Why Portfolio Allocation is So Important in Both Trading and Investing:
Portfolio allocation refers to the percentage of your portfolio that is being utilized for each individual trade or investment. Allocation is critical to trading success because it helps manage risk. For example, if you have a $5,000 portfolio and a 10% per trade allocation rule, then the most you’ll put into any single trade is $500. On a per trade basis, you’re only risking 10% of your portfolio, so if things go south quickly, only a small portion of your entire portfolio is at risk.
Without firm allocation rules, traders can tend to get too heavily invested into just one or two positions, putting large portions of their portfolios at risk. Going all-in, so to speak, can certainly result in larger profits when things are going in your favor, but it only takes one bad trade to bring your entire portfolio right back down to where you started or lower. And no trader, no matter how great they are, can profit on every single trade they make. Losses will always be a part of the game. With proper portfolio allocation techniques, however, trading doesn’t need to be stressful or risky. Risk management is critical to trading success.