Protect your investment portfolio

In the previous chapter we informed you about the purpose of the position size, how it is determined, and the reason why risk management is so important.

In the following, we would like to explain why you should always invest only one small part of your investment portfolio in trades. Almost all experts agree that investors should risk a maximum of 10 percent of the entire portfolio in one single trade. 10 percent represent a considerably high part of the depot and most experts recommend investing about 2 to 5 percent of the investment portfolio into a single trade.

Rule № 1: Never lose money.
Rule № 2: Never forget rule № 1.
Warren Buffett

Limitations serve spreading of risk

Basically, there are two reasons why most experts recommend investing only 2 to 5 percent of the total investment portfolio in an individual value. The first reason is spreading of risk that can easily be achieved by sticking with this rule. In case investors trade with securities or invest in derivatives, they generally accept a high level of risk. If the investment itself is risky already, you should at least take into account that a possible total loss of one position does not consequently lead to a high overall loss. This would be the case, if you invested 30 percent or more of your portfolio in only one single trade. You should always resist these temptations, even if that is easier said than done. This is especially difficult when you are absolutely convinced that the trading value will evolve in a certain direction. Nevertheless, you should keep the guideline in mind – only invest a small part of our your investment portfolio in one trade.

Loss coverage through limited investment volume

Spreading of risk, as explained, is in reality linked to a second reason that suggests to invest only part of your investment portfolio in each trade. The spreading of risk automatically results in the hedging of loss, at least in terms of liquid assets and existing portfolio. If, for example, you have decided to invest three percent of your total assets in a trade, your maximum loss regarding this investment can amount to no more than three percent. It is certainly aggravating to accept the total loss of this investment, but this is no serious financial harm when considering the size of the entire investment portfolio. Over and above that, limited investment can prevent emotional outbursts and spontaneous changes in risk-attitude that can drive you to bet 30, 40, or 50 percent of your total assets on one single trade.

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