I realize this is a shorter term trading forum, however I am looking for some insight into risk management. I use fundamentals to pick holdings with a time frame of a year or more. In the short term fundamentals are useless but I feel they are quite useful longer term. My philosophy is that the market over-does things in both directions and that over time stocks revert to some mean valuation. If one can buy a stock that is trading at a very low foreward P/E, and one can assume that the even if the company misses estimates it will still trade at a low FY PE then it seems to be a good long term low risk buy. Take TYC for example. I assess that company to be worth at least 30. Essentially buying here is a bet that over time the stock will double before it goes to zero. Comprising a company of say 20-30 such picks (long as described and short do the opposite) would seem to yield impressive results over time while minimizing transactions and taxes. Once the stock reaches its "fair value" you cover or sell. In trading the idea of 2-1 or 1-1 reward/risk comes up often. Isn't what I described similar except over a much longer time frame. Please note this is not a challenge to short term trading or a knock on TA, I am simply trying to gather opinions on how to make long term investing more profitable assuming valuations tend to revert to some mean.
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Buy and Hold Trading
- Thread starter bignatty
- Start date
What you are really trying to do is to intellectualize the price of a stock...that is to justify the price based on reason and logic. There may be times when that appears to "work", but the price is based on emotion - fear and greed.
There is no practical way to practice realistic risk management utilizing your criteria. In essence you are trading on hope. So long as you make your purchases based on hope, the best that you can do is to hope the trade won't go against you.
There is no practical way to practice realistic risk management utilizing your criteria. In essence you are trading on hope. So long as you make your purchases based on hope, the best that you can do is to hope the trade won't go against you.
Not true. I trade when emotion has driven the price of a stock to level so low that it is irrational given that one can reasonably determine that a company will have earnings in the future. As you point out emotions drive the market. Emotion is temporary and dynamic. Therefore if one can see past temporary irrationality one can profit.
bignatty,
The approach you describe is undoubtedly the dominant approach to managing money in this country. It typically goes by the name "value" or "growth at a reasonable price" investing.
I think there are three principal objections to it. One, there is a certain intellectual arrogance to thinking you are better able to analyze the company than the rest of the market, whcih implicitly disagrees with your analysis.
Two, over reasonable time frames, the psychological factors tend to overwhelm the fundamental ones, even if your analysis is correct. We have many examples of companies moving 40-50% over relatively minor news that has no long term effect.
Three, this type of investing creates a "value trap" in that you logically should buy more as the stock gets cheaper. After all, it is more attractive. But we know from history that concentrating your funds in underperforming issues is not the way to outperform. In fact, it puts you in considerable risk, can anyone say "Enron" or "Worldcom"?
There is no doubt that great fortunes have been made with this approach. Warren Buffett comes to mind. The "market" is often dead wrong. Look at the chart of Sun if you doubt that. Was there a company more well-positioned? And how great did everyone think Lucent was?
Although I'm primarily a trader, I have invested some of my assets in what I perceive to be undervalued plays in the cable, broadcasting and telecom areas. If history is any guide, I'll be buried.
The approach you describe is undoubtedly the dominant approach to managing money in this country. It typically goes by the name "value" or "growth at a reasonable price" investing.
I think there are three principal objections to it. One, there is a certain intellectual arrogance to thinking you are better able to analyze the company than the rest of the market, whcih implicitly disagrees with your analysis.
Two, over reasonable time frames, the psychological factors tend to overwhelm the fundamental ones, even if your analysis is correct. We have many examples of companies moving 40-50% over relatively minor news that has no long term effect.
Three, this type of investing creates a "value trap" in that you logically should buy more as the stock gets cheaper. After all, it is more attractive. But we know from history that concentrating your funds in underperforming issues is not the way to outperform. In fact, it puts you in considerable risk, can anyone say "Enron" or "Worldcom"?
There is no doubt that great fortunes have been made with this approach. Warren Buffett comes to mind. The "market" is often dead wrong. Look at the chart of Sun if you doubt that. Was there a company more well-positioned? And how great did everyone think Lucent was?
Although I'm primarily a trader, I have invested some of my assets in what I perceive to be undervalued plays in the cable, broadcasting and telecom areas. If history is any guide, I'll be buried.
If you want to longer term trade that's fine. I know lots of guys who make a great living doing maybe 15-70 trades a year as longer term traders.
You need to have much smaller position size per trade and a stop that is far enough away from the market to not take you out during daily or even weekly noise.
The reason for less of a position size is that you will be risking a lot more by having a far away stop. You need to reduce your risk per trade by reducing the position size.
You can add more positions though.
Robert
You need to have much smaller position size per trade and a stop that is far enough away from the market to not take you out during daily or even weekly noise.
The reason for less of a position size is that you will be risking a lot more by having a far away stop. You need to reduce your risk per trade by reducing the position size.
You can add more positions though.
Robert
Originally posted by bignatty
I realize this is a shorter term trading forum, however I am looking for some insight into risk management. I use fundamentals to pick holdings with a time frame of a year or more. In the short term fundamentals are useless but I feel they are quite useful longer term. My philosophy is that the market over-does things in both directions and that over time stocks revert to some mean valuation. If one can buy a stock that is trading at a very low foreward P/E, and one can assume that the even if the company misses estimates it will still trade at a low FY PE then it seems to be a good long term low risk buy. Take TYC for example. I assess that company to be worth at least 30. Essentially buying here is a bet that over time the stock will double before it goes to zero. Comprising a company of say 20-30 such picks (long as described and short do the opposite) would seem to yield impressive results over time while minimizing transactions and taxes. Once the stock reaches its "fair value" you cover or sell. In trading the idea of 2-1 or 1-1 reward/risk comes up often. Isn't what I described similar except over a much longer time frame. Please note this is not a challenge to short term trading or a knock on TA, I am simply trying to gather opinions on how to make long term investing more profitable assuming valuations tend to revert to some mean.
My suggestion is to use Leap Put options to hedge your longs.
Right bignatty, a low p/e is an oversold indicator just like a low rsi is an oversold indicator. Lots of traders like to buy when their indicators go oversold and sell when they go overbought. Same thing. What's the difference whether you hold one minute or one year? You stay long as long as your indicator is bullish.
You can probably save yourself some grief with some backtesting, but if it meets with your approval, then all you need is some risk management.
www.iitm.com check this out for some ideas. It is a game which takes forever to download, but it lets you play with different risk levels on an imaginary porfolio of stocks. It's free and then if you want more they charge you.
You can probably save yourself some grief with some backtesting, but if it meets with your approval, then all you need is some risk management.
www.iitm.com check this out for some ideas. It is a game which takes forever to download, but it lets you play with different risk levels on an imaginary porfolio of stocks. It's free and then if you want more they charge you.
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"If one can buy a stock that is trading at a very low foreward P/E...."
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Forward P/E's are just projections, many of them made up by investment banks that are biased. Even if the projections are accurate, they have very little to do with risk management. You could buy an S&P 500 stock at $20/shr that has a P/E of 20, and rising earnings. The stock could then proceed to drop to $10 due to bad market conditions, a negative news article, a lawsuit, or whatever. P/E and risk are very loosely related. You really can't say that a stock with a P/E of 20 is really safer than a stock with a P/E of 23, even if they are in the same industry.
"If one can buy a stock that is trading at a very low foreward P/E...."
----------------
Forward P/E's are just projections, many of them made up by investment banks that are biased. Even if the projections are accurate, they have very little to do with risk management. You could buy an S&P 500 stock at $20/shr that has a P/E of 20, and rising earnings. The stock could then proceed to drop to $10 due to bad market conditions, a negative news article, a lawsuit, or whatever. P/E and risk are very loosely related. You really can't say that a stock with a P/E of 20 is really safer than a stock with a P/E of 23, even if they are in the same industry.
I'm not yet at a prop firm, but I'm thinking of taking that route in the future. I plan on making some longer term trades like those mentioned by the starter of this thread.
Although the topic of intraday margin is often discussed here (10:1 being the usual quoted), I am wondering how much overnight margin is available at prop firms (for unhedged positions), and what is the largest position size (% of equity) allowed per overnight (unhedged) position.
Although the topic of intraday margin is often discussed here (10:1 being the usual quoted), I am wondering how much overnight margin is available at prop firms (for unhedged positions), and what is the largest position size (% of equity) allowed per overnight (unhedged) position.
Thanks to all all who replied. Rthap's comment is along the lines of what I was thinking. In other words a porfolio of 50 stocks, one going bankrupt is only a 2% loss. Perfectly acceptable. Most traders don't risk more than 2% on any one trade. As far the theory of selection being valid, there have been many studies showing that low pe, low p/sales, low p/book stocks outperform over time. I believe James O'shugnessy wrote a book along theses lines and the results were quite impressive. The idea revolves around the theory that a good % of severely punished stocks will rise 2x, 3x, 4x, etc. over a number of years. Some will go to zero but the ones that rise will overcome the losers.