All Risk – No Return

Dow Industrial Average

The Dow Jones Industrial Average (click chart above to enlarge) traded today below the critical 18,000 level. That leaves the index unchanged since December 5th 2014. While sideways markets are always frustrating for most investment styles, the good news is that markets tend to alternate between trending and consolidating environments. Therefore, it is likely that a trend will emerge from this flat market environment providing opportunities for profit for those positioned properly.

The past two years has produced zero price appreciation in the Dow, but has delivered plenty of downside volatility for those investors who have been drawn into the passive buy and hold approach by seven plus years of rising US equity prices. These investors have assumed all of the risk with no return to show for it. A resumed uptrend would reward their patience while a new bear market will crush their portfolio as people quickly head towards the exits.

The AW Portfolios are primarily a trend following strategy that adapts to changing market conditions. The past two years have not provided any lasting trends to follow, but our approach will position us to profit from a new trend in either direction. This differs from the passive strategy that relies on prices always rising while being constantly exposed to all of the market risk. Our goal can be summed up by the simple phrase – participate in bull markets while protecting in bear markets.

 

 

 

Autopilot Investing

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One of my first memories on an airplane is the frightening sight of seeing the captain walking down the aisle talking to the passengers.  My question was obviously, “Who is flying the plane!?”  I was assured we were on autopilot and that everything was OK.  My life was in the hands of a machine and it was a bit unnerving.  Today, our world is filled with computer automation and it begs the question of whether “autopilot investing” makes any sense.

There is an active debate regarding the role of computers in a money manager’s decision making process.  Some argue that we should rely exclusively on machines while others insist that only a human can be trusted to make investment decisions.  There are advantages to each approach.

“Autopilot Investing”

  • System inputs are based on proven investment concepts.
  • The system can be tested and refined by looking at past data.
  • Human emotion is removed from the decision making process.

Discretionary Investing

  • The human brain is the most powerful computer on the planet.
  • Changing market conditions require the flexibility of a human mind.
  • Human intuition and live analysis can be very helpful in unique situations.

Here’s my take on the debate.  I go back to the airplane analogy.  The autopilot system is programmed based on sound aeronautical concepts and takes human emotion away from the mundane aspects of flying.  This translates well to designing an investment process and the guiding rules supporting it.  Computers can be used to gather market data for analysis, and for testing and fine tuning investment ideas to create strategies that have a statistical edge.  They can also be used to neutralize the emotion attached to the day to day noise of the market that can lead to unwise emotional decisions.  So I believe one must have a sound investment process backed by a tested statistical edge, logic, psychology and risk management. But that is not enough.  Here’s why.

The words you never want to hear from a pilot are, “prepare for an emergency landing.”  The only thing worse is when a flight attendant later adds in a shaky voice, “assume the crash position”.  I experienced this nightmare twenty years ago on a flight from Pittsburgh to Chicago.  The plane lost all hydraulic power which prevented the plane from slowing down and gliding in for a safe landing.  The brakes and steering were also not working which would cause other problems after hitting the runway at a high speed.  This was a unique situation that required the pilot to take control of the plane and take decisive action.  Autopilot wasn’t programmed for this situation.  I’m alive today due to the skill of the pilot and the rescue teams on the ground.

So, I also believe that there are times of crisis and opportunity when a money manager should take control of an automated system and use their judgment, experience and skill to implement the system’s rules with some discretion.

The takeaway from this is that the most prudent approach to money management is to use the human mind to devise, test and optimize a strategy that provides an edge, and then let the machine dictate the day to day decision making.  A portfolio manager can step in to provide some discretion in implementing the rules during rare extreme market environments in order to provide the benefits of human skill and experience.  That is the approach we take with AW Portfolios.

 

Gregg Indovina                                                                                                   VP of Investment Strategies                                                                               Accelerated Wealth

 

 

Poker Face

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Yes, this has to do with investing.  Just bear with me.

Phil Ivey moved out of his house at age 19, took a job as a telemarketer and drove to Atlantic City every weekend to play poker.  He would play eighteen hours a day and sleep under the boardwalk when he went broke. He aspired to be a professional poker player and has achieved his dream and much more.  He first won the World Series of Poker at age 23.  He is the youngest player to attain nine World Series of Poker bracelets and has a total of ten.  He has won tens of millions of dollars (he once won $16 million in three days). Phil is widely regarded as the best poker player on the planet.

I decided to study him in order to see if there was anything about his approach to poker that could improve my investment process.  I was particularly interested in three aspects of how he approached the game.  I wanted to know about his strategy, approach to risk management and his psychology.  Here is what I learned.

Strategy

He says his strategy is based on probability.  He calculates his odds based upon the known possible outcomes of each hand combination.  What’s interesting is that he says that at the level he plays, this does not give him an advantage because all top players understand these odds.

Risk Management

Poker requires an initial investment (called an ante) in order to see your first cards.  He sees this as a cost of doing business and gladly pays this amount to see if his cards warrant additional risk of capital. He will gladly quit the game (fold) and lose this small amount in order to see if there is a potential for a larger gain.  Losing is part of his overall strategy, as long as the losses remain small (by folding early).  His goal is to win the majority of the big pots he decides to play.  His winning percentage does not determine his success, but rather the size of the pots won or lost.

Psychology

As I suspected, psychology is what separates him from the top players in the world.  He has an uncanny ability to decipher his opponent’s cards by their physical signs, and what and how they say things during the game. Simply put, he can read people’s reactions and is masterful at hiding his excitement or disappointment.  That is his edge, and it is huge.

Here is what I’ve learned by studying him.

– He had a dream that was his primary focus.

– He put in thousands of hours into mastering poker and himself.

– He is fearless and aggressive when he perceives an advantage.

– He wins through skill over time, not luck on any given hand.

– He capitalizes on his opponent’s psychological weaknesses.

– He is not afraid to lose and embraces small losses.

– He is a master of personal psychology (both his and others).

Let’s apply these lessons to being an investor.

– Be committed to being a lifelong investor and do not waver.

– Put in the necessary time to understand markets.

– Be fearless in executing your strategy according to your plan.

– Investing is a probability-based venture that works over time.

– Poor investment behavior by the masses creates opportunity.

– Taking small losses is part of the game of being an investor.

– Execute your strategy flawlessly without emotion.

I apply these lessons as a way to gain an edge on the very sophisticated Wall Street competition.  Uncommon wisdom from strange places has been very profitable for me in the past, and I see these lessons as just another way to increase my chances of success.

Gregg

 

The Parable of the Mexican Fisherman and the Investment Banker

Mexicanfisherman

Money is a necessary part of life in the modern world.  We trade our ideas, time and labor in exchange for money in the hopes of building a fulfilling life today and to build financial security for the future.  We must remember, however, that money is the means to an end, not the end itself. Many people have lost sight of this and pursue money as an idol and lose sight of its true purpose.

The parable below is a great reminder of this lesson.

An American investment banker was taking a much-needed vacation in a small coastal Mexican village when a small boat with just one fisherman docked. The boat had several large, fresh fish in it.

The investment banker was impressed by the quality of the fish and asked the Mexican how long it took to catch them. The Mexican replied, “Only a little while.” The banker then asked why he didn’t stay out longer and catch more fish?

The Mexican fisherman replied he had enough to support his family’s immediate needs.

The American then asked “But what do you do with the rest of your time?”

The Mexican fisherman replied, “I sleep late, fish a little, play with my children, take siesta with my wife, stroll into the village each evening where I sip wine and play guitar with my amigos: I have a full and busy life, senor.”

The investment banker scoffed, “I am an Ivy League MBA, and I could help you. You could spend more time fishing and with the proceeds buy a bigger boat, and with the proceeds from the bigger boat you could buy several boats until eventually you would have a whole fleet of fishing boats. Instead of selling your catch to the middleman you could sell directly to the processor, eventually opening your own cannery. You could control the product, processing and distribution.”

Then he added, “Of course, you would need to leave this small coastal fishing village and move to Mexico City where you would run your growing enterprise.”

The Mexican fisherman asked, “But senor, how long will this all take?”

To which the American replied, “15-20 years.”

“But what then?” asked the Mexican.

The American laughed and said, “That’s the best part. When the time is right you would announce an IPO and sell your company stock to the public and become very rich. You could make millions.”

“Millions, senor? Then what?”

To which the investment banker replied, “Then you would retire. You could move to a small coastal fishing village where you would sleep late, fish a little, play with your kids, take siesta with your wife, stroll to the village in the evenings where you could sip wine and play your guitar with your amigos.”

The fisherman, still smiling, looked up and said, “Isn’t that what I’m doing right now?”

– Author Unknown