How Much Of Your Portfolio Should You Have At Risk?

  • September 27, 2004
  • Rob Hanna

The
market continues to pull back.  I’m not seeing any panic.  I wish I
was.  Notable support for the S&P 500 and Nasdaq are the 50-day moving
averages.  The flat slope of this line for both indices indicates it may not
provide much support at all.  While the next few days may see some quarter-end
window dressing, lower prices still seem likely in the coming weeks.  On
Wednesday I’ll provide my full month-end market breakdown.

 

One topic that I’m sometimes
asked about when discussing risk management is the use of margin.  When is it
appropriate?  Should traders use margin liberally?  Not at all?  Only when
things are going well for them?

 

From my point of view, I
believe that the important number to measure is not the % margin you are using
or have available, but rather the amount of risk in your portfolio.  How much of
a drawdown would you suffer if you were stopped out of all of your positions,
both long and short?  This number should give a more realistic view of the
inherent risk in the portfolio.  Obviously, the more heavily invested you are
the higher the number will typically be, but with tight stops you will be able
invest a greater amount of capital than if you would if you were using looser
stops.  When the market is extended, you may have many positions that are
stretched far from your stops, causing you to invest more cautiously (or not at
all).  When the market pulls back, many positions will likely be closer to their
stop points, allowing you to invest more aggressively.

 

So how much of your portfolio
should you have at risk?  I believe that can be a function of trading style. 
For instance, in Mark Boucher’s book “The Hedge Fund Edge”, he suggests keeping
this number to between 15% and 20% (page 155).  This is an appropriate guideline
for intermediate-term traders who utilize Boucher’s strategies.  For a swing
trader who is 100% invested with 3 or 4 positions, this number should probably
be a bit lower.

 

If you’re not sure of the
proper level of risk for your trading style, consider simply tracking this
number for a period of time.  It shouldn’t take long before you begin to realize
the risk level that you are comfortable with.  By measuring your risk in this
manner rather than looking at the amount of margin you are using, it allows you
to invest aggressively at appropriate times (when stops are tight), and more
conservatively when your portfolio (and the market) are getting extended.

 

Best of luck with your trading,

 

Rob


robhanna@comcast.net

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