Portfolio Heat is not a professional basketball team it is an essential piece in managing a traders portfolio. In order to be a successful trader we have to be aware of the risks and how it can affect our portfolio. In many ways when we enter positions we have to think what is the worst-case scenario and plan for it.
Portfolio heat is how many potions we have open and the portfolio risk that each trade carries. Lets say for example you have portfolio risk of 1% meaning that if the position you open losses everything only 1% of your portfolio will be lost.
Now lets say we open 5 positions our portfolio heat stands at 5% that is if everything goes belly up we only lose 5% of the portfolio.
If you wanted to open more positions with 5% portfolio heat you would then have to adjust your portfolio risk. In this case if you wanted to establish 10 positions you would have to adjust your portfolio risk downward to .50%
The formula is pretty easy to calculate:
Portfolio risk x Number of positions = Portfolio Heat
The amount of portfolio heat is really dependent upon the trader. For more risk averse traders portfolio heat can come somewhere between 5 to 10%. Especially if you are a new trader it helps to have a lower portfolio heat so you can preserve your capital.
Some more experienced traders can tolerate a higher portfolio heat, mainly because the have more experience managing positions and their systems are more refined, the system they maybe using could have higher winning percentage.
The key with portfolio heat is it's a way to manage your overall portfolio exposure.