Here is my submission to your first question, kindly let me know if you need further clarification.
I have four stocks in my core portfolio now:
- Stock A- acquired during 1997-2001, average cost is 41.50 (multiple transactions), CMP is 18964, my current capital protection point is 12500 (around35% from CMP). There is no risk.
- The Stock B and Stock C acquired during 2013-14 are sitting on risk free as well.
- The last Stock D (new entrant in 2017) have 4 transactions so far. 3 out of 4 transactions have been risk free except the last addition.
So basically, there is one transaction where I will lose my original capital if market turned against me and I am able to sell my shares at my protection point. I have calculated risk tolerance as the risk divided by capital invested into core portfolio.
Say I buy a stock X (transaction 1: 100 shares at 100 first and I decided I will sell at 80. So, my inherent risk here is 2000 ((100-80) *100), residual risk is also 2000 ((100-80) *100).
Now assume stock X moves to 140. I changed my selling point to 100. Now my inherent risk will remain same i.e. 2000 ((100-80) *100) but my residual risk becomes Zero ((100-100) *100). Here my risk commitment in transaction 1 which was 2000 becomes zero now. It’s available for next transaction- transaction 2.
Now imagine same example the current price is 3000. As the stock has move up and making me happy I have decided to give 35% protection to play around i.e. I will sell at 1950. My inherent risk will be same i.e. 2000 ((100-80) *100) but my residual risk would be MINUS 18500 ((100-1950) *100).
I will never add a stock which will increase my initial inherent risk on transaction 1. This means if I have committed 2000 risk on transaction 1, I will not add anywhere if this figure goes beyond 2000. That would be all residual risk combined is either 2000 or less. Sometime this allows me to average down also (rarely I do though), how? Here it is:
Same stock X- after a price of 3000, it fell to 2500. Now my residual risk number would be still MINUS 18500 ((100-1950) *100). Even I commit 2000 additional risk through a new transaction the total residual risk will still be negative.
So, 0.16% is calculated on the POSITIVE (without considering NEGATIVE) residual risk of portfolio divided by capital invested. Now If I add both positive and negative residual risk it is a huge negative. But my selling point are transaction wise (at the time of fall I may sell them at one go, that’s different), so now one transaction in entire portfolio carries a positive risk for now. For last 8/9 years its been like that.
The 700 times premise was derived from this:
If the market kicks me out from current portfolio I will lose 0.16% of original capital invested. In totality the residual risk would be negative, hence no loss of capital. I extrapolated the fact in 4/5 years old portfolio if I can make a plan where I lose 0.16% then I will survive 700 times with same plan. This argument is flawed to some extent, I concede but with conservative bias. This is how:
- Actually, there is no loss of capital. Though overall risk is negative I am still taking last transaction for risk exposure assuming I will sell the transaction at capital protection point.
But yes, next portfolio construction will get into many more years. It would be difficult to assume to maintain the same level of 0.16% risk again. But considering my residual risk being mostly in single digits across 22 years I extrapolated the number to absolute which of course can be theoretical.
Let us conclude this way, I have to be knocked out many many more times by market before I rap up my belongings here.
No, we will never touch portfolio 700 times in a decade even. 2016-2017 I have added only one stock to core portfolio that to 5 transactions so far.
I hope I could explain to your need, I am answering your next question.