Tactical operations are those in which we benefit from short and medium-term opinions. These can be macroeconomic views on things like inflation and interest rates, or specific views on stock investing, such as predicting a price rise related to earnings season. But taking advantage of the short-term opportunities we see in the markets obviously requires a slightly different size approach, and today we're going to teach you in three simple steps how to position yourself to efficiently take advantage of stock investment opportunities and how much to allocate to each of them. they.
1. Determine how much we are willing to lose.
There are three crucial factors here: our level of conviction, the degree of diversification of our idea compared to the rest of our portfolio, and the volume of tactical trades we are already making. The more convinced we are of the operation and the greater our diversification advantages, the more we can reasonably risk... As a general rule, we recommend risking no less than 0,5% nor more than 5% of your "active budget" in a single operation . If you have a strong thesis about investment in commodity stocks, but you consider the limited diversification potential of the operation (since the profitability of both investing in commodities and investing in global stocks depends on a strong economic recovery), we could risk 3% in the ETF of the following example:
Let's choose the Invesco DB Commodity Index Tracking Fund (NYSE:DBC) currently trading at $25. We are going to risk 3% of a budget of $3.000, that is, we are risking $60 in the short term. It may not seem like much, but remember that at this point we are still focused on how much we are willing to lose, rather than finding the final amount we will actually buy from the ETF.
2. Determine when we will sell if the forecast goes wrong.
The objective of this step is to find the price that shows us that our thesis is wrong. Obviously, this depends in part on the reason for our operation. If it is a short-term investment in stocks and you trust that you know how to sell at the right time, a stop loss order at $24 could work in our example. If, on the other hand, we are willing to operate on a slightly longer time frame, then it would be better to use a wider stop, at $23, for example. This way, we benefit even if an unexpected turn occurs in the near future. Whatever our choice, it is important to select a stop that is wide enough to accommodate “market noise.” For example, if we make our investment in ETF shares at $25, it is clear that we only risk $2 in the operation. But the reality can be more complicated, since the execution price could be lower, especially in extreme market conditions. We recommend adding a small margin of safety to have everything under control.
A stop-loss at $23 means we risk $2 for each share of the ETF we buy. Source: Tradingview
Step 3: Use these parameters to determine the size of our stock investment.
In the example of our stock investment tactic, we are willing to risk $60 in the short term and our initial stop loss level is $2 for each share we buy. So…
...How much weight do we give to our investment?⚖️
Let's divide the two parameters ($60 we risk / $2 per share) and the equivalent is 30. At $25 per share for our commodities ETF, this gives us a total exposure of $750, that is, slightly less of half of our total investment budget. Interestingly, if we had used the stricter stop loss level of $24, we could have bought 60 shares instead of 30 (60/1). This must be taken into account, although in both cases the same total amount would be risked ($60). It is advisable to make a trade-off between the potential profit and the probability of leaving with a loss. With a stop twice as tight we could earn twice as much, but the risk of losing money is also greater.
What are the risks of this stock investment strategy?
Although it is important to note that this is only one of the many ways to position tactical operations, we believe that there are three main advantages in using this method: -It forces us to define in advance at what level we will exit the operation, which allows us helps limit our potential losses. -It allows us to focus on exactly how much we are risking each time we make an investment in stocks. -It forces us to reflect on our investment logic. To what extent do we trust the entry point? When will the market prove us wrong? Do we want to maximize our probability of winning or invest for greater benefits? Tactical trading is not for everyone. It may very well be easier to passively invest in indices and some individual stock selections. But for those of you looking to monetize short-term stock investing opinions, doing so with a real process means significant success for our long-term passive portfolio.