Now I would like to talk about Risk.
People do not understand risk very well. They are looking at the upside but not the downside. There was a very smart investor, that used to post a lot, but has slowed down. He lost a lot of money in the last down turn and was trying to make it back. To me, he looked like he was doing an astounding job. He really knows how to make money but I am not sure if he knew how to limit risk. He went on a board and told everyone, because he was always completely honest in what he was doing, that he had 3 stocks and around 2 million dollars in them. One of the board members told him that he shouldn’t be posting because that wasn’t a portfolio. I thought to myself, and I should have posted, that board member was a complete newby. Had no clue what he was talking about. What he should have said is How are you managing your risk. So let’s talk about that.
So let’s say you have a portfolio of $100,000 dollars. We do what that guy did and buy 3 stocks. So we have about 33,000 dollars in each stock. Gasp you are risking 33 percent of your portfolio on each stock but that isn’t correct.
We put a stop on each of those 33 percent positions at 5 percent. So in reality We are only risking 1.65% of the portfolio on each position. So that is one way to limit risk. Of course there are variation of that considering the position size and the percent for the stop. So we could take a 10 percent position with a 10 percent stop if the stock was more volatile. I like to keep my risk at about 1 percent for each position.
If you are a value investor that buys and holds forever you need to think about that. Because you are going to hold each position no matter what. If that is the case you are risking your whole position. Is it likely to go to 0 , no, but is it likely to lose 70 or 80 percent? yes. So if you are a value investor you have to be very careful in the companies you invest in and the size of your position.