How to Allocate Capital and Manage Risk in Trading

I promise you that this week I’ll be answering the question "Do I want the market to go up or down?" from the Trading Lesson of the Day. But because so many subscribers have recently asked me about position sizing and portfolio structure, today is a good day to get this covered.

How you structure your portfolio will likely have a greater impact than the strategies you choose. Commit too much money to a position, and you run the risk of getting hurt badly if it moves against you. You also have the opportunity to make a lot of money if you’re correct. Commit too little capital, and your gains will be smaller as will your losses. Finding that right balance is the key.

For the Daily Battle Plan Model Portfolio, we look to find the right balance of scaling into positions (averaging into positions) in ETFs and soon in stocks too. The allocation process is as follows:

Allocating Capital

1 unit equals 1/3 of a position
2 units equals 2/3 of a position
3 units equal a full position

We can have up to 4 full ETF positions in Daily Battle Plan (the market will be extremely overbought or oversold when this level is reached).

We use the same allocation for stocks (this will begin next week for those of you who are looking for more positions each day, especially in stocks).

Risks

1. Market Risk: The market keeps moving in one direction. This is especially true the further the investment vehicle is stretched above or below the 200 day.

2. Correlation Risk: Today most ETFs are moving in the same direction. This is not always true and this is an ongoing dynamic process - mostly science, but some art.

Protection Against Risks

1. Buy OTM (out the money) calls or puts when initiating positions

2. Use smaller position size.

3. Use credit spreads or ratio spreads instead of buying or shorting the security.

Over the next few weeks I’ll go deeper into this process. It can be a bit complex, but understanding it goes a long way in helping you develop a portfolio which you can actively manage both for asset protection and for gains. And following along with me doing this in the Daily Battle Plan Model Portfolio will also help you understand this further.

Every day in our Battle Plan we’ll provide you with incisive, before-the-bell commentary and analysis on the day’s markets to help put your trading in context. We’ll give you suggested entries and exits for short term trading opportunities in stocks, ETFs and options that may be only hours away. And we’ll give you what many other people can’t: model-driven percentages so that you know the historical win rate going back to 1995 for every single trade idea—long and short.

Give the Daily Battle Plan a read before the next market open. Click here to start your subscription or call us today at 888-484-8220.