Fund allocation process for stock and crypto traders

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Knowing how much funds to allocate towards a particular trade/investment forms one of the most essential part of growing wealth while managing your risk.

“To manage risk during volatility its important that your trading and investment activities are time allocated.”

You can create three buckets to allocate the funds:

  1. Short-term bucket
  2. Medium-term bucket
  3. Long-term bucket

1. Trading in short term bucket (ONLY):

Short term trades are those investments which you may hold upto 3 months.

** Suitable for only aggressive investors with a higher risk tolerance.

What needs to be done?

  1. Planning and executing multiple trades.
  2. Having risk reward ratio for each planned trade of 1:2 or 1:3.
  3. Do you really want to bet 100% of your funds in the short term trading? If yes, allocating all funds to one trade or taking multiple trades? 

Benefits:

  1. We can have early exit on our losing trades. But, may allow winning trades to go longer.
  2. Higher liquidity will be available to make new better trades when opportunities arise.
  3. Daily review of all positions.

Drawbacks:

  1. We may exit early on our winning trades. But, may allow losing trades to go longer.
  2. Usually profits/losses per trade is small as we trade on small percentage move.
  3. Investment size that is too large are hard to manage for short term trades: Its not only risky betting entire capital on a single trade; its also not feasible to monitor multiple trades that would need quick entry or exit.

2. Trading in medium term bucket (ONLY):

Medium term trades are those investments which you may hold more than 3 months but less than a year.

** Suitable for aggressive as well as defensive style of investing. Risk tolerance is lower than short term traders.

What needs to be done?

  1. Planning and executing fewer trades.
  2. Having risk reward ratio for each planned trade of 1:2 or 1:3.
  3. Target and stop loss per trade is relatively bigger as we trade to capture higher percentage move. 
  4. Monitoring the positions should be done only once in each month and not daily, as this doesn’t allow the price to move freely. Also, frequent monitoring of positions will create confusion and should be avoided. 

Benefits:

  1. We can aim for higher profits per trade.
  2. We can manage multiple positions simultaneously as the need for urgency is lower. 
  3. Position are reviewed regularly but with less or no modification done on daily basis.

Drawbacks:

  1. Capital erosion is higher at times as positions were not reviewed and closed on daily basis.
  2. Target profit may not be achieved as prices are dependent on both systematic and non-systematic risk. While non systematic risk can still be predicted. It is hard/ impossible to predict a systematic risk.
  3. Getting success from investment in this bucket will require patience and experience. 

3. Trading in long term bucket (ONLY):

Long term trades are those investments which you may hold more than a year.

** Suitable for defensive style of investing. Risk tolerance is lowest.

What needs to be done?

  1. Planning and executing very few trades.
  2. Having risk reward ratio for each planned trade of 1:2 or 1:3.
  3. Target and stop loss per trade is huge as we trade to capture high percentage move. 
  4. Monitoring the positions should be done quarterly and not daily or monthly, as this doesn’t allow the price to move freely. Also, frequent monitoring of positions will create confusion and should be avoided. 
  5. Keeping spare cash in hand for hedging and rebalancing is necessary in high volatility and changing economic macros.

Benefits:

  1. We can aim for higher profits per trade.
  2. We only need to manage very trades. 
  3. Position are reviewed regularly but with less or no modification done on daily or monthly basis.
  4. Hedging/Rebalancing can bring additional money inflows.
  5. Benefits of investing through corporate actions like dividends, bonus, rights etc increases your potential returns rapidly.

Drawbacks:

  1. Capital erosion is higher at times as positions were not reviewed and closed on daily or monthly basis.
  2. Target profit may not be achieved as prices are dependent on both systematic and non-systematic risk. While non systematic risk can still be predicted. It is hard/ impossible to predict a systematic risk.
  3. Getting success from investment in this bucket will require patience, experience and expertise. 

You may choose to allocate the funds as per your risk appetite. For optimum returns its advisable that you allocate funds in all three buckets: 

  1. Short-term bucket can have 20% of your investing capital.
  2. Medium-term bucket can have 30% of your investing capital.
  3. Long-term bucket may have 50% of your investing capital.

NOTE: When you move a trade from one bucket to another, the funds allocated to the trade should be adjusted in the bucket where the trade is currently kept.

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