My name is Anders Bøgebeck. My mission is to help you become a better investor and trader. Why is this important? We are not only helping ourselves by becoming financially free. Along the way we help society by either allocating capital the right places or creating better products and services. That's why I want to help you achieve the life you desire!
Have you ever wondered how to construct an optimal portfolio, which can wheather most storms? As a stock trader, we must constantly think about risk. Risk is everything. We want as high as possible a return relative to the risk we are putting on. To do this, we use the portfolio metrics Sharpe ratio, Sortino ratio and Treynor ratio to backtest a portfolio composition, which yielded an optimal return. I would highly recommend to go to https://www.portfoliovisualizer.com/backtest-portfolio to play around with possible portfolios as you are reading this post.
1. Why even care about how to construct a portfolio?
We need to understand how to construct a portfolio, so the market does not steal our wealth. If we do not understand our exposures, or just do random things, it is very possible to blow up your entire account. Why is that? Because it makes you sell like everybody else, at the bottom of a crash. To get extraordinary returns, we must do something different than the amateurs and follow the pros. The pros know that the market can be very unpredictable. And just because of that, we need to wheather all kinds of storms being thrown at us. It is not good enough to have a wonderful month and then the next month giving it all back and then some.
2. Which elements make up a good portfolio?
My recommendation is to have a composition of 50% highly growing and popular companies and 50 % spent on hedges. Hedges are the ones that either do not care about the other aggressive 50% or move in the opposite direction of these. I.e. they have a 0 or negative correlation with the US market. Think of the first 50 % as your growth vehicle. These are the companies, that will justify an increase in your net worth. But you just cannot afford to be down 60% because of some crazy macro-economic event. By using leverage you would be at 0 in these events. The "good" portfolio is the one where you don't worry about whether the market is up or down tomorrow and you sleep well at night. Usually you will find exactly that with a low standard deviation and a low US market correlation. By having a low correlated portfolio with a low standard deviation, you can enjoy some leverage, because it will not hurt you in a negative way.
3. How to use the portfolio-visualizer tool
When I played around with the portfolio-visualizer tool, I found a portfolio with very small drawdowns (2-3% at most) by having my hedges 40% allocated to put options or positions with a very negative market correlation. I used the TAIL ETF as an easy way to make money when the market plummets. The rest 10% could go to gold or silver miners, which generally have very low correlation with the other positions. Stocks in the sectors utility or consumer defensive also have a very low correlation with growing technology stocks. But notice, that you also want absolute gains on these hedges. So you want to allocate the 10 % to good growing and popular companies. You could also stay 10% in cash to buy into some very rare opportunities, which typically happen 1-2 times a year.
In the backtester tool, you will find an option whether to rebalance the portfolio or not. You rebalance the portfolio in order to get the same percentage allocations as when you started out. This implies some selling and some buying eventually. Once a day, you log into your trading platform as check out whether some of your positions should be bought or sold. It does not mean that you sell the whole tail risk position, just because you had some good gains on this position. You just sell some, so that you can accumulate some profits and make the position smaller percentage-wise again. If you never sell, you will not enjoy the benefits of compounding your gains, so this way of treating your portfolio is very important to understand.
If you want to be a succesful trader, you have to understand the market dynamics. How do all the other traders behave and what causes people to act in a certain way. As Warren Buffet uses to say "only when the tide goes out do you discover who's been swimming naked". The market can trick you into short term gains and then suddenly shift direction ruthlessly. We have to make money no matter the direction of the broader market. And the best way to do that is to stay neutral. Your portfolio should be neutral to any event, so that nothing can hurt you. By being neutral I'm not refering to lousy returns. It is your portfolio that should be setup, so you never panic.
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