Every so-called market “expert” preaches the virtues of diversification, but what they mean by diversification is holding long dozens of different stocks or several stock index mutual funds or ETFs. They don’t pay attention to correlation and in the event of a market downturn will see all their portfolios take a hit. What we have seen on the Market Measures segment from May 31, 2016 is that what is really needed is “Strategy Diversification”. So what does “Strategy Diversification” mean in practice for an IRA account? How many different type of strategies can we use and how many of them in a representative $100K IRA?
We want to have on many different positions in many different underlyings utilizing many different strategies. This is to increase our number of occurrences so we take advantage of the “Law of Large Numbers”. Some strategies that are IRA eligible are:
By holding back 50% of our capital we could still have a few Covered Calls, Long Stock or Cash-Secured Put positions or many more of the defined risk trades. That though wouldn’t provide us the strategic diversification or the percentages we seek in things like Return on Capital (ROC) and Probability of Profit (POP). Too much money in similar strategies can also make our account vulnerable to Greek risks such as Delta, Gamma and Vega.
A table provided an example of a strategic diversified portfolio that could be constructed using $50K of the $100K account. The table listed the number of positions that could be in the portfolio for each strategy, the Capital Allocation in percentage terms, the Max ROC, the Max ROC per day and the POP [note: it’s not possible to list a POP for Diagonals or Calendars].
For more on Capital Allocation see:
Market Measures from October 24, 2014: “Risk | Capital Allocation”
Strategies For Your IRA from August 17, 2015: “Capital Allocation Awareness”
Strategies For Your IRA from May 24, 2016: “Dynamic Iron Condors: Capital Allocation”
Watch this segment of Strategies For Your IRA with Tom Sosnoff and Tony Battista for the important takeaways, and to see how Strategic Diversification can be put into practice to reduce our risk in an IRA account.
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