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AMR
01-05-2008, 08:46 PM
A quick poll to see who are the risk-takers and who is risk-intolerant.

I myself would have been the riskiest of risk takers until a short while back when I learnt about expectancy and money management the hard way:o. Now I use a small stop loss and don't have the urge to check my positions every 10 minutes :), and trade smaller markets like CFD indices.

axion
01-05-2008, 09:51 PM
I'd say educated gambles. Like doubling down on 11.

Small amount of capital, which if I lose I'm not going to be completely cut up about. I'm also relatively young (19), so losing all my money isn't the end of the world.

Although I'm starting to read a bit about position sizing and such, but I'm still quite a bit away from having enough capital to make it worth while.

Halebop
01-05-2008, 09:52 PM
Risk is a strange beast. Identifying risk is in the eye of the beholder. But unfortunately, seen or not, it soon makes itself known.

From my perspective CFD's are inherently risky - even if the instrument is DMA you don't really own an underlying security yet you simultaneously exaggerate your exposure to debt and volatility. Finally, you must be a more active trader which requires timing skills. None of this reads like a low risk activity.

Risk management is a misnomer. There are only two risks - the ones we aren't exposed to through avoidance and the ones we don't understand through participation (known risks that are discounted either aren't risks or aren't fully understood). Only one of these choices leaves an investor as a patsy at the poker table. An obvious recent example of risk is the Opes Prime collapse. Investors thought they were taking "market" risks when their biggest risk was the "market maker". This is typical of risk - you just don't see it coming and it confounds your "risk management".

So its not a matter of weighing risk. If risk could be emphatically calculated insurance companies would be really good at it. They are not. What the better ones are good at is saying no when the risk is high or the price is too low. ...and better still no when the risk is simply difficult to quantify.

Kiwis will be aware of the Icepack building fire in Hamilton. Aside from tragic loss of a fireman's life, the loss of improvements, plant and stock was large. Much of the losses were insured but the building insurance is the interesting part. To many underwriters the building is uninsurable - cool stores are counter-intuitively less than ideal physical risks and this one had no suitable water source with which to fight a fire - a big red flag when insuring big buildings. The underwriter thought they were taking a calculated risk for a somewhat higher premium but in fact were just taking an undisciplined and ultimately foolish risk (rumour has it they had the business for just days - ouch). The story goes back further though. The original developers got a somewhat cheaper investment for much the same reason - cheaper outlying land with no water. There was a hidden cost to that transaction that took years to show itself. While the replaced stock sits in other cool stores what do you think Icepack is thinking of their business risk now? A few months ago they probably thought they had it covered with their business interruption insurance but it won't cover them for permanent loss of custom. Suspect Fonterra and others will also be taking a harder look at suppliers and those little things like sprinkler systems and water supply. This is all part of the risk they collectively under-rated but none the less had covered under meticulously documented risk management and catastrophe recovery plans.
The lesson in short, risk cannot be managed. Only avoided. ...And even then you have to at least a little canny to know when to walk away.

Because I trade, invest in equities and private businesses and dine at dubious looking ethnic eateries, my risk profile would be in the upper half, not withstanding robust risk avoidance practices. I doubt anyone characterising themselves as a trader could be lower. The bad news for more sedate investors is that their actual risk profile will be no better if the quality of their decision making lacks proper criteria and benchmarks. Simple Beta / volatility tolerance tells me a share investor has to be in the upper half of risk takers.

FarmerGeorge
02-05-2008, 12:37 AM
Interesting position Halebop, I tend to agree.
One smart guy I talked to recently, who has the privilege of managing many billions of other peoples money, likened risk to energy. You can never get rid of it completely you can only change it into another form of risk. The key, it seems, to running a hedge fund (or investment portfolio) is to convert all risk into a type which you can understand and quantify. The definitions may be a little different from you Halebop but I think the principle is the same. It is the uncertain probability of loss which you are really trying to avoid.
As for me I'm well in the higher bounds of risk tolerance, if I feel I will be appropriately rewarded for taking on that risk. Look at the 18 month history of PDZ and PDZO's charts to give an idea of what I mean ;)

Year of the Tiger
02-05-2008, 07:23 AM
From my point of view, it is pretty hard to work out my risk profile because there are so many issues that need to be considered.

First point: I try to adopt the attitude that I invest in shares only with money that I would be prepared to lose if the the bum fell out of it, but that really is a load of crap, I would be pretty gutted to lose any amount of money regardless of how much and how often.

Second point: I still have a fairly limited knowledge about FA / TA and more often just read up about a company to gain as much knowledge as I can. If I get a warm fuzzy about the company at the end of the day, then I'll invest in some shares.

Third point: I still haven't organised a hard and fast exit strategy that I follow religiously, in fact usually when that warm fuzzy in point 2 becomes a cold reality, I usually head for the hills. Sadly, that doesn't happen soon enough on most occasions so end up reducing my profits at times, by significant sums.

So from all of the points above, I would say that my risk is fairly high. Now from the opposite angle.

Point 1: I don't have large sums to invest so I guess the lesser the capital, the lesser the risk.

Point 2: I am currently almost out of the market (except for a couple of favourties), and chose to reduce mortgage prior to Xmas.

Point 3: I am becoming expert at sitting on my hands during this current up and down cycle of the market. I know I have definitely lost out on some good opportunities however, at least I sleep well at night.

So in summary, in some respects, I feel that I take a rather risky approach to investing, however, in other ways, my risk profile is extremely low. so I voted just slightly above the midway point and I think that is a pretty fair assessment.

Cheers,
YOTT

shasta
02-05-2008, 12:03 PM
I'd say educated gambles. Like doubling down on 11.

Small amount of capital, which if I lose I'm not going to be completely cut up about. I'm also relatively young (19), so losing all my money isn't the end of the world.

Although I'm starting to read a bit about position sizing and such, but I'm still quite a bit away from having enough capital to make it worth while.

I selected "8", my portfolio would be considered high risk to others...

I see things a little different, but then again i back my research!

Axion - You coming along to the Wellington ST meeting?

STRAT
02-05-2008, 02:40 PM
My risk profile?

Somewhere between a danger unto myself and down right fool hardy :D

AMR
03-05-2008, 06:51 PM
Well I havn't thought of it that way before but I can understand what you mean, as in don't get burnt like Jim Rogers or those Opes prime clients.

I was actually talking more in terms of drawdown and what sort of levels people are comfortable with actually. A CFD indice (which I am only playing with at the moment) gives a maximum loss of 1% with my sort of stops. Forex gives a maximum loss of 3% but has a much much better Risk:Reward ratio.

Grimy
04-05-2008, 04:16 PM
From my point of view, it is pretty hard to work out my risk profile because there are so many issues that need to be considered.

First point: I try to adopt the attitude that I invest in shares only with money that I would be prepared to lose if the the bum fell out of it, but that really is a load of crap, I would be pretty gutted to lose any amount of money regardless of how much and how often.


I'm with you!!

Belumat1
04-05-2008, 04:51 PM
I choose 6 because it's true that the gain has no limits (no end, you can have 1,000 % or more) but on the other hand you can LOSE maximum 100%.

10% a year and you double your account in 8 years .......
what if I can gain 15% a year ?

Thank you
Bye

Lizard
04-05-2008, 06:30 PM
Is this a subjective/relative scale or is there a drawdown calculation that has the answer?

I don't really understand "drawdown" very well - what do you actually do if you reach your tolerance for drawdown? Stop investing? Is it a measure on an individual trade or across a portfolio as a whole?

Sorry AMR, I had a quick trawl around on "drawdown" and didn't really get a very clear picture - if you have a good link it might help! Thanks :o

winner69
04-05-2008, 06:48 PM
What AMR ain't done is quantify the hi or the low to get some consistency in the resilts of the poll .... like does high mean yhe likes of Farmer george are prpared to lose the lot before starting again

Try this Lizard - quite an interesting article

http://www.confidentstrategies.com/maximum-drawdown.htm

Mick100
04-05-2008, 09:02 PM
Is this a subjective/relative scale or is there a drawdown calculation that has the answer?

I don't really understand "drawdown" very well - what do you actually do if you reach your tolerance for drawdown? Stop investing? Is it a measure on an individual trade or across a portfolio as a whole?

Sorry AMR, I had a quick trawl around on "drawdown" and didn't really get a very clear picture - if you have a good link it might help! Thanks :o


Lizard, Drawdown is a term used by traders (how much your portfolio declines from top to bottom when the market goes against you)

I thought it was more the jargen of futures traders rather than that of share investors

I'm not sure what the link is between drawdown and risk tolerance either
.

AMR
04-05-2008, 09:30 PM
It seems I have my terminology in a total twist!

The title should really be something along the lines of "Would you prefer a high drawdown strategy with higher returns, or a lower drawdown strategy with lower returns?"...I guess that equates to greed-fear continuum.

Lizard
04-05-2008, 09:44 PM
Thanks Winner and Mick :)

Interesting concept, though my first impression is that the main benefit would be risk awareness rather than risk control. Maybe more relevant if you have another source of income that can be used to restore capital - i.e. if you reach your drawdown tolerance, you stop trading and start saving until your capital is restored? Otherwise I'm not sure what strategy could be used to guarantee making money again the moment maximum drawdown is reached?

Snoopy
05-05-2008, 12:12 PM
I was actually talking more in terms of drawdown and what sort of levels people are comfortable with actually. A CFD indice (which I am only playing with at the moment) gives a maximum loss of 1% with my sort of stops. Forex gives a maximum loss of 3% but has a much much better Risk:Reward ratio.


Ideally I am looking to stabalize my own investment portfolio to something like a dozen NZ shares (equally weighted) and probably a dozen overseas shares that would be in sectors not available for investment within the NZ market. I guess with that many investments it wouldn't really matter if one of my investments went completely broke.

On that basis my individual share tolerance would be the highest possible (it wouldn't matter if I lost everything). But my portfolio tolerance would be low (I would be concerned if my portfolio dropped more than 4% in any one year). Where do I fit on your risk/reward scale?

SNOOPY

STRAT
05-05-2008, 01:53 PM
Snoopy, you left your guard down there mate.:D
I cant believe Macca let this opportunity slide :eek:

duncan macgregor
05-05-2008, 01:57 PM
SNOOPY, Your in the extreme risk category, by not having a stop loss system when you either male a wrong call, or the market crashes. Knowing how at least half a dozen of your shares have downtrended with you making calls of averaging down makes your risk extreme.
Spreading your investments about like eagle pooh over the countryside will only save you from yourself, not in a market crash as the one looming up. Macdunk

Phaedrus
05-05-2008, 03:39 PM
I'm not at all sure that any of us are capable of objectively assessing the level of risk in our sharemarket dealings. I haven't voted here because I don't know where I would fit on a low - high drawdown scale. I've had days when I have lost in excess of $25,000 for example. Is that high or low? I don't know - you tell me! In any case, I see drawdown as only one measure of risk. Question - do drawdowns equate with volatility? Maybe they do! I know that beanies often use volatility as a measure of risk, but I disagree with that. It is not hard to find stocks with a lot of short-term volatility that have been in uptrends for years. High risk? Not in my book. My theory is that the higher the risks you run, the more money you make BUT the higher the likelihood of failure. Many of the factors that lower risk also lower returns. We are all trying to juggle these 2 factors. Here are a few of my thoughts on the matter. I claim no special knowledge or expertise in this area, so be gentle with me OK?

Factors that I associate with lower risk :-
Uptrending market
Diversification
Use of a proven system
Good fundamentals
Uptrending stock
Sustainable dividend yield
Regular rigorous monitoring
High volume stocks
Low drawdowns
Loss limitation mechanisms

Factors that I associate with higher risks :-
Downtrending market
Lack of diversification.
No formal system.
Ignorance of fundamentals
Ignorance (or disregard) of market sentiment
Unsustainable dividend yield
Buying downtrending stocks
No regular monitoring
Low volume stocks
High drawdowns
Absence of loss limitation mechanisms

Run enough risks and you WILL, without question, go bust. The other extreme is to be so risk averse that you are too fearful to be in the market at all, restricting yourself to bank interest rate returns. Now, don't get angry here Dunc, but if you voted, it would surely have to be at the extreme conservative end of the scale. What could be less risky than leaving all your money in the bank? The problem here is that you now run another risk - that of missing out altogether on the absolutely outstanding profits being made by a lot of people at the moment.

It's a bit like life, really. The safest thing to do is stay in bed - but then more people die there than anywhere else!

duncan macgregor
05-05-2008, 04:22 PM
PHAEDRUS, last year in a bull market i doubled my money with high risk strategies. This year in a bear market i get ridiculed for staying out the market. Play the game to the max when the odds are in your favour, and stand clear when they are not. I would say that my risk increases in a bull market, and reduces in a bear market. How many people had their whole trading account riding on one share like i did with SMM last year?. Then how many people have the will power to stand clear like i am right now?. Macdunk

foodee
05-05-2008, 04:37 PM
Phaedrus
you astound me. What is this 'Random thoughts' bit.
I only wished my best effort is half as good as that, but then what would anyone expect from a 'food junkie' like me.

Crypto Crude
05-05-2008, 07:39 PM
mackdunk,
AGS, one of your favourites hit a low of 65c, now almost $1...
its strange to see you watching all these great stocks hit lows and not acting on them...
:cool:
.^sc

Snoopy
05-05-2008, 08:28 PM
SNOOPY, You're in the extreme risk category, by not having a stop loss system when you either make a wrong call, or the market crashes. Knowing how at least half a dozen of your shares have downtrended with you making calls of averaging down makes your risk extreme.
Spreading your investments about like eagle pooh over the countryside will only save you from yourself, not in a market crash as the one looming up.


Macdunk, what I am getting at here is that you don't need to use stop loss as a risk management tool. There are other ways. If you recognise that the market will always go up and down you don't need to time it. You just wait for a particular sector to weaken and buy in, always into the best one or two companies in that sector. Then wait for the recovery. Of course sometimes that recovery could take days and other times years. If you are patient enough it doesn't matter. And if the market crashes so what? I have never invested in 'the market' anyway. Just my favourites. And over the years I have found they do not all crash at the same time, despite what you believe. It is only those who invest solely in one market in one sector that get into permanent trouble from crashes. At least you have had the good sense to realise your overconfidence is not an enduring fuel for your own investment engine.

I know you don't read, but you should really get hold of Ben Graham's parable of Mr Market some time. It is a chapter and verse picture of how you operate.

SNOOPY

Mick100
05-05-2008, 08:53 PM
Firstly, if your going to measure risk solely on drawdowns I would be way off the scale - probably 20-25

In 2006 I had a 63% drawdown in my commodities account in a period of 3-4 weeks when some palladium futures went south in a hurry - due to my relative inexperience I didn't close them out when they turned and - whamo
(finished the yr up 88% on combined accounts)

Most yrs, on my combined share and commodity accounts i usually have a 15-20% drawdown at some stage throughout the yr
This yr I was down 23% in jan and had it not been for commodities going ballistic my drawdown would have been at least 35%
(currently down 2.8% this yr)

I don't use stop losses and I still buy downtrending shares on occasion - when your in the right sectors and the companies are fundermentally sound the market will always rescue you if you find you have paid too much for a share. I jumped the gun buying PSA for $1.00 a while back and watched the shareprice continue falling to $0.65 but I see they are back up to $1.00 today (that's an extreme example - most of my recent buying has been much closer to the bottom than that)

Snoopy
05-05-2008, 09:18 PM
I see drawdown as only one measure of risk. Question - do drawdowns equate with volatility? Maybe they do! I know that beanies often use volatility as a measure of risk, but I disagree with that. It is not hard to find stocks with a lot of short-term volatility that have been in uptrends for years. High risk? Not in my book.


You are being too modest here Phaedrus. You are dead right in my book. Volatility is a measure of how things can move up and down. I have never heard an investor complain because his share suddenly moved up in price. Drawdown is only half of the volatility measurement - the downside bit. Of course that is where the risk that matters to the investor lies. Not in the more general definition of volatility.



My theory is that the higher the risks you run, the more money you make BUT the higher the likelihood of failure.


And the more high risk bets that you take that come off, the more your overconfidence grows and the rate at which you approach your inevitable failure speeds up.....



Many of the factors that lower risk also lower returns.


True, but not all factors.



Factors that I associate with lower risk :-
Diversification
Use of a proven system
Good fundamentals
Sustainable dividend yield
Regular rigorous monitoring


I agree



Low drawdowns


How do you tell the difference between a low drawdown and a high drawdown before the event?



Uptrending market
Uptrending stock
High volume stocks


I'll have to agree -to disagree- on those. I am wary of both uptrending markets (because both the good and the bad can get swept along in the wave) and uptrending stocks (because you know that eventually the uptrend will go too far and you will need to pay attention so that you don't overshoot the value too far on the high side). I know what your answer is to that Phaedrus. That is why you have 'high volume stocks' in your list. Because high volume is the key to be able to get out 'when the uptrend ends'.

Yes such a strategy will get you out, but at what price? Probably in 19 cases out of 20 within five percent of the peak. It is a pity about the twentieth case though. The problem is when you play with a gun you have to know whether you are playing 'shoot the target' or 'russian roulette'. In market terms, many traders see these two games as the same.



Loss limitation mechanisms


Your best bet to be 'Top Gun' is check that the pilot is good *before* you get into that plane. That way there is much less need to rely on the ejector seat.

I think the biggest factor in avoiding 'large drawdown' is to do your homework before buying in the first place.

SNOOPY

STRAT
05-05-2008, 09:48 PM
PHAEDRUS, last year in a bull market i doubled my money with high risk strategies. This year in a bear market i get ridiculed for staying out the market. Play the game to the max when the odds are in your favour, and stand clear when they are not. I would say that my risk increases in a bull market, and reduces in a bear market. How many people had their whole trading account riding on one share like i did with SMM last year?. Then how many people have the will power to stand clear like i am right now?. Macdunk
Duncan ,
Ive done better this year in 4 months than I did most of last year
Obviously being a relative newbie means Im probably significantly better at this game now than I was a year ago. One always improves at any endeavour at a faster rate when starting out. If I can do ok Im certain you can. Like you, I have little confidence in the market but I have shortened the duration of my holds to within a time frame I feel confident with and its going fairly well. Same game plan shorter time frames. You are missing out here I reckon

Phaedrus
06-05-2008, 11:02 AM
Snoopy, when I said "Many of the factors that lower risk also lower returns" I should have said "Some". I was actually thinking specifically of diversification. I don't think there is any doubt that diversification lowers both risk and return. To be over-diversified ensures average returns with minimal risk, while less diversification gives a greater chance of out-performing (and under-performing!) the average.

"And the more high risk bets that you take that come off, the more your overconfidence grows and the rate at which you approach your inevitable failure speeds up....." You're talking about Duncan, right? Something quite strange has happened here, Snoopy. Dunc has suddenly gone from running a very, very high risk "system" (with ALL his money riding on a single stock!!!!) right to the other extreme of sitting on the sidelines at a time when the market is offering all sorts of technical and fundamental opportunities. As I see it, he has swung directly from being totally reckless to being completely crippled by excessive caution. This abrupt and total about-face came just as Dunc was telling us that he had moved all his money to Australia to become a full-time trader there! Maybe he got a fright. Maybe he suddenly realised the enormity of the risks he had been running and has now lost his nerve. I guess the kindest and most likely explanation, though, is that Duncan is still in the process of developing his system.

"How do you tell the difference between a low drawdown and a high drawdown before the event?".
One way is by backtesting.All other things being equal, a system with a low historical drawdown is less risky than one with a high historical drawdown.

"I am wary of both uptrending markets (because both the good and the bad can get swept along in the wave)......."
Why should that be a cause for concern? Who cares what happens to bad stocks that you have no interest in?
".....and uptrending stocks (because you know that eventually the uptrend will go too far and you will need to pay attention so that you don't overshoot the value too far on the high side)."
So pay attention! You would want to get out of over-valued stocks, surely?

"Your best bet to be 'Top Gun' is check that the pilot is good *before* you get into that plane. That way there is much less need to rely on the ejector seat."
If you are flying without an ejector seat, you are running an unacceptable risk - no matter how good the pilot is!

"I think the biggest factor in avoiding 'large drawdown' is to do your homework before buying in the first place."
True enough. Nevertheless it is inevitable that you will make some mistakes no matter how much homework you do. To my mind it is important to establish what would need to happen for you to consider that you had made a mistake and to develop a suitable response for that eventuality. (And no, buying more simply doesn't cut it, in my book!)

Snoopy, given our totally different approaches to the market, the surprising thing here is just how much we agree on!

Snoopy
06-05-2008, 04:06 PM
I don't think there is any doubt that diversification lowers both risk and return. To be over-diversified ensures average returns with minimal risk, while less diversification gives a greater chance of out-performing (and under-performing!) the average.


I think it is fairly well accepted in investment professional circles that if you have two investments to choose from - and both have identical projected returns - then the 'correct' thing to do is invest in both. If things go exactly according to plan, this means you will get exactly the same return to other investors who simply invested in one or the other. But if things do not go according to plan, then your risk is greatly reduced compared to the investor who 'just backed one horse'. So Phaedrus, I don't accept that diversification automatically reduces both return and risk.

More generally I have pondered the diversification/return trade off for some time. If you had say:

1/ 5 NZX shares on the go at any one time AND
2/ the NZX market long term average return was 10%

-THEN- if one share 'fell over' (for our purposes we'll assume that means lost half its value), the average return on our four remaining shares would have to increase by a factor of 'r', so that your five selections in total met the market average :

4r+0.5=5(1.1)

'r' works out at 1.25. That means on average your four remaining investments will have to increase in value by 25% each, *just to meet the market average*! Now 25% is more than double the market average return rate. So to achieve that on *all* four other shares in your portfolio would be a tough ask.

This is an example of how getting just one thing wrong can stuff up your whole portfolio return if you are not diversified enough.

Now let's say you had 12 shares and one 'fell over' as above. The return needed for the remaining shares to restore an average performance is as follows:

11r+0.5=12(1.1)

This gives 'r'= 1.15. That is still a return 5 percentage points higher than 'the market'. But for a skilled investor I think that kind of target is realistic.

This is why I favour a 12 share portfolio. Because if one share falls over for no tellingly obvious reason (and those in the Australian market in particular will be able to cite several examples where the share price has collapsed by more than 50% in one day), then it still gives you a good chance of coming out ahead on a portfolio basis.

Anyone agree or disagree with this and have other thoughts on this topic?

SNOOPY

Mick100
06-05-2008, 05:14 PM
I'm a great believer in diversification - I maintain a 30 stock portfolio.
The one thing that diversification does not protect you from is market risk as alot of people have found out over the past 6 months.

This market risk, or non diversifiable risk, can be countered by operating in more than one market. If you operate in two seperate markets which are negitively correlated then you can combine the two and greatly smooth your returns. In my case I run a med-high risk share portfolio and a commodity account (futures and options on futures) As mentioned the share account is fairly high risk and the commodities account is right on the outer edge of the risk spectrum (very high risk). Each account on it's own is high risk but the combined accounts are probably no more risky (voltile) than a moderate risk share portflio on it's own.

One thing the academics have got right is that asset allocation stategies are a far superior way to manage risk than diversification.

Halebop
06-05-2008, 05:25 PM
Anyone agree or disagree with this and have other thoughts on this topic?

If I avoid shares that under-perform I reduce the need to seriously outperform on the good ones. Although I'm still seeking outperformance, higher than average performance that is well within the distribution curve will still see me handily outperform quantitative diversified models. Although he might not describe it as above, Buffett earns high returns from avoiding these same low returns. His somewhat better than average performers then make him look like a star, not because they are stellar performers, but because his qualitative approach avoids even an average instance of duds (With a few notable exceptions, including the "original" textile business which they hung on to far too long, he's also pretty good at cutting losses on also-rans before they suck too much opportunity cost).

I'd accept that an investor can still attempt a qualitative diversifed model but frankly often there isn't that much quality-at-a-good-price out there and I'm more dubious of this approach except perhaps following the lowest of low markets.

Snoopy
06-05-2008, 05:37 PM
"And the more high risk bets that you take that come off, the more your overconfidence grows and the rate at which you approach your inevitable failure speeds up....." You're talking about Duncan, right?


I guess FIM (Former Investor MacDunk) might be an obvious loud mouthed example. But I wasn't specifically thinking of him when I wrote that. I was mainly meaning that the more sequential trades you do then the greater the chance that you will encounter one that not only goes wrong, but catastrophically wrong.

We can use FIM as an example here. Let's assume he really has 'got it right' with his system and that his 200% gain he made in 2007 really is typical of what he can do. That's fine except that his same system subsequently selected PEM for 2008 as a single investment which IIRC collapsed in price from something like, $3 to just $1. Thus his overall system, based on a two year sequential performance, produced a multiplier return of:

2.0x0.3333=0.6666

In other words his system based on only three successful trades in 2007 and one poor trade in 2008 resulted in him losing 33% of his capital. Technically his system had a 75% success rate, which sounds good. But it was a losing strategy because he underestimated how wrong he could be on the downside. Despite FIM's "75% success rate" *all* his good work has been undone - and then some.

SNOOPY

PS Duncan/FIM I know you haven't lost 33% of your capital because you didn't put all of the money you won on the table in 2007 back in 2008. But you have yet to convince me that you will ever be back as I suspect you are now waiting for market conditions like we experienced from 2001 to 2007. That will possibly take decades, not years. I think for an in and out of the market strategy to be credible you have to have some re-entry criteria. And waiting for China to bankrupt the USA before you get back in doesn't cut it.

Snoopy
07-05-2008, 09:17 AM
I'm a great believer in diversification - I maintain a 30 stock portfolio.

This market risk, or non diversifiable, risk can be countered by operating in more than one market. If you operate in two seperate markets which are negitively correlated then you can combine the two and greatly smooth your returns. In my case I run a med-high risk share portfolio and a commodity account (futures and options on futures) As mentioned the share account is fairly high risk and the commodities account is right on the outer edge of the risk spectrum. Each account on it's own is high risk but the combined accounts are probably no more risky (volatile) than a moderate risk share portflio on it's own.

One thing the academics have got right is that asset allocation stategies are a far superior way to reduce risk than diversification.

With a thirty stock portfolio, the odds are you would have had a couple of big winners last year Mick? I think that the Oz market where judging by the allocation of your postings you do most of your investing, has a higher long term market growth rate than NZ. Let's say 12%. Let's say you had two 100% winners, with the rest of your portfolio performing in line with 'the market'. That would give you a total portfolio return of:

[28(1.12)+2(2)]/30= 1.178

That would amount to a 17.8% portfolio return for the year, which is 5.8 percentage points above 'market return'. That's pretty good. However, looking after 30 stocks must take some work. And am I correct in assuming that you have a heavy concentration of commodity stocks in your portfolio?

I have only one commodity share- BHP (which is admittedly the worlds largest and most diversified miner, both by commodity type and geogpaphically). Last year I made 21.3% on that one share which beats my hypothetical construction of your portfolio by a handy margin. In addition this has cost me zero effort because I have did no work on it last year.

If you regard BHP as a proxy measuring stick for all miners, could I not argue that your outperformance is due to your riding on the commodities boom? And your actual performance when compared to the commodites index is not that flash? OK, I have made all of your portfolio return figures up Mick. But I am wondering whether running a 30 share portfolio like you do is an efficient use of your time. Fair comment, or not?

I take your point and agree that operating in two markets that quite risky in their own right and not well correlated, is less risky than investing in either market on its own. I am curious as to how you would define the distinction between different markets though. Would you consider a portfolio split 50% between the NZX and ASX sufficiently uncorrelated?

SNOOPY

Snoopy
07-05-2008, 09:44 AM
"I am wary of both uptrending markets (because both the good and the bad can get swept along in the wave)......."
Why should that be a cause for concern? Who cares what happens to bad stocks that you have no interest in?


What if the mere fact that a stock was trending up made me interested in it? Then I bought that stock. Then found out that what I thought was a 'good stock' was really a 'good market' lifting all boats (including my 'bad stock').



".....and uptrending stocks (because you know that eventually the uptrend will go too far and you will need to pay attention so that you don't overshoot the value too far on the high side)."
So pay attention! You would want to get out of over-valued stocks, surely?


Yes, sell shares that have become overvalued, that is a fair enough comment. The problem is that, speaking strictly in terms of fundamentals, not all shares can be judged solely on their *own* fundamentals. They also must be judged on their 'market sector fundamentals'. For example Fletcher Building seems to have performed in an exemplary fashion as a company. Yet domestic building permits and house sales are down, and finance is more difficult to obtain. So the FBU share price is being punished, as I see it, because of wider market factors, largely outside the control of the company.

I must add, I haven't studied FBU in detail and have never held the share myself. But just because the share price has gone down, does that mean the sharemarket has assessed the sector risk and its effect on FBU correctly? I'm not so sure.



"Your best bet to be 'Top Gun' is check that the pilot is good *before* you get into that plane. That way there is much less need to rely on the ejector seat."
If you are flying without an ejector seat, you are running an unacceptable risk - no matter how good the pilot is!


Most aircraft don't have ejector seats. And that doesn't put the passengers off flying!



"I think the biggest factor in avoiding 'large drawdown' is to do your homework before buying in the first place."
True enough. Nevertheless it is inevitable that you will make some mistakes no matter how much homework you do. To my mind it is important to establish what would need to happen for you to consider that you had made a mistake and to develop a suitable response for that eventuality. (And no, buying more simply doesn't cut it, in my book!)


You have more faith in the market to assess things correctly than I do.



Snoopy, given our totally different approaches to the market, the surprising thing here is just how much we agree on!


Yes, and possibly those areas we *do* agree on are good clues as to why we are both still here!

SNOOPY

Mick100
07-05-2008, 04:30 PM
With a thirty stock portfolio, the odds are you would have had a couple of big winners last year Mick? I think that the Oz market where judging by the allocation of your postings you do most of your investing, has a higher long term market growth rate than NZ.

Yes I have 25 oz stocks and 5 nzx
I usually get 2 or 3 of my speccy stocks that would go up by 300% plus

If you regard BHP as a proxy measuring stick for all miners, could I not argue that your outperformance is due to your riding on the commodities boom? And your actual performance when compared to the commodites index is not that flash?

Your correct in saying that my performance is due to the commodity boom - it is. I'm not sure exactly what the CRB rate of return has been but my annual compound rate of return of 55%, over the past 5 years, would compare well I think. The only time I wonder if I'm holding to many stocks is around quarterly reporting time, otherwise I can keep up easily with announcments etc. The reason why I'm so diversified is because about 10 of my stocks are purely speculative (ie - little or no earnings) I expect the odd one to fall over.


I am curious as to how you would define the distinction between different markets though. Would you consider a portfolio split 50% between the NZX and ASX sufficiently uncorrelated?

The NZX and ASX are too closely correlated for my liking. I treat them as one market. International sharemarket diversification is also becoming less effective as globalisation means that all sharemarkets are more closely correlated than they were 15- 20 yrs ago. They tend to move in the same direction as each other now. I think, in order to manage risk really well you have to have some assets out of the sharemarkets altogether.
It turns out the commodity markets have a strong negitive correlation to sharemarkets which makes commodities ideal in my opinion
,

Snoopy
09-05-2008, 12:58 PM
If you regard BHP as a proxy measuring stick for all miners, could I not argue that your outperformance is due to your riding on the commodities boom? And your actual performance when compared to the commodites index is not that flash?

You're correct in saying that my performance is due to the commodity boom - it is. I'm not sure exactly what the CRB rate of return has been but my annual compound rate of return of 55%, over the past 5 years, would compare well I think.


As at 31st March 2003, the BHP share price was $A9.28. As at 31st March 2008 the BHP share price was $A35.81. In that five year period $A2.24 has been paid out in dividends. That gives a compounding rate of return of:

9.28(1+r)^5=(35.81+2.24) => r=0.326

That is a compounding rate of return of 32.6% per year (not including exchange rate gains).
Your annual return rate compares very favourably with that Mick. Well done. It looks like you are genuinely 'adding value' with your methods.



The NZX and ASX are too closely correlated for my liking. I treat them as one market. International sharemarket diversification is also becoming less effective as globalisation means that all sharemarkets are more closely correlated than they were 15- 20 yrs ago. They tend to move in the same direction as each other now. I think, in order to manage risk really well you have to have some assets out of the sharemarkets altogether.
It turns out the commodity markets have a strong negative correlation to sharemarkets which makes commodities ideal in my opinion


I can't argue with your results Mick. But the idea of investing in 'commodity shares' and effectively hedging your share investment performance by trading pure commodities seems counterintuitive. Looking back over your experiences, are you able to tell us, with the benefit of hindsight why the investment performance of 'commodity shares' and 'commodities' are divergent? On my rule of thumb reckoning they should both be going up!

SNOOPY

Mick100
11-05-2008, 10:54 PM
I can't argue with your results Mick. But the idea of investing in 'commodity shares' and effectively hedging your share investment performance by trading pure commodities seems counterintuitive. Looking back over your experiences, are you able to tell us, with the benefit of hindsight why the investment performance of 'commodity shares' and 'commodities' are divergent? On my rule of thumb reckoning they should both be going up!

SNOOPY

Your absolutely right Snoppy. You would think that the shareprices of commodity producing companies would be closely correlated to the price of the commodity being produced, but that's not the case, as anyone invested in oil and gold shares over the past 6 months can testify.

Shares in commodity companies are more like a derivatives over commodies than commodities themselves or to put it another way, commodity shares behave more like shares than commodities over the short and medium term - that's been my experience so far. Over the long term I would think that the commodity shares will track the commodities, at least, I hope so.

To come back to the risk/volatility argument, over the short term, the overall volatility of my portfolio is significantly reduced by the combination of a share account and a commodity account - your right snoopy, it shouldn't make sense but in practice, it does.
.

Snoopy
12-05-2008, 10:51 AM
Shares in commodity companies are more like a derivatives over commodities than commodities themselves or to put it another way, commodity shares behave more like shares than commodities over the short and medium term - that's been my experience so far.


'Ping' the light just went on Mick!

Most commodity businesses have a responsibility to their shareholders to provide some certainty in their business planning. Thus they will take out futures contracts to lock in their commodity prices to provide some certainty to their shareholders. Those shareholders need certainty. Shareholder miners face large capital equipment and wage contract costs to 'get the rock out of the ground'. Shareholder dairy farmers need to be able to satisfy their bankers that they can pay their high interest bills and lock in enough money to see them through the vicissitudes of the weather.

It would appear that your observation Mick of 'commodity shares' behaving more like 'commodity derivatives' is after all easy to explain. 'Commodity shares' are, on the whole, a holding vehicle for 'commodity derivatives', for the reasons I explained in my previous paragraph. So it is not at all surprising that 'commodity shares' behave like 'commodity derivatives' (and are not highly correlated with the spot price of commodities). That's because in operational reality 'commodity shares' and 'commodity derivatives' are almost one and the same!

What I said about listed companies hedging their commodity price outputs -while generally true- is not always true. Not all companies hedge their output prices. So here is the test. If my theory is correct then those listed companies that *do not* hedge their outputs will behave more in line with the movement in price of the underlying commodity. You hold a fair number of commodity companies Mick, some must be unhedged. In your experience have the unhedged companies that you have positions in behaved differently?



Over the long term I would think that the commodity shares will track the commodities, at least, I hope so.


Mick I think your hopes will be borne out. Long term (with the important rider that the costs of harvesting the commodity do not increase faster than the price of the commodity itself) the price of 'commodity shares' should track the price of the commodity as those underlying 'derivative contracts' unwind.

SNOOPY

FarmerGeorge
12-05-2008, 05:02 PM
I just wandered back into this thread and thought I might contribute.
Mick's experience mirrors the historical record which shows shares of commodity producing companies are more highly correlated with the share market than with the commodity market. Someone did a regression and published it and we were taught it this year at b-school. Unfortunately I can't remember off the top of my head the time frames involved in the study, but I have to say it's impressive that Mick noticed this, as most people even those who invest in commodity related shares, would swear that this is not true.
As for the reason, I think that in general it would have to do with companies being valued using DCF's which are not as sensitive to short term movements in underlying revenue (aka commodity price) because historically high growth in commodity prices has not been sustained. The DCF would also be affected by the hedging tactics of the company.