WHAT TO DO WHEN UNDERPERFORMING YOUR BENCHMARK BY 1000+ BASIS POINTS
I underperformed my benchmark by over 1000 basis points in Q1. Drawdowns never become easier regardless of how many times you have been through them and I have been through a lot over the years. What makes them much more manageable after you get past a certain point in your understanding of markets is the melding of mind with action. To put it simply, experience in finance brings with it a required self-understanding. That understanding of self after a period of time allows an individual to essentially observe themselves, correcting potentially harmful thinking before it has a chance to inflict any real damage. Whereas, the uninitiated simply act on negative mental triggers, the experienced investor recognizes them, understands their origin, accepts them for what they are and moves on. Nowhere else in an investor's career, regardless of pedigree, will you be more susceptible to erroneous action than during a drawdown. As obvious as this assessment may be, the lack of understanding surrounding its importance is expressed through countless investors who have overtraded, overexposed and leveraged themselves into obscurity after a difficult period of performance. This happens as often to professional asset managers as it does your run of the mill retail investor. It is as if adversity converges along a mental line of action that is both instinctive and impulsive in nature. The most effective reaction to a drawdown regardless of methodology is defensive in nature. As an example, previous allocation decisions that call for a 10% investment to an asset, should be cut in half, at the very least. Activity should be stemmed rather than encouraged. Decisions should be simplified and spread out, as opposed to convoluted and copious. The instinctive reaction is one of catching up to dull the pain in as quick a manner as possible. If your method of investment is robust then natural progression of that method should naturally lead to desired results, any "pushing" of the method deviates from its original intent. ...
THE WALL STREET FOOL
"There is a time for all things, but I didn't know it. And that is precisely what beats so many men on Wall Street who are very far from being in the main sucker class. There is the plain fool, who does the wrong thing at all times everywhere, but there is the Wall Street fool, who thinks he must trade all the time. No man can always have adequate reasons for buying and selling stocks daily - or sufficient knowledge to make his play an intelligent play." --- Jesse Livermore There is a certain degree of nobility that comes with the act of doing nothing in the business of finance. It is a counter-intuitive trait that does not digest easily with most investors. Yet it is an absolute key building block in the act of creating any formidable wealth within a portfolio of stocks. We are looked at from a very early age not by what we accomplish through stillness, but what we accomplish through action. It is believed that in action is where victory is born. If you are injured by a certain action, then you simply take another action to "get through" your injury, as action is the only way to victory. If, on the other hand, you are injured through the act of stillness, you are automatically labeled as being lazy, incompetent and unable to perform the essential task of taking action. The very act of daydreaming. Imagining. Introspection. They all run completely counter to the key attributes that create success according to popular perception. What is missed by those who constantly preach action, whether in popular books, blog postings or in any form of media is the moments in between when the act of stillness leads to a clear path of action. You cannot have a reason to act at every single moment. Then your actions become diluted within a sea of inconsequential motion. Action should have purpose. And purpose is derived through stillness. In my case, in particular, I have clearly entered a point in the life of the current portfolio holdings (WMIH, HH, IWSY & KFS) that any action taken will be forced. There is nothing to do but sit. Volume is extremely low as all the current portfolio holdings are in between catalysts. To force an action here by attempting to discover momentum that would create basis points would be foolish. It is a negative expected value proposition as it is difficult to duplicate with a high success rate AND it takes away from the key focus of the portfolio that is backed by a strategy seeking asymmetric (overused financial jargon,...
THE STRATEGY OF NOT CARING
Much like anything else in finance, every tool for investment whether fundamental, technical or emotional has its uses and a season for that use. Fear is not always a terrible trait. It could have saved investors greatly in 2007 - 2008. Greed is not terrible either. I know many greedy investors who have done extremely well in the markets. There are no Ten Commandments for success in finance. It makes for a good title to sell books to the hopeful (another trait that can be used sparingly), but the fact of the matter is that the fluidity that is investing will never allow single point of fundamental, technical or emotional success to have an uninterrupted, peaceful existence. Caring is an endearing trait that is celebrated for good reason. That is perhaps why so many individuals will bring the act of caring into perpetuity with them to the realm of investing. It simply doesn't transfer. Investing when approached properly is a simple game of making decisions that have a positive expected value over the long-term. The only way to gain knowledge as to what constitutes positive expected value is through experience. Those who are consistently successful in the markets after 10, 15 or 20 years, have naturally found a path towards decisions that have a positive expected value, whether they realize it or not. Most will chalk it up to dozens of different skills they have gathered. But the essence of what they are doing is good decision making on a consistent basis. The problem with consistently caring, as so many individuals believe it is their duty to do, is that it leads to various peripheral evils that will eventually all gather together like a Chinese sandstorm, collapsing an investors ability to make decisions that have a positive expected value. Those peripheral evils primarily have to do with over-thinking situations that require no thinking at all. When you strip away everything and I mean EVERYTHING from the markets, the situations that an investor faces become abundantly clear. What investors so often fail to realize is that 95% of the price movement that is witnessed on a yearly basis does not require judgement of any sort. It simply IS. This means that out of the 250 or so trading days that we experience each year only 12 of those days (keep in mind, I am talking about investors, not traders here) require our effort or judgement. The rest of time the markets are simply filling space through random movements that are meant for those who care in perpetuity, which is the vast majority. After all, entire companies have been built on the...
PORTFOLIO UPDATE: THE 3 LEAKS OF THE SUBLIMINALLY BLIND
During the trading day today, I tweeted the following: Back to the default stance of 75% invested with 25% in cash. This is a default allocation, so to speak, for my strategy. I'm comfortable with it, actually. It helps with cushioning volatility in what is otherwise a volatile sector: small/micro-cap companies. It is interesting that in bull markets the aura of prosperity seems to blind the lessons of time. I can promise you that a vast majority of those who are making money in this environment will not be able to maintain that success over the next 2, 3, 5 or 8 years. It is the nature of the beast. The markets cannot cater to a majority of participants making money most of the time. For that reason, an investor must be conscious of the leaks that cause those around them to bleed equity at a much faster rate than they can create it. The leaks that plague investors across all categories are too many to mention. I will make note of three that immediately come to mind: 1. Love: Investors love to fall in love with shit. I don't mean shit in terms of investments that seem wonderful but turn out to have putrid underpinnings. I mean shit in the blanket sense of the word. It is as if investors view the market as an extension of their lives instead of an arena where capital is constantly shifting. The markets are not the place to make up for your mommy, girlfriend or mistress issues by becoming starry eyed in the face of abuse. The only thing you should fall in love with as an investor is your equity curve. The moment it starts suffering, you had better make that relationship right. 2. Confidence: We are all terrible at investing. To date, those of us who are positive on the year are simply lucky. You are a footstep away from disaster. Enter the markets each and every day with these thoughts and I promise you that prosperity will follow. Confidence in your ability to profit consistently leads to a slippery slope of mistakes that will not be corrected because your confidence doesn't allow for adjustments to take place. I'm not saying that investors should be a shivering, scared, pale bunch that jumps at every shadow that shows up in the marketplace. I'm just saying that questioning yourself often can make the difference between remaining in the game long-term or just being a flash in the pan. The delicate balance between questioning and being an overly-emotional debutante can only with time...lots of it. 3. Activity: Having the need to act...
SEPARATING MICRO AND MACRO IMPERFECTIONS
In participating in the financial markets, we have all made a silent agreement to be subject to the rules of imperfect information. In fact, a better classification would probably be subjective information. In either case, we use a set of data that is highly subjective in nature to make decisions that we hope will positively impact our financial fate. It should be seen as highly unusual then when a market participant who chooses to make his or her decisions public sports a near flawless record. I am always shocked by the nature of fraud that is reported commonly involving investors who believe in a guaranteed return exceeding Treasury yields by anywhere from 500 to 5000 basis points. I am even more perplexed by individuals who choose to pay for information given by financial charlatans who are posting gains not in the 20-30 percent range per annum, but 200-300 percent range. If it were only this easy we would be all be fighting for parking spots at Whole Foods in our Lamborghinis. The truth of the matter is that incorrect decisions, thesis and hypothesis are as much a part of the landscape of the market as a bid and offer. With that said, I have decided to dedicate tonight's post to a study of my micro imperfections, followed by a commentary on how unrelenting and fatal imperfections of the macro variety can be. You can get away with a host of micro imperfections in the markets, but a macro imperfection is death. Let's start with a plethora of my micro imperfections that those of you who have been reading this site over the years have been subjected to: - Recently I have been eating hairy humble pie (mind out of the gutter, please) on TZA. It has been my biggest losing investment in 2013. It shouldn't be a surprise, as we are facing one of the strongest bull markets of recent memory. Anything with a bearish slant will get you killed. Just ask Bill Ackman. - I have been off with AAPL as of late. A lot more off than at anytime over the past couple of years. According to my studies it was supposed to be below $400 by now. I defer. - Off the top of my head, my call on RGR was atrocious. I actually dedicated an entire post titled: The Technical Case For An 80% Drop In RGR Over The Next 12-18 Months Not only was the title too long, but RGR isn't dropping. It is up 5% since I posted this study in October of last year. To be fair, I still have some time...
FINANCIAL ACROPHOBIA RELATED TO THE ISSUE OF “WHEN”
In life, "when" matters. If your coworkers see you out drinking at 8pm, they will consider you a fun loving guy who enjoys himself after work. However, should your coworkers see you out drinking at 8am, they will consider you an alcoholic who probably won't be their coworker too much longer. To illustrate further, if you take a plate of warm cookies to a new neighbors house at 3pm, you will be considered hospitable and kind. If you take a plate of warm cookies to a new neighbors house at 3am, you will be considered creepy, weird and possibly get shot depending on your geographical location. Yes, "when" does indeed matter in life. In the markets, however, the issue of "when" is much less relevant. This is contrary to the popular wisdom that insists on timing being such an important facet of the investor experience. Obsessing over "when" for investors is one of the biggest stumbling blocks to profits. It creates trepidation, doubt and anxiety that would not come into the equation if the issue of "when" was left in the realm of life and out of the realm of finance. In the past, I've touched on what truly separates an amateur investor from a professional investor. It surely is not a degree, a certificate, any level of training or anything pedigree related, for that matter. I have seen retail investors that could have been all-star fund managers. I have seen fund managers who shouldn't be trading a $20,000 retail account, let alone a $200,000,000 portfolio of retirement assets. True Wall Street professionals, I have found, are much less involved with the issue of "when" in the traditional sense. They are able to buy high and sell higher. They are able to look at the issue of "when" in a much more relative sense, as opposed to the traditionally minded investor who comes into the Wall Street arena with the same tools he uses in everyday life. The very same tools that Wall Street inherently preys upon. Much along the lines of fear and greed. The same emotions that will keep you out of a dangerous part of town at night and keep you motivated when you want to give up. These emotions have no place in the investment world. They are stumbling blocks. The obsession over "when" falls right in line with fear and greed as a classic stumbling block for experienced and less-experienced investors alike. Let's take the market of present day as an example. "When" is killing the average investor here. They are looking at the market from a standpoint of 2009, when the Dow was...
PERUSING THE LABYRINTH OF LEAKS THAT INVESTORS ENJOY
In the portfolios that I manage my concern, focus and energy is consistently on the equity curve that my strategy provides. A sloppy equity curve is a reflection of an inconsistent strategy. Think of it logically: The equity curve of your account reflects the sum total of your decisions as judged by the most accurate, unbiased judge of all....the financial markets. There is no identity in this dark pool of self-serving personalities who are chasing dreams in various stages of completion or degradation. The markets don't care about your skin color or hair color. They don't care if you walk like a monkey or stand upright. They aren't concerned with who you slept with last night or if you've never slept with another human being in 46 years. The only concern of the financial markets, as expressed through the creation of monetary success, is if you have made the correct investment decision at the correct time. When both of those factors - investment decision and timing - manage to be in sync then truly wondrous, beautiful things can take place within an investment portfolio. BUT...the issue of investment decision and timing must be expressed with a consistent output. When it is not, then an erratic equity curve becomes the result. Something along the lines of what you see from a Richter Scale during a 7.1 earthquake off the coast of Indonesia. Consistency in strategy, execution and mental state are the three factors that will result in a consistently upward slopping equity curve. Anytime your strategy starts switching from A to B to R to Z then your equity curve will show the result. This is a leak in your game and your equity curve exposes it. Anytime your execution begins to suffer as a result of indecisiveness built on the foundation of a lack of confidence then your equity curve will show the result. Another leak in your game that your equity curve will strip naked so that you can see all the lurid details of your inefficiencies. Anytime your mental state moves from a place of peace to chaos your equity curve will show the result. Paul Tudor Jones recently said in an interview that if one of his traders is going through a divorce he will yank his money. Mental state matters perhaps more than anything else. I recently visited with an old friend who was attending the Altegris Investment Conference in Carlsbad. He used to manage outside funds but now manages his own money exclusively. He told me that when he managed outside funds he would purposely employ buffers between him and his clients so that...
THE NEED FOR SIMPLICITY THAT WALL STREET WILL NEVER EMBRACE
Within the context of a bull market that voraciously searches for reasons to tack on points to the upside, the default stance of an astute investor should be that of simplicity. Attempting to dissect and digest an abundance of information will do little to justify the persistence of such a market. It only serves to cloud the reasoning of an investor. It is true that often times investors suffer from paralysis through analysis. Information is good to a certain extent. Within the investment community there are very few that escape being information gluttons. It stands to reason then that it is best to keep analysis extraordinarily simple. The greater the extent of the bull, the more simple one must keep their analysis in order to avoid being paralyzed through thought. This market is at a point where the more elementary the analysis, the higher percentage your success rate will be. This phenomenon of simplicity being the modus operandi of true bull markets is the reason you see so many newcomers do extraordinarily well during extended bull runs. Their approach is extraordinarily simple, falling right in the sweet spot of analysis that creates the greatest profit during these types of runs. I am not speaking about longevity here. It is true that those who create extraordinary gains during true bull runs will end up falling flat over the long-term. I am not arguing that point. My sole concern is creating the proper mindset for investors to perform in the here and now. We'll deal with tomorrow...tomorrow. Let's look at two charts that exhibit simplicity to the Nth degree. Without giving much thought in terms of dissecting these price moves, simply look at the essence of what is happening. Allow your eyes to do the work without any "buts" or "ifs" involved. The first chart is the Nasdaq Composite, which was most recently reviewed in the weekly review on Sunday. Here is the outlook after today's move: Next we have the S&P 500, which is putting together picture perfect movement ABOVE its generational trajectory. This is as bullish an intermediate to long-term pattern as can be imagined: You know why Wall Street is filled with underperforming asset managers that have destroyed public perception of aptitude within the industry? The very pedigree that defines the modern day Wall Street employee is the biggest impediment to success. The pedigree that defines asset management in the 21st century is built on analysis to the point of exhaustion. If you are not analyzing a stock, commodity or economy on an hour by hour, minute by minute basis then you are not properly fulfilling your duties. Or so they are...
PORTFOLIO UPDATE: HITTING THE EMERGENCY BUTTON…..TWICE
During the trading day, I tweeted the following: Any good risk manager (and that is what any of you who have interest in the markets are) should have multiple layers of risk control. I often find that instead of focusing on these layers, investors will focus too much on reward. There are all kinds of contingencies and plans made for rewarding trades, but very few, other than your run of the mill stop protection, for the risk. True professionals, who outperform over the long-term, are risk managers. All others are reward managers. The market will quickly call you out for what you are if you play the game on a consistent basis. I used to be a reward manager. I am very familiar with the practice of focusing squarely on reward and accepting drawdowns as a necessary part of the game. The primary issue with being a reward manager is that you can have multiple years of winning streaks, but it will only take one small miscalculation to take back all those years and then some. You can never slip. Keep in mind, that the financial markets, at some point or another, will create an abusive environment for every strategy ever developed by man or machine. The reward manager, therefore, won't survive over the long-term by design. The risk manager, on the other hand, controls the environment by having multiple layers of risk control, as I mentioned earlier. When one defensive wall fails, the other springs up to stop the onslaught. The risk manager realizes that the key to prospering in the game is to remain viable. You remain viable by never suffering a drawdown that will be too cumbersome for your strategy to overcome. The risk manager is good enough at their craft to know that large sums of money can be made when the environment is favorable. There is no need to risk the entire portfolio in an environment that is questionable when patience is the only thing required to reach a point when a significant streak of profitability can occur. I have mentioned my tactical asset allocation strategy that utilizes a short, intermediate and long-term trend following/reversal system to dictate my long exposure to the market many times. What I haven't mentioned is the other layers I utilize to control risk. One of those layers is a mandatory performance stop that slices positions in half when a certain performance threshold is breached. For me, that threshold is a 5% performance decline during any month. I haven't had to mention this risk control measure because I haven't suffered anything close to a 5% down month at anytime...
THE LATEST DISEASE TO AFFLICT THE MINDS OF INVESTORS
I can't blame any trader or investor for the behavior I am about to describe. It is, after all, inherent in the market's DNA to condition an investors mind into thinking a certain path is the only path possible before doing the exact opposite. At times, this conditioning takes a period years or even decades, causing the resulting market reaction to be that much more powerful in the direction of least expectation along the path of minimal participation. The behavior that has become prevalent among even smart, experienced traders is that of attempting to search for peaks in a bull market instead of simply allowing the trend to work in their favor. More time and effort is being devoted to looking for reasons the current bull market is about to peak than looking for opportunities to profit from it. Additionally, there is a disease of weak hands looking to throw their cards into the muck at the first sign of adversity. It literally takes no more than a couple percent on the downside to create such a stir among investors that they either begin selling short, liquidating positions or hedging exposure to avoid pain. This may explain the reluctance of the market to to down for more than a few weeks at a time. Sellers are too quick to show up, not allowing the market the firepower on the downside needed to result in anything substantial. It is the job of both the trader and investor to work in the direction of the prevailing trend. You simply study the conditions, allowing your positions to work in your favor until you have adequate reason to believe the trend is changing. Adequate reason. A somewhat vague qualifier. It seems that adequate reason has come to mean any market that goes down for more than a few days. That is all it takes. The market has fooled the vast majority into thinking that every hiccup is a replay of 2008. Or more recently, August of 2011. How many headlines did we see coming into August about a replay of last year? How many times last year did you hear about a replay of 2008 taking place? Investors and traders are feeling froggy. They want to jump at every shadow and light breeze that blows their way. The brain washing at the hands of the market is complete and now you are being bent over for a wax. That is the essence of the what is occurring here. You have been conditioned, no differently than the bell ringing for Pavlov's dog, that when a market dips terrible boogie men are about to jump...