The Lessons of Portfolio Volatility
If you want more upside, you have to accept more downside. (trading, investing)
We all want to win big, and lose small, ideally never. Unfortunately, that’s not a realistic option in trading and investing. We can keep the losses and portfolio volatility to a minimum, but our potential profits will also be minimal. Choose your path, but know it and accept it!
In crypto and stocks people get flabbergasted by reports of extreme volatility. “100x, 1,000x, from 10,000 USD to a million in one year, etc.” While these things do happen, there are some important facts you need to be aware of.
The mirage of monster profits
Those internet bragging reports you see everywhere are bullshit, as they almost always pertain to a small position growing large, and do not reflect the whole portfolio of one trader.
Leverage lies
In simple terms, you can put on a leveraged position of 100x on a leveraged account insured by “cross margin.” This will create some fantastic P&L (profit and loss) figures, but they’re complete make-belief.
If you have a 100,000 USD trading account and open a position worth 1,000 USD on cross margin, slide the magic leverage slider to 100x, you’ll get some bonkers numbers, as the P&L percentage meter will assume 100x leverage, even though you’re nowhere near it in reality.
If your position increases 10%, the P&L meter will say you’ve just made 10x profit on that position, but not the whole portfolio!
It’s not even realistic regarding the trade itself.
Why? It’s assuming a margin of 1%. It’s a play of numbers, not a realistic result of your trading.
One small position doesn’t make a portfolio
Likewise, let’s assume you have a 100,000 USD trading account that represents your entire portfolio. You buy 1,000 USD worth of a shitcoin that then explodes 10x. That’s 1,000%, mind you. A lot, by any standard!
How much did you really make?
You’ve made an excellent 10% on your portfolio, but you’re bragging with a 1,000% profit.
The truth as I’ve come to know it
You can have low portfolio volatility (small accumulation of losses and profits) or significant portfolio volatility.
You cannot have it both ways, and therefore enjoy monstrous profits without hefty losses along the way.
We all want to make a lot of money and never lose any in the process. Unfortunately, it doesn’t work this way.
You’ll have to risk more money to make more profits.
You’ll have to either play with larger positions or trade more volatile, riskier things.
You’ll have to take a few larger drawdowns along the way to larger profits, or many smaller losses that will accumulate as well.
The best risk-reward is usually found at the places and times of highest risk, etc.
We all have to find our comfort zone regarding risk
Mine is usually minimal. The problem is that when I play with minimal risk, I also make minimal profits, relatively speaking.
Every once in a while, though, the stars align, the market sirens call my name, and my balls drop just enough to make a good year, while screaming from pain (of negative P&L) along the way.
I have made multiples on my whole account quite a few times. The problem is that it always came with elevated volatility to the downside.
I rarely manage to pull off a significant profit on my whole account, without incurring losses between 20 and 50% along the way.
Make a choice, and accept the bad with the good
You won’t make 100x on your whole portfolio with proper risk management. You just won’t. You probably won’t even see the 100% on your entire account, if I’m being honest.
If you risk 0.5 - 1% on your trade, the best you can hope, on average, is about 20-60% per year, depending on a million factors, which is still phenomenal outside of the crypto space!
Why? Because it just takes more risk to make more money.
Decide how much money you are willing to lose, risk, and what kind of account volatility you can handle.
Maybe it’s 100% for you, because you’re young and have nothing to lose. Fine. Have fun. Good luck. YOLO!
On the other hand, it could be only 1 - 5% of acceptable downside if you’re more risk-averse and have accumulated a fortune. Protecting your portfolio becomes more important at that point.
You’ll probably find yourself somewhere in between. Remember, you can’t have it both ways, and anyone who says otherwise is bullshiting you.
A good measure of acceptable risk for you is whether you can sleep peacefully with your open positions. If you can’t, and you catch yourself stressing over a possible loss, you’re risking too much (playing too big)!
It’s not healthy as stress will accumulate.
You’ll make more mistakes because of fear and greed.
Long-term, over-risking will catch you out sooner or later, even with a 90% win rate.
It’s not something you want to make a habit of because you’ll just lose millions down the line. Many never recover, emotionally, mentally, and financially, from the volatility of their net worth.
Know thyself! Play your game and ignore other traders, investors, and prophets on social media.