Ask Colin

Why is 14-15% of your porfolio at risk?

The detailed question was:

I notice your %K risk is around the 14 – 15% mark. Having read Dr Elder’s books, part of his money management strategy is to limit total equity at risk to 6% which won’t allow him to buy stocks until his current stocks have move in his favour, and his overall risk is reduced below 6%.

My Questions:

 Why does your plan allow as much risk as it does?

 What do you think of limiting %K risk to a maximum of 6% and only buying more stock(s) as stop loss levels are raised; and %K risk is reduced to <6%?

 

Dr Elder is a trader and I am an investor. They are quite different occupations and cannot be compared in simple terms by looking at only one element in a complex investment plan.

 

Traders exploit changes in price. Their activity is often quite short-term (especially Dr Elder’s trading plan). Leverage is often involved. The entire focus of a trader is on price/volume alone. This is the Price concept.

 

Investors buy part ownership of a business to obtain an income stream in the form of dividends and imputed credits. If investors invest in good businesses, the management will reinvest retained earnings at a return above cost of capital, so there is the strong possibility of capital growth over time. Their activity therefore tends to be longer term (years rather than days/weeks). The focus is on the rateofretrun the business is generating, rather than the price of the shares. This is the Total Return concept.

 

My investment plan is set out in my book Building Wealth in the Stock Market. I also discussed stops in detail in Members Newsletter 004. One thing that is often missed in what I do is that I have two sell signals that may often occur at higher prices than my trailing stops. So the percentage of capital  at risk tend to  be a worst case, which is also why it is there. This is about preservation of capital, rather than the rate of return in the business which is what drives investment returns. 

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