Adaptive Elastic Portfolio Management

Have too much risk in any one area and you are vulnerable to more substantial decline because you are vulnerable to a large potential draw down. Below is the loss and corresponding gain required to get back to even.
 

loss	required gain to break even
1.0%	1.01%
2.0%	2.04%
3.0%	3.09%
5.0%	5.26%
10.0%	11.11%
15.0%	17.65%
20.0%	25.00%
30.0%	42.86%
40.0%	66.67%
50.0%	100.00%
60.0%	150.00%
70.0%	233.33%
80.0%	400.00%
90.0%	900.00%
95.0%	1900.00%
97.0%	3233.33%
99.0%	9900.00%
99.9%	99900.00%

The more concentrated the portfolio, the greater the risks of consequences of an individual stock decline. But selling short of the target or reducing is not a goos strategy either as it can turn a winning strategy into a losing one as you fail to give your winners room to run. A strategy that is continuously adjusted to maintain the optimal allocation is best.

If we never made adjustments to the dollar amount in our portfolio and just let the long term position grow, then the long term trades would grow and then either finally reach a sell signal, or you would be forced to rebalance, OR they would continue the growth until they eventually composed the entire portfolio.

The amount of risk would increase beyond intended amounts as the positions grew, OR the alternative of selling positions before their targets compromises your otherwise profitable, low volatility strategy, strategy making it very dangerous to have this strategy.


Short term positions suffer the same risks of substantial draw downs of your portfolio, not because size eventually gets too large, but instead because the risk/reward ratios of investments and longer term trades are usually much better (at expense to compounded return and available liquidity to adjust.) The ideal adjustments are to maintain the overall level of "risk" without selling anything "early", and only using the allocation towards stocks as the adjustment.

Short term trading provides thinner profit margins, but more volume. in other words, less per trade, and more risk that small mistakes each trade can make a strategy unprofitable but potentially much more per year. Long term trades have a higher reward to risk but take longer, tie up more capital in a position with lower annually compounded results, and provide less liquidity for making adjustments.

BUT... the combination of short term trades and allocation model in addition to cash, income and potential hedges COMBINED with your long term positions you will produce much more frequent cash inflows from quick trades, and that will allow itself to be distributed among all assets making rebalancing more efficient, more frequent, and your portfolio to only make minor changes. That would cause the rest of your portfolio to grow so that the long term never gets to be too large and the desired balance can be maintained. The positions of each portion complement the other parts of the portfolio.

The result is a reduced need to adjust your portfolio allocation and reduce it to maintain balance of risk, increased overall balance, and better, more stable results.


The allocation to stocks can adapt and adjust to displace the overall amount of risk towards stocks. Short term trades don't last enough to offset the balance, but if you are concerned you may take on short term hedges. For this model we will ignore short term hedging and only focus on a portion of cash on the side either being active as a intermediate term hedge or not.

As long term position grows

As long term positions contracts

As you can see, such a strategy keeps the other positions stable and overall keeps the strategy at the optimal risk according to your goals at all times. Over many trades, there will be many minor and major adjustments that develop as portfolio changes, but this strategy is elastic enough to adapt to various conditions and maintain the desired composition without selling early.