higher. I just dont want to buy too much of those types of stocks.
So, in our scenarios above, heres how much of Tesla Id buy:
- Willing to risk $1,000
buy $2,000 worth of Tesla.
- I have a $100,000 portfolio of which Im 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. Dont get it wrong.
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