Concentration vs. diversified

Discussion in 'Trading' started by mililani, Aug 26, 2009.

  1. mililani


    How much concentration does a good trader make per trade? 10%? 20%? How concentrated or diversified should a portfolio be? There are arguments that concentration pays off with higher percentages, and diversification ends up being diworsification, but I've been thinking about a few money managers and traders that have gone the opposite route of concentration: Rennaissance Tech, Peter Lynch, Graves, and a few others. They've done very well taking very small positions, but owning lots of stocks. RT says they are like the Walmart of equities. I have a new strategy that I'm excited about that utilizes heavy diversification, but concentrates into the best performing equities. This would limit my volatility and exposure to any one company blowing up. And to protect against large blowups like the past year and in 2000, I just look for asset bubbles and use simple timing strategies. Anyone have any opinions on this?
  2. It all depends on your desired risk/reward. As you said, diversification decreases your risk exposure (due to bankruptcies, sector rotation etc.) but limits your potential reward. On the other hand, employing capital in concentrated areas increases the risk but also increases the potential reward.

    With regards to you putting money into the best performing equities, just remember that past performance isn't necessarily indicative of future performance.
  3. Your question is a bit ambiguous, when you ask per trade are you talking per position (i.e. per stock) or are talking about per strategy?

    If we're talking per strategy, assuming you have some sort of edge, I personally really like the kelly criterion for trade sizing. It beats any trade sizing scheme, including investing at the risk-free rate, assuming you have edge. Also, it guarantees that you will never reach 0.