One approach, as outlined by a friend of mine and a well know Investment Guru in India, is to buy 10-15% dips and buy more than 2-3 stocks; more like 10-20. Buy stocks in companies that have good management and good growth, or companies you know well. Some of these stocks will lose money but overall the portfolio will grow.. This also assumes markets are random in nature and that all efforts to be predictive are hopeless.
Another approach, and one that I believe in, is that markets are random for a portion of the time but also predictive for a period. They are predictive during long uptrends when fear is gone, and steep downtrends when fear takes over and there is a herd mentality to head out the door. Technical analysis works well during these times, well enough to offset the uncertain random periods. Technical trading also helps keep drawdowns less. For buy-and-hold types, I will concede that in a strong uptrend, buy-and-hold can generate more profits than technical trading. Still, I prefer to take less risk as I cannot tolerate steep drawdowns.
I think the best method for a person is based on their mind set and what they can tolerate for loss. As your risk tolerance decreases, technical trading looks better and better. If you can stomach huge losses, then the first approach can be quite rewarding.
One last point is that we assume that markets will eventually always go up. If during our critical years the market heads down, then all bets are off for the first approach. I ‘ll take technical trading any day and make money whether the market goes up or down using dynamic hedging.
Rahul and I have had this discussion many times. I am a believer that the avoidance of risk - can actually increase risk. Such as setting technical trading margins to tight - will increase negative trades that happen when minor swings in trading (randomness??) and thus increase the number of negative trades.
ReplyDeleteI have in the past year traded in covered calls (sold short obviously). While this has been effective in reducing risk it has laso lead to more trades than I might desire and some missed opportunities when stocks jumped up quickly. In all I have done a better job of picking good stocks than i have in hedging! But I did so with lower risk factor with the covered calls. A fair trade off in my book - but not for everyone.
Gordon, Too tight a trading system tends to causes losses. Similar to saying ..risking too little will increase risk...
ReplyDeleteCovered calls work well 80% of the time, that is when the market is trading up or sideways. But 20% of time when the market plunges, it would be better to be out of the market and not doing covered calls. A slow trading system that keeps you in more often than not would work very well for covered call trading.