TWO SIMPLE METHODS OF RISK-CONTROL EVERY INVESTOR SHOULD LIVE BY
This forum is constantly evolving. It started out as a means of finding undervalued micro-cap stocks that are involved in a "special situation." Over the months to follow, the website began morphing and I decided to simply allow it to take shape without any preconditions. At one point I began posting more short-term swing trades, eventually deciding to stick to what I do best -- researching and investing in small-cap stocks without the noise of much else attached to it.
I want this over the years to become a specialized forum for sharing investment ideas, as well as general market thoughts. I'm not in this to gain tens of thousands of daily visits so that I can begin attracting advertising revenue, followed by appearances on CNBC and FOX News. What I do here on a daily basis has a niche. That niche is where I want to focus my efforts. Providing the best information possible so that over a significant period of time, everyone will gain.
Those gains will come if there is discipline attached to what you do. I can provide top-notch analysis here on a daily basis, but if you choose to invest in a manner that only looks at reward without assessing risk then you won't benefit from what I am doing here. In fact, you won't benefit from any analysis whatsoever, regardless of its brilliance.
Focusing on reward only without looking at risk is a disease for investors. Not having a strategy to get you out of the markets when the ground beneath you is disintegrating is a severe liability. One leads to the other. Meaning that those who focus on reward only won't have the sense to begin evacuating the premises once the ground beneath them begins to disintegrate because they fear missing out on the potential reward. This type of thinking needs to be abolished from your mental Rolodex of ingrained thoughts.
In a month where the markets are down substantially, the current portfolios I manage are more or less unchanged. That is with the fact that I came into the month 100% long in volatile small-cap names. And the method for getting there is as simple a method as possible. It involves two distinct risk-control strategies that every investor should live by:
1. I have allowed trend-driven indicators to take me into a higher percentage of cash as the markets have weakened. This effectively cushions the blow of any downtrend. And if followed correctly, this type of method will take you to 100% cash ahead of calamitous market falls such as 2008.
2. I have kept the strongest names in my portfolio and sold the weakest.
What do these two methods of risk-control have in common? They are different ways of evacuating losers based on increasing weakness. The only difference between method #1 and #2 is that #1 is macro and #2 is micro.
Unfortunately, a majority of investors have it completely backwards. They add into losing positions and are most skeptical of winners. They love trolling weak markets and hate participating in strong markets. And not coincidentally, a majority of investors end up losing money, blaming the markets for their misfortunes when all is said and done.
Presently, I'm sitting in a 50% cash position. Earlier in the month I took losses on CIS and YELP in order to get to 25% cash when my short-term trend indicator flipped bearish. Just this week I sold out of GSIG and trimmed my position in SYNC in order to get me to the 50% target when my intermediate term trend indicator flipped bearish. I based my decision on which names to get rid of primarily on their performance. The biggest losers go first. The biggest winners remain intact.
If the markets continue to weaken over the coming weeks, then my long-term trend indicator will also flip bearish at which point I will move to a 100% cash position. I will hate doing so just as I did when my short-term trend indicator flipped earlier this month and my intermediate-term trend indicator flipped earlier this week. Fortunately, my attention to risk comes before my anticipation of rewards. For that reason, the internal revolt I face each time I par risk will have to take a backseat.....permanently.
