What is portfolio heat in trading?

Portfolio heat is a common name for total open risk: the combined dollar loss you would take if every open position hit its stop at once, usually shown as a percentage of the account. It is the number you compare against a cap before deciding whether a new trade fits.

Should open risk be measured from your entry price or the current price?

Both tell you something. Measured from entry, open risk shows how much of your original capital is exposed. Measured from the current price, it shows how much you could give back from here, including open profit, which matters once a winner has moved well above its stop.

How Do You Add Up the Risk on All Your Open Trades?

Q: How Do You Add Up the Risk on All Your Open Trades?

For each open position, multiply the share count by the distance from entry to stop, then add the results and divide by the account value. In a hypothetical $45,000 account holding positions that risk $300, $200 and $400, total open risk is $900, or 2%. Then treat correlated positions as one and add extra for gaps around earnings and weekends.

Every stop order resting at your broker is a written statement of how much you are prepared to lose on that idea. Read them together and you have a figure no broker screen shows by default: how much the whole account could lose if the market turned against everything at once.

Everything at once is less rare than it sounds. Stocks that look unrelated on a good day often fall together on a bad one, and then the damage is the sum of every stop in the account.

The steps

1. List each position with its entry and its stop

You need the share count, the entry and the stop. Nothing else. Take them from the positions screen and the open orders screen, not from memory, since a stop you meant to move and never did still counts at its old level.

2. Work out the dollars at risk in each

Take the gap between entry and stop and multiply it by the shares you hold. For a short position, the distance runs from the stop down to the entry.

Position C has the fewest shares. It carries the most risk. Share count tells you almost nothing on its own, which is why a position size calculator works from the stop distance first.

3. Compare the total with your cap

Two percent of the account is at risk. Is that too much? That depends on your cap. Set it in advance, as a share of the account. If the cap were a hypothetical 6%, this account has room for $1,800 more before it stops taking new trades; the question of how many swing trades to hold at once runs that same cap forward.

4. Count stops at or above entry correctly

Move a stop up to the entry price and that position counts as zero. That is fair. It is also only true while the market trades continuously, because a stock that gaps below the stop overnight fills wherever it opens, and a breakeven stop gives no protection from that at all.

If you measure from the current price, the picture changes. A winner at $60 with a stop at $50 puts $10 a share of open profit on the line, and some traders track that figure separately so a run of good trades does not quietly turn into a large amount of money exposed to a single bad morning.

5. Group the positions that move together

Correlated positions behave as one. If A and C are both in the same industry and tend to trade in step, treat them as a single $700 bet, about 1.6% of the account, and check it against whatever per-idea limit you use. Three semiconductor names at 1% each is closer to one 3% semiconductor trade than to three separate ideas.

You do not need a correlation coefficient. A rough test does the job: put the charts side by side over recent months and look at whether the positions fell on the same days.

6. Add gap risk around earnings and weekends

Your stop caps the loss only while prices move smoothly. Earnings reports, weekends and scheduled economic releases are where they stop doing that.

Check the earnings date for every position you hold. A trade carried through a report deserves either a smaller size or an honest entry in the sum at a gap-sized loss.

Which account value goes on the bottom of the fraction?

Your equity. In a cash account that is simply the account value. On margin it is the market value of everything you hold minus the loan, and dividing open risk by the larger gross figure flatters the result, because a $900 loss comes entirely out of the part of the account that is yours while the broker’s loan stays exactly the same size.

Say the same positions sat in a margin account with $45,000 of stock and a $15,000 loan. Equity is $30,000. The $900 of open risk is then 3% of what you own. Nothing about the trades changed. The denominator did, and it is the honest one.

How often should you add it up?

Every time you open a trade, move a stop or head into an event. It takes minutes with a spreadsheet. Skip it and you learn your real exposure on the day everything hits its stop together, which is the worst day to learn it.

The margin of safety is Benjamin Graham’s idea from investing, and Graham’s margin of safety for traders borrows it for sizing trades. More on stops, sizing and limits sits in the risk management section.