How to Balance a Stock Portfolio
The goal of a balanced stock portfolio is to maximize return while minimizing risk. You want to hold the best stocks with maximum return potential while making sure that no one stock position would materially hurt you if the stock price suddenly drops. Portfolio balancing is based on proper stock selection, diversification and risk management.
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Instructions
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Choose stocks that belong to different sectors. Stocks within the same sector or industry group usually move together, up or down, so there's little point in holding several solar or cloud computing stocks. Select the leading stocks in each sector.
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Determine your maximum dollar loss per stock holding, or position. Everyone has a dollar-denominated pain threshold which he is not comfortable going beyond.
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Set the maximum stop loss percentage you are willing to accept per stock position. The goal of a stop loss is to cut your loss while it is still small. Let's say you are willing to accept a 10 percent loss per position. If your maximum dollar loss per position is $500, your maximum position size is $5,000.
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Calculate the maximum number of positions for your portfolio and do not deviate from that number. If your maximum position size is $5,000 and you have a $30,000 stock portfolio, you can carry up to 6 stocks.
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Buy only the best stocks whenever you can find them. There is nothing wrong with staying in cash if there are no stocks to buy that meet your selection criteria. On the other hand, enforcing a maximum position size prevents you from taking too much risk in any one stock, no matter how strongly you feel about it.
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Sell a stock if it hits your stop loss limit; do not rationalize hanging on to it or tweak your parameters.
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Tips & Warnings
Learn how to determine and place stop loss orders to protect against large unexpected losses.
Select stocks within an investment style of your choice. Do not mix and match styles. Many novices try to balance their stock portfolios by holding stocks based on different investment styles, such as growth and value, large- and small-cap, domestic and foreign. There are many ways to make money in the market, but no one can be equally good at all of them. If you try to diversify styles, you won't have enough skill to select the best stocks and your returns will suffer. There are enough stocks within any investment style to build a diversified portfolio.
