Manage Your Risk
Portfolio Risk Management is fundamental to the steady growth of your portfolio, and the protection of your hard earned investment capital.
A quick explanation of the Risk Management Strategy
Many investors & traders use a ‘rule of thumb’ of 5%-10% stop loss/risk factor with their capital. wise-owl.com does not. The stringent risk management strategy applies a limit of 2-3% of portfolio capital per trade.
Let’s assume you have $25,000 to invest. Applying the wise-owl.com rule, the risk exposure per trade is $500 (i.e. $25,000 x 2%).
In other words, the maximum you stand to lose if the trade falls below the stop loss level is $500 or 2% of your capital.
Following the ‘5-10%’ rule, you would stand to between of 5% and 10% of your capital, some $1,250 to $2,500 ($25,000 x 5% = $1,250 or $25,000 x 10% = $2,500).
Equities Report each week you see the trade size formula:
Once you have determined your risk profile (i.e. whether you want to risk 2% or 3% of your capital per trade), you can use the online calculators we provide on the strategy page of each week’s Equities Report to automatically generate the trade size for that stock.
Using Risk Management to Maximise Returns, Minimise Losses
Many investors first look at ‘hit rates’ alone to determine the relative ’success’ of a portfolio. This can be a most inaccurate gauge of the success of any individual’s, report’s or research house’s recommendations. Why? Because results measured by these ‘hit rates’ - such as ‘80% of the stocks picked are winners’ can be very misleading. The 20% of stocks you got wrong might result in a loss that is bigger than the gain made on winning stocks, thus bringing your overall return into the negative.
This is where overall portfolio risk management comes into its own…
A Case Study
Consider the three model portfolios below all based on real wise-owl.com recommendations.
Portfolio 1 demonstrates a good ‘hit rate’ of 70% (7 out of 10 stocks are ‘winners’ - a pretty good hit rate in anyone’s book). It could represent a conservative DIY investor with a small number of speculative stocks mixed in for variety.
Portfolios 2 and 3 both have lower hit rates (50% and 30% respectively). However, the return for Portfolio 1 is less than for both Portfolio 2 and Portfolio 3! Why? Because sometimes a few major negative returns can destroy a whole lot of positive (but smaller) returns. And that is why a simplistic comparison based just on hit rates can be so misleading.
Portfolio 2 has 50% hit rate, and is a mix of top 300 stocks and some smaller cap recommendations - a fairly aggressive portfolio for a growth investor - and the results reflect this. Even with 50% of the stocks yielding a negative return, the portfolio shows strong growth over the period.
Similarly Portfolio 3, with just a 30% ‘hit rate’ still displays dynamic growth and high returns, characterised by a high proportion of ’speculative’ stocks typical of an aggressive investor. Whilst both selections display speculative characteristics, the wise-owl.com risk management strategy of employing stop loss levels to minimise downside, and locking in profits when the stock is on its way up, has led to very strong returns, despite a relatively low ‘hit rate.’
The Stop Loss and Profit Stop
It is a price level that you set in advance, at which you will sell that particular stock. We use it to know when to say goodbye to a stock before it really damages your portfolio by eroding the hard-won profits you have realised on other performers.
The stop loss levels you see in our reports each week are inextricably linked to the risk management strategy, and are designed to minimise losses and maximise longer term capital appreciation.
The profit stop is in essence a revised stop loss put in place when a recommendation starts to realise growth. Another way of looking at this is as a safety net, helping you lock in profits along the way, and thus maximise the value in any performer. Too many times investors watch and wait as a stock goes up, only to have it slide back, and see a 70% (unrealised!) profit slip into the negative…
