Daily Gains Letter

Best Capital Portfolio Available During a Downturn

By for Daily Gains Letter | Mar 20, 2013

200313_DL_zulfiqarIn order to make up for the losses, or just to increase their portfolio quickly, investors might try to get the greatest bang for their investment buck by taking short-term trades—their time period may differ, anywhere from a day to a few weeks to a few months.

As a result of short-term trading, investors become vulnerable to volatility. Their investment positions might take a huge toll on their portfolio. When you’re trying to make short-term trades, you shouldn’t lose touch of your long-term goals—you must focus on capital preservation and growth over time by minimizing the risk.

With that said, there are many capital preservation techniques you can employ to save your portfolio; one of the best ways to do this is through trade management.

In essence, trade management is when someone tries to minimize their portfolio risk by using techniques to control their position rather than predicting the markets.

Consider this scenario: an investor’s portfolio is worth $10,000, and they currently think that it’s a trading market—so they’re taking short-term trades. The investor sees an opportunity and buys shares of ABC Inc. for $10.00 each.

If the price of ABC shares goes up—great for the investor; but what happens if they go down? In order to avoid huge losses, investors may want to decide on the amount of risk they are willing to take per trade based on the portfolio value. For the scenario above, they might decide that they will be risking two percent of their portfolio (notice that it’s a percentage of the portfolio, not the dollar value) on this ABC trade—and they’ll take the loss at that point if things turn against them.

For instance, if the investor decided that they will risk only two percent of their portfolio value on the ABC Inc. trade, if they are on the wrong side, they will only lose $200.00. Similarly, on the next trade, their loss will only be $196.00 ([$10,000-$200] X 2%).

When the investor is in the markets for short-term trades, they must realize that their chances of being wrong are very high. If they keep their losses small and let their winners win, their portfolio can grow significantly.

If an investor risks two percent of their portfolio on every trade, they can be in the markets for a longer period of time, and they will be able to profit.

In contrast, if an investor uses dollar value, instead of percentage, to determine their amount for trades, their portfolio can draw down fairly quickly. For example, if they assume a $200.00 loss on every single trade, then their portfolio will go to zero in just 50 trades.

Regardless of how much potential short-term trading might have, it comes with greater risks. If an investor isn’t careful about what they are doing, short-term trading can wipe out their entire portfolio.

Investors who are trying to save for retirement or who are saving for the long term should focus on capital preservation, rather than trying to risk more than they can afford. A technique as simple as just associating a percentage with the amount of risk can help immensely in the long run.

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