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risk management

This category contains 19 posts
Facing-a-Fear (2)

no need to fear a big drop

“News” that George Soros is shorting stocks grabbed headlines once again this week.  I don’t see why this is getting people so worked up.  Soros has supposedly been making big bearish bets since the beginning of the year.  He’s been warning of a repeat of the 2008 financial crisis and apparently has a 2.1 million share put option against the S&P 500.

I have no clue if George Soros is right.  However, I do know that “news” like this does nothing to help us make money.  We make money when we position our trades in the direction of the 8 and 21 day moving averages.  Right now these moving averages are rising, so we are bullish and long stocks.  In fact, this week the S&P 500 poked through the highs of last November, essentially negating the macro pattern of lower highs and lower lows that has controlled the big picture over the last year.

The only argument bears can make now is that this was a failed breakout which will lead to a fast drop lower.

failed move leads to a fast move?

failed move leads to a fast move lower?

I will grant that this is a possible scenario.  However, the weight of the evidence we have right now still points to higher prices.

If Mr. Soros and the bears turn out to be right, we will have plenty of time to change our stance and position our portfolios accordingly.  We would lock in profits and raise cash as our holdings give us 821x sell signals one by one.  We could look to move some money into other asset classes such as bonds and/or gold.  Finally, we may take bearish bets against stocks alongside Soros by purchasing inverse ETFs,

We will have sufficient early warning.

We have a plan of action.

There is no reason to fear.

stare(crop)

patience pays

A dangerous misconception many DIY Investors have is that our job day-to-day is to “make money”.  Obviously, that is the outcome we are hoping to achieve, but it is not what we actually do.  Remember, we have no control over the direction of the market or of our holdings at any point in time.

No, our primary job is to manage risk.  Day in, day out this is what we  are actually doing.  The stock market can provide life changing monetary rewards, but with those rewards come enormous risks.  The only way to safely gain exposure to the rewards of trading is to strictly define and manage the risk you are taking.

There are two primary ways we do this:

  • Position size – I touched on this in my trading manual, but basically we NEVER want to go “all in” on any single trade.  We need diversification.
  • Stop-losses – This is the price at which we would admit that the trade setup is no longer valid and would therefore sell.  This level should be identified BEFORE we enter any trade.

Our position sizing tool combines these concepts.  I encourage you to play around with it so you can get a good handle on how much you are risking on any given trade.

There is, however, another often overlooked component of risk management that is perhaps even MORE important than the ones above: patience.

By this I mean having the discipline to allow marginal or higher risk trade ideas go without you while patiently waiting for the BEST, low risk, high probability setups.

Warren Buffett has a famous quote that’s relevant: “The stock market is a no-called-strike game. You don’t have to swing at everything — you can wait for your pitch.

The fact is, every time we enter a trade we are putting our money at risk.  Therefore, we should always take a moment beforehand to ask ourselves, “is the perceived reward worth the risk?”  Be picky.  Be patient.  I promise you, it will pay off.

This concept comes to mind when looking at a chart of the S&P 500.  The market has just run 15% higher in about two months.  It’s just below a declining trend line that connects the closing highs from last July and November.

showing downtrend line connecting lower highs in SPY

right back up to the downtrend line connecting lower highs in SPY

If the current rate of ascent continues, we could be looking at new all-time highs in just a few weeks!  However, what is most likely to happen?  Personally, I think that after such a big run and at an important trend line, it’s more likely that the market will pull back in this area.  This doesn’t necessarily mean that we should get short.  The market doesn’t HAVE to pull back.  And if it does, keep in mind that it would actually be bullish for the market to put in a definitive higher low before breaking the macro pattern of lower highs and lower lows.

The bottom line is we have a short term bullish market still within a larger bearish look.  These mixed messages are about to come to a head so I believe the best course of action right now is patience.  It makes no sense to increase exposure to risk in the face of this uncertainty by taking big bets here.  Let’s continue to manage our open positions and patiently observe market action in this pivotal area.  There will be plenty of time to pounce when the outlook becomes clearer.

 

stubborn (560x372)

don’t be stubborn!

Stubbornly defending what you believe to be right in the face of harsh opposition is an admirable quality.  It takes strong inner fortitude to enable someone to not be swayed to and fro by the opinions of others.

As admirable as this quality can be when dealing with others, it is possibly one of the WORST traits you can have when dealing with the market.  Allow me to explain.

No matter how smart you are or how much research you do, there is no way to be right 100% of the time.  The only reason you buy a stock is because you believe it will increase in value. However, before you put one penny at risk make sure you know where you will cut your losses.  If your trade gives you your predetermined sell signal, have the humility to admit you were wrong.  Don’t be stubborn.  Don’t rationalize.  Don’t hold and hope.  Hit the eject button and sell.  Yes it sucks to book losses, but it’s not worth the risk to continue to hold.  If the stock is any good it will setup again and give you another buy signal down the road.  If not, you can watch it implode from the sidelines.

It makes sense and sounds easy to do when talking in the abstract, but the fact is, even billionaire hedge fund managers can be prone to stubbornly digging in their heels when they have a trade going against them .  Case in point: Bill Ackman of  Pershing Square Capital Management and his dogged determination in defending one of it’s top holdings, Valeant Pharmaceuticals (VRX).

In fairness, being a “contrarian” has always been a part of Ackman’s shtick and he IS a billionaire, but wow, from a distance this looks like pig-headed obstinance on a grand scale.  When VRX got cut in half from August to October 2015 Ackman doubled down and increased his stake.  Then, earlier this year when VRX was hovering around $90, he added to his position again!  Now after another bloody week. VRX has just one tenth of the value it had seven months ago.

ouch!

there has to be a sell signal in there somewhere!

I know that there are many different ways to make money in the market, but WE NEVER ADD TO LOSING TRADES in the 821x system.  We take our loss and move on.  Why would we want to tie up fresh money in a down trending stock?

As Bill Ackman can attest, stubbornness when trading can be quite expensive.

"If I believe that I am right, I will take it to the end of the earth until I am proven right."
- Bill Ackman
goldwatch

time to watch gold

I made a lot of money on gold’s massive run from 2008 to 2011.  Unfortunately, I unnecessarily gave much of it back because I had not yet been introduced to technical analysis.   Technical analysis of price action allows you to identify and trade along with trends.  Without this knowledge, you are essentially trading blind.  You might as well be gambling.

Gold peaked in 2011, went sideways in 2012 and started heading lower in 2013.  It’s been trending down ever since, going from a high of nearly $1,900 an ounce in late 2012 to a low of  $1,045 in December of last year.

There is no compelling reason to buy (or even own) something in a downtrend if you are trying to make money.  Sure, you could happen to buy in at the exact bottom by pure luck, but do you really want the success of your trades to be reliant on luck?  Trying to pick exact bottoms and tops is a fool’s game.

It’s much smarter to put the odds in your favor BEFORE risking your hard-earned money.  If buyers are gaining control of an asset over sellers we WILL see it in the price action.  That’s our cue to start paying closer attention.  Don’t worry, there’s usually plenty of meat in the middle of a move for us to profit on.

We are starting to see signs that the down trend in gold is possibly coming to an end.  Gold is up 16% year to date, breaking the down trend line of lower highs for the last two years.  Price is well above the 50 week and 200 day moving averages, both of which are starting to turn up.

gold is breaking the down trend line in place for the last two years

gold is breaking the down trend line that’s been in place for the last two years

Gold is currently extended to the upside.  With the possible exception of buying physical coins as “insurance”, I would not chase it here.  However, I believe consolidations above the 200 day moving average are buyable for a trade.  Watch $GLD, $GDX and $GDXJ for low risk 821x buy signals.

It may finally be time to take gold out of the penalty box and start keeping a closer eye on it.

bear hug

embrace a bear, in cash

The 821x system is a trend following system.  However, it’s not enough to know the direction of the trend for a trade idea.   We also have to stay in touch with the direction of the market as a whole.  We always want to have the wind at our back.  This is even more important in a down trending market where even “good” stocks gets dragged down with the “bad”.  Very few stocks make it through a bear market unscathed.

So what is the evidence that the market is currently in a primary downtrend?  First off, the S&P 500 is below a DECLINING 200 day moving average.  Furthermore, the definition of a downtrend is lower highs and lower lows.  The market just made a pronounced lower high and lower low that is visible even on a monthly chart.

no one rings a bell at the top?

nobody rings a bell at the top?

By the end of the first week of trading in 2016, my retirement account was almost completely in cash as my remaining positions flashed 821x sell signals one by one.  By the middle of the following week, my IRA was completely in cash as our model 821x trade at the time triggered a sell.  There is no absolutely no sign of an end to the current down trend.  It may take MONTHS for the market to heal and the primary trend to reverse.  I am thankful that the 821x system has moved my money out of harms way.

Many beginner DIY Investors feel like they have to stay fully invested all the time because “their cash isn’t growing if it’s on the sidelines”.  It’s important to remember however, that when stocks go down, the value of your cash is actually increasing in that you can buy more and more shares.  In fact, market declines are what set up some of the biggest and fastest gains as the downtrend comes to an end and the market reverses back up, refreshed.

When looked at this way, one starts to understand that maybe we should embrace a bear market.  This is obviously much easier to do when most of your money is safely in cash.

 

Before I finish, it’s important that I ask and that you answer the following questions honestly:

  • Do you know how to identify a potential market bottom?
  • Would you know when it’s appropriate to start aggressively buying stocks again?

Unless you can confidently answer yes to both questions, you absolutely should NOT put your retirement accounts in cash.

why average investors should not "flip to cash"

why average investors should not “flip to cash”

If you are on this site, I generally assume that you are a do-it-yourself investor or at least an aspiring DIY investor.  You are someone who wants to take an active role in growing your investment accounts by executing smart, higher probability trades.

However, when the market starts tanking, average investors start freaking out and do stupid things that hurt them in the long run.  Just in case any of these people have stumbled in, I want to make clear that average investors SHOULD NOT be flipping their long term retirement accounts into and out of cash.  They will likely miss the resumption of a bull market which would put their long term financial goals at risk.  Know thyself.

stoicism

focus on the process

Some things are within our control.  This category is the internal realm which includes our actions, perceptions and attitudes.

Then there is everything else; things we only have limited influence over at best.  This is the world external to us which includes the actions of others and nature for example.

Stoic philosophy contends that confusing these categories is the primary source of our unhappiness.  How many people fret over things which they cannot control, resulting in unnecessary stress and frustration?  There is no reason to allow external events to hold our happiness hostage.  We hold the power to avoid this self-imposed trap by simply changing our attitude and focus.

Again, obsessing or stressing about things outside of our control is counterproductive. 

Instead, we should focus our effort and energy on those things we actually do control.  

I make it a point to live by these principles.  Not because I’m such a great guy, but because I’m allergic to stress.  Seriously, I detest stress.  Stress ages youStress makes you fatStress weakens the immune system.  Stress just plain sucks.

Also, I don’t want to pointlessly spin my wheels.  Life’s too short.  I only want to invest my limited time and energy on action that counts.

One example of how this principle looks applied is process vs. outcome.  We control the processes we develop and follow.  However, we do NOT control the outcome of those processes.

Let me give you a real life example.  When we were trying to sell our house in San Antonio, it took much longer than expected or hoped.  As the summer started to draw to a close, I could feel the stress level my wife and I experienced start to elevate.  After every showing, we were consumed with self-doubt, second guessing ourselves with questions: “Are they going to make an offer?”  “Why aren’t they calling?”  “What’s wrong with this house?” etc.

Eventually I started to remind my wife (and myself) that we don’t control the whether the person viewing the house will buy it or not (outcome) so there is no point in worrying about that.  Let’s just focus on cleaning the house and making it appear inviting before each showing (process) and be content with doing our best.

If we focus on improving and following our process, the outcome will generally take care of itself.

Of course, we eventually did sell that house and importantly, we did it while also saving ourselves a lot of unnecessary stress when we changed our focus and mindset.

This principle can be helpful in many areas of our lives, such as if we are trying to lose weight or learn a new skill.

It also happens to be especially useful when trading.

We have absolutely no control whether a stock goes up or down.  The only thing we control is when we buy and when we sell.

It’s critical to remember this, especially when we inevitably hit a string of losing trades.  It’s easy to lose our confidence which can paralyze us from taking further action.  Worse, we may lose our discipline and try to “make it all back” by taking on too much risk and then end up blowing up our trading account.

We must remember to focus on what WE control.

Develop and follow a proven trading system.  If you need help, start with my 821x system.

Don’t obsess on whether a trade was profitable or not.  Again, you have no control over that.  It’s pointless to beat yourself up over a losing trade.

Instead, evaluate how well you followed your trading system.  Did you chase a stock that was spiking higher?  Did you panic and sell early or get stubborn and hold on too long?  Did you break your own rules?

Over time your decision making skills will become congruent with your system.  It will become habit.  It will become second nature.

Only after you reach this level can you start to gain enough experience to know when a market environment dictates that you deviate from your system.  This is the level of the elite performer and is obviously not something a beginner should attempt.  It’s just like any other competency.  You must start with the fundamentals and internalize them before you can begin to attempt to understand when it may be appropriate to override them.

So learn your trading system.  Internalize the rules.  Consistently follow your process.

Your trading system should be designed to identify and cut losing trades quickly and let your winning trades run.

Trust that over time you WILL achieve the outcome you desire, an overall increase in wealth.

If you are distressed by anything external, the pain is not due to the thing itself, but to your estimate of it; and this you have the power to 
revoke at any moment. - Marcus Aurelius

portfolio introduction and new trade

(watch video for details)

IRMD – buy with a limit price of $26.50.

Other idea INFN – buy with a limit price of $19.76.

a powerful savings growth vehicle

a powerful savings growth vehicle

Enough about the ineffectual helper.

Where can you find a valuable partner who will actually move the needle in advancing your financial goals?

In other words, how can you actually GROW your savings?

Hard assets such as real estate and precious metals are viable ways to store and sometimes grow your wealth.  However, they are illiquid, meaning they are generally difficult and time consuming to sell and transaction costs are high.

Rental properties are an excellent way to grow your savings that I highly recommend.  I have a rental property myself and it has been a fantastic investment.  Like any investment though, it’s critical that you buy well.   In the case of rental properties this means the right price, the right house and the right neighborhood among other things .  You also have to be prepared to handle ongoing maintenance which can include things such as fixing leaky plumbing and dealing with late rent checks.

This brings me to my favorite way to growth wealth; the stock market.

Financial markets are one of most powerful and convenient vehicles for wealth creation in the history of world.  There’s a reason the wealthiest 10% in America own 81% of all stock assets.

Stocks don’t suffer the same drawbacks that the other asset classes mentioned above do.  They are extremely easy to buy and sell (i.e. they are liquid).  They don’t require ongoing maintenance the way rental properties do.  Another often overlooked advantage they have is you can make money whether they increase or even decrease in value.  In general, all other asset classes must increase in value in order for you to make money.  However, you can make a fortune in stocks even if the stock market crashes by selling short, buying puts or using inverse ETFs.

I understand though, that there are two major hurdles keeping most on the sidelines:

– lack of time

– fear of losing money

Let me briefly address both of these concerns.  Frankly, the learning curve to consistently making money with stocks is actually pretty steep.  You will need to spend a significant amount of time initially to develop a trading system that you trust works.  However, once you have that down it doesn’t really need to take a long time to manage your portfolio.

The second concern is also a valid one.  The stock market is like a minefield.  Buy the wrong stock at the wrong time without a robust risk management plan and you can easily blow up your account.  At a high level, the key is to cut your losers quickly and be patient with your winning trades.  If you do this consistently, you can have more losers than winners and still make money overall.  This is because some of your winning trades will represent much larger percentages than your losers.  For example, if your position sizes are all the same, a single 25% winner more than makes for four 5% losers

I’m not going to lie.  Making money with stocks is not easy.  However, the rewards are immense if you can develop these skills.  I share the nuts and bolts of one of my trading systems in the 821x eBook.  Feel free to take that as a starting place as you start to develop a trading system of your own.

libertopia (800x450)

how I went from spender to saver

I spent every penny I made.  Knowing that I would usually receive an annual bonus, I would buy something from Best Buy or somewhere else a year in advance on credit, with no payments and no interest for a year.  When my bonus came, I would pay off whatever I bought in the prior year and then buy something else.  I would literally spend my bonus a year before I received it!  I did this year after year.

Since I had no savings, I sold stock options I’d received from my employer so that my family could attend my sister’s wedding in Hawaii.  We planned to visit my brother-in-law’s family in California in the following year.  However, when it came time for the trip in the fall of 2008, the market was tanking and my stock options were worthless.  I had to cancel the trip.  It was humiliating.

I’ve mentioned before that the market crash of 2008 is what marked the beginning of my interest in stocks.  But the last post got me thinking; specifically, what was it that caused me to make the switch from spender to saver?

The Journey

Thinking back, the shift actually began at around the same time.  It’s amazing how seeing your 401k chopped in half can focus the mind.  Prior to this, I was just kind of floating through life with no concrete long-term plans.  The 2008 crisis shook me up and inspired me to start looking for ways to mitigate economic risks that I’d never even noticed before.  Saving money and buying precious metals was part of it.  Increasing personal resilience by planting fruit trees and starting a garden was another step we took.  Unfortunately, I also thought that “spreading the word” and political action were solutions as well.

This is where I can point to a second pivotal event in my journey.  In 2011, I was spending a lot of time (and money) making music with my band, Rothbard.  We were invited to participate in an event called Libertopia in San Diego.  We played our set and the rest of the time I listened to many of the speakers.  The overarching theme and philosophy I took away from that conference literally changed the trajectory of my life.

I realized that it’s futile to try to “mobilize a majority”.  There’s no need to try to conjure up a “consensus”.  For the first time in my life, I ascertained the true essence of government; coercion.  The majority forcing it’s will on the minority is immoral and I want no part of it, even if my ideas happen to be in the majority.  Secondly, the elusive if not impossible goal of trying to change the minds of enough people can become convenient excuses that ultimately keep me spinning my wheels but going nowhere.

The reality is I can live a rich life of freedom NOW without these things.

Prior to this, I had been fixated on a lot of the doom and gloom out there.  Out of control government spending and debt, stifling regulations, corrupt politicians, etc., etc.  Of course, there are plenty of negatives I can and did focus on, but wasting my limited time and energy fretting about things out of my control left me feeling frustrated and unhappy.

Governments will do what governments do.  Politicians will continue to do what politicians do.  I can’t control them.  I can, however, improve society by leading by example; by presenting it with “one improved unit“, as Albert Jay Nock has said.

The truth is, the people and institutions I thought were holding me back, can actually do little to stop me from living a life of freedom.  All I had to do was define what being free meant to me and then find creative ways to get there.  As I started confronting the obstacles in my path, I found that many of them existed only in my mind.

Let me give you some idea of how Libertopia elevated my vision.  Prior to this event, I was arguing with my HOA about my right to put a Ron Paul sign in my front yard.  I was also spending a lot of my free time going through boxes of coins looking for copper and silver.

After the event, my wife and I looked at investment property in the Dominican Republic and then purchased a rental house in San Antonio.   I also started getting serious about learning how to make money with stocks.

Key Concepts

Given that background information, I’ve isolated two key concepts that were instrumental in my transformation from spender to saver.

  1. A clear vision – once you get a clear picture of where you want to go, it makes all of your other decisions so much easier, including your spending decisions.
  2. Viewing money as capital – Basically, this is the realization that you can use money to make even more money.  This hit me as I started to make money with stocks.  I even got a taste of this when I saw the value of the gold and silver coins I had purchased rise in value.

Of course, no two people take the exact same path, but I hope this little walk down memory lane is helpful to you on your journey towards a life of freedom.