Cutting losses - not the best idea

stockfrosty · Oct 31, 2003

You don't eliminate your non-systematic risk (alpha) through 14 way diversification...you reduce it. And what about your beta risk, how do you manage that. Recorded earnings are accurate sometimes, and other times not. But what people are willing to pay for them (the multiple) is very much subjective. The problem with your value models is that they contain way to many assumptions. In a run away bull people will pay 100 times earnings because of exuberance. In a bear they might only pay 5 times. How do you accurately determine what a business is worth...well I know....you assume what people are going to pay based on what they have in the past.

Word to the wise, just because they paid 10 times earnings last year doesn't mean they will next year or the year after that. Also their are plenty of unknowns, are management trustworth, could laws or patents change, as a retail investor, will you be the first or the last to know.

The problem with your academic approach to investing is that in the world of stocks there are a plathora of key factors affecting value that you can't possibly account for. Mr Market, you seem to know allot.....but risk control is there to handle what you don't know...not what you do.

mrmarket · Oct 31, 2003

Quote from stockfrosty:

You don't eliminate your non-systematic risk (alpha) through 14 way diversification...you reduce it. And what about your beta risk, how do you manage that. Recorded earnings are accurate sometimes, and other times not. But what people are willing to pay for them (the multiple) is very much subjective. The problem with your value models is that they contain way to many assumptions. In a run away bull people will pay 100 times earnings because of exuberance. In a bear they might only pay 5 times. How do you accurately determine what a business is worth...well I know....you assume what people are going to pay based on what they have in the past.

Word to the wise, just because they paid 10 times earnings last year doesn't mean they will next year or the year after that. Also their are plenty of unknowns, are management trustworth, could laws or patents change, as a retail investor, will you be the first or the last to know.

The problem with your academic approach to investing is that in the world of stocks there are a plathora of key factors affecting value that you can't possibly account for. Mr Market, you seem to know allot.....but risk control is there to handle what you don't know...not what you do.

Frosty,

I will humbly say I admire your intelligence and eloquence. I wish there were more like you.

stock777 · Oct 31, 2003

Quote from Cutten:

Fair enough - that's the difference between an investor and a trder.

Just look at Buffett - no stops, adds massively to losers, likes buying during bear markets, bets 30% of equity on one position, very low turnover of capital. Everything that traders swear against!

Please. Buffet isn't TRADING. He is in effect the owner or part owner of the things he invests in. He is privy to all the gory details, unless he's lied to, and I doubt that has happened very often.
Can't be compared to some quote jockey hoping they don't halt his stock and announce that the last 5 billion in earnings was the result of a misplaced comma.

stockfrosty · Oct 31, 2003

...vote of approval. I generally understand your approach to investing because I've got my level II CFA and studied business also. But frankly, when it comes to trading stocks I've found that on balance, fundamental analysis has cost me cash. Hence I've discarded it all together. Fundamental Analysis gets me fixated on what SHOULD be happening, when what I need to do is accept the reality of what IS happening and act in my own best interest. Now what IS happening is reflected in price and volume...these are the only realities in the world of trading. Regardless of your opinion price action does not warp reality.

Do what ever works makes ya cash...it is the bottom line that counts. But I think it is wise to wait for the market (price) to begin to confirm your fundamental opinion before you commit capital to a position. Once your in, if the market begins to disagree with you, step aside, get out, and ask yourself, 'what does the market see that I don't". Remain humble and respect the markets judgement. I believe a healthy respect for the markets opinion as expressed through price is a key to success in this business. But that is just my 2 cents.

Perhaps some day you'll relate to what I'm saying.

electron · Oct 31, 2003

Quote from Mecro:

I can't believe he is still talking smack.

Look man, your record is horrible. I don't know why true traders still bother to even respond to you.

Because they are not true traders. There is an inverse correlation between the number of someone' s posts on this board and his trading prowess. It does not take a Ph.D. in anything to spot it. Talk is cheap, ask them about their returns proved by brokerage statements. That's when they stop talking...

mrmarket · Nov 1, 2003

Quote from electron:

Because they are not true traders. There is an inverse correlation between the number of someone' s posts on this board and his trading prowess. It does not take a Ph.D. in anything to spot it. Talk is cheap, ask them about their returns proved by brokerage statements. That's when they stop talking...

All of my trades are documented in real time on my homepage.

NUTSNEAL · Nov 1, 2003

Quote from mrmarket:

If your overall strategy is to merely outperform the market, you don't even worry about the bear markets.

MrMarket

First let me say I think you have considerably above average ability, but I don't think you are maximizing it.

Overall Strategy???

I am a very avid Holdem Poker play.
You make me think of a poker playing friend of mine.
He plays a lot more than I do and is a better player than I am.
He has had over 20+ winning secessions in a row.
In fact I have seen him leave a very good game where he should and probably could win $1500 or more with only a $100 to $200 win in order to protect his winning streak!!!! When he is on one of these ego trips I make more money total than he does, otherwise he makes much more than I do.

It appears to me you may have fallen into this same type of trap.

In the past I have looked at your record and each purchase and sale. I think I remember on occasion you missed your original 15% target gain by only a small amount and then rode the position into a loss for a considerable amount of time tying up precious capital and incurring considerable opportunity cost.

It would appear to me your risk adjusted performance (standard deviation of portfolio although I much prefer semi variance as a measure of risk for a portfolio) would be greatly improved if you were to look more to maximization of capital rather than winners in a row. Yes it sounds great to say X number of winners in a row with 15% or greater gains. But have you considered or backtested to see what your total annualized return would be with an 8 or 10% target or even adjusting your return target based on whether you are in sink with or counter trend to the S&P etc.

I must say it appears to me the winner is the person ( whether investor or trader) getting the most total risk adjusted return from their capital.

I would be interest in seeing your total return for each of the last eight quarters. I am sure you could greatly improve them if you were to make some capital maximization adjustments.

Good Luck

mrmarket · Nov 1, 2003

Quote from NUTSNEAL:

MrMarket

First let me say I think you have considerably above average ability, but I don't think you are maximizing it.

Overall Strategy???

I am a very avid Holdem Poker play.
You make me think of a poker playing friend of mine.
He plays a lot more than I do and is a better player than I am.
He has had over 20+ winning secessions in a row.
In fact I have seen him leave a very good game where he should and probably could win $1500 or more with only a $100 to $200 win in order to protect his winning streak!!!! When he is on one of these ego trips I make more money total than he does, otherwise he makes much more than I do.

It appears to me you may have fallen into this same type of trap.

In the past I have looked at your record and each purchase and sale. I think I remember on occasion you missed your original 15% target gain by only a small amount and then rode the position into a loss for a considerable amount of time tying up precious capital and incurring considerable opportunity cost.

It would appear to me your risk adjusted performance (standard deviation of portfolio although I much prefer semi variance as a measure of risk for a portfolio) would be greatly improved if you were to look more to maximization of capital rather than winners in a row. Yes it sounds great to say X number of winners in a row with 15% or greater gains. But have you considered or backtested to see what your total annualized return would be with an 8 or 10% target or even adjusting your return target based on whether you are in sink with or counter trend to the S&P etc.

I must say it appears to me the winner is the person ( whether investor or trader) getting the most total risk adjusted return from their capital.

I would be interest in seeing your total return for each of the last eight quarters. I am sure you could greatly improve them if you were to make some capital maximization adjustments.

Good Luck

I commend you on your flawless analysis. Certainly adjusting my target to better conform to macro conditions would be an optimization technique, but alas, I'm too busy enjoying life to waste too much time trying to make more money. I think it gets to a point where your incremental marginal returns relative to the amount of time you put in just ain't worth it. I think one of the beauties of my model lies in its simplicity.

To summarize, I think everything you say is accurate and I'm actually flattered that you took the time to study my performance. I'd love to hear more from you in my forum.

Cutten · Nov 1, 2003

Quote from stockfrosty:

"I suspect he controls his risk by the proper selection of stocks."

The 'proper' selection of stocks is not a comprehesive risk control strategy.

I'm not asking how he gets into a stock. I could care less, everyone has their own means of deterning an entry. I'm asking how he gets out. I'm suggesting he clarify what gets him out of a losing position. Now the definition of a losing position is very straight forward. It's basic arithmetic based on price action.

It follows logincally that ones exit strategy should also be based on price action.

You don't get any profits or losses from fundamentals. You get profits or losses from buying and selling.

If you select stocks well enough, then you will not have many losers in the first place.

You can have risk control without technical analysis or price stops, by only purchasing a stock when it is significantly below its intrinsic value, and by exiting a stock when the fundamental value of the business falls below the valuation implied by the current price quote.

If you buy for cash, then a losing position is not determined by the current price quote, but rather a negative total return during the total period held. If you buy at 100 and sell at 150, does the fact that the stock went to 50 in the meantime mean that you have a loser?? It is irrelevant if the price falls, as long as you can hold on and sell for a profit later (meanwhile you still collect dividends). In fact it may be beneficial as you can acquire more stock at lower prices.

Since changing fundamentals are what drive prices in the long-run, it is incorrect to say that fundamentals don't make you a profit or loss. Yes, price change is the sign that you have made or lost money, but it is fundamentals and people's reaction to them that ultimately drives the price. In the long-run, the ability to sell at a higher price will be the result of improving fundamentals, and not short-term price action. Finally, you can still profit from dividends, quite regardless of the price quote.

Now there is definitely a risk that an investor's analysis of fair value is incorrect. However I don't see why this risk should instrinsically be any higher than the risk of a technician being incorrect in his analysis of future price movement. Or indeed, why it should be any higher than the risk of setting stops incorrectly and thus repeatedly getting stopped out of potentially large winning positions.

Overall, the success of the method is dependent on how good the trader/investor is. A bad fundamental analyst will not perform well, but neither will a bad technician. The fact remains that there are good fundamental analysts who have significantly outperformed the markets without using any technical analysis whatsoever.

mrmarket · Nov 1, 2003

Quote from Cutten:

If you select stocks well enough, then you will not have many losers in the first place.

You can have risk control without technical analysis or price stops, by only purchasing a stock when it is significantly below its intrinsic value, and by exiting a stock when the fundamental value of the business falls below the valuation implied by the current price quote.

If you buy for cash, then a losing position is not determined by the current price quote, but rather a negative total return during the total period held. If you buy at 100 and sell at 150, does the fact that the stock went to 50 in the meantime mean that you have a loser?? It is irrelevant if the price falls, as long as you can hold on and sell for a profit later (meanwhile you still collect dividends). In fact it may be beneficial as you can acquire more stock at lower prices.

Since changing fundamentals are what drive prices in the long-run, it is incorrect to say that fundamentals don't make you a profit or loss. Yes, price change is the sign that you have made or lost money, but it is fundamentals and people's reaction to them that ultimately drives the price. In the long-run, the ability to sell at a higher price will be the result of improving fundamentals, and not short-term price action. Finally, you can still profit from dividends, quite regardless of the price quote.

Now there is definitely a risk that an investor's analysis of fair value is incorrect. However I don't see why this risk should instrinsically be any higher than the risk of a technician being incorrect in his analysis of future price movement. Or indeed, why it should be any higher than the risk of setting stops incorrectly and thus repeatedly getting stopped out of potentially large winning positions.

Overall, the success of the method is dependent on how good the trader/investor is. A bad fundamental analyst will not perform well, but neither will a bad technician. The fact remains that there are good fundamental analysts who have significantly outperformed the markets without using any technical analysis whatsoever.

Cutten...you just wrote my biography. Thanks so much for writing it so well.