By Chuck LeBeau
Watching the bank stocks this week was like watching a yo-yo. After six weeks of impressive gains, during which we saw Bank of America (BAC), Wells Fargo (WFC), and Citigroup (C) gain 238%, 106% and 255% respectively, we started the week with big declines. For example Bank of America lost 24% of its value on Monday. This alarming loss was followed by a Tuesday rally of 9% , a Wednesday loss of almost 6% and a Thursday rally of almost 7%. Many other banking stocks were equally as athletic.
While volatile markets such as these are the most challenging environment for setting protective stops, they can also be the most rewarding if you manage to hold on and avoid the dreaded “whipsaw”. So how does one determine the optimal stop price; one that will provide adequate protection while limiting the chances of being whipsawed? Two key factors to consider are the current trading range for a stock and the strength and direction of its current trend. We want to place our stop just outside the current trading range, so that it would only be triggered as the result of “abnormal” price weakness. We also need to take into account the direction and strength of the current trend. The logic is to adjust the stops further away from prices in a strong uptrend, were the opportunity cost of whipsaw may be high, thus giving the stock more room to run.
For a sideways or downward moving stock, where the opportunity cost of a whipsaw is lower, we want to tighten the stop to better protect our capital. Following this strategy, Monday’s trailing stops would have been set unusually low as the financial stocks were coming off a strong but volatile uptrend. As the week progressed, we would begin tightening our stops as the uptrend ended and the stock’s primary direction became unclear. This process may sound complicated but there are helpful services such as SmartStops.net that incorporate this logic in the stops they calculate and publish. And in fact, the SmartStops for BAC, WSF and C were all set quite low on Monday and successfully avoided any whipsaw.
In spite of banking stocks and many other stocks posting earnings this week that were well above estimates, the market remains uncomfortable with the recent gains and continues to be subject to severe corrections. Investors would be well advised to protect recent gains with trailing stops while hoping that any of the anticipated corrections prove to be short lived. Caution continues to be the order of the day.
Note: SmartStop alert prices change daily. For up to date daily alerts visit www.SmartStops.net.
Apr 27, 2009
Mar 30, 2009
Strategies of Portfolio Protection
SmartStops commentary: Below are some ideas for using ETFs to hedge a portfolio. The list of ETFs that go short is worth saving.
Investment Portfolio Protection
Strategies of Portfolio Protection
http://knol.google.com/k/samuel-gap/investment-portfolio-protection/7x625mtk3b8m/11#
These days the question of how to protect the investment portfolio becomes essential and central.
Most of us have lost some (or big) money as result of the Subprime crisis. Since this crisis crossed borders and sectors most of the individuals’ and corporations’ investment portfolios had to suffer. Even cases of sophisticated and wise investors could not show positive returns on the portfolios as the market trends and physiology around the world were negative. In such days the question of how to protect the investment portfolio becomes essential and central. Obviously the ultimate way to protect the portfolio is to sell it and hold cash only – however this is only a theoretical solution since investors expect some returns on their money and selling the entire portfolio can also cause huge transaction costs.
Portfolio Protection – Introduction
In the last decades the financial markets evolved to enable professional investors to protect their investments by short and hedge position. The simple way of protection is by purchasing PUT options or Future contracts betting the decrease of a specific company, sector or market. These instruments are costly as they reflect the option and time price in the option price. These instruments also require the investor not only to bet on the direction of the share or market (increase or decrease) but also to bet the timeframe since options and contracts expire at a certain date. Another instrument which requires high expertise is short selling of specific shares covered by stock lending arrangement. The latter enables the investor to sell shares that he does not own and buy later buyback the shares at a lower price (in case the bet succeeds and the share price falls). This short selling requires complicated procedures and high sophistication and usually cannot be performed by an ordinary individual. Therefore, the next step of the market evolvement was of professional fund managers to offer the public many types of mutual funds, hedge funds or private fund that manage short positions on specific markets or sectors. Recently, some fund managers also offer equity traded funds which aim at inverse exposure to specific sectors or indexes. These ETFs are simple and quick way to protect a portfolio and the transaction (buy/sell) is handled like any other listed share in the market.
Thus, an interesting protection structure which investor may choose is to hold shares and funds of markets and sectors he believes will perform well (“to go long”) and to purchase short ETFs or funds in markets or sectors what he believes will underperform (“to go short”).
Such a structure will enable you to be more balanced on your entire portfolio if markets will continue falling crossing all sectors and markets (in such case your short funds will make some gains), but will still allow you to bet on specific markets and sectors you believe will rise or fall. When buying short ETFs important to notice that some of them are leveraged and volatile promising the investor “twice the inverse daily return of the index”.
ETFs Short Funds:
Below are some examples of “bear market” (short position) ETFs traded in the US markets-
UltraShort SmallCap600 ProShares (US symbol: SDD) which goal is to “correspond to twice the inverse of the daily performance of the S&P SmallCap 600 index”. http://finance.yahoo.com/q?s=sdd
Short Russell2000 (US symbol: RWM) which goal is to “correspond to the inverse of the daily performance of the Russell 2000 index”. http://finance.yahoo.com/q?s=rwm
UltraShort Industrials ProShares (US symbol: SIJ) which goal is to “correspond to twice the inverse of the daily performance of the Dow Jones U.S. Industrials index”. http://finance.yahoo.com/q?s=sij
UltraShort Consumer Services ProShares (US symbol: SCC) which goal is to “correspond to twice the inverse of the daily performance of the Dow Jones U.S. Consumer Services index”. http://finance.yahoo.com/q?s=scc
UltraShort MSCI Emerging Mrkts ProShares (US symbol: EEV) which goal is to “correspond to twice the inverse of the daily performance of the MSCI Emerging Markets index”. http://finance.yahoo.com/q?s=eev
UltraShort FTSE/Xinhua China 25 Proshare (US Symbol: FXP) which goal is to “correspond to twice the inverse of the daily performance of the FTSE/Xinhua China 25 index”. http://finance.yahoo.com/q?s=fxp
UltraShort Financials ProShares (US Symbol: SKF) which goal is to “correspond to twice the inverse of the daily performance of the Dow Jones U.S. Financials index”. http://finance.yahoo.com/q?s=skf
UltraShort Oil & Gas ProShares (US Symbol: DUG) which goal is to “correspond to twice the inverse of the daily performance of the Dow Jones U.S. Oil & Gas index”. http://finance.yahoo.com/q?s=dug
UltraShort Technology ProShares (US Symbol: REW) which goal is to “correspond to twice the inverse of the daily performance of the Dow Jones U.S. Technology index”. http://finance.yahoo.com/q?s=rew
UltraShort MSCI Japan Proshares (US Symbol: EWV) which goal is to “correspond to twice the inverse of the daily performance of the MSCI Japan index”. http://finance.yahoo.com/q?s=ewv
UltraShort Utilities ProShares (US Symbol: SDP) which goal is to “correspond to twice the inverse of the daily performance of the Dow Jones U.S. Utilities index”. http://finance.yahoo.com/q?s=sdp
UltraShort Semiconductor ProShares (US Symbol: SSG) which goal is to “correspond to twice the inverse of the daily performance of the Dow Jones U.S. Semiconductor index”. http://finance.yahoo.com/q?s=ssg
Disclaimer:
The information contained in this article and from any communication related to this article is for information purposes only. The author does not hold itself out as providing any legal, financial or other advice, and is not authorized to do so. The author also does not make any recommendation or endorsement as to any investment, advisor or other service or product or to any material submitted by third parties or linked to this article. In addition, the article does not offer any advice regarding the nature, potential value or suitability of any particular investment, security or investment strategy. The material in this article does not constitute advice and you should not rely on any material in this article to make (or refrain from making) any decision or take (or refrain from making) any action.
Mar 11, 2009
Stupid Investment of the Week
Stupid Investment of the Week
Commentary: Find a stop-loss point before you go any further with stocks
By Chuck Jaffe, MarketWatch
BOSTON (MarketWatch) -- Maybe you're investing because you believe that stocks are "on sale," or perhaps it's because you believe in the long-term prospects for recovery. Perhaps you hold stocks that have been good to you in the past, or which you've been in so long that you don't want to go through the headache of calculating your capital gains.
Or you could be trading for a quick profit, or following the discipline of dollar-cost averaging.
Whatever the reason, if you haven't come up with a stop-loss point -- either a real trigger to get out of an investment if it falls too far or an emotional point where you would sell -- you're making the Stupid Investment of the Week.
Stupid Investment of the Week typically highlights conditions and characteristics that make a security less than ideal for average consumers, focusing on one example to showcase common pitfalls.
This week, however, the trait under review belongs to the investor and not the investment. Specifically it's about people who buy or hold a stock in a trader's market without having a concrete exit strategy.
"The hardest thing investors have to do is to determine when they can make money in this kind of market, and when they have to preserve capital, because those things are often at odds with each other," said Richard Geist, head of the Institute on the Psychology of Investing.
He added: "You are looking at something saying 'It's a bargain,' or feeling like it can't go down much further from here, and yet you are also looking at your portfolio and wondering how much of a loss you can take if you are wrong."
Set limits
There are plenty of stop-loss strategies, typically involving a standing order to sell shares if they fall to a specific level. That said, rigid stop-loss programs typically are wrong for casual investors, as they can trigger losses again and again, especially in a volatile market.
So while many investors who follow trading systems will always set a stop-loss at, say, 8% or 10% down from their buying point, an average investor could find themselves with a slew of investments all delivering a quick loss and never reaching the longer-term prospects that are behind the holding.
"A trader or someone with a system basically is using stop-losses to avoid being wrong," said Ken Shreve, markets desk anchor for Investor's Business Daily. "Someone who buys and holds blue-chips, they're trying not to be concerned with the short-term losses, figuring that they will get paid off over time."
But, he added, "At some point, however, those losses start to add up and the math is not on your side. The problem with riding things down is that a 50% loss in a stock requires a 100% move back up. ... The math is the best argument for basically setting a selling point, one where you avoid losses or protect your gains."
For long-term investors, finding a selling point may not mean setting a stop-loss order at a specific price per share. Instead, it may be an emotional price, one where the investor says they are willing to gamble with some of their winnings, but they are not going to allow a long-time winner to morph into a long-time loser.
Unlike the person with a trading strategy, who takes proceeds from a stop-loss trade and puts it toward the next investment that meets their buying profile, a long-term buy-and-holder is looking more to create their reason to get out the door, without regard to the next investment. They are more concerned about protecting what they have than finding a faster horse at the track.
Consider General Motors (GM) , which was trading 12 months ago north of $26 per share. At that price, there were still plenty of long-term believers, employees and former workers with huge slugs of stock in their retirement plan and more. While the market was waking up to the problems that have led to the company calling for a federal bailout to avoid bankruptcy, the long-term, 'I-have-faith-in-America, it's-too-important-to-fail' crowd was hanging on, and their accounts were being slaughtered for it.
Avoid the worst
Likewise, the financial services industry spent the late 1990s and early 2000s rewarding investors many times over, and yet a long-term holder who simply figured "things couldn't get much worse" basically has watched decades of gains evaporate.
Behavioral finance experts say that investors tend to go through a progression that includes some measure of denial about just how bad things can get. When they wake up to horrendous losses, they are looking at account balances so low that they may ride things out until the bitter end.
Instead, Geist noted, they should have a mental selling point, one where they say they will allow that long-term winner to shrink back to maybe double the initial investment or all the way to break-even, but that when it reaches those scary levels it gets sold in order to avoid the possible bitter end.
This "emotional stop-loss" is just as important as the actual trade; effectively, it is like setting your limit at the casino and saying "this is the point beyond which I need to stop gambling."
And while some of the issue is based on emotions -- the point where you start losing sleep at night based on the shrinking value of your biggest holdings or your entire portfolio -- some of the decision will also be based on your needs and plans.
"The more stress people are under, the worse their decisions tend to become," Geist said. "So if you are holding something today and you know there is a point where enough is enough -- where you just can't take more loss or you just have to acknowledge that whatever had you buying or holding the stock just isn't working right now -- that point becomes your emotional stop-loss. If you know it in advance -- and setting it is the hard part -- it will protect you from letting things get worse while you try to figure out if you should hang on or not."
Chuck Jaffe is a senior MarketWatch columnist. His work appears in dozens of U.S. newspapers. www.marketwatch.com
Article: http://preview.tinyurl.com/aqvtd5
Commentary: Find a stop-loss point before you go any further with stocks
By Chuck Jaffe, MarketWatch
BOSTON (MarketWatch) -- Maybe you're investing because you believe that stocks are "on sale," or perhaps it's because you believe in the long-term prospects for recovery. Perhaps you hold stocks that have been good to you in the past, or which you've been in so long that you don't want to go through the headache of calculating your capital gains.
Or you could be trading for a quick profit, or following the discipline of dollar-cost averaging.
Whatever the reason, if you haven't come up with a stop-loss point -- either a real trigger to get out of an investment if it falls too far or an emotional point where you would sell -- you're making the Stupid Investment of the Week.
Stupid Investment of the Week typically highlights conditions and characteristics that make a security less than ideal for average consumers, focusing on one example to showcase common pitfalls.
This week, however, the trait under review belongs to the investor and not the investment. Specifically it's about people who buy or hold a stock in a trader's market without having a concrete exit strategy.
"The hardest thing investors have to do is to determine when they can make money in this kind of market, and when they have to preserve capital, because those things are often at odds with each other," said Richard Geist, head of the Institute on the Psychology of Investing.
He added: "You are looking at something saying 'It's a bargain,' or feeling like it can't go down much further from here, and yet you are also looking at your portfolio and wondering how much of a loss you can take if you are wrong."
Set limits
There are plenty of stop-loss strategies, typically involving a standing order to sell shares if they fall to a specific level. That said, rigid stop-loss programs typically are wrong for casual investors, as they can trigger losses again and again, especially in a volatile market.
So while many investors who follow trading systems will always set a stop-loss at, say, 8% or 10% down from their buying point, an average investor could find themselves with a slew of investments all delivering a quick loss and never reaching the longer-term prospects that are behind the holding.
"A trader or someone with a system basically is using stop-losses to avoid being wrong," said Ken Shreve, markets desk anchor for Investor's Business Daily. "Someone who buys and holds blue-chips, they're trying not to be concerned with the short-term losses, figuring that they will get paid off over time."
But, he added, "At some point, however, those losses start to add up and the math is not on your side. The problem with riding things down is that a 50% loss in a stock requires a 100% move back up. ... The math is the best argument for basically setting a selling point, one where you avoid losses or protect your gains."
For long-term investors, finding a selling point may not mean setting a stop-loss order at a specific price per share. Instead, it may be an emotional price, one where the investor says they are willing to gamble with some of their winnings, but they are not going to allow a long-time winner to morph into a long-time loser.
Unlike the person with a trading strategy, who takes proceeds from a stop-loss trade and puts it toward the next investment that meets their buying profile, a long-term buy-and-holder is looking more to create their reason to get out the door, without regard to the next investment. They are more concerned about protecting what they have than finding a faster horse at the track.
Consider General Motors (GM) , which was trading 12 months ago north of $26 per share. At that price, there were still plenty of long-term believers, employees and former workers with huge slugs of stock in their retirement plan and more. While the market was waking up to the problems that have led to the company calling for a federal bailout to avoid bankruptcy, the long-term, 'I-have-faith-in-America, it's-too-important-to-fail' crowd was hanging on, and their accounts were being slaughtered for it.
Avoid the worst
Likewise, the financial services industry spent the late 1990s and early 2000s rewarding investors many times over, and yet a long-term holder who simply figured "things couldn't get much worse" basically has watched decades of gains evaporate.
Behavioral finance experts say that investors tend to go through a progression that includes some measure of denial about just how bad things can get. When they wake up to horrendous losses, they are looking at account balances so low that they may ride things out until the bitter end.
Instead, Geist noted, they should have a mental selling point, one where they say they will allow that long-term winner to shrink back to maybe double the initial investment or all the way to break-even, but that when it reaches those scary levels it gets sold in order to avoid the possible bitter end.
This "emotional stop-loss" is just as important as the actual trade; effectively, it is like setting your limit at the casino and saying "this is the point beyond which I need to stop gambling."
And while some of the issue is based on emotions -- the point where you start losing sleep at night based on the shrinking value of your biggest holdings or your entire portfolio -- some of the decision will also be based on your needs and plans.
"The more stress people are under, the worse their decisions tend to become," Geist said. "So if you are holding something today and you know there is a point where enough is enough -- where you just can't take more loss or you just have to acknowledge that whatever had you buying or holding the stock just isn't working right now -- that point becomes your emotional stop-loss. If you know it in advance -- and setting it is the hard part -- it will protect you from letting things get worse while you try to figure out if you should hang on or not."
Chuck Jaffe is a senior MarketWatch columnist. His work appears in dozens of U.S. newspapers. www.marketwatch.com
Article: http://preview.tinyurl.com/aqvtd5
Feb 26, 2009
Avoiding Black Swans
This Article written by Chuck LeBeau was originally published in Trading Markets and has been since re-posted in many websites
It is a great article and it demonstrate the absolute need of having a valid exit strategy.
A very comprehensive study of the Dow Jones Industrials caught my eye recently and I want to share some thoughts and conclusions based on the data in the study. The data I will be referring to is from a study encompassing more than 100 years of daily data on the Dow Jones Industrial Average. (Black Swans and Market Timing: How Not To Generate Alpha, by Javier Estrada, International Graduate School of Management, Barcelona, Spain) The data presented in this study begins on December 31, 1899 and ends on December 31, 2006. In total the study encompasses 29,190 trading days. I have highlighted the data about the worst days because it is usually ignored.
1) A $100 investment at the beginning of 1900 turned into $25,746 by the end 2006, and delivered a mean annual compound return of 5.3%.
2) Missing the best 10 days reduced the terminal wealth by 65% to $9,008, and the mean annual compound return one percentage point to 4.3%. But avoiding the worst 10 days increased the terminal wealth by 206% to $78,781, and the mean annual compound return by more than one percentage point to 6.4%.
3) Missing the best 20 days reduced the terminal wealth by 83.2% to $4,313, and the mean annual compound return to 3.6%. But avoiding the worst 20 days increased the terminal wealth by 531.5% to $162,588, and the mean annual compound return to 7.2%.
4) Missing the best 100 days reduced the terminal wealth by 99.7% to just $83 ($17 less than the initial capital invested), and reduced the mean annual compound return to −0.2%. But avoiding the worst 100 days increased the terminal wealth by a staggering 43,396.8% to $11,198,734, and more than doubled the mean annual compound return to 11.5%.
The author of this study concludes that these outlier days in either direction (the Black Swans) are so rare that it would be impossible for market timers to capture or avoid them.
I strongly disagree.
First let’s look at what it is we want to do with market timing. Do we want to capture the positive Black Swans or simply avoid the negative Black Swans? It would seem obvious that we would want to do both but if we had to choose only one course of action it is clear that we can derive the most benefit from avoiding the negative Black Swans so let’s start with that. Let’s see if we can avoid big declines using market timing.
As director of quantitative analytics at SmartStops.net I recently directed a ten-year study of the stocks in the S&P 500 Index. The study was intended to measure the various peak-to-valley drawdowns of each of the 500 stocks. Any drawdown of 15% or more was identified and measured. Since this article is focused on big drawdowns (the Black Swans) we will only look at peak-to-valley declines of 60% or more. Here is the data:
1) Of the 500 stocks 267 of them had experienced a drawdown of 60% or more.
2) 175 of them had experienced a drawdown of 70% or more.
3) 105 of them had experienced a drawdown of 80% or more
4) And 51 of them had experienced a drawdown of 90% or more.
5) The average of the largest drawdown of the 500 stocks was 61.67%
Those numbers might seem high at first glance but they are actually understated by quite a bit. The drawdown study ended in May of 2008 and we all know that the market has gone down a great deal since the study so the magnitude of the drawdowns would be even greater if the same study were conducted today. Also, as in any long-term study of a group of stocks, the results are skewed by “survivorship bias”. There were a lot of stocks that might have been in the S&P 500 ten years ago but for one reason or another they are no longer in the current index. Some of those stocks have declined to zero and are not included in the study.
Having looked at the nature of the problem let’s get back to the task at hand. Can market timing help us to avoid these drawdowns? Yes, it definitely can. A logical application of trailing stops would have avoided most of the big declines. Here are the results using the SmartStops trailing exits that are available for free on our web site.
1) Of the 500 stocks only 4 of them had declines of 60% or more.
2) There were no stocks that had declines of 70%, 80% or 90%.
3) The average of the largest drawdown of the 500 stocks was 22.58%
Now I must admit that I think that our SmartStops trailing exits are more sophisticated and effective than most trailing exits because the SmartStops are adjusted daily for trend direction and changes in volatility. However any serious effort at limiting the drawdowns with conventional trailing stops would certainly have had a very positive effect in reducing the magnitude of these declines. As the quoted Black Swan study clearly shows the avoidance of big declines improves performance very significantly. Here is a reminder of how that works:
1) It takes a gain of 150% to recover from a 60% decline.
2) It takes a gain of 333% to recover from a 70% decline.
3) It takes a gain of 500% to recover from an 80% decline.
4) It takes a gain of 900% to recover from a 90% decline.
5) It takes a government bailout to recover from any decline greater than 90%
Skeptics of market timing usually argue that efforts to avoid big down moves will result in missing the biggest up moves. However[The Discount code is SG2FREE30]I have never seen a study that shows any evidence to support that preposterous assumption. If you limit your losses and are willing to enter on strength you will not miss any major up trends. With a little planning and effort you can capture the Black Swans on the up side and avoid the Black Swans on the down side.
Chuck LeBeau is director of quantitative analytics at SmartStops.net and co-author of Computer Analysis of the Futures Markets (McGraw-Hill). For more of Chuck's commentary, visit www.smartstops.net
Trading Market http://preview.tinyurl.com/beadqz
It is a great article and it demonstrate the absolute need of having a valid exit strategy.
A very comprehensive study of the Dow Jones Industrials caught my eye recently and I want to share some thoughts and conclusions based on the data in the study. The data I will be referring to is from a study encompassing more than 100 years of daily data on the Dow Jones Industrial Average. (Black Swans and Market Timing: How Not To Generate Alpha, by Javier Estrada, International Graduate School of Management, Barcelona, Spain) The data presented in this study begins on December 31, 1899 and ends on December 31, 2006. In total the study encompasses 29,190 trading days. I have highlighted the data about the worst days because it is usually ignored.
1) A $100 investment at the beginning of 1900 turned into $25,746 by the end 2006, and delivered a mean annual compound return of 5.3%.
2) Missing the best 10 days reduced the terminal wealth by 65% to $9,008, and the mean annual compound return one percentage point to 4.3%. But avoiding the worst 10 days increased the terminal wealth by 206% to $78,781, and the mean annual compound return by more than one percentage point to 6.4%.
3) Missing the best 20 days reduced the terminal wealth by 83.2% to $4,313, and the mean annual compound return to 3.6%. But avoiding the worst 20 days increased the terminal wealth by 531.5% to $162,588, and the mean annual compound return to 7.2%.
4) Missing the best 100 days reduced the terminal wealth by 99.7% to just $83 ($17 less than the initial capital invested), and reduced the mean annual compound return to −0.2%. But avoiding the worst 100 days increased the terminal wealth by a staggering 43,396.8% to $11,198,734, and more than doubled the mean annual compound return to 11.5%.
The author of this study concludes that these outlier days in either direction (the Black Swans) are so rare that it would be impossible for market timers to capture or avoid them.
I strongly disagree.
First let’s look at what it is we want to do with market timing. Do we want to capture the positive Black Swans or simply avoid the negative Black Swans? It would seem obvious that we would want to do both but if we had to choose only one course of action it is clear that we can derive the most benefit from avoiding the negative Black Swans so let’s start with that. Let’s see if we can avoid big declines using market timing.
As director of quantitative analytics at SmartStops.net I recently directed a ten-year study of the stocks in the S&P 500 Index. The study was intended to measure the various peak-to-valley drawdowns of each of the 500 stocks. Any drawdown of 15% or more was identified and measured. Since this article is focused on big drawdowns (the Black Swans) we will only look at peak-to-valley declines of 60% or more. Here is the data:
1) Of the 500 stocks 267 of them had experienced a drawdown of 60% or more.
2) 175 of them had experienced a drawdown of 70% or more.
3) 105 of them had experienced a drawdown of 80% or more
4) And 51 of them had experienced a drawdown of 90% or more.
5) The average of the largest drawdown of the 500 stocks was 61.67%
Those numbers might seem high at first glance but they are actually understated by quite a bit. The drawdown study ended in May of 2008 and we all know that the market has gone down a great deal since the study so the magnitude of the drawdowns would be even greater if the same study were conducted today. Also, as in any long-term study of a group of stocks, the results are skewed by “survivorship bias”. There were a lot of stocks that might have been in the S&P 500 ten years ago but for one reason or another they are no longer in the current index. Some of those stocks have declined to zero and are not included in the study.
Having looked at the nature of the problem let’s get back to the task at hand. Can market timing help us to avoid these drawdowns? Yes, it definitely can. A logical application of trailing stops would have avoided most of the big declines. Here are the results using the SmartStops trailing exits that are available for free on our web site.
1) Of the 500 stocks only 4 of them had declines of 60% or more.
2) There were no stocks that had declines of 70%, 80% or 90%.
3) The average of the largest drawdown of the 500 stocks was 22.58%
Now I must admit that I think that our SmartStops trailing exits are more sophisticated and effective than most trailing exits because the SmartStops are adjusted daily for trend direction and changes in volatility. However any serious effort at limiting the drawdowns with conventional trailing stops would certainly have had a very positive effect in reducing the magnitude of these declines. As the quoted Black Swan study clearly shows the avoidance of big declines improves performance very significantly. Here is a reminder of how that works:
1) It takes a gain of 150% to recover from a 60% decline.
2) It takes a gain of 333% to recover from a 70% decline.
3) It takes a gain of 500% to recover from an 80% decline.
4) It takes a gain of 900% to recover from a 90% decline.
5) It takes a government bailout to recover from any decline greater than 90%
Skeptics of market timing usually argue that efforts to avoid big down moves will result in missing the biggest up moves. However[The Discount code is SG2FREE30]I have never seen a study that shows any evidence to support that preposterous assumption. If you limit your losses and are willing to enter on strength you will not miss any major up trends. With a little planning and effort you can capture the Black Swans on the up side and avoid the Black Swans on the down side.
Chuck LeBeau is director of quantitative analytics at SmartStops.net and co-author of Computer Analysis of the Futures Markets (McGraw-Hill). For more of Chuck's commentary, visit www.smartstops.net
Trading Market http://preview.tinyurl.com/beadqz
Quote of the day
“The highest form of ignorance is when you reject something you don't know anything about.”
Wayne Dyer (b1940)
Wayne Dyer (b1940)
Feb 25, 2009
Trading Messages From Mars
Chuck LeBeau Wisdom
"This excerpt is from Chuck LeBeau. Chuck happens to be one of the pioneers in the field of trading systems. His wisdom should be absorbed by all"
Michael Covel
Michael Covel is the Author of The Complete TurtleTrader & the bestseller Trend Following
Covel Is also the Director of the New Documentary Film Broke: The New American Dream
"[This] happens to be a true story, which contains a very valuable trading lesson that has influenced my trading for many years now. We thought the story might make an interesting topic...Here is the story: Back in the late 1960s I was a young commodity broker at E. F. Hutton and Company. Our office was a brand new high-tech office (for its time) which was considered the "flagship office" for E. F. Hutton. In this office about thirty brokers and as many clients shared one very large boardroom and there were no private offices. The brokers had elegant and expensive desks and the clients had a comfortable seating area in the front of the office where they could hang out and watch the tapes and monitor our state of the art commodity "clacker board". Sitting at my desk near the front of the boardroom I could read my Wall Street Journal and keep track of the commodity markets without looking at the board. By just listening to the rhythm and tempo of the mechanical clicks as the prices changed I could easily tell when anything important was going on because the tempo of the clicks would increase noticeably. Just in front of my desk were a half dozen comfortable sofas facing a high mahogany paneled wall with the tapes and the "clacker board". A gallery of traders, mostly retired "old timers" who were trading real commodities like grains and pork bellies, lounged around on the sofas plotting their charts and talking about life and the markets. They typically arrived early to get a good seat in their usual spot and then spent the day trading, exchanging commentaries and offering unsolicited advice to one another on any subject. For the most part they were a very sociable group who would take coffee breaks together and greeted each other on a first name basis. These traders enjoyed the elegant atmosphere and treated our well-appointed boardroom as their private men's club. (Were you aware that women were not allowed to trade commodities back in those days? My how times have changed!) However, one of these "old timers" kept to himself and was not interested in becoming a member of the friendly and often boisterous social circle. He usually sat quietly by himself intently watching the price changes on the commodity board and holding an old glass Coca-Cola bottle up near his ear. The vintage shaped Coke bottle had been emptied many years before and now contained only a 12-inch tube of bent and broken radio antennae which extended awkwardly out of the top of the bottle. Keep in mind that in the 1960s no one had yet heard of cell phones so the purpose of this Coke bottle was a real mystery to everyone. When the trader would talk to the bottle from time to time all the heads would turn and the traders nearby would try to listen to the conversation. But the trader spoke very softly and no one was able to eavesdrop on his conversations with the bottle. The traders knew that the fellow with the coke bottle was a client of mine and eventually a representative of the group came to me and explained that they were extremely puzzled about this guy and his Coke bottle and asked me if I knew what was going on. I didn't know the purpose or meaning of the Coke bottle but I was as curious as anyone was and I promised I would find out. The next time the client came back to my desk I promptly placed his order and then politely asked him about the Coke bottle. With a serious expression and no embarrassment he explained to me that the Coke bottle was an inter-planetary communication device that had been given to him by aliens. He said that the aliens were very interested in our commodity markets and they often gave him trading advice from their various observation points on other planets. He said that he had just had a message from Mars and they were buying soybeans so he had also purchased soybeans. After revealing his unique trading methodology he returned to his seat and resumed his whispered conversations with the Coke bottle. As soon as I revealed my discovery of the meaning of the Coke bottle to the other traders, all attention was immediately focused on the Coke bottle trader and the soybean market. The soybean market proceeded to go the wrong way and the trade from Mars was eventually closed out at a loss. The other traders were had no sympathy and were quick to begin ridiculing the the trader and poke fun at his beliefs. The next trade however turned out to be a big winner and the Coke bottle trader went from sofa to sofa telling his story and pointing to the clacker board while waiving his Coke bottle and bragging about the profitability of his most recent message from outer space. Because he was making money now his previous critics had to endure his bragging about his success on the current winning trade. As time went on and a few winning and losing trades later a clear pattern of behavior began to emerge. The Coke bottle trader was ridiculed unmercifully on his losing trades but was able to get his revenge and the last laugh during the winning trades. This trader might have been a little bit crazy but he wasn't stupid. He soon learned that his only defense against ridicule was to hold on to winning trades as long as possible and to quickly get out of his losses. As long as he was sitting on his sofa with a winning trade no one could tell him he was crazy and make cruel jokes about his messages from Mars. In fact while he was winning he was quick to wander around the room and ridicule the methods of the other traders who were not making as much money as he was. He displayed the profits in his trading account as hard evidence of the validity of his methods and offered copies of his statements as irrefutable proof that he was getting valuable advice from his alien contacts. Who could argue when his advice from other planets was obviously working? As a young broker this experience and the first hand observation of the Coke bottle trader who suddenly became profitable gave me my first important lesson about the importance of exits. I knew the entry signals had nothing at all to do with his success. His batting average was not any better than that of any other trader. However, this crazy old trader seemed to be able to make money consistently while other traders with more "sanity" and more valid entry methods were losing. Before long I was able to recognize that this man had become a successful trader simply by his efforts to avoid ridicule. He knew that he was vulnerable during his losing trades so he closed them out very promptly. His winning trades became his shield against the ridicule of the other traders and he kept his winners much longer than before his unorthodox methods were revealed. In the many years since this experience I have encountered many claims of success for entry methods that probably have even less validity than the Coke bottle messages. I have learned to look only briefly at the entries of winning traders and to examine their exit strategies very carefully. I am very fortunate that more than thirty years ago I learned from the Coke bottle trader that success in trading depends on our exits and not our entries."
Chuck LeBeau
"This excerpt is from Chuck LeBeau. Chuck happens to be one of the pioneers in the field of trading systems. His wisdom should be absorbed by all"
Michael Covel
Michael Covel is the Author of The Complete TurtleTrader & the bestseller Trend Following
Covel Is also the Director of the New Documentary Film Broke: The New American Dream
"[This] happens to be a true story, which contains a very valuable trading lesson that has influenced my trading for many years now. We thought the story might make an interesting topic...Here is the story: Back in the late 1960s I was a young commodity broker at E. F. Hutton and Company. Our office was a brand new high-tech office (for its time) which was considered the "flagship office" for E. F. Hutton. In this office about thirty brokers and as many clients shared one very large boardroom and there were no private offices. The brokers had elegant and expensive desks and the clients had a comfortable seating area in the front of the office where they could hang out and watch the tapes and monitor our state of the art commodity "clacker board". Sitting at my desk near the front of the boardroom I could read my Wall Street Journal and keep track of the commodity markets without looking at the board. By just listening to the rhythm and tempo of the mechanical clicks as the prices changed I could easily tell when anything important was going on because the tempo of the clicks would increase noticeably. Just in front of my desk were a half dozen comfortable sofas facing a high mahogany paneled wall with the tapes and the "clacker board". A gallery of traders, mostly retired "old timers" who were trading real commodities like grains and pork bellies, lounged around on the sofas plotting their charts and talking about life and the markets. They typically arrived early to get a good seat in their usual spot and then spent the day trading, exchanging commentaries and offering unsolicited advice to one another on any subject. For the most part they were a very sociable group who would take coffee breaks together and greeted each other on a first name basis. These traders enjoyed the elegant atmosphere and treated our well-appointed boardroom as their private men's club. (Were you aware that women were not allowed to trade commodities back in those days? My how times have changed!) However, one of these "old timers" kept to himself and was not interested in becoming a member of the friendly and often boisterous social circle. He usually sat quietly by himself intently watching the price changes on the commodity board and holding an old glass Coca-Cola bottle up near his ear. The vintage shaped Coke bottle had been emptied many years before and now contained only a 12-inch tube of bent and broken radio antennae which extended awkwardly out of the top of the bottle. Keep in mind that in the 1960s no one had yet heard of cell phones so the purpose of this Coke bottle was a real mystery to everyone. When the trader would talk to the bottle from time to time all the heads would turn and the traders nearby would try to listen to the conversation. But the trader spoke very softly and no one was able to eavesdrop on his conversations with the bottle. The traders knew that the fellow with the coke bottle was a client of mine and eventually a representative of the group came to me and explained that they were extremely puzzled about this guy and his Coke bottle and asked me if I knew what was going on. I didn't know the purpose or meaning of the Coke bottle but I was as curious as anyone was and I promised I would find out. The next time the client came back to my desk I promptly placed his order and then politely asked him about the Coke bottle. With a serious expression and no embarrassment he explained to me that the Coke bottle was an inter-planetary communication device that had been given to him by aliens. He said that the aliens were very interested in our commodity markets and they often gave him trading advice from their various observation points on other planets. He said that he had just had a message from Mars and they were buying soybeans so he had also purchased soybeans. After revealing his unique trading methodology he returned to his seat and resumed his whispered conversations with the Coke bottle. As soon as I revealed my discovery of the meaning of the Coke bottle to the other traders, all attention was immediately focused on the Coke bottle trader and the soybean market. The soybean market proceeded to go the wrong way and the trade from Mars was eventually closed out at a loss. The other traders were had no sympathy and were quick to begin ridiculing the the trader and poke fun at his beliefs. The next trade however turned out to be a big winner and the Coke bottle trader went from sofa to sofa telling his story and pointing to the clacker board while waiving his Coke bottle and bragging about the profitability of his most recent message from outer space. Because he was making money now his previous critics had to endure his bragging about his success on the current winning trade. As time went on and a few winning and losing trades later a clear pattern of behavior began to emerge. The Coke bottle trader was ridiculed unmercifully on his losing trades but was able to get his revenge and the last laugh during the winning trades. This trader might have been a little bit crazy but he wasn't stupid. He soon learned that his only defense against ridicule was to hold on to winning trades as long as possible and to quickly get out of his losses. As long as he was sitting on his sofa with a winning trade no one could tell him he was crazy and make cruel jokes about his messages from Mars. In fact while he was winning he was quick to wander around the room and ridicule the methods of the other traders who were not making as much money as he was. He displayed the profits in his trading account as hard evidence of the validity of his methods and offered copies of his statements as irrefutable proof that he was getting valuable advice from his alien contacts. Who could argue when his advice from other planets was obviously working? As a young broker this experience and the first hand observation of the Coke bottle trader who suddenly became profitable gave me my first important lesson about the importance of exits. I knew the entry signals had nothing at all to do with his success. His batting average was not any better than that of any other trader. However, this crazy old trader seemed to be able to make money consistently while other traders with more "sanity" and more valid entry methods were losing. Before long I was able to recognize that this man had become a successful trader simply by his efforts to avoid ridicule. He knew that he was vulnerable during his losing trades so he closed them out very promptly. His winning trades became his shield against the ridicule of the other traders and he kept his winners much longer than before his unorthodox methods were revealed. In the many years since this experience I have encountered many claims of success for entry methods that probably have even less validity than the Coke bottle messages. I have learned to look only briefly at the entries of winning traders and to examine their exit strategies very carefully. I am very fortunate that more than thirty years ago I learned from the Coke bottle trader that success in trading depends on our exits and not our entries."
Chuck LeBeau
Feb 24, 2009
A great Article...
By John Waggoner, USA Today
One definition of madness is doing the same thing over and over, and expecting different results. If you have tried to snatch up a cheap stock in the past six months or so, you're probably questioning your sanity. Cheap stocks just keep getting cheaper.
For people who like bargains, stocks remain tempting. Many stocks are lower now than they were a decade ago. Before you decide to dive in again, however, make sure you have an exit strategy. You'll save yourself some money and, sooner or later, you might lose that twitch.
For many years, selling a stock was considered something that was Not Done, like bringing a clown to a funeral. After all, stocks always went up. Patience was the only answer to a stock tumble.
These days, however, those who hesitate are often lost. Say you bought 100 shares of Bank of America on Dec. 31 at $14.08. Price: $1,408.
You could have argued that Bank of America, the nation's third-largest bank holding company, was a cheap stock. It had already fallen 63% since Oct. 1. And it sold for 2.3 times its estimated 2010 earnings. (The price-earnings ratio, or P-E, measures how cheap a company's stock is relative to its earnings. The higher the P-E, the pricier the stock. Bank stocks typically sell for lower P-Es than most other stocks, but 2.3 is still inexpensive.)
Cheap or not, BAC wasn't a great buy. By Thursday, BAC closed at $3.93 a share, meaning you have lost $1,015, or 72%. In short, you've suffered a devastating loss: To get back even after losing 72%, you have to gain about 270%.
Ideally, you'd like to sell before taking such a huge loss. But how do you decide when to sell a stock?
Dan Chung, chief investment officer for the Alger funds, has a few general rules about selling. If the company produces a startling earnings disappointment, for example, you should consider selling, he says. You might also consider selling if you think another stock has better potential.
But you should also set a limit on how much you are prepared to lose the moment you buy a stock. One way to make sure you stick to that limit is to use a stop-loss order, which tells your broker to ditch the stock if it falls to a specific price.
You can put in a new stop-loss order every day, using a day order, or you can specify that your stop-loss will be good until you cancel it. (These orders don't last for all eternity; depending on your broker, they may last only six months or so.)
The next question: Where should you set your stop-loss order? In most cases, setting the stop at a 10% loss makes sense. You'll have to earn 11% to get back even, but an 11% loss is not a fatal error. Had you set a 10% stop on your Bank of America investment, for example, you'd be out about $141, plus commissions, rather than $1,015.
A stop-loss might not help in all circumstances. If your stock is down 10% when the Standard & Poor's 500 is down 15%, for example, it's holding up reasonably well. Some highly volatile (and low-priced) stocks will move up and down 10% pretty frequently. And, inevitably, you'll have some stocks that fall 10% and promptly rebound.
"Basically, we're talking about controlling risk," says Chuck LeBeau, director of analytics for SmartStops.net, a website that tells you when to sell. When you buy a stock, LeBeau says, you can't control how much it will go up. But you can limit your losses by using a stop-loss order.
SmartStops.net uses proprietary formulas, based on a stock's general direction and its volatility, to determine when to sell. The stop recommendations change every day. You can monitor a portfolio of three stocks or exchange traded funds for free, or get five stop recommendations a day for free.
If you're thinking of selling a mutual fund, which is typically a longer-term holding, then you need to examine the fund's record against other, similar funds over time. By and large, if a fund has lagged behind its peers for the past one, three and five years, it's time to ditch it. The chart shows five funds with assets of more than $1 billion that fit the sell criteria.
One place to get further guidance: The website FundAlarm, which is aimed at telling you when to send your fund to Palookaville.
Many investors have been burned enough by this market to sit on the sidelines for a while. If you're brave, or even mildly mad, be sure to have a sell point in mind the moment you buy.
John Waggoner is a personal finance columnist for USA TODAY. His Investing column appears Fridays. new book,Bailout: What the Rescue of Bear Stearns and the Credit Crisis Mean for Your Investments, is available through John Wiley & Sons. Click here for an index of Investing columns. His e-mail is jwaggoner@usatoday.com.
full link to the article
http://www.usatoday.com/money/perfi/columnist/waggon/2009-02-19-investing-stock-stop-loss_N.htm
One definition of madness is doing the same thing over and over, and expecting different results. If you have tried to snatch up a cheap stock in the past six months or so, you're probably questioning your sanity. Cheap stocks just keep getting cheaper.
For people who like bargains, stocks remain tempting. Many stocks are lower now than they were a decade ago. Before you decide to dive in again, however, make sure you have an exit strategy. You'll save yourself some money and, sooner or later, you might lose that twitch.
For many years, selling a stock was considered something that was Not Done, like bringing a clown to a funeral. After all, stocks always went up. Patience was the only answer to a stock tumble.
These days, however, those who hesitate are often lost. Say you bought 100 shares of Bank of America on Dec. 31 at $14.08. Price: $1,408.
You could have argued that Bank of America, the nation's third-largest bank holding company, was a cheap stock. It had already fallen 63% since Oct. 1. And it sold for 2.3 times its estimated 2010 earnings. (The price-earnings ratio, or P-E, measures how cheap a company's stock is relative to its earnings. The higher the P-E, the pricier the stock. Bank stocks typically sell for lower P-Es than most other stocks, but 2.3 is still inexpensive.)
Cheap or not, BAC wasn't a great buy. By Thursday, BAC closed at $3.93 a share, meaning you have lost $1,015, or 72%. In short, you've suffered a devastating loss: To get back even after losing 72%, you have to gain about 270%.
Ideally, you'd like to sell before taking such a huge loss. But how do you decide when to sell a stock?
Dan Chung, chief investment officer for the Alger funds, has a few general rules about selling. If the company produces a startling earnings disappointment, for example, you should consider selling, he says. You might also consider selling if you think another stock has better potential.
But you should also set a limit on how much you are prepared to lose the moment you buy a stock. One way to make sure you stick to that limit is to use a stop-loss order, which tells your broker to ditch the stock if it falls to a specific price.
You can put in a new stop-loss order every day, using a day order, or you can specify that your stop-loss will be good until you cancel it. (These orders don't last for all eternity; depending on your broker, they may last only six months or so.)
The next question: Where should you set your stop-loss order? In most cases, setting the stop at a 10% loss makes sense. You'll have to earn 11% to get back even, but an 11% loss is not a fatal error. Had you set a 10% stop on your Bank of America investment, for example, you'd be out about $141, plus commissions, rather than $1,015.
A stop-loss might not help in all circumstances. If your stock is down 10% when the Standard & Poor's 500 is down 15%, for example, it's holding up reasonably well. Some highly volatile (and low-priced) stocks will move up and down 10% pretty frequently. And, inevitably, you'll have some stocks that fall 10% and promptly rebound.
"Basically, we're talking about controlling risk," says Chuck LeBeau, director of analytics for SmartStops.net, a website that tells you when to sell. When you buy a stock, LeBeau says, you can't control how much it will go up. But you can limit your losses by using a stop-loss order.
SmartStops.net uses proprietary formulas, based on a stock's general direction and its volatility, to determine when to sell. The stop recommendations change every day. You can monitor a portfolio of three stocks or exchange traded funds for free, or get five stop recommendations a day for free.
If you're thinking of selling a mutual fund, which is typically a longer-term holding, then you need to examine the fund's record against other, similar funds over time. By and large, if a fund has lagged behind its peers for the past one, three and five years, it's time to ditch it. The chart shows five funds with assets of more than $1 billion that fit the sell criteria.
One place to get further guidance: The website FundAlarm, which is aimed at telling you when to send your fund to Palookaville.
Many investors have been burned enough by this market to sit on the sidelines for a while. If you're brave, or even mildly mad, be sure to have a sell point in mind the moment you buy.
John Waggoner is a personal finance columnist for USA TODAY. His Investing column appears Fridays. new book,Bailout: What the Rescue of Bear Stearns and the Credit Crisis Mean for Your Investments, is available through John Wiley & Sons. Click here for an index of Investing columns. His e-mail is jwaggoner@usatoday.com.
full link to the article
http://www.usatoday.com/money/perfi/columnist/waggon/2009-02-19-investing-stock-stop-loss_N.htm
Feb 17, 2009
So Much for Buy-and-Hold Advice
So Much for Buy-and-Hold Advice
You bet on stocks. You diversified. You lost a bundle. Should you get out? Experts disagree.
SmartStops comment: In this day and age diversification offers very little protection and can even make things worse. You need protection on a stock by stock basis using SmartStops.
Excerpts: They were reassured that stocks have the best long-run returns, so they plowed their savings into the market—only to watch in dismay as government bonds outperformed stocks over an entire decade. Moreover, investors were lectured again and again on the wisdom of diversifying their portfolios internationally. So they did. But foreign markets have done even worse than their U.S. counterparts lately. The most exasperating example is Japan, whose key stock market index is now back to where it was in 1981.
What many investors have failed to realize is that "the long run" can sometimes be very, very long. So says London Business School economist Elroy Dimson, co-author with his LBS colleagues Paul Marsh and Mike Staunton of the 2002 book Triumph of the Optimists, which challenged work by University of Pennsylvania Wharton School professor Jeremy Siegel, author of Stocks for the Long Run. The climb back into the black after a fall can take even longer outside the U.S., says Dimson. In Italy, he says, stocks failed to keep up with inflation over a 73-year period through 1978.
But even in the absence of such a doomsday scenario, international diversification doesn't always lower the volatility of returns—because in major crises, stocks fall in every market. Thus, in 2008 global diversification isn't protecting investors from the financial crisis that originated in the U.S. In sum, two pillars of investment advice—buy stocks and go global—have proved to be weak reeds lately. No wonder pundits such as Jim Cramer, the CNBC stockpicker, are sounding off about "how the best way to invest is not to buy a bunch of stocks and just sit on them."
Link to full article:
You bet on stocks. You diversified. You lost a bundle. Should you get out? Experts disagree.
SmartStops comment: In this day and age diversification offers very little protection and can even make things worse. You need protection on a stock by stock basis using SmartStops.
Excerpts: They were reassured that stocks have the best long-run returns, so they plowed their savings into the market—only to watch in dismay as government bonds outperformed stocks over an entire decade. Moreover, investors were lectured again and again on the wisdom of diversifying their portfolios internationally. So they did. But foreign markets have done even worse than their U.S. counterparts lately. The most exasperating example is Japan, whose key stock market index is now back to where it was in 1981.
What many investors have failed to realize is that "the long run" can sometimes be very, very long. So says London Business School economist Elroy Dimson, co-author with his LBS colleagues Paul Marsh and Mike Staunton of the 2002 book Triumph of the Optimists, which challenged work by University of Pennsylvania Wharton School professor Jeremy Siegel, author of Stocks for the Long Run. The climb back into the black after a fall can take even longer outside the U.S., says Dimson. In Italy, he says, stocks failed to keep up with inflation over a 73-year period through 1978.
But even in the absence of such a doomsday scenario, international diversification doesn't always lower the volatility of returns—because in major crises, stocks fall in every market. Thus, in 2008 global diversification isn't protecting investors from the financial crisis that originated in the U.S. In sum, two pillars of investment advice—buy stocks and go global—have proved to be weak reeds lately. No wonder pundits such as Jim Cramer, the CNBC stockpicker, are sounding off about "how the best way to invest is not to buy a bunch of stocks and just sit on them."
Link to full article:
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