The title is a mouthful, I know. Lots of big words and such. Here’s the gist of today’s message: I’m going to show you how to calculate the proper amount of exposure for your active trading portfolio.

When I say “active trading portfolio,” I’m not talking about your passive accounts that include a bunch of long stock positions (with or without covered calls). I’m thinking more about an active trader who carries a handful of swing or position trades using stocks or options.

I supposed you could use this for a passive account, but keep in mind the more shares of stock you own, the higher your overall exposure. So it will grow alongside your account value.

Three Simple Steps

Coming up with the appropriate range for your exposure involves three simple steps. Before I get into them, let me mention one important takeaway. There isn’t one right way to do this. You could use a variety of metrics to determine an appropriate amount of exposure. My preference is to focus on your willing daily fluctuation of the account value. Think of it as how much movement you’re willing to stomach in your account value.

Step One: determine your willing daily fluctuation in dollar terms

Step Two: find the Average True Range (ATR) of the S&P 500 ETF (SPY)

Step Three: Divide the willing daily fluctuation by the ATR

The final number is the max beta weighted delta appropriate for your account.

Case Study

If you read the three steps and grasped everything on the first pass, congratulations. You’re smarter than the average bear. For everyone else (like me), an example will help. We’re going to assume you have a $30k account and are comfortable seeing it rise or fall 2% ($600) a day.

Step One: Willing daily fluctuation = $600

Step Two: SPY ATR = $3.21

Step Three: $600 / $3.21 = 187

187 is the magic number. That’s the max delta you want to have in your portfolio. And, to be clear, we’re talking about the SPY beta weighted delta. If you let it creep above 187, then you will likely see greater than +/- 2% fluctuations in your account. Also, remember that the ATR is the average day. That means the average trading session should deliver a gain/loss of 2% to your portfolio. Days boasting more volatility than normal will likely see greater than 2% swings in your account value.

Here would be the appropriate range for my $30k account:

Max bullish: +187 delta

Neutral: 0 delta

Max bearish: -187 delta

At times when I’m aggressively bullish (a +3 in our oft-referenced bias spectrum), I could let my account delta push towards, but not beyond +187 deltas. When I’m aggressively bearish (-3), I could let my account delta drift towards -187.

This hypothetical account has a +102 delta. That means on the typical day where the SPY moves $3.21 this account will fluctuate $327 (delta x ATR). If my willing fluctuation was only $200, then this account delta is too high, and I need to cut it down by either exiting bullish positions or adding bearish ones.

That’s the basic idea.

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