Keith Kaplan here. I’m stepping in today with Jason’s permission to tell you exactly how NOT to buy a stock …
How do I know? Because I made this mistake over and over again when I was younger.
Here is how it typically happened: I’d read a great story about a stock and get excited. And then I’d make an emotional, in-the-moment decision to buy.
Soon after jumping in with great excitement, I’d get cold feet … minutes, hours, or days later, and I’d sell.
Or, I’d buy a stock that was rising slowly, and I’d get impatient and sell early.
For instance, it happened with Advanced Micro Devices (AMD). I read a story that made it clear to me that AMD was about to soar to new heights. That meant I had to buy AMD right then and there.
At that time, AMD was trading under $10 a share. The stock went sideways and then down after a short time. I got nervous and sold all of it.
As I’m writing this, AMD is up more than 1,500% in the eight years that have passed.
So, I was right in buying. But I did it all wrong. And that caused me to sell pretty quickly, losing 3.5% instead of following a unique set of proprietary signals that would have helped me make more than 1,300%.
Sheesh.
The rollercoaster of the market, or the individual stock, used to throw me for a loop every single time. 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, not the risk of owning a stock.
And that’s really because I didn’t understand how to buy a stock. I didn’t understand how to blend it 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.
Being a software guy, I decided I needed a tool to help me do this. My investing was getting killed by my emotional reactions. I know Jason has shared similar stories about his early days investing.
And like Jason, I knew if I could find a way to get my emotions out of it … using cold, hard data… my results would be better.
Let me show you how I did it.
Investing like the pros
We’re talking about “position size” here — the number of shares of a stock you buy, establishing a “position” in that stock.
Position sizing will make all the difference in the world in your portfolio.
We want to establish a portfolio of stocks (or other instruments) that gains over time and minimizes losses.
I developed several tools to help do this, including our proprietary TradeStops system that Jason uses in his services for Risk Points. They can definitely help minimize risk and maximize gains.
But here’s the thing – the real geniuses use risk parity.
Ray Dalio, a billionaire hedge fund manager, uses risk parity at his quant-based hedge fund, Bridgewater Associates. This guy is a genius and inspired me many years ago with his “All Weather Portfolio” designed to weather storms by minimizing losses and maximizing gains. 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 used metrics (such as market cap). You essentially wind up buying the same stocks, but you put LESS money into higher volatility (riskier) stocks and MORE money into lower volatility (less risky) stocks. 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. Risk parity is the answer.
In our TradeSmith system, we offer something called a Position Size Calculator. 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?”
- And 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 user friendly, and it’s set to walk you through the perfect position sizing for your portfolio in less than a minute.
So, let’s say I want to buy Tesla (TSLA) using the examples above. We classify TSLA as 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.
Andif you love it, there’s no reason not to buy it; you want to have some risky/volatile 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 TSLA you’d buy:
- Willing to risk $1,000 … buy about $2,000 worth of TSLA.
- You have a $100,000 portfolio that you’re willing to risk 2% – buy about $4,000 worth of TSLA. I know $4,000 is 4%, but you follow the VQ trailing stop, it would get you out at -50%, meaning you risk $2,000.
- You have an existing portfolio in which you want equal risk among your positions – that will vary depending on each individual portfolio, but it will give you a specific number of shares to buy.
The goal here is to buy the right amount of a stock to minimize your risk while maximizing your gains.
Your position 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 must find (and keep!) the right blend to maximize your potential gains while lowering your risk.
It’s time to get better sleep, so discover how you can lower your risk on the same stocks you own today and maximize your reward …
This concept has never been more important than it is right now. On Feb. 27 at 8 p.m. Eastern, I’m unveiling the biggest prediction in my company’s history during an event I’m calling The Last Melt-Up. I’ll explain more, and you’ll learn why position size and risk management have never been more important to help you find success in the stock market – and protect you from what comes afterwards.
It’s free to attend. All you have to do is register, here.
All the best,
Keith Kaplan
CEO, TradeSmith