Tag Archive | allocation

Position Sizing: Key to Maximizing Returns

In a time when market volatility and equity preservation is of utmost importance, determining the correct number of shares to buy, or “position sizing”, is key to maximizing returns and minimizing risk.

The common investor generally doesn’t spend much time thinking about how many shares to buy or how significant of a position to take.  Instead, most investors use a common methodology of trading the same number of shares each time, which usually translates to a specific dollar amount.  Other, more sophisticated investors, opt to allocate a certain percentage of their portfolio value to a specific position. Following this train of thought, a new position in a portfolio of $100,000 would transcribe either a $10,000, or 10%, investment or a usual position of 50 shares.

Although these methods may work for some, using the volatility of a specific portfolio is likely to be the most effective decision tool.  Measuring a portfolio’s overall volatility enables an investor to decide on what percentage of that portfolio he is willing to risk losing on the new position.  This methodology is better explained through the following example. Read More…

A New Risk Indicator To Sidestep Market Downturns: Is It Better Than VIX?

By Chris Georgopoulos, originally published on 11/14/11

Without question the most popular model to predict market crashes is the VIX, commonly referred to as the “Fear Gauge,” a market index that measures the implied volatility of the S&P 500 index options. Its concept is quite simple, when the uncertainty and fear among investors rises, they commonly run to the S&P 500 options to either hedge or speculate. The increased interest in the options usually leads to higher premiums and as the premiums increase so does the VIX. However, predicting the future isn’t 100% accurate, most of the time it’s not even close. Every forecasting model has its flaws and the VIX is not an exception. There are many problems skeptics have found with the VIX such as; its population study is limited to only the 500 stocks of the S&P 500 and” {the} model is similar to that of plain-vanilla measures, such as simple past volatility” (Wikipedia). A blog post on sensibleinvestments.com summarized the VIX as “simply an indicator of actual volatility in the market but one that is very sensitive to changes in actual volatility particularly if it is on the downside.” Is there a better way?

An elementary statistics theory states that the larger the population size, the greater the likelihood that the sample will be represented. If markets are graded by the performance of popular indexes such as the S&P 500, why limit a forecasting model’s population to only 500 stocks? The economy has become global; interactions from every corner of the world’s businesses affect every other business. If there is a model that forecasts market direction, should it limit itself to just the largest companies? As for only using a month or two of short term option premiums to garner a prediction, as the VIX does, it seems to limit itself to only a single variable. Instead of short term options premiums and limited samples what if we could measure real-time individual stock trend alerts on thousands of domestic and foreign stocks and ETFs? Or simply what if we analyzed the micro components (every stock) to develop a macro forecast of the market based off trends and risk?

By studying the history of risk alerts from SmartStops.net, an intelligent risk management service, two proven alternatives to the VIX were found. SmartStops.net has developed their own proprietary risk model that monitors the trends and risks to over 4,000 of the most popular stocks and ETFs. If the risks grow on any individual investment SmartStops.net alert their subscribers with both long and short term exit triggers. However not only do these alerts help individual and institutional investors manage specific investment risk, the reviews of the alerts themselves have predictive capabilities. By back-testing every alert that SmartStops.net has issued from their inception versus the S&P 500 performance, there is proof of this and the results speak for themselves.


There have only been 7 days for which the amount of Long-Term Exit Triggers (stop alerts) as a percentage of every stock and ETF covered by SmartStops.net has been over 20%. The subsequent market action of the S&P 500 has averaged a negative return for the time periods of 1 week, 1 month, 3 months, 6 months and a year. The 6 month average return is over -7% and when examined from the absolute lows of the S&P 500, the returns average over -19%. If you remove the knee-jerk market reactions caused by “Flash Crash” on 5-6-2010, the returns are even lower.
Another metric offered by SmartStops.net is their SRBI(tm) (SmartStops Risk Barometer Index); this index measures the current percentage of stocks and ETFs that are in “Above Normal Risk” state (ANR) divided by the 100 day average above normal risk percent. By definition, a stock that is listed ANR experienced a risk alert as its last SmartStop alert identifying a downtrend. Conversely, a stock that is listed in a “Normal Risk State” experienced a reentry alert as its last SmartStop alert indicating trading strength and an upward trend. Back-testing historical SRBI data since inception shows that the repercussions to the market when the percentage of downtrends increases to over 40% of all stocks and ETFs covered are profound. Below you will see that there have been only five occasions where this has happened. In each case the S&P returns for the following year were all negative.

Is this a better way?

Before a concrete conclusion can be determined, the predictive capabilities of the VIX must also be analyzed. Read More…

NETFLIX Investors – Did you Protect Yourself?

NETFLIX , NFLX, drops but SmartStops keeps investors and traders from major losses.

This is why Risk Management and Protection are a must in every investor and trader’s arsenal.   SmartStops triggered its short-term protection for Netflix at $74.13 at 9:32AM.  NFLX closes at $60.28 today, 7/25/12.

In the most recent Netflix downtrend SmartStops saved its clients  $42.46 per share!  

See chart at: http://www.smartstops.net/PublicPages/SmartStopsOnDemand.aspx?symbol=NFLX

 

ETFs And Allocations To Protect Portfolios In The Current Financial Storm

excerpt from article at Seeking Alpha: 

 This is a followup to a previous postings suggesting how investors can take refuge in the oncoming financial storm. If you’ve not done so already, be sure to read my previous post Say It Ain’t So for a description of our dismal macroeconomic picture.

The purpose of this article today is to explore any safe havens for your investments to shelter them from this worldwide slump. What are we protecting against? Problem is, we don’t yet know. And we won’t until the elections play out next year, and events in Europe unfold.

The market may not wait for the politicians. Technical indicators suggest a very large correction in the market can be expected, and fundamental macroeconoomic trends unfortunately offer no consolation.

How severe will the downturn be?

In my view, that will depend in part on what fiscal and monetary policies we pursue, and how international political relations progress. There my crystal ball is a little cloudy.

Scenario one sees a continuation of monetary easing, as pursued by both the Bush and Obama administrations, and largely aped by European governments to a lesser degree.

In this scenario, the policy response will be pure Keynes, with large bouts of government spending to build out our country’s infrastructure and hopefully create jobs. The Fed will assist with gobs of money dished out to offset rapidly deleveraging private expenditures and to support our wobbling real estate market.

for rest of article, click here

Read More…

Chicken or Egg? Risk Tolerance as a Driver of Financial Success

SmartStops would like to draw your attention to this article’s statement:    Overall, by taking more risk Bill can expect to be significantly better off.    As SmartStops will remind you, you can take on more risk by ensuring there is constant active oversight for it.  See other articles on that subject.   

 published originally at:  Advisor One by Geoff Davey, FinaMetrica

Many studies have shown that risk tolerance correlates positively with income and wealth. The correlations are not strong, usually around 0.3, but they seem to be universal.

There is a temptation to think that higher income and/or higher wealth lead to higher risk tolerance. However, there is always a danger in trying to read a cause and effect relationship into a correlation. To know for sure we would need to conduct a longitudinal study measuring risk tolerance, income and wealth as we went along.

Failing that, we can conduct a thought experiment. Suppose that Bill and Bob have different appetites for risk. Presented with a choice between taking a certain $100 and a 50/50 gamble of winning $0 or $X, Bill will take the gamble when X is $250 but Bob won’t take the gamble until it reaches $300. Looking at any single $250 gamble choice, Bill has a 50% chance of being no worse off than Bill.  However, if Bill and Bob are presented with a series of such choices, the longer the series runs the more certain it is that Bill will finish up better off than Bob. With a series of 10, Bill has an 83% chance of being no worse off than Bob and by the time we get to a series of 100 that chance has increased to 98%.  Over 10 choices, Bill will finish with $1,000 but Bob could expect to have $1,250, though he may have nothing or $2500.

Now suppose that Bill and Bob both started with a kitty of $1,000 and that rather than the choices being framed from a base of $100, they were framed from a base of 10% of the kitty at the time. For 10 choices, Bob’s kitty grows to $2,593 but Bill’s grows to an expected average of $3,260 and 62% of the time will be greater than $2,590. At worst Bill will have $1,000 and at best $9,300.

Overall, by taking more risk Bill can expect to be significantly better off.

So how does this relate to real life? Clearly, life’s choices are rarely as simple as in our example and rather than a series of identical choices we face a series of mainly different choices where there are usually more than two alternatives—and those alternatives will often include the possibility of losses. Further, the range of outcomes is often not clear and they must be estimated rather than calculated. Finally, we may make cognitive errors in assessing the situation and in identifying and evaluating the alternatives.

As we know from experience, risky choices take many forms and occur in different contexts including employment, borrowing, insurance and investment. For the riskier alternatives to be considered there would be a commensurately greater expected reward, but this will come with the possibility of an unfavorable outcome. The more risk tolerant amongst us will need less of an incentive to take the riskier alternatives. If we continue that pattern over time, all other things being equal, we should finish up better off.

So my hypothesis is that risk tolerance is a driver of financial success rather than the converse.

If you can’t beat them join them, Best Buy. BBY

by  Chris Georgopoulos, SmartStops contributor

Reading financial articles can be, let’s say boring at times. This article we are going to try to spice it up, let’s play a game of role playing.  Famed speculator, Jesse Livermore once was quoted…

“If I were walking down a railroad track and saw an express train coming at me at 60 miles an hours.  I would be a damned fool not to get off the track and let the train go by. After it had passed, I could always get back on the track, if I desired.” –Reminiscences of a Stock Operator, Edwin Lefevre.  

For this game let’s rename the train, Best Buy stock (BBY: NYSE), the ““I” in walking down the track” we can call the shareholders of Best Buy and the speed of the train, the issues.  The game is scored by the costs of each decision. Whoever has the best return wins!

It is the end of summer 2005, Best Buy is approaching $80/share and the future couldn’t be brighter. The tech bubble burst is ancient history, the housing market is hot, interest rates are low and every house in America is an ATM for consumer spending.  You are on the railroad track…there isn’t a train in sight! 

It is now the beginning of fall 2008; Best Buy has fallen to the mid $40s in defiance of the market making new highs and there are rumors of problems in Mortgage backed securities.  (Note:  Sidestepping risk is now made possible with the release of SmartStops.net  which if had been available would have had you out in the $70 range in 2005).  Your friend has made a fortune flipping speculative properties in south Florida and Las Vegas, but you see he is worried. He still has five houses on the market with almost no personal income… (You know how this story ends)  You can hear a train coming and it sounds like it’s really moving!

Only a few months later, Best Buy is trading under $18/share!   The rumors are true; the housing market has crushed the stock market. It seems nobody thought housing prices would ever go down and the economy is on the verge of total failure. You can now see the train, its moving fast and finally you start to consider if you should actually get off the tracks.

(SmartStops.net   issued two Long-Term exit signals in 2008 the first January 4, 2008 at $46.80 and on September 16, 2008 at $40.68. That’s a  $22 per share savings by sidestepping risk.)

It is two years later; Best Buy is trading back in the mid $40s. Read More…

Rethinking Modern Portfolio Theory

Are we all doing it wrong — or is the theory in need of updating and repair?

I think MPT died 30 years ago,” says Jeffrey Saut, chief investment strategist at Raymond James. “If the theory were correct, Warren Buffett, Peter Lynch and Paul Tudor Jones wouldn’t have their track records.” He says that although 60% of Lynch’s trades resulted in losses, he could manage downside risk precisely because he wasn’t tied to a strategic asset allocation. “Asset allocation-and just about any other model-works in a bull market,” Saut scoffs. “But the driver of returns in a bear or range-bound market is stock selection and risk management.”

By Joan Warner
February 1, 2010

So far, no other single method has knocked the Modern Portfolio Theory off its perch as a coherent way of structuring portfolios and pricing assets. But more and more practitioners believe the theory doesn’t deal adequately with today’s world.

Poor Harry Markowitz. Every time investors get whipped in the financial markets, they take it out on his Modern Portfolio Theory (MPT).

Never mind that the groundbreaking concept has governed investment discipline for more than 40 years and that Markowitz won a Nobel Prize for it in 1990. Its central tenet-that diversification mitigates portfolio risk-seemed to collapse in 2008 when the bear market left no asset class unmauled. Only Treasuries provided a haven, and according to MPT, Treasuries don’t even count. They’re just the risk-free baseline at the bottom of the return axis. If you had furious clients asking what the hell happened to your age-appropriate asset allocation strategy, you weren’t alone.

Investors don’t kick Markowitz only when they’re down. MPT also came under gleeful attack during the technology boom of the late 1990s, when “risk” was a dirty word. What sense does it make to diversify out of an asset class that’s returning 30%? Plenty, of course-but try telling clients to keep a little money in cash during a raging bull market.

Why does MPT look so good on paper, yet fail so spectacularly every few years?

Read More…

Know when to Hold ‘em, Know when to Fold ‘em

SmartStops comment:   Its why this service was brought to fruition.  Follow SmartStops and you can be protected before you lose it all. 

Unprecedented Monthly Volume Sell-Off Suggests Now’s the Time to Take Shelter - published at Minyanville by Kevin A. Tuttle

Do not concern yourself if the market goes up today, tomorrow, or a month from now. The risk of entering is not worth the reward.

Over the weekend I had the pleasure of speaking with a very prominent European money manager – overseeing hundreds of billions – about the “across-the-pond” financial crisis unwind and looming hazard of a potential domino-effect coming to fruition. Without rehashing the entire conversation, the consensus is not “if,” it’s “when” will the developing pressure finally blow. He actually went so far as to say it could truly begin unraveling within the next few weeks considering the catalysts currently in play.

The intent of providing the conversation synopsis is not for sake of fear, but understanding the potential ramifications. About three years ago, in one of my firm’s quarterly reports, we opined on a unique situation in regard to the GDP measurements of Global Nations. It stated the unprecedented growth statistics from the 56 nations tracked. “History is currently being made in the sense that all the globally tracked economic growth nations (56), every one… 100%…, are showing expansion.” This lead to my next comment… “If the economic cycle pendulum swings in both directions what would happen if the inverse occurred?” Are 2011/2012 the years we are about to find out? Maybe that’s somewhat extreme, but yet… is it possible?

We at my firm do not pretend to be intelligent enough to figure out all the nuances, catalysts, causes and reasons why the markets could fall apart; we’ll leave it to the team of economists and officials to attempt to sort that out. What we do instead is try to determine when the storm is coming and how to take shelter, which brings me to my point: Now is the time. Take shelter! Do not concern yourself if the market goes up today, tomorrow or a month from now. Clarity is key! Would you sail your boat into rocky waters with a potential hurricane looming because of your love of sailing? Is the risk worth the reward? For some, maybe; but for most, probably not.

S&P 500 Index

Since the “2011 Channel of Indecision” broke on August 4, the seas have picked up dramatically and have begun swallowing ships. The markets have never seen this type of monthly volume sell-off – 47% above average (unprecedented), as seen in the monthly chart above. As Kenny Rogers put it so eloquently… “Know when to hold em’ and know when to fold em’, know when to walk away, know when to run!”

Are ETFs Responsible for Rising Market Correlations?

SmartStops commentary:  Diversification alone is not going to be enough to manage risk in our 21st century markets.  Smartstops offers a superior dynamic intelligent risk management service.   Ask yourself, who is watching your back?

originally published at ETFTrends

S&P 500 stocks are moving as a herd and the increased presence of exchange traded funds in financial markets may be partly responsible for the spike in correlations, according to a report Monday.

Stocks in the S&P 500 over the past month have a correlation of 80%, higher than the peak reached during the financial crisis in late 2008, The Wall Street Journal reported.

“One potential reason is the popularity of exchange traded funds. ETFs account for more than 30% of volume in U.S. stock markets, compared with just 2% in 2000,” the newspaper said. “It’s reasonable to expect ETF trading to drive correlation higher because many of the vehicles are tied to stock indexes.”

The three-month stock correlation in the S&P 500 is the highest in at least the past 20 years, while sector correlation is also elevated, according to a recent note from Goldman Sachs analysts.

A higher correlation means prices are moving together, rather than going their separate ways. [Sector ETF Correlations at Two-Year High: Strategist]

Correlations have spiked recently amid the so-called risk-on and risk-off trades. High correlations are not indicative of a healthy or normal market, analysts say. [Rising Correlations]

“Elevated correlation is generally considered a poor environment for long-only fundamental investors,” Goldman Sachs said.

One man responsible for shaking the world of finance….and everyone’s retirement capital gets his due

  Douglas Peterson to Become President of S&P

By Katrina Nicholas and John Detrixhe -Aug 23, 2011 originally published at Bloomberg

Douglas Peterson, Citibank NA Chief Operating Officer, will be replacing Deven Sharma as the new president of S&P.

 Standard & Poor’s, the ratings company that downgraded the U.S. AAA credit ranking for the first time, will replace President Deven Sharma with Citibank NA Chief Operating Officer Douglas Peterson.

Sharma, 55, will leave at the end of the year to “pursue other opportunities,” S&P’s parent McGraw-Hill Cos. said in an e-mailed statement. Peterson, 53, will take over Sept. 12 and Sharma will work on the company’s strategic review in the meantime.

S&P’s Aug. 5 decision to reduce the U.S. credit rating to AA+ roiled global markets and boosted demand for Treasuries, sending the yield on the 10-year note, the benchmark for home mortgages and car loans, to a record low 2.03 percent. The New York-based company, which was blamed in an April Senate report for helping fuel the credit crisis, was criticized by the world’s most successful investor, Warren Buffett, who said the U.S. should be “quadruple-A.” The cut conflicted with Moody’s Investors Service and Fitch Ratings, which kept their AAA grades.

“It looks like he’s being helped out the door,” Noel Hebert, a credit strategist at Mitsubishi UFJ Securities USA Inc. in New York, said in a phone interview. “If it was a planned retirement, it should have been handled in a different way.”

$2 Trillion Error

S&P downgraded the U.S. even after Treasury Department officials told the firm it had overestimated future national debt by $2 trillion. The company said the error didn’t affect its decision, and based its conclusion on the U.S. government becoming “less stable, less effective and less predictable.”

S&P said the U.S. failed to meet targets for reducing the budget deficit. “The fiscal consolidation plan that Congress and the Administration recently agreed to falls short of what, in our view, would be necessary to stabilize the government’s medium-term debt dynamics,” the company said in a statement after markets closed on Aug. 5.

The market value of global stocks tumbled by $7.6 trillion between Aug. 5 and Aug. 12, according to data compiled by Bloomberg. Read More…

Follow

Get every new post delivered to your Inbox.

Join 889 other followers

%d bloggers like this: