# What has your hit and miss ratio been?



## damdin

Hi guys,

I have a question from experienced punters or investors. I am just wondering what has your hit and miss ratio been since you have started punting/investing on stocks. I am just wondering if it is possible to keep hit ratio over 50% in the long term. What I am saying is how many times you call turned out to be right compared to total call (including wrong call) for each specific time frame target?

Cheers


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## tinhat

damdin said:


> Hi guys,
> 
> I have a question from experienced punters or investors. I am just wondering what has your hit and miss ratio been since you have started punting/investing on stocks. I am just wondering if it is possible to keep hit ratio over 50% in the long term. What I am saying is how many times you call turned out to be right compared to total call (including wrong call) for each specific time frame target?
> 
> Cheers




I'm not a trader so I can't share any personal experience with you. My observation, from reading 'Unholy Grails' by Nick Radge is that most of the trading systems back tested for that book had a win rate under 50%. I think the greatest psychological challenge for a trader would probably be the draw down rate (how far and for how long can you endure a loosing streak and deciding if it is just down to chance or if your strategy is fundamentally flawed or if it still fits the market).


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## brty

How about, it doesn't matter.

Sorry, but the question really involves what you are doing to have any relevance. You could have a system that involves very small losses but adds to winners and have a 10% hit "success" rate but make a fortune over the longer term.

Likewise it is possible to have a great percentage of small winners, a few massive losers and be out of the game in a couple of years.


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## damdin

brty said:


> How about, it doesn't matter.
> 
> Sorry, but the question really involves what you are doing to have any relevance. You could have a system that involves very small losses but adds to winners and have a 10% hit "success" rate but make a fortune over the longer term.
> 
> Likewise it is possible to have a great percentage of small winners, a few massive losers and be out of the game in a couple of years.




Agree on the size of loss or win that render meaning of hit and miss ratio useless. However, based on the assumption the size of the win or loss is not considered given the you employ same exit strategy for every trade/investment if your call goes wrong. In other words if we leave out size of win or loss in this scenario, is it possible to keep winning ratio over 50% in reality for discretionary trading (not black box) in the long term?


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## MichaelD

damdin said:


> given the you employ same exit strategy for every trade/investment...is it possible to keep winning ratio over 50%




Your exit strategy almost entirely determines your win-loss ratio, so yes you can set things up so that your win-loss ratio is greater than 50% in the long term.

The more above 50% your win-loss ratio gets, the bigger your losers become in relation to your winners.


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## So_Cynical

Its all about time, time allows the price to move, events to happen and cycles to play out, short time frames don't. Given an open time frame and a more investment skewed mind set it is possible to have a winning ratio of over 75%

Screen shot below is my main portfolio started May 2007, and i just sold my biggest loser last week.
~


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## damdin

So_Cynical said:


> Its all about time, time allows the price to move, events to happen and cycles to play out, short time frames don't. Given an open time frame and a more investment skewed mind set it is possible to have a winning ratio of over 75%
> 
> Screen shot below is my main portfolio started May 2007, and i just sold my biggest loser last week.
> ~




Thanks for the replies, guys.

I understand that if you initial call was wrong for a target time frame, then you can wait and turn that loser into winner after some time (of month, year etc.) when price turn around. What I really mean is that is there any chance to keep initial call correct persistently over 50% in the long term in reality?


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## Julia

damdin said:


> I understand that if you initial call was wrong for a target time frame, then you can wait and turn that loser into winner after some time (of month, year etc.) when price turn around.



You seem to be assuming here that if you wait long enough it's inevitable the price fall will reverse.
Absolutely no assurance of that happening and in the meantime opportunity cost is increasing.

By cutting your losers quickly you can put that capital into something more healthy.

All these years after the start of the GFC the XAO is still about 1400 pts off the pre-GFC high.
If you sold even after the losses had started, sat it out in cash at much higher interest rates than we're seeing these days until confidence returned, you'd have been able to buy back about twice as many shares as you previously held.


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## MichaelD

damdin said:


> What I really mean is that is there any chance to keep initial call correct persistently over 50% in the long term in reality?




Trading stocks long only with random picks and an infinite supply of money will see your win % sit at about 55% simply due to the long bias of the market overall.

You won't be very profitable, though.

But seriously, what is it about wanting to be RIGHT rather than PROFITABLE?


Here's a system which will see you 100% right but go bankrupt very quickly;

Trade futures long only with a profit limit of 1 tick.
Hold all losing positions.

You'll be 100% right but broke because you've blown up.


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## damdin

MichaelD said:


> Trading stocks long only with random picks and an infinite supply of money will see your win % sit at about 55% simply due to the long bias of the market overall.
> 
> You won't be very profitable, though.
> 
> But seriously, what is it about wanting to be RIGHT rather than PROFITABLE?
> 
> 
> Here's a system which will see you 100% right but go bankrupt very quickly;
> 
> Trade futures long only with a profit limit of 1 tick.
> Hold all losing positions.
> 
> You'll be 100% right but broke because you've blown up.




Like I put in my first post, every losing position will be closed out on a strict exit strategy, so assuming the losses won't be big in these cases. On the other hand if the call is right then let profit run. So I am assuming if your call is more than 50% consistently right then you are in the money or would not you be profitable in long term?


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## DeepState

damdin said:


> What I really mean is that is there any chance to keep initial call correct persistently over 50% in the long term in reality?




Yes, it's easy.  But you're fooling yourself.

Here's how you do it.  Sell deep out of the money options where the delta on the options are essentially zero.  This is like selling an insurance policy on BHP collapsing into a sinkhole.  The likelihood of making money on each trade is massive...as massive as you like depending on how out of the money the option is vs implied volatility and other matters.   You can estimate the chances of making a loss through various methods.  So, let's say you wanted a 99% HR, too easy.  Sell 0.01 delta call options on XYZ and just wait. XYZ is anything with a heartbeat...stocks, bonds, currency.  Derivatives upon those, derivatives on their correlations, blah blah.  About 99% of those contracts will complete in your favour and you will keep your full premium.

Congratulations...99%HR.  Pure genius.  Wow...walk the block.  Post your prowess.  Buy a house believing you've cracked it.

The problem arises when that rainy day comes.  The losses on that day when something big happens can erase all of the profits of the 99 other profitable trades.  You see a hint of it in So_Cynical's figures.  The losses when lost are greater than the gains when won.  The more extreme you push your HR, the more extreme these ratios become.  The super-senior CDOs held on investment bank balance sheets that internally consumed them in the GFC are an example of when happens when you push it to the max.  You look sensational for years....until you don't.

Profit = HR x Slug ratio.  Changing one impacts the other.  You need to think of both.  Ultimately, you need to have an edge. What matters is expected return per trade. HR and SR are just ways to slice that up. Some of the best investors in the world have HR well below 50%.  Given the pain you feel on taking any single loss (regardless of extent...it's how the brain works..win/loss is different to actual extent in the way we 'feel' it), you can understand that people avoid situations where losses are common...and whaddya know, profit materialises. 

All the best with that.


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## damdin

Ok I see now the point that it all comes down to the "edge", when to enter and when to exit or know what you are doing.


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## DeepState

damdin said:


> Ok I see now the point that it all comes down to the "edge", when to enter and when to exit or know what you are doing.




It would be the sweetest thing if you found your edge amongst low HR strategies!  

For avoidance of doubt, my mention of So_Cynical's figures are not in any way a negative criticism of his strategy or his outcomes as posted.


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## MichaelD

damdin said:


> Like I put in my first post, every losing position will be closed out on a strict exit strategy, so assuming the losses won't be big in these cases. On the other hand if the call is right then let profit run. So I am assuming if your call is more than 50% consistently right then you are in the money or would not you be profitable in long term?



Your entry strategy has very little to do with your win % and is by far the least important aspect of a profitable trader's edge.

Your exit strategy sets your win %.

Your overall profitability comes from position sizing and money management.


A win % of 40% with winners left to run and losers cut short can be highly profitable.

On the other hand, as various of us here have pointed out, a win % of 99% can still be a disaster.


It is unlikely that you can get a win % much higher than 40% whilst at the same time cutting losers short. To get high win % rates requires giving losing trades a lot of room to come good.


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## DeepState

MichaelD said:


> Your entry strategy has very little to do with your win % and is by far the least important aspect of a profitable trader's edge.
> 
> Your exit strategy sets your win %.
> 
> Your overall profitability comes from position sizing and money management.
> 
> A win % of 40% with winners left to run and losers cut short can be highly profitable.




G'Day

No argument on the above.  But curious about your thoughts. [Others too]

1. You have mentioned or paraphrased the trader adage 'let winners run and cut your losers short' which is also something that Julia has posted a couple of times.
2. You have also discussed markets as essentially a supply of Brownian motion with drift entities.

What's your perspective on a rules based approach which terminates all trades when they reach neg x% to initiation and the indefinite (let's call it 10 year horizon to pick a number) holding period of winners?  You can redeploy proceeds from investments cut short.  Basically the straight up keep your winners and crush your losers strategy.

I ask, in part, because you have a psych bent.  But it is also a straight up investment question.

Cheers


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## MichaelD

DeepState said:


> What's your perspective on a rules based approach which terminates all trades when they reach neg x% to initiation and the indefinite (let's call it 10 year horizon to pick a number) holding period of winners?  You can redeploy proceeds from investments cut short.  Basically the straight up keep your winners and crush your losers strategy.




Almost perfect. The only thing to improve on this is a trailing stop. Otherwise you'll have some of the big winners turn into losers.

eg A perfectly sound strategy is
"Buy at market"
"Sell when price drops 10% from the highest high since entry"


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## DeepState

MichaelD said:


> Almost perfect. The only thing to improve on this is a trailing stop. Otherwise you'll have some of the big winners turn into losers.
> 
> eg A perfectly sound strategy is
> "Buy at market"
> "Sell when price drops 10% from the highest high since entry"




Appreciate your response.  Hope you won't mind expanding a little because this concept is very impt to successful investing but loaded with magical thinking.  I am hoping you won't mind letting a polite discussion unfold because I'd like to understand this in more depth.

To progress:

How is this perfectly sound relative to the alternative of no trailing/other stop?  How does it improve your returns and return/risk, for example.  Let's say we stay in your world of the market being a stream of Brownian motion entities with drift and we begin with 10 stocks at equal weight.  Let's make this ultra simple and assume that all the stocks in the market have equal volatility, drift and zero correlation to one another.  This is the most basic investment environment imaginable.


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## MichaelD

DeepState said:


> How is this perfectly sound relative to the alternative of no trailing/other stop?  How does it improve your returns and return/risk, for example.  Let's say we stay in your world of the market being a stream of Brownian motion entities with drift and we begin with 10 stocks at equal weight.  Let's make this ultra simple and assume that all the stocks in the market have equal volatility, drift and zero correlation to one another.  This is the most basic investment environment imaginable.




You're starting with a false assumption.

If you look at the distribution of returns from stocks, they do not show a Normal distribution. Instead, they show a return skewed with long tail profitable outliers.

A trailing stop is needed to take better advantage of the long tail profitable outliers.


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## DeepState

MichaelD said:


> You're starting with a false assumption.
> 
> If you look at the distribution of returns from stocks, they do not show a Normal distribution. Instead, they show a return skewed with long tail profitable outliers.
> 
> A trailing stop is needed to take better advantage of the long tail profitable outliers.




Excellent. Thanks for the push-back. Let's move on.  

I should have said "geometric Brownian motion" for clarity and to avoid ambiguity. The distribution looks like it has positive skew because you are not adjusting for geometric movement and seeing it in nominal space.  But +100% is not the mirror of -100%.   In the former, you double your money, in the latter you are toast and out. If you lose 50% you need to make up for it by earning 200%.  That's why you think there is positive skew.  But it's vapour.  You need to transform that via the lens of a log-adjustment to get closer to the truth.  If you did, you'd find a leptokurtotic, negatively skewed distribution that looks very normal otherwise.  That's actually the polar opposite of your observation.

Nonetheless, even if people aren't aware of this, people use trailing stops etc. I am skeptical - not cynical. I use a kind of 'stop' that is of an entirely different classification, for disclosure. But I'm curious about these popular rules. We can be right even if we don't fully know why. I have no idea how my TV works, but I use it. Managing money is a little bit different to that, but I'll go with what works as opposed to theories which don't accord to reality.  The fact that traders/investors do use this stuff suggests that there is some benefit...maybe.  I'd just like to know where it is and why it works given it is so pervasive.  Given how widely it is used, it should be obvious...but it isn't to me - beyond soothing your amygdala and adrenal system.  Hope you can help.  

If you prefer, we can take this off the thread. But I'm hoping to hear what others may think too.


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## MichaelD

DeepState said:


> But +100% is not the mirror of -100%.   In the former, you double your money, in the latter you are toast and out. If you lose 50% you need to make up for it by earning 200%.  That's why you think there is positive skew.  But it's vapour.




Trading shares long only without a trailing stop.

1 position - maximum loss is 100%
1 position - maximum profit is infinity

The same with a stop

1 position - maximum loss is < 100%
1 position - maximum profit is still infinity


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## damdin

Interesting discussion guys, so keep it going (despite some contradictory suggestions (hold onto losers to turn it to winners vs close out losing position strictly etc))


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## DeepState

MichaelD said:


> Trading shares long only without a trailing stop.
> 
> 1 position - maximum loss is 100%
> 1 position - maximum profit is infinity
> 
> The same with a stop
> 
> 1 position - maximum loss is < 100%
> 1 position - maximum profit is still infinity




Thanks again.  This is good. I am learning from you, which is appreciated.

As you mentioned in an earlier post, what matters is expected returns.  Quoting a min-max outcome boundary does not say much for the expected return.  It just quotes the outcome boundary for a single gamble.

Let's make this really simple.  Even simpler than before....which I didn't imagine was possible when I wrote it...surprised myself.  Let's focus on a portfolio consisting of a single stock which moves with Geometric Brownian motion with drift.  It can, as you point out, move asymptotically to zero, to drift on up towards infinity.

Strategy 1: Buy and hold a the stock...no stop-loss, no nothing
Strategy 2: Buy the stock with 10% trailing  (or any kind of stop method for that matter, for any magnitude of trail or fixed or some algo) stop...replace the stock with another drawn from the stream of stocks in the market and repeat to infinite time horizon.

I suggest that, with respect, you aren't aware that the expected return from both of the above is actually identical (ignoring brokerage and trading frictions and tax realization which would actually favour Strategy 1 under conditions of a positive drift).

Once again, it obviously works for you.  So I don't dismiss it because of divergence between belief and underlying empirical or theoretical observation.  I should add that we are talking about a situation where leverage doesn't come into the picture. 

Why else do you, or others, do this?


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## DeepState

damdin said:


> Interesting discussion guys, so keep it going (despite some contradictory suggestions (hold onto losers to turn it to winners vs close out losing position strictly etc))




Those suggestions may seem contradictory, but they are not, actually.  Although both are straw men.  Both broad concepts, without taking it to the zealous extreme, are deep features of what happens in practice in professional management. But my question here relates to the pervasive use of these rules in retail.  You see it all over the place in FX and share trading. I'm hoping this thread will allow us to explore this. Let's see where it goes.  Thanks for starting the thread.

Might as well chip in something here about why I think it is useful.  It is a practice which overcomes a finding made by Shefrin and Statman in 1985 about the behavior and false beliefs of investors under conditions of uncertainty.  The finding was called "Disposition Theory" or the "Disposition Effect". Without training, we sell winners too early and hang onto losers thinking they will revert. It results in high HR.  It's the same impulse that drove you to want a high HR. Thanks for volunteering to be a lab rat! This was built upon heavily by a guy called Terrance Odean. These findings, though, just highlight false beliefs that heaps of us have before being confronted with actual data.   And even then, heaps will not be convinced by data or know how to use it and continue on to believe in investment fairies.  That's why you can find an edge if you work at it - but it's not as if people are that stupid to make it easy for you.

MichaelD is into investment psych, from prior posts, so I'm glad we are in dialog.  I am hoping others will jump in because a ton of people on this site are doing it.


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## MichaelD

DeepState said:


> Why else do you, or others, do this?




The stock market is in a permanent uptrend. Has been for 200 years.

That's why a portfolio of 20-odd stocks with a trailing stop is profitable. It won't work with 1 stock. You need 20-odd, appropriately position sized.

Limits the downside.
Doesn't limit the upside.

Individual stocks can go to zero.
A diversified portfolio won't.

A trailing stop can be almost anything, so long as the winners are allowed to run and the losers are limited in some way. It can be technical, it can be fundamental, it can be astrological. It can even be zero.


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## DeepState

MichaelD said:


> The stock market is in a permanent uptrend. Has been for 200 years.
> 
> That's why a portfolio of 20-odd stocks with a trailing stop is profitable. It won't work with 1 stock. You need 20-odd, appropriately position sized.
> 
> Limits the downside.
> Doesn't limit the upside.
> 
> Individual stocks can go to zero.
> A diversified portfolio won't.
> 
> A trailing stop can be almost anything, so long as the winners are allowed to run and the losers are limited in some way. It can be technical, it can be fundamental, it can be astrological. It can even be zero.




Thanks for continuing with the dialog.  

We have allowed for the 'permanent uptrend' in assigning a positive drift to the stream of returns.

In my prior post I highlighted that a single stock strategy which is left to float along in the positive drift is expected to perform equally well as one with stops in place using any of the strategies you have mentioned, even those with zero stop limit. These stops can be developed via any method including via random number generator or Fibonacci sequence. Hence, applying stop losses that let trends run whilst cutting losses on a single stock portfolio does not add value.  You seem to allow for this in your latest response when you say it won't work for a single stock.

You go on to suggest that it would work for a portfolio of 20 such stocks and applying this strategy.  It actually doesn't.  If it doesn't work for one stock, building a portfolio of 20 or arbitrarily large number of stocks and weighting them in any scheme you like will not change the fact that stop losses of any description considered here will not generate value add vs the buy-hold scenario under the conditions we have described.  It simply shifts the slug ratio more positively if the stops are tighter, but (as you have noted) damages the HR.  The net result is no gain...ignoring t-cost. Since you've raised it, I'll go further and say that it doesn't even shift the overall risk vs a buy-hold portfolio as the expected distributions are identical...not just the return expectations.  That is, the risk of effective bankruptcy are identical in both cases.  Though ours is a toy world, any approximations to the real world on this issue due to jumps or gaps washes away with modest diversification. 

There is no alpha generation in stop losses based on arguments related to
- skew
- outcome range
- portfolio diversification.

Yet...here it is...alive and kicking.  It is clear that you believe there is alpha but the rationale provided (I am grateful, your reasoning matches with that provided elsewhere and is representative) actually doesn't bear out for the most part unless there are special conditions present which have not been raised.  I am happy to stand corrected. I want to be corrected. Who wouldn't want to sit by a beach with stop loses on generating additional value over the market? Ship it in!

You are clearly experienced and it is very nice to correspond with someone whose actually been around a bit.  If I may, where/how did you learn to apply stop losses?  Why did you find the concept attractive from a psych viewpoint?


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## MichaelD

DeepState said:


> You go on to suggest that it would work for a portfolio of 20 such stocks and applying this strategy.  It actually doesn't.
> 
> You are clearly experienced and it is very nice to correspond with someone whose actually been around a bit.  If I may, where/how did you learn to apply stop losses?  Why did you find the concept attractive from a psych viewpoint?




We'd have to agree to disagree on the value of a trailing stop. All the extensive backtesting I did way back in the past confirmed a dramatically improved result when a stop loss was applied.

Where did I adopt the practice of using a stop loss? I'd say I picked it up from several of the trading books I read early on and then verified what it did with a lot of backtesting.

I don't find the concept attractive psychologically. I hate a 40% win rate. I am, however, still in the game despite only trading long with copious leverage during the GFC. I also have a portfolio that traded exactly as suggested by backtesting - a string of small losses to begin with, and now almost everything I hold is hugely profitable.

In short - it has worked for me as I expected it to.


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## DeepState

MichaelD said:


> We'd have to agree to disagree on the value of a trailing stop. All the extensive backtesting I did way back in the past confirmed a dramatically improved result when a stop loss was applied.
> 
> Where did I adopt the practice of using a stop loss? I'd say I picked it up from several of the trading books I read early on and then verified what it did with a lot of backtesting.
> 
> I don't find the concept attractive psychologically. I hate a 40% win rate. I am, however, still in the game despite only trading long with copious leverage during the GFC. I also have a portfolio that traded exactly as suggested by backtesting - a string of small losses to begin with, and now almost everything I hold is hugely profitable.
> 
> In short - it has worked for me as I expected it to.




Backtest!  You are truly a goldmine MichaelD.  With the ECB putting a ceiling on the EUR vs RoW your stock looks good indeed, particularly in EUR numeraire.. 

BTW, please recall that I use a version of stops too although the method wouldn't be recognizable. Believe it or not, there are elements in it that are distant cousins of trailing stops.  So we don't disagree in philosophy at all or have to agree to disagree.  Is that agreed?

When you conducted your backtest...what did you code for the action taken subsequent to hitting a stop?


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## MichaelD

DeepState said:


> When you conducted your backtest...what did you code for the action taken subsequent to hitting a stop?



Hit stop -> close position.
Open another.


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## DeepState

MichaelD said:


> Hit stop -> close position.
> Open another.



In the same stock? With equivalent size? With no delay?


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## MichaelD

DeepState said:


> In the same stock? With equivalent size? With no delay?




No, in a different stock.

Sell the downtrending one.
Buy an uptrending one.

Position size is 0.5% risk so depends on where the stop is and on overall capital.


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## DeepState

MichaelD said:


> No, in a different stock.
> 
> Sell the downtrending one.
> Buy an uptrending one.
> 
> Position size is 0.5% risk so depends on where the stop is and on overall capital.




Two fat ladies 88. Bingo. Welcome to the world of special conditions.  

I can see where you are coming from and why your opinions and outcomes are as they are now.  Keep it going. Thoughtful risk management too.  But, ultimately, it's not actually the trailing stop loss that is creating the value other than, perhaps, acting as a form of alert. Despite the pain of a 40% HR, you clearly derive benefit from the belief that it protects you from going bust. That's totally understandable if you are investing with leverage. Leaving the issue of leverage aside, in reality, the trailing stop just helps you get what's available from your personal decision rule.  ie. it works, but not for the reasons we have been discussing. The trailing stop is actually a rebalancing trigger for you and it happens to broadly suit the real thing that's making your money. On its own, it does nothing.

We can agree that you are making money. All power to you. You should consider going equitized long-short to make even more. I will have to agree to disagree with you if you are still of the view that the trailing stop actually MAKES money.

This is thoroughly fantastic to discover from a range of perspectives.

I appreciate this dialog very much.  You've been most generous in your views and opinions. I hope we have many more opportunities to exchange. May the trend be your friend forever more.

Best.


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## brty

Watching this thread with interest. 
2 opposing views. 
A sell winners add to losers, ie re-balance.
B sell losers add winners (stocks in uptrend).

Both will work with the correct stocks. 

Consider A, in a market decline where everything is going down (ie 2008), re-balancing gives more money to the biggest losers from the smallest losers.

Consider B all stocks get sold, stay in cash until market turns.

I prefer B, did B in 2008. From trading a 6 figure sum, lost less than interest for year.
I add to winners not losers, seems the opposite of most people.
Love Ed Seykota's rules. 
 1. Cut losses. 2. Ride winners. 3. Keep bets small. 4. Follow the rules without question. 5. Know when to break the rules.

Every stock is different. 

Retired Young, you seem to be on a crusade to have everyone re-balance, why?


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## burglar

damdin said:


> Interesting discussion guys, so keep it going (despite some contradictory suggestions (hold onto losers to turn it to winners vs close out losing position strictly etc))




Contradictory because people are different.
It makes an auction possible.
If everyone was the same, the price would stagnate.

Keep trying to work it out ... but don't go nuts! :


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## DeepState

brty said:


> Watching this thread with interest.
> 2 opposing views.
> A sell winners add to losers, ie re-balance.
> B sell losers add winners (stocks in uptrend).
> 
> Both will work with the correct stocks.
> 
> Consider A, in a market decline where everything is going down (ie 2008), re-balancing gives more money to the biggest losers from the smallest losers.
> 
> Consider B all stocks get sold, stay in cash until market turns.
> 
> I prefer B, did B in 2008. From trading a 6 figure sum, lost less than interest for year.
> I add to winners not losers, seems the opposite of most people.
> Love Ed Seykota's rules.
> 1. Cut losses. 2. Ride winners. 3. Keep bets small. 4. Follow the rules without question. 5. Know when to break the rules.
> 
> Every stock is different.
> 
> Retired Young, you seem to be on a crusade to have everyone re-balance, why?




Hi Brty and also Burglr

They are not actually opposing positions. But let me build it up.

There are extremely few pure arbitrage opportunities in the market.  Nothing is for sure.  So we move to statistical arbitrage.  We try to find a way to predict stock returns that, on average, have a positive profit expectation over time.

1. If you found $10k sitting on the street gutter, would you pick it up?  I sure would.  I'm pretty sure 99% of people here would.  There might be 1% who believe in Efficient Markets Hypothesis who'll say "if it were real, it would be taken already" or another few percent who have a bad back.

2. If you found a box which contains an unknown amount of cash, including the possibility of losing cash, but on average gives you $10k...to make this better, I'll say the max/min is $15k and -5k?  I sure would.

3. What if you could be presented with many situations like 2. ? It will smooth your experience out over time and increase the chances of getting a positive result despite the real risk of individual draws costing you money.  Would you take it then?  Apparently, most people would not. How awesome.

Rebalancing is like 3. Yet strangely, from the dialog, no-one seems to want to take it.  That $10k expecations box just swings on by.  I come across as on a crusade because of the number of posts and in trying to align beliefs with the reality (at least as I perceive it to be...and also the entire professional finance community, but no matter).  In reality I don't know any of you.  So, I'm really not crusading. I have no dog in this fight. I am, however, fascinated by the beliefs being brought here and the arguments being raised.  I have benefited from McLovin, Smurf1976, So_Cynical and MichaelD.  We can disagree, but I am richer for the experience. 

Let's move to rebalancing. Why does it work? Why does it generate a positive expectancy?  Let's use a simple example drawn from the research paper Bouchey et al (2012):




You can buy Apple and Starbucks.  By rebalancing between the two to a fixed weight shown along the horizontal axis your portfolio (the curved line) will always exceed the return from a buy and hold (the straight line) starting with the same weights.  Depending on the initial weights, you can get huge gains relative to the unbalanced portfolio.

That's the Black Box in action....chug chug chug.  Booooooring. Yawn. 

When the universe was created and all the laws of physics were set, the laws relating to the profitability of rebalancing were one of them.  Here is the equivalent of the E=mc-squared of rebalancing for your viewing pleasure (from same source). 




This equation is water tight.  Feel free to kick it around. We've had 30 years to do it and instead of being killed, there are entire institutes and huge firms devoted to it.  I think the guy who started it all off was Robert Fernholz in 1982.  If you want to investigate how to make money boringly via rebalancing, then you might want to check out his work on Stochastic Portfolio Theory.

So, have we achieved the point that rebalancing has positive expectancy and that it is not a small thing.  Further, although it can be very sophisticated to implement if you want to move into the professional leagues, you can benefit quite readily by just robotically doing it very simply.

You can do quite well just rebalancing to some reasonable weighting scheme in all stock portfolios or in multi-asset class portfolios.

Everyone on this site is a RockStar and thinks they have some method that will slaughter these returns.  They can't all do so, and expenses will be incurred in the effort by brokers, market makers, sec lenders and margin financers.  They are laughing their pants off at the over-trading that goes on in the market.  They have yachts.  Most on this site will never get close to it.  Yet the game continues.  Such is the lure.

When you enter the market, the best starting point is that you are average.  You have no idea who you are up against and your best guess should be they are as good as you until proven otherwise.  This is Bayesian adjustment.  What actually happens is we generally have overbuilt expectations, overtrade, cause excess volatility and feed the rebalancing process.  In aggregate we will underperform the, say, equity market by a couple of percent after fees, expenses and tax.  Roughly 80% will fall behind a simple rebalancing program.

But, ask a roomfull of people if they are above average drivers and 80-90% will say yes.  Same thing applies here.  Awesome.  20% will actually do very well.  I could give you study after study, fact after fact, but a man convinced against his will is a man unconvinced.

Here is a stream of black boxes for you.  If you want it, feel free to pick it up.  You'll beat 80% of the market over time just by doing it. If not...that's fine.

Now, I get the sense that this idea is seen as an either/or.  It doesn't have to be.  Let's say that you are a stop the losses and run with profits kind of guy.  Doesn't it make sense to look at the portfolio you are holding at any time and check that it makes sense and is not drifting into stupid concentrations?  Rebalance the thing to reasonable target weights.  It doesn't have to be opposing.  The concept is simply to rebalance to some fixed weights...then let the magic just do its thing over time.

The same applies to any method to make money that anyone can concoct.  It could be astrological, as MichaelD suggests, which will actually do as well as the average.  Actually it might do better given planets and celestial objects move slowly from Earth's perspective and thus generate fewer trades.

I hope this responds to your query.  Please feel free to continue the dialog.


----------



## qldfrog

I really like you facts about rebalancing.I had no idea rebalancing had a positive twist.
Thanks


----------



## burglar

DeepState said:


> Hi Brty and also Burglr ...




The contradictions are either real or apparent.
To newbies they are real, palpable.

To the connoisseur they are apparent and can be explained away with a white paper on rebalancing

Okay! I didn't fully understand it, nor would a newbie.

I come to auction with a buy order hoping the price will rise.
It is met by a sell order. 
A fair assumption, it is from someone expecting the price will fall?? 

I would then hypothesize that there are investors and traders at work.
And further, I would believe that these are two different animals.

One is buying in belief that the company is undervalued.

The other is buying and selling with no regard to the value of the company.
He is trading on the expectation that he understands what the market is doing.

Not in disagreement, just continuing the dialogue!


----------



## DeepState

burglar said:


> just continuing the dialogue!




Hi Burglar.  Sorry about the typo on your name before. Someone flogged the 'a'. Payback is a bitch.

Thanks for pushing on.

There are buyers and sellers.  They move prices RELATIVE to one another. It doesn't matter what their motivations are.  They could be buying on expectations of a rise, trimming their portfolio despite continuing to anticipate a rise, market making, redeeming to fund a $30pa budget requirement.....

Let's focus on Apple and Starbucks.  Let's say you have an  20% Flipper / 80% Shark strategy whose algo was written by the Grand Master himself.  You can even add your own fundamental overlay and then check the star signs with Athena.  You discover that you favour Apple over Starbucks and after running it through your Northfield optimizer using its multi-factor risk engine, figure that a 80% weight to Apple and 20% weight to Starbucks is the right thing for you.

Because you are a total RockStar, anointed by the Grand Master himself, it so turns out that Apple did outperform Starbucks like you said it would.  Can I please hang out with you?  

If you don't rebal, the return to the portfolio is just 0.8 x Apple's return + 0.2 x Starbuck's return.  That can be read off the graph before, producing a portfolio ending value of $40. Yeah?

Now, here comes the magic.  I couldn't believe it myself when I first saw this and had to double and triple take. Holy smoke, a money pump. Really?  BS.  Then I saw the maths and all was good.  But let's try to explain what's going on behind the maths.  Breathe.

Each stock can be assumed to just drift upwards, but wiggles along on its path.  Apple drifts upwards faster.  As the prices wiggle around, the portfolio weights shift away from your target 80/20 weights.  Now, at the start, the wiggling for a month, let's say, can either tilt the portfolio towards or away from Apple's initial weight. In the next month, the wiggling can either bring the weights further away from the initial weights OR back towards the target weights.  Got this?  We are only looking at two months.  There are four possible outcomes.  Super simple.  Up-Up, Up-Down, Down-Down, Down-Up.

If you don't rebal, you can never profit from the times when the wiggling brings the weights closer to the initial weights...when the portfolio reverts. Rebalancing prior to reversion will always make you money (prior to t-cost). You are buying low and selling high.  Or selling high and buying low.  Rebalancing or not rebalancing for the Up-Up and Down-Down scenarios produce the same expected returns. The expected return for Up-Up and Down-Down are the same in combination, so any weighting scheme you come up with produces identical outcomes in expectations.  In this case the weighting schemes are whatever the drifted portfolio has become, and the rebalanced portfolio weights (the initial weights). 

So, if you rebal, every time the portfolio reverts, you make money. Buy-hold never grabs this.  If the portfolio does not revert, you are no worse off than buy-hold. Hence, as time passes and the portfolio wiggles around, coins just appear and fill your money jar.  

Voila. 

This process basically pumps profit from the wiggling.  This wiggling is better known as volatility.  Hence this process is commonly known as volatility pumping or volatility harvesting.

So...you can express your investment insight AND you can juice it a heck of a lot more than most would give credit for, by volatility harvesting.  From the example provided your rebal portfolio grew to $60 and your Buy-hold la-de-da portfolio, although built with awesome insight, grew only to $40.  Please note, you have to allow for t-cost.

The more stocks you have, the more extreme they wiggle about and the less they wiggle in harmony....the faster you buy a yacht for yourself if you don't already own one.

So, hopefully this has demonstrated how rebal generates coin.  Also, hopefully, it is abundantly clear that there is no either/or which is necessary between applying rebal and having your own insights. 

Hope that helps.



Disclaimer:  In this and prior posts on this thread, I am not providing advice.  I am not recommending the purchase and sale of any securities.  I am offering illustrations of finance concepts in passing conversation.  I do not know your financial circumstances. Please do your own work.


----------



## burglar

DeepState said:


> ... There are buyers and sellers.  They move prices RELATIVE to one another. It doesn't matter what their motivations are.  They could be buying on expectations of a rise, trimming their portfolio despite continuing to anticipate a rise, market making, redeeming to fund a $30pa budget requirement ...




I was aware, but you say it so much better than me.
Since landing here, ASF, I have found out about some forces in the market which were obscure to me earlier.
Obvious to me now, from reading your posts, that there are even more forces.



DeepState said:


> ... Hope that helps ...




I'm not in your league, but I would be interested in your view of averaging down.


I leave this post with a quote:



> “The stock market by its very nature is designed for you to lose money. The rallies and reactions within any trend ensure this process is at work constantly. It is created automatically. The market behaves this way because it has to! The weak have to perish so that the strong can survive. Professional traders are fully aware of the weaknesses in traders under stress and will capitalise on this at every opportunity.”



Read more:
free download from “Master the Markets”, Tom Williams

http://www.tradeguider.com/mtm_251058.pdf


----------



## Bill M

DeepState said:


> If you don't rebal, you can never profit from the times when the wiggling brings the weights closer to the initial weights...when the portfolio reverts. Rebalancing prior to reversion will always make you money (prior to t-cost). You are buying low and selling high.  Or selling high and buying low.  Rebalancing or not rebalancing for the Up-Up and Down-Down scenarios produce the same expected returns. The expected return for Up-Up and Down-Down are the same in combination, so any weighting scheme you come up with produces identical outcomes in expectations.  In this case the weighting schemes are whatever the drifted portfolio has become, and the rebalanced portfolio weights (the initial weights).
> 
> So, if you rebal, every time the portfolio reverts, you make money. Buy-hold never grabs this.  If the portfolio does not revert, you are no worse off than buy-hold. Hence, as time passes and the portfolio wiggles around, coins just appear and fill your money jar.




Hey DeepState I am enjoying reading your posts. I am way out of depth trying to understand some of the mechansims of rebalancing so if you don't mind confirming something for me. How often do think rebalancing should take place? I think every 3 Months "feels right" but I am not sure. Secondly you say _Rebalancing or not rebalancing for the Up-Up and Down-Down scenarios produce the same expected returns._ 

My question is, do you rebalance at your preset intervals (in my case 3 Months) or do you rebalance when you have major market moves? Which scenario do you think works best?


----------



## brty

Being out of the market at times is also a postion.

Taking an Apple vs Starbucks example is the same as taking any two stocks that always go up as an example, very poor in the real world.



> Each stock can be assumed to just drift upwards, but wiggles along on its path.




NO!! You cannot assume stocks will always drift upwards. How does your re-balancing work on the Japanese market during the same time period of your apple and starbuck example??

If you start with incorrect assumptions, ie stocks always go up, you ignore the probability the assumption is wrong. The Japanese market is the exception that kills the assumption. Waiting more than 20 years for the market to return to normal is clearly to long.

I like, and have stated on numerous occasions that the Piotroski method is extremely useful is choosing from a basket of stocks, and yes that is re-balancing every year, but not with the same set of stocks, though it is a subset of all stocks.
Do I use that? Some of the time, especially when they go up in price, I'm happy to add.


----------



## DeepState

brty said:


> Being out of the market at times is also a postion.
> 
> Taking an Apple vs Starbucks example is the same as taking any two stocks that always go up as an example, very poor in the real world.
> 
> 
> 
> NO!! You cannot assume stocks will always drift upwards. How does your re-balancing work on the Japanese market during the same time period of your apple and starbuck example??
> 
> If you start with incorrect assumptions, ie stocks always go up, you ignore the probability the assumption is wrong. The Japanese market is the exception that kills the assumption. Waiting more than 20 years for the market to return to normal is clearly to long.
> 
> I like, and have stated on numerous occasions that the Piotroski method is extremely useful is choosing from a basket of stocks, and yes that is re-balancing every year, but not with the same set of stocks, though it is a subset of all stocks.
> Do I use that? Some of the time, especially when they go up in price, I'm happy to add.




Brty...

I assumed that both go up with drift because that's actually what happened and, in my post to Burglar, assumed he was a Rockstar with a direct line to the Grand Master.  I'm hope you'll agree that these are the stupidest assumptions possible.  He had perfect hindsight to make that call. Hopefully you'll agree that I'm not actually quite that stupid....although sometimes I wonder myself.

The point was to demonstrate that even with skill in selecting two stocks' relative and absolute performance, rebalancing adds material value.  This process would add value if the drift terms were negative, positive or in between to any magnitude you want and in different or the same direction. 

The point is that rebalancing adds value.  The formula I gave you is non-specific about return expectation.  Put in any number you want for g.  Piotroski screened or not (good stuff on that by the way...so refreshing to hear you do that.. ).  So, if you screen by Piotroski and rebalance by risk or some other method which is ignorant of price drift...guess what...you are...rebalancing.  Did you know that?  You are already picking up the boxes.  GOOD ON YOU. 

If you threw darts at a dart board and picked stocks...and equally weighted them, you are rebalancing too.  Darts have no idea what the drift term is either and make no assumptions.  But this will eventually outperform a portfolio of equally weighted stocks that are subsequently left to drift, given enough time.  You don't need to know what the drift terms are.  Whatever they are...rebalancing will add value to them.  Like magic isn't it?

Being out of the market and in the market is rebalancing between cash and equity.  Same same.  You are just applying this to a multi-asset class situation rather than a stock position. Rebalancing will work if your neutral position is not 100% on either side.  But because cash is not volatile, the results won't be as strong, but they will be there.

Keep pushing back...


----------



## DeepState

Bill M said:


> Hey DeepState I am enjoying reading your posts. I am way out of depth trying to understand some of the mechansims of rebalancing so if you don't mind confirming something for me. How often do think rebalancing should take place? I think every 3 Months "feels right" but I am not sure. Secondly you say _Rebalancing or not rebalancing for the Up-Up and Down-Down scenarios produce the same expected returns._
> 
> My question is, do you rebalance at your preset intervals (in my case 3 Months) or do you rebalance when you have major market moves? Which scenario do you think works best?




Dear Bill M

Thanks for the question.  It's a great one.  Both suggestions you have made are feasible - clearly.  Which works best?  The crappy answer is - it depends.

The "quants" who really work this angle hard are rebalancing at fixed intervals.  They run the view that trying to time this stuff is a joke.  They figure you can't tell if an extreme market move is about to become more extreme.  So, they rebalance without making too much of a deal about whether the movement has been big or not.

The fundamental guys/gals don't rebalance at fixed intervals.  Rebal is typically just part and parcel of good portfolio management where they say I'd like 10% in BHP and 5% in NAB and so on based on their views.  They then make sure that the portfolio is brought back to those weights if the view holds.  So they are rebalancing most when the markets move most.

In insto superfund land, some have rebal triggers.  So if the weights of the asset classes, or to fund managers, exceeds a certain set of percent away from target, they bring it back to target.  So this is something of a hybrid between the above two.

Bill M, your analysis and your words suggest to me that you actually have a very grounded sense of your forecasting power and are fully aware of your hard floor.  I hope the above three examples provides a guide to which is the better option for you.

As to rebal frequency, the task is to figure out the profit from rebal less the cost of rebal and whatever else you are scared about and trade them all off.  Some of the most massive shops in this area rebal once a year! 

Given your penchant for analysis and your careful nature that just jumps off your posts, perhaps the rebal rule for superfunds might be attractive, or, rebal at fixed interval.  I don't know what you are holding so I don't know how to trade-off cost vs benefit in your case.

Very best wishes to you, sir.


Disclaimer: This is not advice.  I do not know your circumstances.  I do not know you, although it would be my privilege.  This is not a recommendation to purchase or sell securities. Please do your own work.


----------



## DeepState

burglar said:


> I would be interested in your view of averaging down.




Hmmmm.  This is not as straight forward as it seems.

Let's go the to land of the Wiggling stock.  At this time, there is no drift term.  We EXPECT that the stock will do nothing each period.  However, it's ACTUAL move is some random figure.  Let's make it super simple and call it Heads or Tails.  Heads - Up.  Tails - Down.

Go ahead and flip the coin.  The Stock price wiggles along HHTHTHTTHHTHTHTH and so on.

Should you average down when the stock price goes down, under these circumstances? What do you think?

If you intend to average down in a way that you can make money, then the way to do it is to Martingale.  Double down baby.  Tails - no problem.  Double down. Another Tails?  No problem..Double down.  And keep going.  As soon as the first heads comes along, you are in profit and high fiving everyone and pulling out Wolf of Wall Street lines. Then you return to the original position size.  This is the quintessential averaging down strategy most people have in mind.

Wow...another money making machine.  Uhhh. Not really.

If you have a finite pot of money.  That is, a pot of money that is less than infinity, if you do this, there will be a day that you are guaranteed to go bankrupt.  So the process of doubling down under these conditions makes you ZERO expected return.  Any profit divided by infinity equals zero.

Here's the thing, most people have less than infinite amounts of money.  And lots of people average down.  And, most of the time, you will get that Heads before you run out of money and feel like a legend.  You will tell your friends and some will write books extolling the virtues of this zero (under these conditions) expected return strategy. It's total BS.

But wait, the real world is not like Wiggle land.  First, since I've been quizzed on drift, let's assume stocks drift.  It doesn't change the picture under reasonable conditions (drift not being 100% per period etc.).  Sooner or later, if you average down, you will run out of money.  In the case of a positive drift, it is just less likely at the commencement of any drawdown than under our first scenario.  Obviously, if the stock drifts down, you increase the chances of bankruptcy at the commencement of any drawdown.  Ultimately, you bankrupt if you do this long enough for any arbitrarily large pool of money vs the stock position.

But wait, the real world is not like that either.  Stocks are actually overly volatile.  They do mean revert.  It is as if the coin gets sort of sick of pulling Tails all the time and starts loading the coin towards Heads.  This is where it gets tricky.  If that's only a weak force, you're still going down.  But, if there is real strength in that reversionary force and it gets stronger the longer the Tails goes, then you can do alright - as it turns out.

Ummm. how do you know when to hold and when to fold?  If you know absolutely that the stock is worth $100 because the Grand Master told you and it is drifting  to $90, $80... there will be a strong impulse to revert to $100.  That's called fundamental investing with a contrarian tilt, buy into falling markets.  But if the Grand Master forgets to call you....what do you do?  Well, if you play...you risk going bankrupt.  If you don't play, you will live.  Hence, you don't play.

In the real world, your knowledge of stocks is like getting a mobile phone call from the Grand Master when you are in the outback on Vodaphone.  You can't quite make out what the heck he's saying.  And he doesn't have WhatsApp, FB, Twitter, SMS or whatever. So you make an educated guess.  If you think the stock is worth $80-120 and the stock price gets below $80, start accumulating.  If you fall to $50, you have to start thinking whether your thesis is right or whether to cut and make sure you live for tomorrow.  

In short: If you have no idea about the valuation of a stock, averaging down does not make sense in the long run, but it might make you feel great until you go broke.  If you have an absolutely fabulous idea and can ensure others get to know about and move to the stock, obviously, you should do it.  If you are somewhere in between, the reality is you average down but keep checking.  It turns out, though, that you will die in the end too and with higher probability at any point than not doing so.  Even if you cut your losses, you are just playing this game from a lower point each time you end up in a position where you have to cut losses until your finite pot evaporates (for reasonable conditions and forecast accuracy).

This is different to rebal which only adds incrementally to positions, not Martingale or equivalent, and adds value RELATIVE to a portfolio of unbalanced stocks.  


Disclaimer: I am making all this up on the fly.  I have no investment expertise whatsoever and you should do your own work.  This is not advice.  I mean it.


----------



## burglar

DeepState said:


> ... Disclaimer: I am making all this up on the fly.  I have no investment expertise whatsoever and you should do your own work.  This is not advice.  I mean it.




I hope you enjoyed writing it as much as I enjoyed reading it.


It is a most entertaining post. 



I knew it would be.
I must be telepathetic! :


----------



## So_Cynical

Rebalancing 2 or 3 or 10 stocks all drifting up at their own pace, sure i can see the positives of rebalancing, taking little profits along the way, moving money from the top and putting it back in at the bottom...fine. Now introduce a big loser into your portfolio and your rebalancing exercise turns into a disaster as your constantly taking money from your winners and throwing it at your one big loser. 

After reading through RY's posts in this thread it has come to mind that what i have been doing with my portfolio over the last 7 years has been a kind of rebalancing act, what i have called "recycling cash" has really been a type of haphazard rebalancing, part selling winners to buy into 'dipping' portfolio stocks and or adding new 'dipping' stocks to the portfolio.

Doing so in the belief that buying into XYZ at the right time (significant low points) is better than dollar cost averaging and or random buying, financing that buying activity by part selling winners and the odd loser but mostly winners...it works on the whole but that 1 in 10 big loser hurts, hurts a lot and can bring the whole portfolio down significantly.

-----------

As i said in another thread, i don't think rebalancing can make anyone rich, name me one famous rebalancer? but it could help an average portfolio be a little better, but wouldn't make as much difference as say one really good stock pick, one big trend reversal and or emerging trend pick, buying Amazon or CSL at $5 and holding all the way will make a big difference.


----------



## burglar

So_Cynical said:


> ... it works on the whole but that 1 in 10 big loser hurts, hurts a lot and can bring the whole portfolio down significantly ...




Hi S_C,

Can I take it from the tone of your post that you are softening you view on averaging-down?

It is great if that one big loser is Starbucks and it is drifting up!
But some of us don't follow Starbucks.


----------



## So_Cynical

burglar said:


> Hi S_C,
> 
> Can I take it from the tone of your post that you are softening you view on averaging-down?




Hey burglar

I have recently sold 3 of the largest losing parcels in my biggest loser, APN was a stock that got me caught up in a big industry reversal of fortunes, the death of print media (entry/exit links below)

https://www.aussiestockforums.com/forums/showthread.php?t=2504&p=587204&viewfull=1#post587204

https://www.aussiestockforums.com/forums/showthread.php?t=2504&page=3&p=821151&viewfull=1#post821151

I followed my usual somewhat aggressive averaging down strategy as the APN share price kept falling for the first year or so...took a big average down at 0.755 (see below link)

https://www.aussiestockforums.com/forums/showthread.php?t=2504&page=2&p=653354&viewfull=1#post653354

My APN position is now in 30% open profit thanks to the deep discount offered to holders via the recent rights issue, the subsequent SP rally and the sale of my older losing parcels...in the wash up of it all i have taken a very large loss and taken yet another large average down in order to end up with the open profit i now have in this stock.

Conclusions and lessons learnt:


 Stock SELECTION is critical, make dam sure you don't have a lot of money in a stock that goes to 0.
 Be VERY patient when averaging down.
 DO NOT DOUBLE down unless there is a clear and unequivocal, very low risk advantage in doing so.
 Fortune favours the brave however there is a big difference between brave and stupid.
 DON'T be stupid.


----------



## sydboy007

Not been running my SMSF for too long but around middle of last year after a few of my shares had run hard ie 30-50% I decided to sell them and invest elsewhere.

I sold out of AAD which has since gone on for a big run up from my sale price - I'd be sitting on oer 100% profit instead of the 30% I sold out at, along witht eh decent dividend, but selling at a profit wont send me broke 

SGN I sold out near their peak

NAB has recovered to be just slightly above where I sold out.

I'm not 100% decided if I did the right thing or not, but the investments I've moved the sales proceeds into have done all right, but i suppose taking into account how well AAD has done and the capital gains tax i paid, I'd probably have been better to have stayed how I was, thought the shares did all take a decent dive not so long after i sold out so at that point I was feeling quite chuffed.

My feeling is know why you bought the stock, then ask yourself if those reasons are stuill valid.  Maybe you don't know as much as you think you do, but a rational market doesn't bounce around as much as it does day to day.  So much of the "information" we can access is just noise.  

I'll admit it's sometimes hard to hold your nerve when prices are down 10%, but now I've gone through a few bounces I'm starting to have more confidence in myself.  I might change my tune if we do have a decent 20% correction, but I'm not confident in timing the market, but I keep an investment journal detailing why I do each trade and that has helped me to block out much of the noise that might make you want to jump out of the market.

If you can't handle the volatility go invest in bonds or pretend to invest in cash and let inflation eat away most of your investment gains.


----------



## DeepState

So_Cynical said:


> 1. Now introduce a big loser into your portfolio and your rebalancing exercise turns into a disaster as your constantly taking money from your winners and throwing it at your one big loser.
> 
> 
> 2. As i said in another thread, i don't think rebalancing can make anyone rich, name me one famous rebalancer? but it could help an average portfolio be a little better, but wouldn't make as much difference as say one really good stock pick, one big trend reversal and or emerging trend pick, buying Amazon or CSL at $5 and holding all the way will make a big difference.




Hi So_Cynical...

Thanks for your post.

Rebalancing is a stochastic process.  It involves chance.  It is like playing roulette as the house.  There will be times when some guy called Martin Gale walks in and takes out great winnings from you despite negative odds.  That's your big loser.  It happens.  But...if you are going to play, I'd rather be the dealer.  In the end, they are MORE LIKELY to get rich, but not assuredly so. The more you play, the more diversified the portfolio (table limits), the smoother the ride.

If your portfolio was going to hold that loser grenade, rebalancing will LIKELY help the portfolio you hold do better than if you did not rebalance.  It cannot choose stocks for you.

You post your results for others to examine.  I have examined. In a prior post, I mentioned I noticed your stats and that, for your HR to be as high as that you are either full of BS or a 1:840 billion investor OR writing gamma.  I don't think you are full of BS.  Let's get that out of the way.  I feel I understand what you are doing because I've managed to largely reproduce your results in my lab in less than an hour...actually, I've done better...and I'll even give the magic formula to all the RockStars on this site so they can reproduce it and attempt to contravene the casino's edge by altering the payoff.

From your stats and from the discussion on APN, it's clear you average down.  Your stats aren't done on a parcel basis but on a total trade basis, which is fine.  It's how the figures make more sense to me.

I was going on about all this option stuff thinking your wrote gamma.  You most likely had no idea what I was frothing on about.  You are, actually, writing synthetic put options into the market.  

Options pricing has certain deep assumptions at its heart.  These are the same assumptions from which rebalancing is built from.  They are cousins.  Given you write options, you should think stochastically or you are asking to die as you stand.  Like I said in a prior prost, you need to be rock solid if you are doing this.  You weren't trading options, but you are doing it synthetically.  Same same.  Stochastically, the edge lies with rebalancing. I think you mostly appreciate it.  But many seem to dismiss it on the grounds that other portfolio activity dominates.  It does.  Then again, a casino's edge is just about 3% in roulette.  Piss-ant. Somehow, it manages to build and finance Las Vegas, Macao, Sentosa Island, Monaco..... 3%.   

So, thanks for your stats.  Let's compare them with some of mine. I figure you are an Australian equity trader.  I just guessing.  So I took the ASX 200 data from July 2007 to yesterday.  Here's the decision rule:
Start with $1
Martingale up to 10 steps for every decline on a daily basis
Stop Loss at -$2
Exit trade $0.50
If you hit the Martingale limit, stop out.

You can muck about with the Stops and Exits, but the profitability remains superior for this period.

140 trades
Hit Rate 83%
Expectancy 56.24

This is the kind of result you get from writing synthetic puts.  

But I think I'm really stupid because a guy who doesn't know jack-sh*t  did better than me:

Buy and Hold (uhhh..markets go up):
1 trade
Hit Rate 100%
Expectancy cannot be determined.

So, now that we've established that you are an options writer, let's proceed to find some people who actually became rich.  Let's start with the little people.  There are around US $300bn in equities alone managed to this process.  Pure.  Not including the run of the mill portfolio tidying up.  These portfolios are generally earning about 2% above the indices they are tracking.   That's about $6bn a year coming out of the market and going to the little people from pure processes.  When alpha is zero sum, that puts them well ahead of average...enough to go to Las Vegas and spend a bit more than average.

Because you are writing options, someone else is actually picking them up.  Oh yes, they are.  Their names include Susquehanna, Optiva and Timber Hill.  These guys rebalance too.  In managing a book of options, these guys rebalance to tweaks on the market and continually straighten their book.  Let's see...who's the head of Susquehanna?  




His name is Jeff Yass.  He is a multi-billionaire.  He rebalances.  He also learned to trade by going to casinos where he learned odds.  He trains his employees by making them play poker for a year before they can get into the pit.

Meanwhile, going for giant wins on the stock selection is what equity hedge funds do.  Let's count the names who are truly awesome.  Baupost Capital, Third Point, Blue Ridge Capital, Pershing Square, Greenlight Capital (Einhorn is an awesome poker player), ... not many.  Meanwhile, the mortality rate of hedge funds is such that the median life is only 3 years.  In the spirit of balance, let's list the hedge funds who have toasted so much capital chasing big equity gains that they had to close their doors and disperse whatever was left....actually let's not.  It would number in the thousands.  Nice odds.

The boxes are there, take them, ignore them...it's up to you. I hope your education isn't too expensive.

Good trading to you.


----------



## muir

damdin said:


> Hi guys,
> 
> I have a question from experienced punters or investors. I am just wondering what has your hit and miss ratio been since you have started punting/investing on stocks. I am just wondering if it is possible to keep hit ratio over 50% in the long term. What I am saying is how many times you call turned out to be right compared to total call (including wrong call) for each specific time frame target?
> 
> Cheers




I wasn't going to comment but then decided to.

First, make sure this isn't an ego thing.

Here's what I mean.

It costs $1 to control a future's contract worth $117,000, $2 roundtrip.

If I put on a trade, say I sell, and after my order blinks as completed, I do not fell comfortable, it's best to cover and buy, screw the win/loss ratio.

So it went up a tick, or maybe or I buy at same price, I lose $2 or $10, and I feel lucky, that's all it took for me to know that now is not the time, maybe in 5 minutes maybe later, but not now.

Your question never even enters my mind.

And, yes others have pointed out that results versus losses are independent of a win loss ratio, but even here ego can intrude.


----------



## brty

Retired Young,

You have obviously been around the, traps, possibly working for one of the larger groups. Could you please tell us a little more about yourself and your career. You have come across as a little bit condescendingly in your posts, as if your answers/statements are the only correct way to do things.

However considering your posts in this thread, it occurs to me that you maybe speaking to the converted, in people who trade. By trading you are constantly re-balancing, either between cash and stocks, or between stocks.

The type of stock holdings your referring to with the rebalancing is large portfolio based, mainly buy and hold. The B+H approach seems to be an anathema to virtually all who post on these threads, whether FA or TA. There would be few that hold a core portfolio looking at the timeframe of forever(even FA gets overvalued, plus in TA stocks don't just go up forever).

Poor stock selection, and continued holding of poor stocks, from a limited portfolio, will send you broke. If you had HIH, One-tel and Pasminco as part of a 10 stock portfolio, then constant rebalancing will take more money from winning stocks into these that eventually went broke, all around the same time. 
So even with rebalancing, there must be a limit to what you add to any one stock.

It took me many years to learn to not add to losing stocks, I was a slow learner, made just about every mistake in the book.


----------



## DeepState

brty said:


> Retired Young,
> 
> You have obviously been around the, traps, possibly working for one of the larger groups. Could you please tell us a little more about yourself and your career. You have come across as a little bit condescendingly in your posts, as if your answers/statements are the only correct way to do things.
> 
> However considering your posts in this thread, it occurs to me that you maybe speaking to the converted, in people who trade. By trading you are constantly re-balancing, either between cash and stocks, or between stocks.
> 
> The type of stock holdings your referring to with the rebalancing is large portfolio based, mainly buy and hold. The B+H approach seems to be an anathema to virtually all who post on these threads, whether FA or TA. There would be few that hold a core portfolio looking at the timeframe of forever(even FA gets overvalued, plus in TA stocks don't just go up forever).
> 
> Poor stock selection, and continued holding of poor stocks, from a limited portfolio, will send you broke. If you had HIH, One-tel and Pasminco as part of a 10 stock portfolio, then constant rebalancing will take more money from winning stocks into these that eventually went broke, all around the same time.
> So even with rebalancing, there must be a limit to what you add to any one stock.
> 
> It took me many years to learn to not add to losing stocks, I was a slow learner, made just about every mistake in the book.




Hi Brty

In my (former) world, rebalancing is taken for granted.  We don't even debate it or think about it. It's like breathing. So I talk/write as if it is the only way to go because that battle was fought a very long time ago and decided.   So, sorry if this angle and posture has caused you and others offence.  I take it as given.  But this doesn't mean I should shout, but the same questions keep coming up in different forms, so I am repeating myself trying to communicate this issue from different angles explaining it's worth. But, I don't know anyone on this site personally - at least I don't think so, so I have no real interest in the outcome.   

A few years ago I had the privilege of leading a team of people who were amongst the smartest on the planet.  We used some amazing methods to extract money from the market on a large asset base measured in many billions.  We touched the sky.  As part of a very large global organization, I had the honor of working with some of the greatest investors in the world.  Many have gone on to become centi-millionaires.  They actually were RockStars.  I was just their opening act. But that was already beyond anything I could have hoped for.  

As for being a slow learner, if it is any consolation, I think my learning curve is as steep today as it was when I was 23 and just starting out. Everything was confusing. Every mistake that could be made - was. This business has a way of making you feel stupid all day long.  Welcome to investments.

To your question, poor stock selection will certainly send you broke.  Rebalancing would have a hard time overcoming very poor stock selection.  But so long as the decline is not straight down, but wiggles around, rebal has the opportunity to add incrementally.  It works best when you have more stocks, which is why I can understand the concerns when people on the thread think in terms of concentrated portfolios where there is a decaying situation. If the stock is plummeting rapidly and hardly wiggling, rebal can't help.  However, if you knew that, you should sell the stock.  If you don't know that, rebal is the way to go. Since perfect foresight is just a theory and the market is taken as a pretty good guess of what a stock is actually worth at any given time, rebal works out to be the best probabilistic move to take in the absence of an overwhelming insight. In a well diversified portfolio, the inclusion of an HIH etc. would not cost the portfolio too much relative to the gains that can be made from rebal. Hopefully that scenario is more evident and you can work your mind backwards to a scenario of increasing concentration.   

I suspect, but do not know, that the lesson you learned about not adding to falling stocks is something which you have learned because you've had large losses and these losses have been seared into your mind.   You may not have taken into account the potential profits of buying low and selling high encountered in less extreme circumstances that don't tend to leave lasting memories because they don't cause pain.  Rebal is not like Martingale.  The moves are much more slight and in a different ratio to the losses taken RELATIVE to the rest of the portfolio.  If this is true, you are experiencing something called representativeness bias...we used to make money from it - so watch out!  You might need to alter the meaning of the education you received.

Nice to meet you Brty.


----------



## DeepState

brty said:


> The type of stock holdings your referring to with the rebalancing is large portfolio based, mainly buy and hold. The B+H approach seems to be an anathema to virtually all who post on these threads, whether FA or TA. There would be few that hold a core portfolio looking at the timeframe of forever(even FA gets overvalued, plus in TA stocks don't just go up forever).




Brty

I didn't answer this bit of your question.  You're right. This concept largely makes no sense to people who think in terms of absolute returns by single stocks.  I'd say that is a large proportion of people here and agree that this is a major hurdle to overcome cognitively.  It is a framing issue.  They are framing by single stocks.  What matters is the portfolio.  Rebal the portfolio.

To their credit, some who must be thinking along single stock lines for the most part feel that they are doing a form of rebal.  This is usually thought of as being achieved by rotating positions. However, you need to rebal the non-rotated positions.  Replacing one with another in an otherwise unrebalanced portfolio isn't going to give you any benefit from this concept.  Otherwise, pretty much anything which trims stocks which have gone up and buys stocks which have gone down by enough such that any concept of a model portfolio is out of whack will do you.  This stuff is just trimming the sails.  But people who manage their portfolio this way, I think - but there will be exceptions, tend to hold very concentrated portfolios where this concept will hardly impact because there's not enough wiggling going on in the portfolio. It's very understandable, then, that this concept can be dismissed as irrelevant or a waste of time for them.

At this point, thanks for the thoughtful question actually, there is a decision to make in terms of the relative merits of concentrated portfolios and the benefit of rebal.  Let's say that, for the most part, a better result would generally be achieved by building a more diversified portfolio and having rebal as part of the management process.  If you have skill in picking stocks, it's hard for that skill to show through if you are focused only on a few of them.  It's like flipping a biased coin.  Flip it 5 times and anything can happen.  Flip it 100 times and the bias comes through loud and clear.  So the idea is to flip more coins, if you have the bandwidth, and rebal periodically over more of them for extra cream on top.  This is one reason insto portfolios are rarely more concentrated than 25 stocks and generally hold over 50, with some holding around 120 or more.

If you don't have bandwidth and must run a concentrated portfolio, results become much closer to random outcomes and rebal hardly does anything. In near random situations, much bigger mistakes get made and learning is much harder to obtain because there is so much randomness in what you are observing.  All in all, more diversification is usually thought of as a good idea....but some disagree.  Amongst those, you will find a very large dispersion of outcomes, but some will certainly shine through.


----------



## Ves

As a long-term fundamental investor,  who bothers to value stocks using DCF   (with full consideration to how arbitrary this is,  but accepting that this is your way of understanding the investment world),  why would you consider rebalancing without further consideration of the current valuation of the investment and the current yield vs what you are rebalancing into?

From memory rebalancing has its best effects when there is a massive differential between current yield in current portfolio vs rebalanced portfolio.

Buffett,  never did it,  and that says a lot.   He made plenty of comments on the concept too.


----------



## DeepState

Ves said:


> As a long-term fundamental investor,  who bothers to value stocks using DCF   (with full consideration to how arbitrary this is,  but accepting that this is your way of understanding the investment world),  why would you consider rebalancing without further consideration of the current valuation of the investment and the current yield vs what you are rebalancing into?
> 
> From memory rebalancing has its best effects when there is a massive differential between current yield in current portfolio vs rebalanced portfolio.
> 
> Buffett,  never did it,  and that says a lot.   He made plenty of comments on the concept too.




His Ves, nice to hear from you.

This is an absolutely stunningly great question.  Thanks for raising it.

The short answer is that, if you have a reliable insight, like Buffett, you should take it into account for rebal. In prior posts, I have mentioned that rebal is cream on cake and can be applied over whatever portfolio of stocks you think is right for you.  What matters is that you rebalance against the drift.

Since you do DCF, I'm going to dive in.

The purest theory of rebal goes like this...

For today, find me the best portfolio that 
Maximises [Expected return from stock selection over the next period until rebal + Rebal Profit Expected over that same period - LAMBDA x Risk - Transactions Costs of moving from the current portfolio] subject to restrictions

LAMBA is just a parameter to say how much you dislike whatever measure of risk is right for you.
Notice the Expected Return from Stock Selection part.  That's the part where you think stocks are cheap or rich.
But, note that there is room for rebal profits, which will tend to want to make the portfolio more diverse, move it to volatile stocks and find ones which are less correlated.
Risk is anything...risk of losing capital, volatility, less than inflation, less than your friend next door, less than market...
Then there are trading frictions which may or may not include tax, brokerage, spread and market impact.
Restrictions may be things like not sort selling, maximum exposure to cash, industry exposure limits.... whatever you can dream up which is important to you.

If you change your view about stocks, it will affect the portfolio in the direction you anticipate.  Rebal is not an excuse to turn your brain off.

Buffett has earned the right to place enormous weight on the Expected return from portfolio selection bit so it completely dominates considerations related to rebal.  But he's the only Warren Buffett there is.

As we move from Grand Master to mortal, the Expected Return from Stock Selection becomes much more like the expected return from the share market and rebal profit becomes more important no matter what your definition of risk.  One way to consider this, if your case is that your portfolio can be considered as the sum of two parts, is as follows:

+ Just being in the market at all; and
+ Your skill in beating the market.

As a buy and hold the above is possibly the most useful way of thinking, although other ways are reasonable too.  So, if you could otherwise just buy an ASX 200 ETF super-cheaply and it is the average of all investors in the market, but choose to manage actively, it is reasonable to say that "why bother" risk is performance relative to the ETF.  In that case, for reasonable levels of forecasting power, even enough that - if you worked in some major investment shop - would make you a centi-millionaire, you'll find yourself being asked to produce a fairly diverse portfolio where the lion's share of the skill in beating the market is derived from your stock picks, but where maybe 10-20% or so over time is derived from rebal depending on how tolerant you are of underperforming the ETF. The impact of rebal is not overwhelming, but nothing to sneeze at either and probably would be worth $50m to you in career earnings given how pointy pay for performance is.  Cream on the cake.

The less forecast skill you have, the greater the relative importance of rebal and the less that changes in your view will affect the portfolio....hope that makes sense.  In the absence of any stock selection skill, you just move straight to the pure rebal portfolio which tends to produce around 2% per annum outperformance in general over time and would be responsible for 100% of outperformance.  On average, skill is zero.  Hence, on average it is better for anyone to just hold a diverse portfolio and rebal and be done with it.  But almost everyone considers themselves to be above average and, in aggregate, places too much emphasis on the portfolio expected returns part and this is a probablistically bad thing to do.  

To more directly answer your question, you would think about your view on stocks before rebalancing.  If a stock rose, and your view became that is still cheap because of some development, the outcome would most likely be that you wouldn't rebalance the stock down or down by not as much.  It all depends on the strength of your view and, ideally, some notion of your abilities as a forecaster. You may even increase the weight.  In a prior post, I called rebalancing just a point of departure.  It isn't necessarily your destination.


----------



## Ves

DeepState said:


> To more directly answer your question, you would think about your view on stocks before rebalancing.  If a stock rose, and your view became that is still cheap because of some development, the outcome would most likely be that you wouldn't rebalance the stock down or down by not as much.  You may even increase the weight.  In a prior post, I called rebalancing just a point of departure.  It isn't necessarily your destination.



Certainly not trying to detract from your overall message in this thread,  because in my opinion you have communicated many thoughtful ideas that people worry about,  but this sums up the whole idea to me.

One other point of reference that potential long-term investors that may consider re-balancing should think about is the concept of deferred tax liabilities  (ie. free leverage) and its impact on compounding in the long-term.


----------



## DeepState

Ves said:


> .
> 
> One other point of reference that potential long-term investors that may consider re-balancing should think about is the concept of deferred tax liabilities  (ie. free leverage) and its impact on compounding in the long-term.




Absolutely, that would be caught in transaction costs.  The larger the liabilities which are unrealised, the more 'sticky' the portfolio tends to be to any movement, all things equal.

BTW what's "thought worry"?


----------



## Ves

DeepState said:


> BTW what's "thought worry"?



It's a typo.  Edited.


----------



## brty

Hi RY,

Thankyou for your insights into the market and on rebalancing. I certainly can see the merits on the larger scale. However, on the smaller scale I have great difficulty seeing any merit in a constant change. Transaction and tax considerations are going to kill any benefit in even a $500k portfolio of 20 stocks.

From RY....



> So, sorry if this angle and posture has caused you and others offence. I take it as given. But this doesn't mean I should shout, but the same questions keep coming up in different forms, so I am repeating myself trying to communicate this issue from different angles explaining it's worth.




No offence taken at all, just the scale and cost of doing business for someone in larger organizations makes a world of difference to performance outcomes compared to small individual traders that pay retail transaction costs (my assumption I'll check).

Looking at my own situation, I'm trying to look at how I would have performed over the last year if I had rebalanced instead of outright selling of stocks. It is a hard exercise as I have a different timeframe for different stocks. So I went back to about 28 months ago to see what the portfolio was then, and if I had kept, but rebalanced instead of trading for others, using the first 20 stocks I traded. The account size is in the hundreds of $k, so reasonable for many on this forum.
As I started doing this, just realized how long this will take, will have to get back to you. I've been trading my own account for over 34 years, still time to learn new tricks.

Again RV, thankyou for your contributions, I was just trying to portray how you sounded from a strangers point of view, I meant no offence and I'm glad for your contributions. Anything that makes me sit up, take notice, and do research is welcome.


----------



## damdin

muir said:


> I wasn't going to comment but then decided to.
> 
> First, make sure this isn't an ego thing.
> 
> ....
> 
> Your question never even enters my mind.
> 
> And, yes others have pointed out that results versus losses are independent of a win loss ratio, but even here ego can intrude.




You have misunderstood my question. It is not about ego and I understand that ratio does not mean anything if you can't manage your win and loss size. As I newbie I simply wanted to know from experienced guys if it is possible to keep the ratio above 50 percent in real world (I know it is pretty hard). Given the you manage your reward/risk accordingly I assume you are in profit, just to picture it in very simple term (even on 30/70 hit/miss ratio). Obviously managing reward/risk successfully is whole different topic to discuss and it is dependent on one's experience and skill, i guess.  

By the way it is good to hear an insight from even ex-professionals on long term strategy of the game and managing portfolio.


----------



## DeepState

brty said:


> Hi RY,
> 
> Thankyou for your insights into the market and on rebalancing. I certainly can see the merits on the larger scale. However, on the smaller scale I have great difficulty seeing any merit in a constant change. Transaction and tax considerations are going to kill any benefit in even a $500k portfolio of 20 stocks.
> 
> From RY....
> 
> 
> 
> No offence taken at all, just the scale and cost of doing business for someone in larger organizations makes a world of difference to performance outcomes compared to small individual traders that pay retail transaction costs (my assumption I'll check).
> 
> Looking at my own situation, I'm trying to look at how I would have performed over the last year if I had rebalanced instead of outright selling of stocks. It is a hard exercise as I have a different timeframe for different stocks. So I went back to about 28 months ago to see what the portfolio was then, and if I had kept, but rebalanced instead of trading for others, using the first 20 stocks I traded. The account size is in the hundreds of $k, so reasonable for many on this forum.
> As I started doing this, just realized how long this will take, will have to get back to you. I've been trading my own account for over 34 years, still time to learn new tricks.
> 
> Again RV, thankyou for your contributions, I was just trying to portray how you sounded from a strangers point of view, I meant no offence and I'm glad for your contributions. Anything that makes me sit up, take notice, and do research is welcome.




Brty

It's a pleasure.  You are absolutely right that t-cost considerations are important.  If you are hitting minimum trade limits, this is prohibitive. That's definitely a hurdle. Brokerage rates for the on-line services at the main banks are 0.11% or $20. Whichever rips you off more.

I ran a rebalance exercise out of interest.  It involved only stocks in the ASX 20 at the moment.  Due to some activity, data was missing for Westfield in the early years and I just left that out.  As it has been left out of both the unbalanced and rebal process, I hope you'll accept the study remains valid. The study was for the 10 years to June 2012.  For some reason my data vendor has problems dumping data for 2013 via this particular extract tool that I was using for annual returns, but I doubt it'll change the picture. It's an honest attempt at a demonstration.  Here's the figures.  I assumed ANNUAL rebalancing each 30 June.  Nothing could be simpler. Here are the results.  Please sit down...

Unbalanced portfolio starting at 1/19th in each stock in 2002: 9.63% per annum

Annual rebalanced portfolio to 1/19th for each stock without t-cost: .................................................  oh yeah................wait for it........................15.2% per annum.

Please jump around.

Now, that 5.5%pa difference is far higher than I would anticipate so luck was with the rebalance process and I'm not going to claim it.  But the point is that, for a $500k portfolio, if you rebalanced maybe 10 stocks out of your 20 - those with greatest deviation - the cost will be $200 max.  $200/$500k = 0.04% per annum.  That's tiny compared to the potential gains...not including tax or market impact.  Market impact for this trade size is essentially zero.  There is no rush, so sit on the limit order book.  Tax....that's yours to figure out.

I think that rebal remains valid for your portfolio despite not being a multi-billion active fund.  It would be valid for portfolios much smaller than you happen to be managing.

Best


----------



## brty

Hi RY,

Look at this bit from your sums, I'm surprised you didn't recognize the survivorship bias immediately....



> It involved only stocks in the ASX 20 at the moment.




A far better comparison is taking the ASX20 from 2002, and walking forward. The current ASX20 are where they are because they performed better than others over that period, with wiggles.

I am still working on mine, the old fashioned way, number crunching each trade to see the strengths and weaknesses. The portfolio is close to random with a scattering from different market segments and vast differences in size of company. I'm doing it quarterly over the last couple of years.


----------



## DeepState

brty said:


> Hi RY,
> 
> Look at this bit from your sums, I'm surprised you didn't recognize the survivorship bias immediately....
> 
> 
> 
> A far better comparison is taking the ASX20 from 2002, and walking forward. The current ASX20 are where they are because they performed better than others over that period, with wiggles.
> 
> I am still working on mine, the old fashioned way, number crunching each trade to see the strengths and weaknesses. The portfolio is close to random with a scattering from different market segments and vast differences in size of company. I'm doing it quarterly over the last couple of years.




Hi Brty



Thanks for being surprised.  This stuff was bread and butter for us.  The universe selection was deliberate.

Yes, the figures include bias because it includes stocks that are present in the ASX20 today.  The key figure of interest is the difference between the two sets of returns. Since the universe is identical for both the unbalanced and balanced portfolios the difference between them remains largely valid.

Actually, the use of this universe is actually meant to make things harder.  ASX 20 stocks or those that became them are less volatile.  For them to have become ASX 20 stocks or stayed there, they would have been successful in general.  Hence, the correlation between them is higher than the average random pick of 19 or 20 stocks.  Further, at least fundamentally and many people also think technically, the ASX 20 is almost impossible to make money from in a relative sense because it is so closely followed.  Lastly, it was only rebalancing over a relatively concentrated portfolio of 19 stocks.

Under these 'harsh' conditions for rebalancing, the worth of it shone through - by a margin greater than I would have expected.  I caution against the magnitude reported.  However, it demonstrates that rebal probably adds value over whatever portfolio you happen to be holding if given a chance to do so.

All the best with your own tests.  Just remember that everything is probability and whatever you find is just one draw from the biased pool.  On average, if you build portfolios pseudo randomly and did it a gazzillion times, it'll be as clear as daylight.  Pls also remember that, the presence of expected profitability from rebal is a given. You don't argue with gravity. And you shouldn't argue with rebal probablistically.   However, it remains just a point of departure or a default position unless you have a better idea which is strong enough to overcome it.  Hopefully the examples/rationale provided to Julia gives you a notion of how it is actually done in practice when pushed to the max.

BTW, we know a thing or two about Piotroski. It's useful. Rebal is about twice as profitable in a diversified long only portfolio. Yup.


Cheers


----------



## Julia

DeepState said:


> Pls also remember that, the presence of expected profitability from rebal is a given. You don't argue with gravity. And you shouldn't argue with rebal probablistically.   However, it remains just a point of departure or a default position unless you have a better idea which is strong enough to overcome it.  Hopefully the examples/rationale provided to Julia gives you a notion of how it is actually done in practice when pushed to the max.



 Um, can you say what examples/rationale were provided to me ?
I don't recall asking a question amongst this discussion.
My only participation in the thread has been a brief response to the OP on his apparent assumption that if he waited long enough a loss would reverse.


----------



## DeepState

Julia said:


> Um, can you say what examples/rationale were provided to me ?
> I don't recall asking a question amongst this discussion.
> My only participation in the thread has been a brief response to the OP on his apparent assumption that if he waited long enough a loss would reverse.




Whoops. My bad.  Sorry.  I should have written Ves. Apologies.


----------



## brty

RY,

If you really think using the current ASX20 as a means to prove a point, your assumptions are sadly mistaken. I could prove anything works better than just buy and hold using the stocks that make up the top of the tree now, with the benefit of hindsight.



> Actually, the use of this universe is actually meant to make things harder.




Utter garbage, this universe makes 'things' much easier to 'prove'.



> This stuff was bread and butter for us.




Hmmm. I've been involved with investing for 34 years, never was anything, bread and butter. There are always risks. Just ask LTCM, the masters of the universe, how the bread and butter trades are going, or for that matter Victor Neiderhoffer, again with bread and butter trading.



> Just remember that everything is probability and whatever you find is just one draw from the biased pool.




Has your tune already changed from always working? Especially when you quoted this.....



> This equation is water tight. Feel free to kick it around. We've had 30 years to do it and instead of being killed, there are entire institutes and huge firms devoted to it.




So which is it? watertight or one draw from a biased universe? I'm kicking it around, slowly but surely. I'll tell you my finding when I get there.


----------



## DeepState

brty said:


> RY,
> 
> If you really think using the current ASX20 as a means to prove a point, your assumptions are sadly mistaken. I could prove anything works better than just buy and hold using the stocks that make up the top of the tree now, with the benefit of hindsight.
> 
> 
> 
> Utter garbage, this universe makes 'things' much easier to 'prove'.
> 
> 
> 
> Hmmm. I've been involved with investing for 34 years, never was anything, bread and butter. There are always risks. Just ask LTCM, the masters of the universe, how the bread and butter trades are going, or for that matter Victor Neiderhoffer, again with bread and butter trading.
> 
> 
> 
> Has your tune already changed from always working? Especially when you quoted this.....
> 
> 
> 
> So which is it? watertight or one draw from a biased universe? I'm kicking it around, slowly but surely. I'll tell you my finding when I get there.





What the... ???

The analysis uses stocks in the top 20 now against another portfolio of stocks in the top 20 now.  The analysis takes place amongst those at the top of the tree under both situations.  Like for like. Same stocks. I am not showing analysis that says the Top 20 beat the next 20 or something, which is what you seem to be implying.  Top of the tree vs top of the tree.  It could easily be done for bottom of the tree vs bottom of the tree.  This would work very well for the, say, bottom half of the universe. The roots. What would you likely accuse me of then - deliberately aiming to torpedo the analysis?   They would be more reliable sources of value add via rebalancing, actually, over time, and would likely deliver a more favourable rebalancing profit than for stocks in the Top 20 whose characteristics in aggregate disfavor rebal profits.  The samples demonstrate that outperformance would have been earned by rebalancing amongst a universe of stocks whose characteristics are unhelpful to the value-add from rebalancing.

Once again: yes, there is survivorship bias.  However, both samples being compared are drawn from the same biased sample and are thus comparable.  I have not made any statements or claims about the portfolio of unbalanced stocks or balanced stocks outperforming anything else, no matter where on the tree they might happen to be.  Rebalancing profits are the difference between an unbalanced portfolio of stocks - however selected, biased sample or not - and their rebalanced counterpart.  These are reasonably compared.

Being aware of basics like 1+1 = 2 is bread and butter to me. It's an axiom. Perhaps you might disagree - to each his own.  Being aware of survivorship bias is the same. There's nothing to assume. You are just aware of it. In fact, if I wasn't capable of buttering my own bread and just plain idiotically forgot about it along with tying my shoelaces, I didn't even need to be aware of it on this occasion.  Both portfolios contained survivorship bias of the same source. I was mistaken, it's not even to the level of bread and butter. You are right to suggest survivorship is important to consider.  However, in this analysis, it's actually pretty much nothing at all for this analysis which is all that I am talking about here. 

When you work at 100x leverage at LTCM and make assumptions that don't hold tightly enough to handle the approximations in reality, that's not bread and butter either. Estimating reversion times for on-off the run bonds and other arb activity is nowhere near the axioms at the base of this simple concept. John Merriwhether and co-founding partner Victor Haghani were deliberately and knowingly pushing the bounds. What they were doing brought material risk to LTCM's solvency and they pushed well beyond their zone of comfort as liquidity availability failed to meet the demands of their growing AUM and greed.  That is agency risk.  John Meriwether blew a hole in Solomon Brothers and he also blew a hole in the hedge fund he set up after LTCM.  

This process is vastly different in its assumption load and any discrediting bread and butter like statements ought to be cogniscent of that before tarring everything indiscriminately. There's bread and butter and there is bread and butter. Is there any agency risk trying to convince a guy with a $500k portfolio to rebal?  Crikey!  I don't even get carry for all of this effort. Am I asking for a commission? Sheesh. The insto crowd would be shaking their heads for all the pushback I'm getting for handing money out, drizzling around the parks and streets.  And very pleased.  Hi guys - you've identified me already haven't you - life's good thanks. They are monitoring us you know.

Neiderhoffer's work required a lot of assumptions to come through at material leverage and it was found wanting.  He was bending assumptions and hoping they would be right.  They are judgments which you see fit to label as bread an butter. Maybe he felt like they were. For me, that's not bread and butter and I would not claim it was.  You don't do things for Soros that are bread and butter, I know because I worked with his former Head of Trading who was a creature of Wall Street.  What they were cooking up was some three-hat French restaurant dessert and the soufflÃ© fell over under the weight of all the elaborate decorations.  Nonetheless, it is reasonable to be skeptical when someone says that something is bread and butter and you feel concerned.  It has obviously served you adequately over your many years of investment and an important part of this game...is to stay in it.

The equation is water tight.  Feel free to unfurl it and find fault with it. Please. If it's wrong, I need to know.  You and I will then have to spend the next 34 years re-writing the textbooks and on the speaker circuit. You can choose whether you want to be the straight guy or funny guy.  I'm flexible.  It states that rebalancing will probably help you achieve a higher return than a portfolio of unbalanced securities amongst other things.  This probability improves with time. I have not changed my tune.  I have repeated the probabilistic nature of this several times. And then some. The two are perfectly consistent.  My statement is drawn from the equation.  It may sound inconsistent because, from what I have encountered, thinking probablistically is very unnatural.  Most seem to think of single scenarios...like hold all the way down..or missing out on huge upside...and focus on that.  

All the best with your own analysis on your own portfolio.  It is important to remember that the wiggles in your portfolio are but one path in a garden of forking paths (actually, in your case, it is a 20 dimension hyperplane - try picturing that in your head!).  Most of those paths will lead to outperformance.  The longer you meander, the greater the likelihood of this being the case.  A backtest of a single portfolio over 28 months balancing quarterly is going to have a hard time proving anything in of itself, good or bad.  However, that doesn't diminish the fact that it may be important to you and will help you come to whatever decision is right for you.  

If you have the time, try it with all sorts of portfolios that, had things been different, you might have otherwise held and run it back over a longer period of time.  Do that enough, and I don't need to await your results...it's already in the equation.  And, seriously, this equation is not vaguely disputed by those who do this stuff for a living. Before you say it, this is not like flat earth etc... either. So if your facts don't happen to match the theory - in this case - maybe you might need to get more facts.

All the best with it.


----------



## CanOz

DeepState said:


> You can choose whether you want to be the straight guy or funny guy.  I'm flexible.





ROTF....


----------



## brty

My conclusions, though not complete, are clearly showing a trend. Rebalancing in a portfolio of stocks, where some trend down over the time period selected, is much worse than buy and hold.

In a random portfolio that ended up with 10 stocks going down in price (some of these were positive when dividends were added) 1 that stayed flat(positive with divs) and 9 that went up in price, when all dividends were added to the pool during rebalancing, yet just added to the total for buy and hold, the buy and hold finished 27% ahead, before commissions and taxes were added to the cost of rebalancing.

The reason is clear, there were 2 outstanding stocks that had major outperformance. Rebalancing killed off the excess profit from those. The losers were kept in the portfolio, and at the end of the period, these had large holdings, yet had continued to go down in price, in the rebalanced portfolio, yet stayed a lower percentage of the buy and hold portfolio.

The figures quickly, start $500k, 20 stocks with an equal dollar investment, ie $25,000 or slightly less rounding to the nearest share.

Rebalancing quarterly adding dividends into the mix for the rebalance, finished at $570,541, before subtracting costs for the rebalance, roughly $400/Qr for commissions. As you would be selling winners only (usually), there is a considerable tax payable as well. There was no need to work this out as it subtracts from rebalancing even more. For example the selling of winning shares in the first quarter alone was $25,898, despite the portfolio being down $6000 in total at that point. You would be creating a current tax liability while losing money on the entire portfolio. Not smart!

Straight buy and hold, with just the dividends added at the end and not redistributed to the shares, finished with $589,714. 

By the time you added commissions and taxes to rebalancing, while allowing buy and hold to go into Cap gain lower taxes territory, the buy and hold probably outperformed by over 35%.
Rebalancing, which is really stealing from winners to add to losers clearly does not work in the real world where stocks go down and some stay down.
If the universe of stocks included only the stocks that went up in price, say the current ASX20 from 10 years ago, then yes it probably works.

Is anyone prepared to say the current ASX20 will be the same in 10 years time? I'm certainly not.

The stocks used were STO, BSA, OKN, GAP, NBL, MND, AGK, BHP, CAB, NWH, GUD, SHV, ROC, CYG, TGR, RDM, AGO, MGX, NCM, NST. The start date was 9/2/2012, finish 10/2/2014. Closing prices were used.

 I traded all the above stocks, in that order, at totally different prices from those on 9/2/2012. This portfolio vastly underperformed the indexes over the time period, my personal results were different.

I was skeptical of the gains claimed, now I'm absolutely certain.

Thankyou RY for making me do the exercise, it was enlightening.


----------



## burglar

brty said:


> ... Thankyou RY for making me do the exercise, it was enlightening.



@brty
I have read RY's posts and found them entertaining!
According to his moniker he retired young.

Read your posts over many years.  Also found them entertaining!
According to your signature, you made your money selling too soon.

So now, I'm torn! :


----------



## brty

Hi Burglar,

I'm happy to hear you find my posts entertaining, some of them anyway.

This thread seems to have gone awfully quiet, perhaps it was something I said.

Sorry my fault.


----------



## Julia

brty said:


> This thread seems to have gone awfully quiet, perhaps it was something I said.
> 
> Sorry my fault.



Nothing to apologise for imho.
My only criticism of your posts, brty, is their infrequency.  Over now many years I've read from you not especially entertainment, but sensible, mature comments which reflect your obvious experience.


----------



## DeepState

brty said:


> 1. In a random portfolio that ended up with 10 stocks going down in price (some of these were positive when dividends were added) 1 that stayed flat(positive with divs) and 9 that went up in price, when all dividends were added to the pool during rebalancing, yet just added to the total for buy and hold, the buy and hold finished 27% ahead, before commissions and taxes were added to the cost of rebalancing.
> 
> Rebalancing quarterly adding dividends into the mix for the rebalance, finished at $570,541, before subtracting costs for the rebalance, roughly $400/Qr for commissions. As you would be selling winners only (usually), there is a considerable tax payable as well. There was no need to work this out as it subtracts from rebalancing even more. For example the selling of winning shares in the first quarter alone was $25,898, despite the portfolio being down $6000 in total at that point. You would be creating a current tax liability while losing money on the entire portfolio. Not smart!
> 
> 
> 2. By the time you added commissions and taxes to rebalancing, while allowing buy and hold to go into Cap gain lower taxes territory,
> 
> 
> 3. Rebalancing, which is really stealing from winners to add to losers clearly does not work in the real world where stocks go down and some stay down.
> 
> 
> 4. If the universe of stocks included only the stocks that went up in price, say the current ASX20 from 10 years ago, then yes it probably works.
> 
> 
> 5. Is anyone prepared to say the current ASX20 will be the same in 10 years time? I'm certainly not.
> 
> 
> The stocks used were STO, BSA, OKN, GAP, NBL, MND, AGK, BHP, CAB, NWH, GUD, SHV, ROC, CYG, TGR, RDM, AGO, MGX, NCM, NST. The start date was 9/2/2012, finish 10/2/2014. Closing prices were used.
> 
> 
> 6.  I was skeptical of the gains claimed, now I'm absolutely certain.
> 
> 
> 7. Thankyou RY for making me do the exercise, it was enlightening.




Wow.  I certainly am impressed.

Let's examine the results.  I have used the same universe as you have conducted the analysis from.  Very good of you to allow your tests to be examined.  Research dates are 1/1/2012 to 31/3/2014 to allow clean quarterly rebalancing but otherwise are a representation of the same investment period.  I trust they are satisfactory from a survivorship or whatever bias given you were prepared to use it.  The data included dividends reinvested as per research convention.  They are easily obtained from the ASX or your favoured data vendor.

1. I mentioned earlier, that every portfolio history is just one journey from a garden of forking (got to check my spelling) paths. Just one.  And this assertion is a probabilistic one.  This message hasn't come through.  So let's step it out.

I have taken the selection universe of 20 stocks.  We form portfolios in 10% blocks.  So each portfolio we are testing contains 10 blocks of 10% initial weight.  We then truly randomly build portfolios consisting of 10% blocks taken from the universe of 20.  One path in a garden of forking paths.

This simple Monte-Carlo selection method for building portfolios allows for several paths...each of which is at least as valid as the one random portfolio reported.  Feel free to question it...it just is. But just in case this helps, I have run the numbers for a 20 unit portfolio, each of 5% which allows up to 20 stocks in the portfolio and the results are stronger than the ones I'll show below.

How many paths are there for the really simple 10 unit portfolio?  So many that, if we were to process a portfolio per millisecond (one-thousandth of a second), and assuming the age of the universe is 13.8 bn years as is generally assumed by astronomers and physicists at present, it would need 630 million times as long to check every one.  That's a lot of forking paths to explore.  

So, given I can't spend all day, let alone 630 million universe years (sure makes dog years pretty trivial), doing this stuff, I'm going to do what everyone else does who understands stochastic processes and has not been able to communicate closed form solutions despite copious efforts - we're going brute force.  This is called a Monte-Carlo simulation.  It just tries to bring to life what is hard to comprehend behind some squiggly lines full of symbolic stuff.

So, I'm going to make a horrific assumption that a sample of 10,000 portfolios consisting of up to 10 stocks will do and we'll run it through.  Oh, if you checked the trivial example of equal weighted stocks in the entire universe at commencement to see where that went, a portfolio of equal validity to any that could be chosen, you'd find that the cumulative return of the unbalanced portfolio was 35.12% vs the rebalanced result of 39.17.  Not to shabby. Anyone out there can verify it.  Now we have one random portfolio vs another.  Reds-1 vs Blues-1. 

So, what do the results reveal?  From 10,000 (since I ran the 20-unit portfolio too, it is actually more like 20k vs 1 - and Themistokles  thought he was having a bad day) draws vs 1.  Well, blow me down...the average unrebalanced portfolio return was 34.99% over the period.  This compares unfavourably with its MATCHING rebalanced portfolio counterpart which outperformed by 39.21%.  Again, not too shabby over a short period like we are examining.

The chances that this is due to luck as developed by 2-sample t-test on a two-tailed basis (given rebal is being contested, we test for 2-sided instead of one.  But what the heck, check the p-tests if you want to quibble) is less likely than drawing 4 ROYAL flushes in a row from a clean deck of cards.  That's pretty special. $1 per draw down at Monte-Carlo and four hands later you'll have a couple of million bucks. Keep your winnings in play, assuming anyone could stake you and you'd be richer than all the universe....and then some.  Better than Rain Man.   Also, the likelihood of the rebal portfolio achieving a superior outcome to the unrebalanced portfolio was 60%.  That's a whopping edge when sample sizes are this big, but I am talking to Rockstars (not you, unless you voluntarily wish to be classified as such) who think in terms of certainty - so we'll move on. 

There is overwhelming statistical evidence that rebal works in the universe which has been specified and the time period used.  This result overwhelms any inference that can reasonably be drawn from a single random portfolio.  Four thousand portfolios created in this sample underperformed as well.  But six thousand outperformed.  This is a probabilistic process.  Like everything else in investments except pure arbitrage.  It is quite outlandish to draw an inference from a single draw in a stochastic process.  It is like using Newtonian Laws in the world of relativity and quantum mechanics.  Whatever world that is, it's not the real world.  It's the stuff of Laplace. And it's so 17th century.  

The longer the time period, the higher the probability of success.


2.  Let's see.  Didn't we already go through this on Commissions? $500k portfolio.  Minimum expenses $20 per trade.  Trade quarterly. - which is actually stupid because the people who do this don't just get smacked in the head by expenses but think about it.  If we rebal all 10 stocks each quarter, brokerage is approximately 0.5% per annum.  Tax?  Let's say the stock market goes up 10% per annum or 7.5% real before franking. Feel free to muck about up to +2% before you start being put on CNBC as entertainment fodder. 4% is dividend.  6% is cap gain.  This is rebal...it doesn't generate full portfolio turnover every tick of the clock. They are small movements. Pensions are not taxed - but let's make that explicit...NOT TAXED.  Superannuation taxes cap gain at 15% worse case.  Top Tax rate at around 50%. So let's be nuts. Full turnover in a year will generate 3% tax cost for top tax bracket.  Full turnover in a year for Pension will generate 0.9% cap gains.  If you know anything about tax at all, you'd know that you have discretion around tax parceling and can use modified HIFO standard, you will also reinvest dividends which creates 4% fresh parcels per year, and you might even have savings contribution going in if you happen to be in anything other than pension - and even then. Turnover is frequently reverse as might be expected. All this keeps your parceling fresh and allows low tax cost turnover for anything that is vaguely in the zone of the real world.  Then, if you still want to hold out on this argument, you can lock out stocks with no fresh parcels from any rebal.  Please see Ves correspondence for how it is actually done.

Woosh...hurdle cleared.  If not, then why are you trading at all?  Any trading activity outside of rebal freshens parcels. It is a valid concern for embedded capital gains in place.  But parcels freshen with cashflows.  If you have negative cashflow, you are probably in pension phase. If you happen to be in the situation of drawdown at max tax rate, there is a balancing act, but the basics apply.


3. Yes it does, welcome to the real real world.  Take the Blue pill Neo.


4. In the universe of stocks provided, there were 7 that recorded negative returns over the period inclusive of dividends: BSA, MND, NWH, GUD, AGO, MGX, NCM.  Building a trivial portfolio of equally weighting these and comparing the unbalanced vs rebalanced portfolios yields...are you getting tired of this yet (?)...unbalanced -31.57% vs rebalanced -27.37%.  Rebalancing adds probable value to any portfolio, including those consisting of stocks that go down - including portfolios consisting entirely of stocks that go down - so long as they wiggle on their merry way to oblivion.


5. Per discussion with MichaelD, this process works if a monkey or astrologer, or monkey who is an astrologer, with a low IQ threw 20 darts and randomly selected stock names. New dart throws can take place every period.  It doesn't matter if the monkey was trained by NASA. It doesn't matter if the stocks come from the top, bottom or inside out 20. They can be random numbers as long as they wiggle.  Please go ahead and run 10,000 tests and verify this for yourself (you are not the monkey - whether astrologer or other).  But in tests, they actually used monkeys to prove the point.


6. I wouldn't be so sure.  But that's me.  This is not bread and butter.  Further, it is probabilistic.  So there is always the chance that a single draw won't add value.  There is no certainty in a world where Heisenberg exists. To reject rebal with certainty seems...somewhat unsupported.


7. Likewise.  It's been fun.  All the best with it.


----------



## brty

Julia,

Thankyou for the kind words. I usually don't say much because I don't like getting into arguments on forums. There are so many posters that post so much rubbish that I tell myself to just let it go after putting forward my point of view. Hence I don't post that often.

Every now and again though, a person or group of people propagate a load of tripe and I get involved, the thread on CFU comes to mind here. Then there are those claiming to represent the masters of the universe, have all the answers and use big words to impress the uninitiated poor traders looking for the secret to investing/trading.

RY, I don't have time tonight, perhaps tomorrow, but congratulations for turning a losing portfolio into a winning one by changing lots of parameters, something that is stunningly easy to do with hindsight.


----------



## TPI

DeepState said:


> Wow.  I certainly am impressed.
> 
> Let's examine the results.
> 
> ...
> 
> It's been fun.  All the best with it.




You sound very knowledgeable and this all sounds great for institutional or high-net worth investors.

But this is not the "real world" for retail investors.

In their world, they have most of their wealth tied up in their own home, residential investment properties, own business premises, commercial investment properties, cash in offset accounts etc.

And of course they pay taxes.

The dominant purpose of investing for these people is to fund a retirement in the long-term and extract themselves from jobs they don't like in the short to medium-term.

ie. Objective/outcome/purpose/"liability"-driven investing. 

Rebalancing is not that relevant here, though I don't doubt your evidence.

And it obviously only works for highly liquid assets like listed shares.

Perhaps you have paid off your home loan, and have millions in highly liquid assets, more than enough to meet any retirement income requirements - if so, then these academic theories may have more practical application to your situation, but this is not the norm.

You must have read Buffet's last annual report and his statements about his old farm house property?

And Yale's David Swensen's advice to institutional investors as distinctly opposed to retail investors?


----------



## DeepState

TPI said:


> 1. this all sounds great for institutional or high-net worth investors. But this is not the "real world" for retail investors.  In their world, they have most of their wealth tied up in their own home, residential investment properties, own business premises, commercial investment properties, cash in offset accounts etc.
> 
> 
> 2. The dominant purpose of investing for these people is to fund a retirement in the long-term and extract themselves from jobs they don't like in the short to medium-term.
> 
> ie. Objective/outcome/purpose/"liability"-driven investing.
> Rebalancing is not that relevant here.
> 
> 3. And it obviously only works for highly liquid assets like listed shares.
> 
> 
> 4. You must have read Buffet's last annual report and his statements about his old farm house property?




I'm really glad you've jumped into this discussion.  You are obviously in the game and I look forward to learning heaps from you.

Believe it or not, I could care less if anyone takes this concept up.  I am just responding to queries and trying to bring factual truth to the surface and getting my concept of truth better honed.  Rebal is a tiny part of investing and I'm sprouting off like an academic having to defend real world activity like I've never seen daylight when I used to have ~$100m daily VaR 95 and know just a little bit more than this concept and stuff out of textbooks.

1. I think this is an extent issue.  If the meaning of your statement is that the pots of money are too small to spend effort with rebal in person, then I tend to agree that the point is relevant for accounts maybe <250k or something, but not because of irrelevance.  People on this site, Aussie STOCK forums, tend to be more inclined to manage their portfolio intensely and the portfolio size of relevance can drop further, particularly as portfolio concentrations tend to be correlated with AUM ie. smaller number of stocks for smaller AUM - in general but with plenty of exceptions.  The tax figures are as per above and t-cost is more of an issue but readily overcome by trimming the rebal only for extreme misweights. So, economically, it remains valid for smaller portfolios than HNW or insto.  Further, there are $300bn in AUM managed to such strategies in pure form and plenty plenty plenty more than uses it at the periphery which they can access and live pretty quietly on without any more effort than setting up another mutual fund purchase where AUM can get very small.  So it is relevant well below the thresholds you are talking about - I believe.


2. If something makes more money, then it will help you to achieve your financial goals sooner.  You know the compound math for a simple increment of 1%.  Let's do it for the viewers.  Aged 45, a $100k portfolio earning 8% per annum after all frictions accumulates to $466k by 65 and if this were boosted by 1%, a figure which I hope you can see is achievable from the above and is actually below the margin earned by intense rebal processes, that figure rises to $560k.  What's so irrelevant about that?

I am, as it turns out, thoroughly familiar with liability matching, target based investing , life cycle investing and on and on.  Rebal remains relevant.  Any matching asset brings risk of mismatch unless we can construct perfect matching streams on assets and liabilities.  That situation only exists in the first chapter of introductory books that deal with this stuff.  All practical problems in this field are just degrees of matching to the investor objective whose own liability stream is not even known for reasons of inflation, death, and so on.  Even target return funds - what a joke - seek to hit their target stochastically - and have fallen into complete disrepair when everyone discovered sequencing risk.

You have to look into a microscope to see the impact that any reasonable rebal has on the gross features of a portfolio.  The greatest impacts, as you are undoubtedly aware, are driven by macro, common factors.  Just being in equities or bonds totally dominates the risk arising from marginal yet profitable activity like rebal.  Go ahead and do the variance decomposition and you'll find that you can't find rebal greater than 1% of overall risk contribution.  Yet it's so profitable.  In absolute or relative space, this concept is worthy.


3.  It works best for liquid assets for all practical reality.  Agreed.

But if you have made the decision to be in shares, why not work it hard?


4.  Indeed I have.  Pls read entry #55 of this thread.

I am utterly indifferent about whether people do this.  I just hope it's clear enough now that a decision not to do it comes with probabilistic economic opportunity costs.  If you find $50 on the floor and are a retail investor with all sorts of other investments and savings objectives, no-one here is saying you HAVE TO pick it up.  But, after conducting a time-motion study and weighing up my alternative uses for the time it takes to bend down and do it, it's likely to be worth it in a financial sense in my case.  Maybe others are in a different situation.


----------



## burglar

DeepState said:


> ... the pots of money are too small to spend effort with rebal in person, then I tend to agree that the point is relevant for accounts maybe <250k or something, but not because of irrelevance ...




Some here have smallish accounts because they are unsuccessful ...
But "winners are losers who keep trying!"

(I don't know who to attribute that saying to)


----------



## DeepState

burglar said:


> Some here have smallish accounts because they are unsuccessful ...
> But "winners are losers who keep trying!"
> 
> (I don't know who to attribute that saying to)




Hey champ.  It's the cost of education as RoE more or less implies or says.  A Harvard/Stanford MBA costs around USD 100k including various costs.  It opens a lot of doors and is readily repayed.  If the quote refers to you, may your education be fruitful and your future success assured.


----------



## McLovin

RY

I have enjoyed your posts in this thread. Plenty to mull over and a good discussion.


----------



## DeepState

McLovin said:


> RY
> 
> I have enjoyed your posts in this thread. Plenty to mull over and a good discussion.




I enjoyed our discourse.  I look forward to many more.  You are seriously smart and reasoned (been trailing your thoughts) and I'm a huge fan.


----------



## burglar

DeepState said:


> Hey champ.  It's the cost of education as RoE more or less implies or says.  A Harvard/Stanford MBA costs around USD 100k including various costs.  It opens a lot of doors and is readily repayed.  If the quote refers to you, may your education be fruitful and your future success assured.




Ok. Yah picked me!
Not just me, but many others.
We find our portfolios do not balloon whilst we learn.

Stock market investment is not my life.
It is my hobby.

So far it is cheaper than boating or 4wheel driving!


----------



## brty

RY,

I haven't had time to go through all of your long post today at all, but just had a quick reread, and this springs up...



> There is overwhelming statistical evidence that rebal works in the universe which has been specified and the time period used.




That is just garbage. In the real world the rebalancing cost money over buy and hold during the period, thousands of dollars before transaction costs or tax, both of which in reality are higher than you make out. It is a shame my duaghter who is doing a Phd in statistics left after visiting yesterday before you posted your post. Next time she is home I'll show her your statistical insights and get comments from her.
Needless to say though, your tune on rebalancing changed as the real world example, that lost money (compared to buy and hold), went through it's changes. 
Instead of just using the example, you changed the example to a universe of stocks. No it wasn't, it was a group of stocks in a theoretical portfolio of 20 stocks, not 10, nor 10 groups of 2, all of which are changes in parameters to prove something works that clearly did not.

Running Monte-carlo simulations is something that Tech/A does, I don't, as I don't agree with the assumption that anything can happen. Clearly price movements are in responce to real world events/prices, not statistical outliers that have no chance of occurring in the real world.

Rebalancing is just a fancy way of re-stating averaging down, by selling your winners on a regular basis to add to your losers, the results of my small study highlighted this. If I were to continue andjust one of the stocks continued to go down in price and then get delisted, over a period of years, the entire funds of the portfolio would be directed toards that one stock, a rediculous situation. Yet that is where re-balancing leads.

If I get time, I will go back over that portfolio and instead of rebalancing, do the opposite, add to winners and cull the losers to see where it would lead. my real life trading experience tells me it will work well, especially asI have the advantage of hindsight to optimise it. However I will do several different types of adding and culling.
I may even do a live real time thread on trades with a small $100k portfolio to see where it leads as I will have plenty of free time thanks to surgeon, shortly.


----------



## DeepState

brty said:


> RY,
> 
> I haven't had time to go through all of your long post today at all, but just had a quick reread, and this springs up...
> 
> 
> 
> 1. That is just garbage. In the real world the rebalancing cost money over buy and hold during the period, thousands of dollars before transaction costs or tax, both of which in reality are higher than you make out.
> 
> 2. It is a shame my duaghter who is doing a Phd in statistics left after visiting yesterday before you posted your post. Next time she is home I'll show her your statistical insights and get comments from her.
> 
> 3. Needless to say though, your tune on rebalancing changed as the real world example, that lost money (compared to buy and hold), went through it's changes.
> 
> 4. Instead of just using the example, you changed the example to a universe of stocks. No it wasn't, it was a group of stocks in a theoretical portfolio of 20 stocks, not 10, nor 10 groups of 2, all of which are changes in parameters to prove something works that clearly did not.
> 
> 5. Running Monte-carlo simulations is something that Tech/A does, I don't, as I don't agree with the assumption that anything can happen. Clearly price movements are in responce to real world events/prices, not statistical outliers that have no chance of occurring in the real world.
> 
> 6. Rebalancing is just a fancy way of re-stating averaging down, by selling your winners on a regular basis to add to your losers, the results of my small study highlighted this. If I were to continue andjust one of the stocks continued to go down in price and then get delisted, over a period of years, the entire funds of the portfolio would be directed toards that one stock, a rediculous situation. Yet that is where re-balancing leads.
> 
> 7. If I get time, I will go back over that portfolio and instead of rebalancing, do the opposite, add to winners and cull the losers to see where it would lead. my real life trading experience tells me it will work well, especially asI have the advantage of hindsight to optimise it. However I will do several different types of adding and culling.
> I may even do a live real time thread on trades with a small $100k portfolio to see where it leads as I will have plenty of free time thanks to surgeon, shortly.




Nice to hear from you.

1. Where were my assumptions off?  The commissions assumptions matched yours.  The tax rates are the tax rates.  Do you think we should factor in long term returns of 20% per annum or something outrageous?  Do you think turnover of a rebal portfolio exceeds 100% per annum?  Do you think you will move markets when you conduct non-urgent trades and sit on the limit order book?  Do you think that the Tax Act is different to the one in Australia?

2. You must be proud. Sure, ask her about a two sided, two sample, t-test is and what a P-value less than 0.000000001 implies for the hypothesis of H0 (buy-hold equals rebal) vs H1 (buy-hold is different to rebal) on a sample of 10,000 where mean(rebal) > mean(buy-hold).  She would have learned it in Statistics 101.  So did I.

3. Where was the tune changed?  I think I've been humming this Top 40 hit throughout.  The equation is water tight and this is a probabilistic stochastic process (your daughter would nail this).

4. You haven't had the chance to read the post and absorb it. I made mention that I also ran this for 20 stock portfolios.  The results were superior to the ones I reported for the 10 stock example.  

5. The Monte Carlo (ask your daughter again about whether it is useful for testing stochastic processes, I studied it for 6 years and have made a tidy sum from it in the - OMG - real world.  You will find that Monte Carlo is used all the time for statistical inference and in econometrics.  Further, rather than returns gleaned from investment fairies, I used the ACTUAL returns from stocks in your universe.  These aren't made up.  They are available from the ASX.  They take into account everything you mentioned because they are real and actually happened.  This was clearly stated, but you didn't have time to read it carefully.

6. If you hold a portfolio of stocks and they get liquidated, rebal is toast.  Guess what, so is buy-hold.  If you argue that you'll get out of the dog stocks, great.  Rebal is just added to that too.  It is not either or.  Refer post to Ves #55.

7. Thanks for that tickler.  Ask your daughter about Monte Carlo and hindsight bias from within sample analysis for the purposes of a within sample analysis. Let her tell you about hindsight bias.  I have no idea what portfolios are going to be formed.  They are randomly generated.  All other data was drawn from the example you provided.  If you think this is hindsight bias...have a chat to your daughter and see if your life experience improves.

Brty, in all seriousness, please do what you want with your money.  In my useless and inexperienced opinion and the useless opinion of $300bn managed to this process (btw, I do know these Masters of the Universe, I have their private numbers and we chat over lunch about many things including bicycle training methods and why certain behaviours and stickiness of beliefs will pump out more returns - but I do not claim to represent them.  I just know what they do and think it makes sense), and trillions which practice it in equity portfolios alone let alone the trillions more in multi-asset class portfolio who believe in it with entire agencies set up to research further into it - who employ the best of the best many of whom have a couple of PHD's and then some - think it works.  You, of course, may know better. Good for you.  Pretty awesome.  Light must shine from you.

Please ask your daughter to check the formula and explain it to you and tell you it isn't BS. I gave you the references and originating author in prior posts. Just send these through on email or pigeon. If she finds it to be BS, tell her to check again or write a book and get on the lecture circuit.  If she doesn't understand it, ask her to give it to the Professor of Finance at her favourite university for verification. They probably will take one second after seeing who the authors were and probably read that exact paper years ago.  I have tried and failed. 

Bad trade. Stop loss.  Position closed at a net loss with major slippage before allowance for tax and commission.  

All the best with it.


----------



## cynic

DeepState said:


> Nice to hear from you.
> ...
> 6. If you hold a portfolio of stocks and they get liquidated, rebal is toast.  Guess what, so is buy-hold.  If you argue that you'll get out of the dog stocks, great.  Rebal is just added to that too.  It is not either or.  Refer post to Ves #55.
> ...



Guess What?

Unsurprisingly, you've conveniently misconstrued a perfectly valid argument against the case for rebalancing.

Did you really think we wouldn't notice?

Many of us are already aware of how terribly easy it is to derive a living from managing billions of dollars of other peoples' money. Try doing it with your own funds and see how well your fanciful and idealistic investment theories work. 

Do you think you could survive a whole year, solely reliant on investment returns from a sub six figure sum (i.e. <$100k) without diminishing your capital or drawing income from other sources? 
(I believe that some of the posters challenging your rebalancing claims are able to do this! The question is, with all your purported financial "wisdom" could you?!!!)


----------



## TPI

DeepState said:


> Believe it or not, I could care less if anyone takes this concept up.  I am just responding to queries and trying to bring factual truth to the surface and getting my concept of truth better honed.




Yes, same as many of us here.



DeepState said:


> Rebal is a tiny part of investing and I'm sprouting off like an academic having to defend real world activity like I've never seen daylight when I used to have ~$100m daily VaR 95 and know just a little bit more than this concept and stuff out of textbooks.




It is a small part, what other similarly simple strategies do you think give investors an edge?



DeepState said:


> 2. If something makes more money, then it will help you to achieve your financial goals sooner.  You know the compound math for a simple increment of 1%.  Let's do it for the viewers.  Aged 45, a $100k portfolio earning 8% per annum after all frictions accumulates to $466k by 65 and if this were boosted by 1%, a figure which I hope you can see is achievable from the above and is actually below the margin earned by intense rebal processes, that figure rises to $560k.  What's so irrelevant about that?




This is fine if your focus is on total returns.

For people who invest to provide _passive_ income to meet expenses, retire or follow other passions, the income component is more important. 



DeepState said:


> Any matching asset brings risk of mismatch unless we can construct perfect matching streams on assets and liabilities.




It doesn't have to be perfect in practice though.


----------



## craft

DeepState said:


> Let's examine the results.  I have used the same universe as you have conducted the analysis from.  Very good of you to allow your tests to be examined.  Research dates are 1/1/2012 to 31/3/2014 to allow clean quarterly rebalancing but otherwise are a representation of the same investment period.  I trust they are satisfactory from a survivorship or whatever bias given you were prepared to use it.  The data included dividends reinvested as per research convention.  They are easily obtained from the ASX or your favoured data vendor.
> 
> 1. I mentioned earlier, that every portfolio history is just one journey from a garden of forking (got to check my spelling) paths. Just one.  And this assertion is a probabilistic one.  This message hasn't come through.  So let's step it out.
> 
> I have taken the selection universe of 20 stocks.  We form portfolios in 10% blocks.  So each portfolio we are testing contains 10 blocks of 10% initial weight.  We then truly randomly build portfolios consisting of 10% blocks taken from the universe of 20.  One path in a garden of forking paths.
> 
> This simple Monte-Carlo selection method for building portfolios allows for several paths...each of which is at least as valid as the one random portfolio reported.  Feel free to question it...it just is. But just in case this helps, I have run the numbers for a 20 unit portfolio, each of 5% which allows up to 20 stocks in the portfolio and the results are stronger than the ones I'll show below.
> 
> How many paths are there for the really simple 10 unit portfolio?  So many that, if we were to process a portfolio per millisecond (one-thousandth of a second), and assuming the age of the universe is 13.8 bn years as is generally assumed by astronomers and physicists at present, it would need 630 million times as long to check every one.  That's a lot of forking paths to explore.
> 
> ......




Interesting discussion going on here.

Retired Young - unless my probability math fails me there is only 184,756 unique 10 stock portfolios that can be drawn from the 20 stock universe covering the time frame stated, and of course only 1, 20 stock portfolio.

Using quartly returns as data points in the Monte Carlo simulation would give you the sort of permutations you are suggesting but it would also invalidate the validity of the Monte Carlo results because the data has serial correlation. Would it not?

Back testing validity aside - Interesting discussion on how much of the statistical academic research can be translated into retail investing.  Similar excess return is academically indicated for value stocks, small caps etc. 

Real question is if you can structure (financially, psychologically) to capture the returns as a retail sized investor.

I tend to differ in opinion to you on wether rebalancing can be cream on the cake under *all* circumstances.  The advantage is only statistically defined under certain structures ie wide enough diversification, enough volatility, similarity in ultimate performance etc.


----------



## Ves

craft said:


> Interesting discussion going on here.
> 
> Retired Young - unless my probability math fails me there is only 184,756 unique 10 stock portfolios that can be drawn from the 20 stock universe covering the time frame stated, and of course only 1, 20 stock portfolio.



My memory is fairly bad when it needs to go back to something I haven't used since university....  so I looked it up.

Mainly for my own benefit,  but someone else might be interested.

20! / (10! x (20! - 10!))
= 20! / (10! x 10!)

= 184,756.    

! represents factorial.  In long hand 4!  is just 4 x 3 x 2 x 1

I even know how to do it in Excel now.   The function is Fact(number).

It is amazing what you can figure out if you spend 10 minutes.


----------



## KnowThePast

craft said:


> Interesting discussion going on here.
> 
> Retired Young - unless my probability math fails me there is only 184,756 unique 10 stock portfolios that can be drawn from the 20 stock universe covering the time frame stated, and of course only 1, 20 stock portfolio.
> 
> Using quartly returns as data points in the Monte Carlo simulation would give you the sort of permutations you are suggesting but it would also invalidate the validity of the Monte Carlo results because the data has serial correlation. Would it not?
> 
> Back testing validity aside - Interesting discussion on how much of the statistical academic research can be translated into retail investing.  Similar excess return is academically indicated for value stocks, small caps etc.
> 
> Real question is if you can structure (financially, psychologically) to capture the returns as a retail sized investor.
> 
> I tend to differ in opinion to you on wether rebalancing can be cream on the cake under *all* circumstances.  The advantage is only statistically defined under certain structures ie wide enough diversification, enough volatility, similarity in ultimate performance etc.




I wasn't involved in the discussion, just wanted to say it's very nice to see you posting again, craft.

On the topic - why treat re-balancing as a simple yes/no?
Averaging up/down is also a form of rebalancing.
As is only averaging into losers/winners/other criteria.
An infinite number of combinations, some of which produce very interesting results when backtested.

I agree with brty that tax + transaction costs are a big hindrance. But it's mainly a problem when you scale positions down. If you only average up (buy), it's not an issue.


----------



## DeepState

cynic said:


> 1. Guess What?  Unsurprisingly, you've conveniently misconstrued a perfectly valid argument against the case for rebalancing.  Did you really think we wouldn't notice?
> 
> 2. Many of us are already aware of how terribly easy it is to derive a living from managing billions of dollars of other peoples' money. Try doing it with your own funds and see how well your fanciful and idealistic investment theories work.
> 
> 3. Do you think you could survive a whole year, solely reliant on investment returns from a sub six figure sum (i.e. <$100k) without diminishing your capital or drawing income from other sources?
> (I believe that some of the posters challenging your rebalancing claims are able to do this! The question is, with all your purported financial "wisdom" could you?!!!)





Hi Cynic!  It's great to meet such positive people in this site. Nice of you to come out of your hole.

1. If you think item 6. from BRTY was an accurate depiction of portfolio activity then - guess what - you're off plantation. Under real world conditions, stocks don't go down in straight lines and stocks don't go up in straight lines.  The fact that they behave like this produces rebal profits.  In a diversified, equally weighted, portfolio of, let's say, 50 securities, 2% would be invested in the loser stock called Cynical-AU.  As this drifts to zero, positive expectancy exceeds the loss of value in the stock in general - although this is a probabilistic statement.  Nonetheless, as the stock moves down and rebal occurs, the portfolio is spread over the entire portfolio, not into the loser stock.  The portfolio is never fully invested into Cynical-AU loser stock under BRTY's scenario.  Think like this - all stocks start with 2% in them.  Cynical-AU drops to zero.  The portfolio takes a hit and the remaining 98% of the portfolio is rebalanced.  At every stage of a gradual decline, it's just this step in smaller increments. At no stage is the portfolio fully invested in Cynical-AU under the conditions that BRTY laid out.

Check your maths before you hurl BS about.  I hope people are noticing.

2. Yeah, work was fun.  A Pina Colada a day keeps the Dr away.  But sometimes, when the seas were rough and my yacht would roll, it made flipping coins for stock selection more challenging.  As to private investing, I am.  It's delicious.  Thanks for asking. I'm quite private in real life but - since you asked - we are living large and are accumulating even if I'm retired.  Crazy huh? 

3. It was 2 generations ago that my family lived under those conditions.  We did it. If it came to it, and survival was at stake, why wouldn't I eat cat food and go dumpster diving?  I'd do that for my family without a doubt.  Thus, if it came to it, I could and would.  However, I applied my financial wisdom to get seriously f^&king rich so that we would not encounter this scenario for at least 3 generations. I want my grandkids to come to ASF and list themselves as "Retired_from_Birth" as they deal with this stuff for kicks. It's not all about cost-cutting you know.  You can't cut your way to growth.  How about that for financial wisdom?  

Lighten up and put a chip in the other shoulder for symmetry.


----------



## DeepState

Ves said:


> My memory is fairly bad when it needs to go back to something I haven't used since university....  so I looked it up.
> 
> Mainly for my own benefit,  but someone else might be interested.
> 
> 20! / (10! x (20! - 10!))
> = 20! / (10! x 10!)
> 
> = 184,756.
> 
> ! represents factorial.  In long hand 4!  is just 4 x 3 x 2 x 1
> 
> I even know how to do it in Excel now.   The function is Fact(number).
> 
> It is amazing what you can figure out if you spend 10 minutes.




Way to go Ves!!


----------



## cynic

DeepState said:


> Hi Cynic!  It's great to meet such positive people in this site. Nice of you to come out of your hole.
> 
> 1. If you think item 6. from BRTY was an accurate depiction of portfolio activity then - guess what - you're off plantation. Under real world conditions, stocks don't go down in straight lines and stocks don't go up in straight lines.  The fact that they behave like this produces rebal profits.  In a diversified, equally weighted, portfolio of, let's say, 50 securities, 2% would be invested in the loser stock called Cynical-AU.  As this drifts to zero, positive expectancy exceeds the loss of value in the stock in general - although this is a probabilistic statement.  Nonetheless, as the stock moves down and rebal occurs, the portfolio is spread over the entire portfolio, not into the loser stock.  The portfolio is never fully invested into Cynical-AU loser stock under BRTY's scenario.  Think like this - all stocks start with 2% in them.  Cynical-AU drops to zero.  The portfolio takes a hit and the remaining 98% of the portfolio is rebalanced.  At every stage of a gradual decline, it's just this step in smaller increments. At no stage is the portfolio fully invested in Cynical-AU under the conditions that BRTY laid out.
> 
> Check your maths before you hurl BS about.  I hope people are noticing.
> 
> 2. Yeah, work was fun.  A Pina Colada a day keeps the Dr away.  But sometimes, when the seas were rough and my yacht would roll, it made flipping coins for stock selection more challenging.  As to private investing, I am.  It's delicious.  Thanks for asking. I'm quite private in real life but - since you asked - we are living large and are accumulating even if I'm retired.  Crazy huh?
> 
> 3. It was 2 generations ago that my family lived under those conditions.  We did it. If it came to it, and survival was at stake, why wouldn't I eat cat food and go dumpster diving?  I'd do that for my family without a doubt.  Thus, if it came to it, I could and would.  However, I applied my financial wisdom to get seriously f^&king rich so that we would not encounter this scenario for at least 3 generations. I want my grandkids to come to ASF and list themselves as "Retired_from_Birth" as they deal with this stuff for kicks. It's not all about cost-cutting you know.  You can't cut your way to growth.  How about that for financial wisdom?
> 
> Lighten up and put a chip in the other shoulder for symmetry.




Thankyou for your cheerful response. I've been enjoying reading your contributions, however, I am still very much in agreement with several others that rebalancing exposes one's portfolio to significant risk from the corrosive effects of components suffering from chronic altitude sickness.

No amount of mathematical, statistical or verbal obfuscation will persuade me to dismiss the evidence of my own experience. 

Whilst I've witnessed some opportune scenarios for rebalancing, I've also witnessed plenty where ardent rebalancing would likely have proved catastrophic!

Imagine twenty buckets placed in different locations for the purpose of catching as much rainfall as possible. Imagine what happens when just one bucket has a hole near its base. Do you think rebalancing will yield the greatest accumulation of rainfall in this scenario?

It doesn't take a rocket scientist to recognise the glaringly obvious flaw in the rebalancing philosophy!!!


----------



## DeepState

craft said:


> Interesting discussion going on here.
> 
> 1. Retired Young - unless my probability math fails me there is only 184,756 unique 10 stock portfolios that can be drawn from the 20 stock universe covering the time frame stated, and of course only 1, 20 stock portfolio.
> 
> 2. Using quartly returns as data points in the Monte Carlo simulation would give you the sort of permutations you are suggesting but it would also invalidate the validity of the Monte Carlo results because the data has serial correlation. Would it not?
> 
> 3. Back testing validity aside - Interesting discussion on how much of the statistical academic research can be translated into retail investing.  Similar excess return is academically indicated for value stocks, small caps etc.
> 
> 4. Real question is if you can structure (financially, psychologically) to capture the returns as a retail sized investor.
> 
> 5. I tend to differ in opinion to you on wether rebalancing can be cream on the cake under *all* circumstances.  The advantage is only statistically defined under certain structures ie wide enough diversification, enough volatility, similarity in ultimate performance etc.




Welcome welcome welcome!  Gosh it's nice to meet you Craft.

1. Your combinatorics is great.  Perhaps my explanation of the simulation approach wasn't clear enough.

If I am pulling 10 stocks from a universe of 20 and equally weighting them by default (or using some other fixed weighting scheme), then the number of draws is 20-C-10 as you have produced.

But I was pushing harder.  I did not want to restrict portfolios to be equally weighted.  I wanted to allow for differential weights as would happen in reality.  Now, we can get ridiculous and allow differentially weighted portfolios by increments of 0.0000000001% (you know what I mean).  That would produce an insane number of portfolios that would blow Excel into the 12th dimension as you plug the figures in.  But, when you are simulating for this purpose, it doesn't matter much at all.  So, I chose to build a portfolio consisting of 10% blocks.  So there are 10x blocks each representing 10% of the portfolio.

If you relax the constraint of equally weighting you can divide each stock into 10x 'stocklets'.  Hence we now have 20 x 10 = 200 stocklets from which we can choose 10 of then to fill our portfolio building blocks.  This means that the portfolio can have up to 10 names in it and individual stock weights can be anything in the range of 0-100%.  This actually produces more concentrated portfolios than 10 equally weighted ones and disfavours the rebal process, but I thought I wouldn't mention that given the technical nature.  Thanks goodness you are here.

200-C-10 is the monster number I was referring to.  Same deal for the 20 stock portfolio.


2. Excellent.  OMG this is bliss.  Give me oxygen.

Monte Carlo can be conducted in many ways and you are thinking of a situation where stock returns are divided by time slices, shuffled and drawn from with or without replacement.  You are entirely correct that, in that circumstance, the time series qualities are completely dismantled.  This method is used for VaR and other forms of scenarios.

In this process, I dumped the stock returns.  Those returns remain unchanged and in the sequence that they were actually delivered to the market.  The time series properties, including serial correlation are fully preserved.  What we changed in the Monte Carlo was the stock weights.  These were randomly generated per 1. and thus reproduces faithfully alternative draws from a very diversified set of forking paths.  So long as the sampling is not biased, 10,000 draws is a large sample which will capture the test results.  This only took 2 sec in my engine, but there was no point in pushing the point and I didn't have a second to waste.


3. Damn, where the heck have you been?  I've made 100+ posts and you only turn up now? You've just been letting be dangle in the wind all this time? I hope you've got a damned good explanation for that mate... 

Yes!  The world is larger than re-bal and there are a stack of ways to make money.  Re-bal is just a tidy-up.

The sorts of things you are talking about are drawn from the concept of 'Premium based investing'  It's a way of being rewarded for taking risks that others can't.  Not all risks are rewarded, but it is believed that value and small caps are amongst them.  Value - for reasons of distress and mispricing.  Small cap - for reasons of stock specific risk and liquidity. It is real, but you need to be patient to harvest it.  Part of the reason why these opportunities exist is because professional funds management has a time horizon which is much shorter than you might have.  There is money to be made by just going to the beach and doing nothing whilst us fundies go nuts worrying about monthly performance.

I invite RoE to outline his thoughts on retail investor advantages in the market.  That guy (he writes like a guy) is sharp.

Retail can do the above.  You don't need much.  If it works in insto, it'll work in retail.  Stocks don't know who is buying them. KnowThePast seems to have backtest results and is willing to share them.  But backtests need to be joined up with economic intuition.  There are heaps of backtests that look great, but very few go on to actually produce something other than noise.  Backtests are very useful to test your economic intuition.  You know that.  I just type out of habit now.


4. I think that's for you to decide.  If you have tiny account size, you are in a different situation.  But if you can see yourself holding 20-40 stocks, all of the above is available.  It's low turnover stuff and far less taxing than watching portfolio turnover each tick and hoping something crosses some line.  


5. Rebal is a stochastic process.  There is an element of chance in it.  In the simulation, I mentioned that 40% of rebal portfolios did worse than their buy-hold counterparts and, obviously, 60% did better.  So I sincerely hope that I have been consistent in saying this is probabilistic and the probability of success improves with the passage of time.  No process other than pure arbitrage will deliver what you have indicated that I said.  If I said it somewhere, I retract it with apologies.

The idea is then to add rebal on some other process which you think also has positive expectancy.  All these edges add up to something closer to a smooth path to a yacht or whatever tickles you.


Thanks for your questions.  They have been a great pleasure to receive.  Good trading to you, Craft.


----------



## brty

Ok, time to look at some details. Despite RY changing opinion on a few matters, I'll go back to the portfolio I randomly started for the following reasons. This from RY in post 55.



> The less forecast skill you have, the greater the relative importance of rebal and the less that changes in your view will affect the portfolio....hope that makes sense. In the absence of any stock selection skill, you just move straight to the pure rebal portfolio which tends to produce around 2% per annum outperformance in general over time and would be responsible for 100% of outperformance. On average, skill is zero. Hence, on average it is better for anyone to just hold a diverse portfolio and rebal and be done with it.




While any argument against the portfolio of 20 stocks chosen is probably accurate, it is a diverse portfolio, and one that with hindsight we can claim the holder had an "absence of stock selection skill" so it meets RYs parameter.

The claim is 2% per annum outperformance. After 2 years there is a 27% underperformance, before tax and transaction costs.

I just spent a couple of hours working out the taxable income along the way. It's unbelievable, on a quarter by quarter basis, the numbers for added taxable income for rebalancing are Q1 $4112 Q2 $3272 Q3 $10,115 Q4 $6209 Q5 $18070 Q6 $11463 Q7 $10224. A total of $57,885 or tax payable at the 30% tax rate of $18233 (including medicare). These numbers EXCLUDE dividends.

The 20 stock portfolio, from randomly drawn stocks, with rebalancing is even worse than first imagined. Out of the gain of $70,541 you would have to allow/deduct tax of $18233 leaving a stock portfolio with a gain of $52,307 against the buy and hold portfolio with a gain of $89,714.

So for this portfolio rebalancing quarterly, there is an outperformance of over 71% for B+H over rebalancing.

The portfolio started as ... and finished the same with $48886 in dividends for B+H


STO	1,779
BSA	102,040
OKN	20,242
GAP	100,000
NBL	40,983
MND	1,106
AGK	1,753
BHP	672
CAB	5,144
NWH	7,763
GUD	3,180
SHV	13,513
ROC	68,493
CYG	10,416
TGR	19,920
RDM	142,857
AGO	7,575
MGX	17,857
NCM	746
NST	25,773

Rebalanced finished with...

STO   1844
BSA   211030
OKN   15632
GAP    94598
NBL    45722
MND   1565
AGK    1787
BHP    722
CAB    7238
NWH   22085
GUD    5006
SHV    6332
ROC    58996
CYG    9458
TGR    8547
RDM    211932
AGO    23856
MGX    27994
NCM    2785
NST    34078

Transaction fees have not been taken into consideration, they would however reduce the taxable income as they are tax deductable. Doesn't matter, rebalancing clearly did not work with this portfolio over the 2 year period. This is totally contrary to the claimed outperformance of 2% for someone without any skill selection in stock performance.

RY, it doesn't matter how you try to slice and dice the results, in the real world this portfolio showed massive underperformance for re-balancing. In fact it highlighted the weaknesses, and it was random, not deliberately done.


----------



## DeepState

cynic said:


> Thankyou for your cheerful response. I've been enjoying reading your contributions, however, I am still very much in agreement with several others that rebalancing exposes one's portfolio to significant risk from the corrosive effects of components suffering from chronic altitude sickness.
> 
> No amount of mathematical, statistical or verbal obfuscation will persuade me to dismiss the evidence of my own experience.
> 
> Whilst I've witnessed some opportune scenarios for rebalancing, I've also witnessed plenty where ardent rebalancing would likely have proved catastrophic!
> 
> Imagine twenty buckets placed in different locations for the purpose of catching as much rainfall as possible. Imagine what happens when just one bucket has a hole near its base. Do you think rebalancing will yield the greatest accumulation of rainfall in this scenario?
> 
> It doesn't take a rocket scientist to recognise the glaringly obvious flaw in the rebalancing philosophy!!!




You are welcome. Thankyou for your somewhat more reasoned tone. 

You are pointing out a valid scenario which, as per BRTY's single scenario, led to the underperformance of re-bal vs buy-hold.  In the extensive simulation, I mentioned that fully 40% failed.  Amongst these will be exactly the scenarios you and BRTY have encountered, experienced or imagine might occur.

Re-bal does not claim to be pure arbitrage.  I have not claimed it is.  The equations, if you were to translate them, don't indicate that either.  There is risk of failure as with any strategy you could name other than printing money. 

So, given that we have risk of failure, why do it?  Because it has positive expectancy and the edge is not trivial even after tax and comm.

Each of the scenarios you have mentioned are real.  They can happen.  As are a range of great scenarios that favour re-bal.  What is missing from this debate is the assignment of probability to these scenarios.  I know it sounds vague and all, but perhaps I can explain this via a casino.

Welcome to Cynic-ville Sentosa, a bloody awesome marble walled casino with lights and glamour.  You, in your hood with digits running over your face are the Roulette dealer.  You have odds stacked in your favour.  Now, the kinds of scenarios you are mentioning are like drawing 5x 32s in a row with some punter re-staking that slot each time.  The Casino loses.  It's a really bad day.  But the chances of that are the same as drawing 5x 0 in a row.  Or some mix of all the numbers.  They are all equally likely.  Bad and good scenarios.  But when you add it all up, the odds in your favour (re-bal profits) make the casino money through time.  You need to assign probability to each scenario and weight it accordingly.  At the moment, what you are doing is pointing out the possibility of a bad outcome.  No argument from me.  They exist. But go on to weight that and all the other ones and you come up with positive expectancy.  It's just unnatural to think it terms of these distributions, so I appreciate this is going to be a bit tough.  People more naturally think in terms of scenarios as you have done.  And, by internal wiring from our ancestors from caveman time, focus more on bad scenarios than good.

There is a note/thesis to So_Cynical (oh, the irony) in the thread "Does Rebalancing Work?" which explains how you can prove it to yourself.  It just requires a spreadsheet and a tiny bit of work.

It doesn't need a rocket scientist to see the massive flaw in rebal.  They wouldn't see it because they understand this stuff.  In fact, I have a friend who actually is a rocket scientist managing portfolio this way.  They are in Australia, manage $8bn and are growing like a weed.  It just needs a spreadsheet that a high school student could put together in an hour to see that this stuff works in the real world.  I hope you have achieved a HS level education and can pull it off.  It's no skin of my nose if you don't do this and can't find the truth of it or can't be convinced of it by display of facts, theory or verbal/written obfuscation.  Actually, why bother even raising this if you are self-declared closed minded and nailed shut?

Chillax dude.


----------



## brty

RY,



> In the simulation, I mentioned that 40% of rebal portfolios did worse than their buy-hold counterparts and, obviously, 60% did better.




This was not a simulation, it was a real world example, it was what happened. All your simulation stuff makes you sound like a university student that has learned a lot from academics that teach. You need to understand that the rebal into losing stocks can and does underperform, plain and simple.

Thanks for making me do the exercise. I have come across others who started funds with similar types of theories, of course they called it something different, dollar cost "something" or dollar avaraging "something" I believe. The GFC brought them undone with the fund folding and the spruiker going bankrupt.

Of course there is nothing wrong with the theory, it works beautifully on the top stocks in hindsight.


----------



## craft

DeepState said:


> Those returns remain unchanged and in the sequence that they were actually delivered to the market.  The time series properties, including serial correlation are fully preserved.  What we changed in the Monte Carlo was the stock weights..




Nice to see somebody understands the implication of correlation of time series when using MC - I've seen it abused so often I now expect it. I didn't twig you were varying the stock weights to get the permutations and feared the worse. Its interesting that the results still hold up.  Gut instinct would have me think a fair bit of rebalance performance over indexes has to do with initial equal weight effect.




DeepState said:


> Damn, where the heck have you been?  I've made 100+ posts and you only turn up now? You've just been letting be dangle in the wind all this time? I hope you've got a damned good explanation for that mate...




Sometimes you just need a break - you may find that also in time..  



DeepState said:


> 5. Rebal is a stochastic process.  There is an element of chance in it.  In the simulation, I mentioned that 40% of rebal portfolios did worse than their buy-hold counterparts and, obviously, 60% did better.  So I sincerely hope that I have been consistent in saying this is probabilistic and the probability of success improves with the passage of time.  No process other than pure arbitrage will deliver what you have indicated that I said.  If I said it somewhere, I retract it with apologies.
> 
> The idea is then to add rebal on some other process which you think also has positive expectancy. * All these edges add up* to something closer to a smooth path to a yacht or whatever tickles you.




What it takes to harvest one edge doesn't necessarily add to another  - and in fact trying to do so can cause damage to the original edge. That's not a discussion for 12:30am but a mighty good topic for one rainy day and could probably go a long way to reconcile the different angles you and BRTY might be coming from. 


Care to detail your data source(total return by quarters -nice) and back testing engines? They appear pretty impressive.


----------



## Zylatis

Monte Carlo in excel? Ew....

</tangent>


----------



## craft

brty said:


> RY,
> 
> 
> 
> This was not a simulation, it was a real world example, it was what happened. All your simulation stuff makes you sound like a university student that has learned a lot from academics that teach. You need to understand that the rebal into losing stocks can and does underperform, plain and simple.
> 
> Thanks for making me do the exercise. I have come across others who started funds with similar types of theories, of course they called it something different, dollar cost "something" or dollar avaraging "something" I believe. The GFC brought them undone with the fund folding and the spruiker going bankrupt.
> 
> Of course there is nothing wrong with the theory, it works beautifully on the top stocks in hindsight.




Understand dollar cost averaging fully and have the disposition to implement it consistently, then GFC type volatility is actually the sort of event you hope for.


----------



## DeepState

brty said:


> Ok, time to look at some details. Despite RY changing opinion on a few matters, I'll go back to the portfolio I randomly started for the following reasons. This from RY in post 55.
> 
> 
> 
> While any argument against the portfolio of 20 stocks chosen is probably accurate, it is a diverse portfolio, and one that with hindsight we can claim the holder had an "absence of stock selection skill" so it meets RYs parameter.
> 
> The claim is 2% per annum outperformance. After 2 years there is a 27% underperformance, before tax and transaction costs.
> 
> I just spent a couple of hours working out the taxable income along the way. It's unbelievable, on a quarter by quarter basis, the numbers for added taxable income for rebalancing are Q1 $4112 Q2 $3272 Q3 $10,115 Q4 $6209 Q5 $18070 Q6 $11463 Q7 $10224. A total of $57,885 or tax payable at the 30% tax rate of $18233 (including medicare). These numbers EXCLUDE dividends.
> 
> The 20 stock portfolio, from randomly drawn stocks, with rebalancing is even worse than first imagined. Out of the gain of $70,541 you would have to allow/deduct tax of $18233 leaving a stock portfolio with a gain of $52,307 against the buy and hold portfolio with a gain of $89,714.
> 
> So for this portfolio rebalancing quarterly, there is an outperformance of over 71% for B+H over rebalancing.
> 
> The portfolio started as ... and finished the same with $48886 in dividends for B+H
> 
> 
> STO	1,779
> BSA	102,040
> OKN	20,242
> GAP	100,000
> NBL	40,983
> MND	1,106
> AGK	1,753
> BHP	672
> CAB	5,144
> NWH	7,763
> GUD	3,180
> SHV	13,513
> ROC	68,493
> CYG	10,416
> TGR	19,920
> RDM	142,857
> AGO	7,575
> MGX	17,857
> NCM	746
> NST	25,773
> 
> Rebalanced finished with...
> 
> STO   1844
> BSA   211030
> OKN   15632
> GAP    94598
> NBL    45722
> MND   1565
> AGK    1787
> BHP    722
> CAB    7238
> NWH   22085
> GUD    5006
> SHV    6332
> ROC    58996
> CYG    9458
> TGR    8547
> RDM    211932
> AGO    23856
> MGX    27994
> NCM    2785
> NST    34078
> 
> Transaction fees have not been taken into consideration, they would however reduce the taxable income as they are tax deductable. Doesn't matter, rebalancing clearly did not work with this portfolio over the 2 year period. This is totally contrary to the claimed outperformance of 2% for someone without any skill selection in stock performance.
> 
> RY, it doesn't matter how you try to slice and dice the results, in the real world this portfolio showed massive underperformance for re-balancing. In fact it highlighted the weaknesses, and it was random, not deliberately done.




What a power of work BRTY!

So, I've changed my opinion?  Please outline for verification.  I'm curious. I've changed my opinion on a few things, but I'm not quite sure what's behind the slur.  Are we still going on about Post #66 and #67?  Will someone please explain that an equation can be watertight and yet uncertainty or risk exists? Please!!!! 

So, I've said "pure rebal portfolio which tends to produce around 2% per annum outperformance in general over time " and you translate that to "The claim is 2% per annum outperformance" and present a single two year scenario for the purposes of inference.  Please call your daughter right now.  If you disguised your name and told her what you've done to form this inference....well, I'd love to be there. Further, you might need a refresher on comprehension.  This kind of comprehension distortion might be behind my change of opinions above.  You might have changed them for me without my consent.

So, you have created a perfectly random portfolio of 20 stocks. 

From post #69:

"_The stocks used were STO, BSA, OKN, GAP, NBL, MND, AGK, BHP, CAB, NWH, GUD, SHV, ROC, CYG, TGR, RDM, AGO, MGX, NCM, NST. The start date was 9/2/2012, finish 10/2/2014. Closing prices were used.

 I traded all the above stocks, in that order_", Yup...totally random selection. What's your idea of non-random?

Even more: _"it is a diverse portfolio, and one that with hindsight we can claim the holder had an "absence of stock selection skill" "_  Does that imply you have no skill?  Which is it?  Given you traded this randomly selected portfolio, you either do not have skill or this test is flawed from the outset?

So, you have run some tax calculations and gotten yourself hot and heavy on the tax realisations. BRTY, you incorrectly called on me for my tax understanding in "Does rebalancing work?" and were found wanting. You've now gone for strike two in one evening by thinking that by not selling you don't incur any tax. You have, you just haven't paid it. And given you are such a skilled investor, will be trading the market and realizing parcels along the way.  This chicanery has a name.  It's called accounting fraud. Publish that for a portfolio and you go to jail. Check out Accounting Standard AAS25 for how it's done in the real world with real money with real people who actually understand this stuff.  RoE can send you a link in a heartbeat.

_"rebalancing clearly did not work with this portfolio over the 2 year period. This is totally contrary to the claimed outperformance of 2% for someone without any skill selection in stock performance."  _This is absolutely hilarious.  Your comprehension of a simple statement "2% per annum outperformance _in general over time_ " to make a certainty statement/inference like that is atrocious in the presence of uncertainty.  Please CALL YOUR DAUGHTER PhD (Forthcoming). Puhleeeeez. You really are that desparate to find a flaw in the space-time continuum Dr Emmett.  You might need to avail yourself of a Flux Capacitor and a Delorian.  

_"rebalancing clearly did not work with this portfolio over the 2 year period".  _Great.  Now do it 9,999 times more and let's see what happens before you present any more of this single scenario conclusions in a stochastic, probabilistic process stuff.  What is so hard to understand about "This is a probabilistic process whose likelihood of success improves with time"?  Who the heck claimed certainty of profit over any single scenario?  The simulations provide displayed a 40% likelihood of failure.  Wow.  It actually includes some failures. 4,000 of them. Tell me, has your portfolio outperformed against all possible randomly selected portfolios? No?  Wow. Amazing.

"post 55" just for the rocket scientists out there.  Post #55 also included further formulations that traded off expected rebal profits vs tax costs, frictions and other risk matters. Of course, this wasn't listed in the pre-amble and neither was it considered in the single scenario.  The starting portfolio weights for this type of analysis would commence from cash and move to the portfolio settings.  In a like for like study that this purports to be, the initial weights would begin at the optimal weights as determined by this formulation.  Naturally this wasn't done in this effort.  Instead, a sort of random portfolio was chosen which thus disfavours rebal as per author intentions.

This is research?


----------



## DeepState

brty said:


> RY,
> 
> 
> 
> This was not a simulation, it was a real world example, it was what happened. All your simulation stuff makes you sound like a university student that has learned a lot from academics that teach. You need to understand that the rebal into losing stocks can and does underperform, plain and simple.
> 
> Thanks for making me do the exercise. I have come across others who started funds with similar types of theories, of course they called it something different, dollar cost "something" or dollar avaraging "something" I believe. The GFC brought them undone with the fund folding and the spruiker going bankrupt.
> 
> Of course there is nothing wrong with the theory, it works beautifully on the top stocks in hindsight.




I sound like a university student for two reasons:

1. I went to one. Actually, I went to two.  No..three.  Heck I forgot.

2. This stuff is so simple that a university student would eat it.  So I don't need to go any further.

Despite numerous exchanges which others clearly comprehend, it is clear you still don't grasp the basic theory when you say "it works beautifully on the top stocks in hindsight" inferring that hindsight bias is important or that rebal of portfolios of stocks which go down will never succeed.  So, perhaps you might want to sound more like a university student?

It would also be unwise to tar all strategies whose names you can't quite remember with the same brush when some spruiker some time and some place screws others for money. That's what my real world experience tells me.


----------



## DeepState

craft said:


> Understand dollar cost averaging fully and have the disposition to implement it consistently, then GFC type volatility is actually the sort of event you hope for.




Can I please give you a hug?  Damn, where have you been all this time????


----------



## DeepState

Zylatis said:


> Monte Carlo in excel? Ew....
> 
> </tangent>




Nah, I meant the single cell calculation for the Combo calc in Excel.

I do my stuff in Matlab.


----------



## cynic

DeepState said:


> You are welcome. Thankyou for your somewhat more reasoned tone.
> 
> You are pointing out a valid scenario which, as per BRTY's single scenario, led to the underperformance of re-bal vs buy-hold.  In the extensive simulation, I mentioned that fully 40% failed.  Amongst these will be exactly the scenarios you and BRTY have encountered, experienced or imagine might occur.
> 
> Re-bal does not claim to be pure arbitrage.  I have not claimed it is.  The equations, if you were to translate them, don't indicate that either.  There is risk of failure as with any strategy you could name other than printing money.
> 
> So, given that we have risk of failure, why do it?  Because it has positive expectancy and the edge is not trivial even after tax and comm.
> 
> Each of the scenarios you have mentioned are real.  They can happen.  As are a range of great scenarios that favour re-bal.  What is missing from this debate is the assignment of probability to these scenarios.  I know it sounds vague and all, but perhaps I can explain this via a casino.
> 
> Welcome to Cynic-ville Sentosa, a bloody awesome marble walled casino with lights and glamour.  You, in your hood with digits running over your face are the Roulette dealer.  You have odds stacked in your favour.  Now, the kinds of scenarios you are mentioning are like drawing 5x 32s in a row with some punter re-staking that slot each time.  The Casino loses.  It's a really bad day.  But the chances of that are the same as drawing 5x 0 in a row.  Or some mix of all the numbers.  They are all equally likely.  Bad and good scenarios.  But when you add it all up, the odds in your favour (re-bal profits) make the casino money through time.  You need to assign probability to each scenario and weight it accordingly.  At the moment, what you are doing is pointing out the possibility of a bad outcome.  No argument from me.  They exist. But go on to weight that and all the other ones and you come up with positive expectancy.  It's just unnatural to think it terms of these distributions, so I appreciate this is going to be a bit tough.  People more naturally think in terms of scenarios as you have done.  And, by internal wiring from our ancestors from caveman time, focus more on bad scenarios than good.
> 
> There is a note/thesis to So_Cynical (oh, the irony) in the thread "Does Rebalancing Work?" which explains how you can prove it to yourself.  It just requires a spreadsheet and a tiny bit of work.
> 
> It doesn't need a rocket scientist to see the massive flaw in rebal.  They wouldn't see it because they understand this stuff.  In fact, I have a friend who actually is a rocket scientist managing portfolio this way.  They are in Australia, manage $8bn and are growing like a weed.  It just needs a spreadsheet that a high school student could put together in an hour to see that this stuff works in the real world.  I hope you have achieved a HS level education and can pull it off.  It's no skin of my nose if you don't do this and can't find the truth of it or can't be convinced of it by display of facts, theory or verbal/written obfuscation.  Actually, why bother even raising this if you are self-declared closed minded and nailed shut?
> 
> Chillax dude.





I have provided an analogy that accurately depicts a significant risk inherent to the rebalancing methodology. One doesn't need to be versed in mathematics, statistics, probability theory, or even casino games to be able to recognise, understand and appreciate said analogy!

As it happens the roullette wheel has been deliberately engineered to more precisely reflect the outcomes that might typically be expected according to probability theory.

Financial markets on the other hand, have not undergone such engineering (their intent, purpose and design are quite different!), hence the casino roullette wheel can hardly be considered a valid comparison. Furthermore, unlike the financial markets, none of the roulette numbers ever go into receivership following a prolonged downturn in fortunes!

Millions upon millions of repetitions are usually required before events can even be expected to conform to the dictates of probability theory, hence any expectancy suggested by such theory could not reasonably be depended upon for investment performance. (The average human life span would only afford a comparatively small event sample - the theoretical expectancy would be unlikely to eventuate!!)

Stocks, commodities, currencies real estate etc. do at times go into prolonged states of decline. History has shown this and continues to do so!
My rainbucket analogy gives ample warning of the perils of rebalancing in respect to such occurences, whereas the roullette wheel has precious little (if anything) to say on such matters!


----------



## brty

RY,

I don't know how some-one types so fast in so many different threads.



> Check out Accounting Standard AAS25 for how it's done in the real world with real money with real people who actually understand this stuff




Thankyou for quoting superannuation standards, I have been talking about trading for ones own account, nothing to do with super, but I take it as another parameter you have added.

A person bothers to go through the work on a random portfolio of traded stocks, and in an attempt to maintain your position of how rebal works, just totally fail to acknowledge the simple fact that it will not always work. Plus the fact that there are times where it can be detrimental to a portfolio.

I will clearly acknowledge there are times and stocks when averaging down from your winners does work but NOT ALWAYS as you have been suggesting.

Trying to take the actual performance of a group of stocks, as being just one path that could be followed for them from a universe of results that are only theoretical, is disengenious at its best.

Shooting the messenger, that you seem to be an expert at, rather than the obvious that rebal or dollar cost averaging or whatever you want to call it, is not a panacea, is so often found on forums.  




> Now do it 9,999 times more and let's see what happens




Why? your claims of how this is the best strategy since sliced bread for any portfolio, even those unskilled, didn't stack up. Nobody has 9,999 life times to spend finding those where it works.

How about you start a thread on a portfolio of your selected stocks with the clear easy rules at the beginning, where we walk forward with actual quarterly rebal and see how it pans out. This forum has been around for years. Instead of theory, getinto the real world as some others have done. That way we can see over time how much actual outperformance your strategy delivers.

Are you up to it?

A simple 10 stock selection, quarterly rebal, compared to buy and hold, $50,000/stock start. You didn't like my selected universe so let's walk forward with any you care to name.


----------



## craft

brty said:


> RY,
> let's walk forward with any you care to name.




Market Vectors Indices have constructed an equal weight index.




I’m not sure of the construction of the two indexes but it looks like Australian total gross equal weight index  has been having a tough time of it compared to the total market over the historical 10year chart. 


They have also launched an equal weight ETF in March (Interestingly, RY joined ASF in March– you don’t have anything to disclose do you RY?) So your comparison can easily be tracked on a go forward basis. ASX code MVW.

There is also a white paper on the subject on the Market Vectors site
http://www.marketvectors-australia.com/library/education/
RY has pretty much covered most of it but the References are always useful if anybody wants to read further.


----------



## DeepState

craft said:


> Market Vectors Indices have constructed an equal weight index.
> 
> View attachment 57773
> 
> 
> I’m not sure of the construction of the two indexes but it looks like Australian total gross equal weight index  has been having a tough time of it compared to the total market over the historical 10year chart.
> 
> 
> They have also launched an equal weight ETF in March (Interestingly, RY joined ASF in March– you don’t have anything to disclose do you RY?) So your comparison can easily be tracked on a go forward basis. ASX code MVW.
> 
> There is also a white paper on the subject on the Market Vectors site
> http://www.marketvectors-australia.com/library/education/
> RY has pretty much covered most of it but the References are always useful if anybody wants to read further.




First...I hope you are kidding about being an employee of MV and joining at roughly the time of this ETF launch.  For avoidance of doubt I am not, and do not endorse or support any of MV's products, its officers, associates or subsidiaries.

This is interesting.  I think it compares the MV ETF you described against the ASX 200 or something.  The MV ETF construction universe is different by design and this is found in: 

http://www.marketvectorsindices.com...utions-licenses-australia-equal-weight-index/

Please note that the universe is different to that of the ASX 200.  Secondly, please note that the index contains only 77 names - as if to highlight that further.  Whilst it is valid to compare this against any index you want, if it is to be taken as a demonstration of rebal, then the stock universes of the two should be identical.  It is not.


----------



## craft

DeepState said:


> First...I hope you are kidding about being an employee of MV and joining at roughly the time of this ETF launch.  For avoidance of doubt I am not, and do not endorse or support any of MV's products, its officers, associates or subsidiaries.




Just probing a coincidence. No offence meant.




DeepState said:


> This is interesting.  I think it compares the MV ETF you described against the ASX 200 or something.  The MV ETF construction universe is different by design and this is found in:
> 
> http://www.marketvectorsindices.com...utions-licenses-australia-equal-weight-index/
> 
> Please note that the universe is different to that of the ASX 200.  Secondly, please note that the index contains only 77 names - as if to highlight that further.  Whilst it is valid to compare this against any index you want, if it is to be taken as a demonstration of rebal, then the stock universes of the two should be identical.  It is not.




As I said I don't know too much about the make up of the indices. the only conclusion I can draw from the historical comparison is that the equally weighted ETF (as its been structured)  would not have beaten a whole of market ETF based on market capitalisation.  

As for the go forward comparison that BRTY requested this seems an easy and transparent comparison of rebalancing - all that needs to be done is record the buy and hold return of the 77 odd companies and see how MVW performs against that over time. (a long time to allow expectancy to rise above randomness)


----------



## DeepState

brty said:


> RY,
> 
> 1. I don't know how some-one types so fast in so many different threads.
> 
> 
> 2. Thankyou for quoting superannuation standards, I have been talking about trading for ones own account, nothing to do with super, but I take it as another parameter you have added.
> 
> 3. A person bothers to go through the work on a random portfolio of traded stocks, and in an attempt to maintain your position of how rebal works, just totally fail to acknowledge the simple fact that it will not always work. Plus the fact that there are times where it can be detrimental to a portfolio.
> 
> 4. I will clearly acknowledge there are times and stocks when averaging down from your winners does work but NOT ALWAYS as you have been suggesting.
> 
> 5. rebal or dollar cost averaging or whatever you want to call it, is not a panacea, is so often found on forums.
> 
> 
> 6. How about you start a thread on a portfolio of your selected stocks with the clear easy rules at the beginning, where we walk forward with actual quarterly rebal and see how it pans out. This forum has been around for years. Instead of theory, getinto the real world as some others have done. That way we can see over time how much actual outperformance your strategy delivers.
> 
> Are you up to it?
> 
> A simple 10 stock selection, quarterly rebal, compared to buy and hold, $50,000/stock start. You didn't like my selected universe so let's walk forward with any you care to name.




1. Getting lots of practice.


2. AAS25 was set up to stop charlatans from presenting data in the format that you have done.  There are myriad other performance standards for performance measurement.  These come from industry groups such as the P-Group and others which mirror this.  The same thing applies overseas. Their standards apply to everything that is taxable. Super or non-super. That's why it was set up. Twenty-seven percent underperformance!  Surely you must imagine there is something odd about that figure.  However, whatever the case, if you want to make a claim about performance without wanting to receive detractions or be accused of being a charlatan, then reference to the P-Group or relevant accounting standards is a good start.  They were set up to protect against charlatans and misrepresentation producing figures like this in the past.  Thanks for highlighting that you are investing PA.  If you were to regard your trading arrangements as being part of your own wider arrangements (ie. BRTY Pty Ltd), then AASB101 82(e)ii will guide you to the same conclusion as per AAS25.  You need to recognize unrealized tax When you report comprehensive income in both portfolios when presenting accounts.  P-Group says the same thing and they are the performance presentation standard setters on investment matters.

3. BRTY, you keep saying this. You are very locked in the belief that I have said this guarantees outperformance. However, what in the phrase:  "This is a probabilistic process whose likelihood of success improves with time" implies certainty of outperformance over any time frame?  'Probablistic' means there is risk...not certainty...of the outcome.  Likelihood means 'chance of' - not certainty of. 'Success' means outperformance over buy-hold.  'Improves with time'  means it ... improves with time.  What about the phrase or any of its subcomponents implies certainty?  The whole thing is about not being sure of the outcome.  

The simulations displayed 40% FAILURE rate.  I presented evidence of FAILURE of the strategy. How is that saying it guarantees success?  I actually went to the trouble of not using single scenarios that can easily be selected to paint any picture you like and actually blasted out 10,000 to search for ones that failed miserably...as well as find those which succeeded.  It was clearly written and you have even clipped it out for rebuttle - which tells me and everyone you actually saw it. So again, what about that implies certainty of success?  How has that not given due credit to scenarios where the re-bal process utterly and dismally underperforms? How many ways can this be said?  

How's this for a cut-down version with smaller, perhaps less technical and hence more readily accessible, words: It is not for sure that re-bal works. But it should do better if you give it more time. Even then, it might not work.


4. Please see 3.


5. I understand your reticence about anything touted as a panacea.  I don't buy from door knockers or phone dialers. In listening to brokers harping on about the latest and greatest idea, maybe 1% actually makes sense.  Perhaps we might have that in common.

I am not saying it is a panacea.  It will not guarantee you of a yacht.  I never claimed it would.  It is just expected to help you get to whatever your financial goals might be and there is a chance it might actually detract from that endeavor.  This re-bal stuff is not pure arbitrage.  It can, and will, fail a lot of the time.  Am I making this clear enough?  It can fail... It can fail...*  Out of 10k scenarios generated from your stock list, 40% failed.  In any other given stock list, this percentage may be higher or lower.  In some stock lists that could be selected, the failure rate could be greater than 50% implying negative expectancy for that set of simulations.  Is this enough of a surgeon general warning?


6. BRTY, I already do it.  My portfolio has over 80 stocks in it, and that's just in Australia and does not include all the other assets that I have in a multi-asset sense which are also being reblanced. I am very happy with it and thought I might share this idea...I would not have guessed that, in doing so, we would be posting backwards and forwards over all sorts of technical issues over something I regard as utterly trivial.

If every person that has disagreed with me, or will disagree with me on anything I have a view on, wanted to challenge ideas by having us posting portfolios in the hope of finding proof of concept I will be updating 100 threads with 80 stock portfolios by next week.  Respectfully, yes - respectfully - I shall decline the duel.  But nothing stops you from running the experiment out if you are so inclined.  Why not use the ASX 20 starting from now.  There is no hindsight bias in selecting those stocks because you would be launching from now. Given the ASX 20 membership could almost be regarded as a sell signal on its own, it might turn out to demonstrate how re-bal works in a down market and can - not must - add value to buy-hold in that eventuality. Start rebal at equal weighting which disfavours it.  Given you aren't a buyer of the concept of Monte Carlo, the next best thing to getting a fair shake of this is to give it time on a real record.  BRTY, we'd have to wait maybe 10 years for this to be achieved to any level that makes sense for a duel and our degree of certainty will improve gradually as we move along.  And even then, the statement can only be made that, whatever the outcome, A beat B on this scenario.  Your daughter, whom I sincerely hope does well in her PhD studies and moves on to make the life she wants for herself, will be able to assist in appreciating how much weight can be placed on the outcome.


BRTY, thanks for the exchange. It's been a challenge but I have learned a thing or two.  I'm going to let this thread go now after final responses.  It's time to move on.  At least for me, life is bigger than a re-bal debate.

All the best with it.


* Re-bal is not pure arbitrage.  It can fail.  It can lose you money against buy-hold.  There are feasible scenarios that the loss relative to buy-hold is such that you will be very very pissed off that you even heard of the idea.

Disclaimer: This is not advice.  This is not an effort to solicit for the purchase or sale of securities or any funds or accounts from anyone on this site or elsewhere.  Please do your own work and, whatever the outcome, all the best with it.  We each make our own way and are free to disagree.


----------



## DeepState

craft said:


> 1.Just probing a coincidence. No offence meant.
> 
> 2. As I said I don't know too much about the make up of the indices. the only conclusion I can draw from the historical comparison is that the equally weighted ETF (as its been structured)  would not have beaten a whole of market ETF based on market capitalisation.
> 
> 3. As for the go forward comparison that BRTY requested this seems an easy and transparent comparison of rebalancing - all that needs to be done is record the buy and hold return of the 77 odd companies and see how MVW performs against that over time. (a long time to allow expectancy to rise above randomness)




1. That's cool.  Thought you might be from ASIC or something!  Nice spotting of the coincidence though.

2. Agree.

3. Yes, but with knowledge that the composition of the universe will change through time and hence the stocks involved in the mar-cap portfolio would also need to be revised with this.  It won't always be the same 77 stocks and might not be 77 stocks but a different number at any given time.  You knew this...I'm just doing the lawyer thing.


----------



## DeepState

cynic said:


> 1. I have provided an analogy that accurately depicts a significant risk inherent to the rebalancing methodology. One doesn't need to be versed in mathematics, statistics, probability theory, or even casino games to be able to recognise, understand and appreciate said analogy!
> 
> 2. As it happens the roullette wheel has been deliberately engineered to more precisely reflect the outcomes that might typically be expected according to probability theory.
> 
> Financial markets on the other hand, have not undergone such engineering (their intent, purpose and design are quite different!), hence the casino roullette wheel can hardly be considered a valid comparison. Furthermore, unlike the financial markets, none of the roulette numbers ever go into receivership following a prolonged downturn in fortunes!
> 
> 3. Millions upon millions of repetitions are usually required before events can even be expected to conform to the dictates of probability theory, hence any expectancy suggested by such theory could not reasonably be depended upon for investment performance. (The average human life span would only afford a comparatively small event sample - the theoretical expectancy would be unlikely to eventuate!!)
> 
> 4, Stocks, commodities, currencies real estate etc. do at times go into prolonged states of decline. History has shown this and continues to do so!
> 
> 5. My rainbucket analogy gives ample warning of the perils of rebalancing in respect to such occurences, whereas the roullette wheel has precious little (if anything) to say on such matters!




1. Totally agree.  The scenario is fine.  The analogy is very attractive and creative.  My point was that that, if you are representing risk to the re-bal process, you also need to couple the scenario with a likelihood.  This is not a detraction from your elegant analogy - which could be adapted for many different purposes.  It's very cool.  Hence I walked into a casino to seek to aid the process of likelihood estimation by illustrative means.  It's fine if you don't like the analogy that I chose.


2. Yes, a casino game, if it isn't rigged like LIBOR, has knowable and stable odds in situations like Roulette.  That's what makes them good starting points for investments and probability theory.  

I just reached out to the first three texts that I have on probability and finance.  After blowing the dust off them, they each use games of chance like tossing coins to introduce the idea.  These texts deal with probability theory.

Title / Page of first mention of coin toss

a. DeGroot & Schervish, "Probability and Statistics", Fourth Edition / p27 of 890
b. Walpole & Myers, "Probability and Statistics for Engineers and Scientists", Fifth Edition / p11 of 765
c. Rudd & Classing, "Modern Portfolio Theory", Second Edition / p35 of 525.

If these texts alone, which are deep into Probability Theory and it's real world applications, see fit to utilize games of chance to introduce more complex issues, then for a guy who eschews all of it, it seemed reasonable to start there.  Do you actually think I think the markets work like a Roulette wheel?  No more than I think the markets actually operate like buckets of water where one has a leak.

Probability Theory, by the way, is perfectly applicable to games like Roulette to Poker and Black Jack.  But you seem to want to go deeper.

Since you have espoused the term Probability Theory and are talking about sample size and parameter stability, you must be versed or making it up.  I'll give you the benefit of the doubt.  If you believe that a Roulette wheel is engineered (yes, it is) and thus is not a valid comparison with markets, then you will need to explain why the moment generating function of the sum of lognormal returns being security price returns, drawn from an unknown and flexible distribution, will not asymptote to the same description for higher moments as the one drawn from draws from a game of Roulette.  But...it does.  Cynic, this is the same stuff that is the bedrock of options pricing using binomial models.  The entire options market disagrees with your statement.

As for Roulette numbers going into receivership.  That's absolutely true.  But they don't need to.  The scenario of effective bankruptcy is where there are several draws in a row where the house loses.  You can give the house starting capital and let it - uh - roll.  The house can bankrupt under Roulette conditions even with positive expectancy.  This is the same as saying that re-bal can lose you tonnes of money relative to buy-hold.  It can and will happen.  Casinos will go bust under certain scenarios.  Re-bal will lose (a lot of) money under certain scenarios. 


3. Where did you get this from?  Early in my career, I was Head of Risk for a $12bn balance sheet which traded global equities, global bonds and credit, FFX and options and this statement surprises me greatly. I must have missed the memo that said I couldn't estimate risk! But what do I know?  Perhaps you can call someone who knows better than me and produces risk management engines for - not millions and millions - but trillions and trillions of dollars.

The Head of Research at MSCI Barra and the CEO of Northfield would be good places to start.  They don't have millions and millions of observations to draw from either.  Yet, surprisingly, their stuff produces risk estimates that pass all statistical tests - Yes, from Probability Theory - and is incredibly valuable given the sensitivity to which portfolio settings are held. 

Seemed to work alright in my lifetime.   And that included the periods like LTCM, Russia/Asia Crisis, Tech Wreck, Iraq and GFC.  

I would guess, because I cannot ever know for sure when we're talking Probability Theory, that you have probably no real concept of convergence and how fast it occurs and how it can be further stabilized.


4. Yes they do.  No argument here.  Please see Post #73, Item 4. Where I ran re-bal for portfolios that were composed entirely of stocks that went down.  It demonstrated that rebal has positive expectancy under these conditions.  Re-bal doesn't care if stocks are going up or down.  All that matters is how they move relative to one another.  The underlying idea behind this re-bal stuff comes directly from Probability Theory and from that, the positive expectancy just falls out.  Much of this debate arises because people can't work through the maths or, failing that, won't take the time to run a basic Monte Carlo simulation to get a feel for it.  I'm done with this debate.  Please just do the work to figure it out.  I'm not here to be your pillar of abuse or punching bag.  I could care less.


5. Your analogy is a great one, describing a horrible scenario for re-bal.  The Roulette wheel spinning 32 ten times in a row with some punter re-staking that number is also a horrible analogous scenario for re-bal.  


All the best, I'm signing off.  Any further correspondence can be directed to the site that Craft has provided.


Disclaimer: I am not endorsing or suggesting that you should purchase or utilize risk models or any other material from MSCI Barra or Northfield.  I am not encouraging you to play Roulette or toss coins.  I am not encouraging you to put holes in any buckets you have either.  Be amply warned.  Re-bal can and will underperform buy-hold in certain scenarios most of which are highly plausible.  Some of these outcomes can be very bad indeed. This statement would apply for any investment strategy you might attempt except for pure arbitrage.  Please do your own work and figure it out for yourself.


----------



## DeepState

craft said:


> 1. Gut instinct would have me think a fair bit of rebalance performance over indexes has to do with initial equal weight effect.
> 
> 2. Sometimes you just need a break - you may find that also in time..
> 
> 
> 3. What it takes to harvest one edge doesn't necessarily add to another  - and in fact trying to do so can cause damage to the original edge. That's not a discussion for 12:30am but a mighty good topic for one rainy day and could probably go a long way to reconcile the different angles you and BRTY might be coming from.
> 
> 
> 4. Care to detail your data source(total return by quarters -nice) and back testing engines? They appear pretty impressive.




Hi Craft

1. That's true.  There is a certain optimal portfolio that re-bal works best for relative to buy-hold.  That's not an equally weighted portfolio and requires some matrix inversion to obtain.  Anything away from that lowers expectancy.  At the extreme, if the initial portfolio consists of one stock, re-bal doesn't work.  But beyond that, there is positive expectancy at some level.  Just less than the maximum that could probablistically be achieved.

2. Yep, I'm retired mate!  Also, on the receipt of your advice, I am taking a permanent break from this thread after this note.

3. Very cool.  Yes, you are right.  Net edge is not the sum of all edges, it must be adjusted for the covariance (or deeper structure) of the expected portfolio of edges.  

I think the difference with BRTY goes a fair way beyond this. But I'll let this pass.

4. My data aggregation platform is FactSet.  My manipulation engine is MatLab.  What I have now just blows mouse farts relative to the hyper-sonic thruster stuff of the past.  But, it'll do me.

Cheers


----------



## DeepState

TPI said:


> 1. It is a small part, what other similarly simple strategies do you think give investors an edge?
> 
> 
> 2. This is fine if your focus is on total returns.
> 
> For people who invest to provide _passive_ income to meet expenses, retire or follow other passions, the income component is more important.




Sorry TPI, I signed off too soon.

1. I think you are looking to low turnover strategies.  If that is so, then Premium Based Strategies are suitable candidates. They are long term in focus an involve some notion of risk bearing that can't otherwise be absorbed by others in the market.  Things like deep value which is screened for credit worthiness, buying small caps.  You may have heard of Low Vol.  That's achievable but more intense and needs valuation and earnings quality overrides.  You can add trend stuff into the mix, which works very powerfully in Australia for some reason, but no where near as powerfully elsewhere.  All that is simple.  

The above is heavily mined so the basic strategies are not going to be super-profit makers any more.  Unfortunately, simple stuff produces fairly simple returns in this type of scenario.  

Otherwise, you get rich by not losing money.  Watch for tax.  Knowing your tax rate, you should either tilt to or away from dividend payers.  Watch comm.  There is massive excess turnover.  Just doing nothing is often better than watching screens.  Harvest the right parcels and know the consequences of harvesting a large CGT parcel requires a very powerful idea to justify it.  This really adds up over time.

You sound like an adviser or planner.  You would be aware of the horrible record of mistiming markets in retail (let along insto).  So a huge part of this is simply sticking to the game plan.  But, it's hard because you don't know if your game plan is busted.  To me, you invest in a way that allows for really bad scenarios but not the extreme ones.  When that's set, you find a way of protecting tail risks so you can hack it in the event of really awful outcomes and stick to the game plan and stay cool as the world melts around you.

That's the simple truth of it.

2. Actually, you can build a portfolio with an income focus and add re-bal on top.  The concept works anyway. It would, for example, work on a portfolio of bonds.


Cheers


----------



## KnowThePast

DeepState said:


> Sorry TPI, I signed off too soon.
> 
> 1. I think you are looking to low turnover strategies.  If that is so, then Premium Based Strategies are suitable candidates. They are long term in focus an involve some notion of risk bearing that can't otherwise be absorbed by others in the market.  Things like deep value which is screened for credit worthiness, buying small caps.  You may have heard of Low Vol.  That's achievable but more intense and needs valuation and earnings quality overrides.  You can add trend stuff into the mix, which works very powerfully in Australia for some reason, but no where near as powerfully elsewhere.  All that is simple.
> 
> The above is heavily mined so the basic strategies are not going to be super-profit makers any more.  Unfortunately, simple stuff produces fairly simple returns in this type of scenario.
> 
> Otherwise, you get rich by not losing money.  Watch for tax.  Knowing your tax rate, you should either tilt to or away from dividend payers.  Watch comm.  There is massive excess turnover.  Just doing nothing is often better than watching screens.  Harvest the right parcels and know the consequences of harvesting a large CGT parcel requires a very powerful idea to justify it.  This really adds up over time.
> 
> You sound like an adviser or planner.  You would be aware of the horrible record of mistiming markets in retail (let along insto).  So a huge part of this is simply sticking to the game plan.  But, it's hard because you don't know if your game plan is busted.  To me, you invest in a way that allows for really bad scenarios but not the extreme ones.  When that's set, you find a way of protecting tail risks so you can hack it in the event of really awful outcomes and stick to the game plan and stay cool as the world melts around you.
> 
> That's the simple truth of it.
> 
> 2. Actually, you can build a portfolio with an income focus and add re-bal on top.  The concept works anyway. It would, for example, work on a portfolio of bonds.
> 
> 
> Cheers




Hey RY,

I am really enjoying your contributions to this forum, you have already given me enough ideas to research and play around with for a long time. Thank you.

If I could please keep you signed in to this thread for a little bit longer..

What are your thoughts on black swan events? A system may have a positive expectancy, but a significant enough chance of a total meltdown. And the longer you run the system, the greater chance of running into one eventually. 

Australian market is an interesting example at the moment. A lot of value strategies, at the moment would be almost totally invested in mining services companies. Chance of a catastrophic event for a portfolio is thus significantly higher, as it only needs to happen in one industry. 

What are your thoughts on controlling systems to lower this risk, what kind of manual overrides to allow, and how to not let those overrides be abused?


----------



## cynic

DeepState said:


> 1. Totally agree.  The scenario is fine.  The analogy is very attractive and creative.  My point was that that, if you are representing risk to the re-bal process, you also need to couple the scenario with a likelihood.




No problem! My trading experience accompanied with observations of others tells me that the likelihood for an ardent trader is extremely high!


> 2. Yes, a casino game, if it isn't rigged like LIBOR, has knowable and stable odds in situations like Roulette.  That's what makes them good starting points for investments and probability theory.




For probability theory perhaps , but certainly not for investments!!!



> I just reached out to the first three texts that I have on probability and finance.  After blowing the dust off them, they each use games of chance like tossing coins to introduce the idea.  These texts deal with probability theory.




Well bully for you! I have some authoritative texts at my disposal also! Better still, I actually take the time to read and understand them!



> Title / Page of first mention of coin toss
> 
> a. DeGroot & Schervish, "Probability and Statistics", Fourth Edition / p27 of 890
> b. Walpole & Myers, "Probability and Statistics for Engineers and Scientists", Fifth Edition / p11 of 765
> c. Rudd & Classing, "Modern Portfolio Theory", Second Edition / p35 of 525.
> 
> If these texts alone, which are deep into Probability Theory and it's real world applications, see fit to utilize games of chance to introduce more complex issues, then for a guy who eschews all of it, it seemed reasonable to start there.  Do you actually think I think the markets work like a Roulette wheel?  No more than I think the markets actually operate like buckets of water where one has a leak.
> 
> Probability Theory, by the way, is perfectly applicable to games like Roulette to Poker and Black Jack.  But you seem to want to go deeper.
> 
> Since you have espoused the term Probability Theory and are talking about sample size and parameter stability, you must be versed or making it up.  I'll give you the benefit of the doubt.  If you believe that a Roulette wheel is engineered (yes, it is) and thus is not a valid comparison with markets, then you will need to explain why the moment generating function of the sum of lognormal returns being security price returns, drawn from an unknown and flexible distribution, will not asymptote to the same description for higher moments as the one drawn from draws from a game of Roulette.  But...it does.  Cynic, this is the same stuff that is the bedrock of options pricing using binomial models.  The entire options market disagrees with your statement.




Not according to Lawrence G. MacMillan (You do know who he is don't you!!!). I suggest you acquaint yourself with the contents of his chapter on stock price distribution (chapter 38, "Options as a Strategic Investment", 4th edition) where he demonstrates that stock prices (and by extension options) do not conform to normal and/or lognormal distributions!



> As for Roulette numbers going into receivership.  That's absolutely true.  But they don't need to.  The scenario of effective bankruptcy is where there are several draws in a row where the house loses.  You can give the house starting capital and let it - uh - roll.  The house can bankrupt under Roulette conditions even with positive expectancy.  This is the same as saying that re-bal can lose you tonnes of money relative to buy-hold.  It can and will happen.  Casinos will go bust under certain scenarios.  Re-bal will lose (a lot of) money under certain scenarios.



As I've already mentioned, Casino games are simply not a valid comparison to the financial markets! 
Incidentally, the behaviour of the options market happens to agree with me on this! I often trade (profitably I might add) using instruments that are priced in accordance with the Black Scholes model.


> 3. Where did you get this from?




Third year high school maths class! Were you asleep in that class? 


> Seemed to work alright in my lifetime.   And that included the periods like LTCM, Russia/Asia Crisis, Tech Wreck, Iraq and GFC.



 Good for you ! Were you trading for a living with your own capital (and no other income) at that time?


> I would guess, because I cannot ever know for sure when we're talking Probability Theory, that you have probably no real concept of convergence and how fast it occurs and how it can be further stabilized.



Well it's a good thing that you're not reliant upon the accuracy of your guesses for income then, isn't it?!!
I find experience gives me a more accurate picture of what can realistically be expected. Fanciful theories work well in theoretical worlds, however, such worlds are distinctly different from the one we live and trade in!


> 4. Yes they do.  No argument here.  Please see Post #73, Item 4. Where I ran re-bal for portfolios that were composed entirely of stocks that went down.



Well what was the point of that! 
Such a portfolio would be even less probable than one with stocks that only go up!! 

The adverse impact of rebalancing could be expected to be greatest when applied to a portfolio comprising a mixture of winners and losers! Incidentally, such mixed portfolios are far more likely to occur in the real world of trading where the future of any given investment is usually uncertain!



> It demonstrated that rebal has positive expectancy under these conditions.  Re-bal doesn't care if stocks are going up or down.  All that matters is how they move relative to one another.  The underlying idea behind this re-bal stuff comes directly from Probability Theory and from that, the positive expectancy just falls out.
> Much of this debate arises because people can't work through the maths or, failing that, won't take the time to run a basic Monte Carlo simulation to get a feel for it.




On the contrary, much of this debate is occurring because some here are able to easily discern the issues with this theory despite your inept efforts to obscure them with mathematical sleight of hand.



> I'm done with this debate.  Please just do the work to figure it out.  I'm not here to be your pillar of abuse or punching bag.  I could care less.



Good to hear! Enjoy your retirement!


----------



## hhse

Forgive my ignorance, but what is the point of rebalancing your share portfolio (in general, they head the same direction as the overall market), all you are effectively doing is either reducing the speed at which your portfolio goes down (or up). In that case, why not just buy an ETF and save on commissions?

To me, in simple terms 'rebalancing' only makes sense in terms of removing 'one type of risk' but taking on board another type of risk to make money.

e.g.

Rebalancing options portfolio to remove directional risk by having bullish and bearish trades, and you taking on 'volatility' risk and profiting from either an expansion or collapse in volatility in the product.


However, in your example, you are effectively trying to slow down your porftfolio's directional movement and yet you are trying to collect money from its movement ... I don't understand this... just buy an ETF.

I can understand people picking companies because they feel its undervalued, but I don't see how regular rebalancing comes into play.


----------



## TPI

DeepState said:


> Sorry TPI, I signed off too soon.
> 
> 1. I think you are looking to low turnover strategies.




Yes that is definitely my preference, low turnover and also low time involvement.



DeepState said:


> If that is so, then Premium Based Strategies are suitable candidates. They are long term in focus an involve some notion of risk bearing that can't otherwise be absorbed by others in the market.  Things like deep value which is screened for credit worthiness, buying small caps.  You may have heard of Low Vol.  That's achievable but more intense and needs valuation and earnings quality overrides.  You can add trend stuff into the mix, which works very powerfully in Australia for some reason, but no where near as powerfully elsewhere.  All that is simple.
> 
> ...
> 
> Otherwise, you get rich by not losing money.  Watch for tax.  Knowing your tax rate, you should either tilt to or away from dividend payers.  Watch comm.  There is massive excess turnover.  Just doing nothing is often better than watching screens.  Harvest the right parcels and know the consequences of harvesting a large CGT parcel requires a very powerful idea to justify it.  This really adds up over time.
> 
> You sound like an adviser or planner.  You would be aware of the horrible record of mistiming markets in retail (let along insto).  So a huge part of this is simply sticking to the game plan.  But, it's hard because you don't know if your game plan is busted.  To me, you invest in a way that allows for really bad scenarios but not the extreme ones.  When that's set, you find a way of protecting tail risks so you can hack it in the event of really awful outcomes and stick to the game plan and stay cool as the world melts around you.
> 
> That's the simple truth of it.




Well put, that sounds more like my style.

Though I'm not currently an adviser or planner, and work mostly in a non-related field.



DeepState said:


> 2. Actually, you can build a portfolio with an income focus and add re-bal on top.




Yes perhaps this is true.

Though I think this also depends on how much capital you have to invest. 

If you have a lot of capital, then you can generate more than enough income to live off very conservatively using cash/term deposits/bonds, and invest the rest more aggressively with a total return focus.

At a lower end eg. <$1M of capital, you may not be able to put everything into cash/term deposits/bonds and generate a sufficient income on which to live off, and one that keeps up with inflation over a potentially very long retirement period.

As such your exposure to risk assets (eg. commercial property, shares) may need to be greater in order to meet your basic income requirements, and the "tilt" of those risk assets I feel should generally be more towards yield (and more passive strategies as in the long-term actively managing money may become a lower priority).

Re-balancing at this level may make creating a regular, reliable and predictable income stream which you can use to pay your bills and expenses a bit more complicated. 

Each time you do this you sell one source of income (eg. a stock) and replace it with another (ie. another stock), but in doing so the income streams (ie. the dividends generated by the old stock vs. the new stock) won't necessarily match, but your living expenses will be the same, and you may end up worse off from an income point of view.

Hence why I feel that for the retail investor, who is mostly trying to generate sufficient income on which to live off, this re-balancing process is more hassle than it's worth.

Once their basic income requirements are more than adequately met though, any excess capital could be directed towards a portfolio with such strategies involved.


----------



## DeepState

KnowThePast said:


> Hey RY,
> 
> I am really enjoying your contributions to this forum, you have already given me enough ideas to research and play around with for a long time. Thank you.
> 
> If I could please keep you signed in to this thread for a little bit longer..
> 
> What are your thoughts on black swan events? A system may have a positive expectancy, but a significant enough chance of a total meltdown. And the longer you run the system, the greater chance of running into one eventually.
> 
> Australian market is an interesting example at the moment. A lot of value strategies, at the moment would be almost totally invested in mining services companies. Chance of a catastrophic event for a portfolio is thus significantly higher, as it only needs to happen in one industry.
> 
> What are your thoughts on controlling systems to lower this risk, what kind of manual overrides to allow, and how to not let those overrides be abused?




Hi KTP, just responded to you via new thread under Derivatives / Return Distributions. Cheers


----------



## brty

While I wont change my tune about the dangers of rebal on stock portfolios, I have done a little preliminary research on an area where rebal should ALWAYS work.

This being in the field of ETFs. Taking any of our long term well managed ETFs, say AFI, MLT, WAM, STW etc and using just a couple of them with at least $100k in each, by rebalancing when they deviate from each other by a certain percent, only 2-3%, because they do correlate very well as you would expect, then it might be possible to add .5% or so to the overall performance per annum over the long term.

When I get the time in a couple of weeks, I'll have ago at doing that to see what I come up with. Of course I'll still be a charlatan by showing an area where it works.


----------



## sinner

I have made pretty much this identical post before, but it's relevant again...for anyone who wants to actually see some research rather than just arguing mindlessly back and forth...

http://gestaltu.blogspot.com.au/2012/02/volatility-harvesting-and-importance-of.html - "Volatility Harvesting and the Importance Of Rebalancing "

Practical application in the Permanent Portfolio (US):

http://gestaltu.blogspot.com.au/2012/08/permanent-portfolio-shakedown-part-1.html
http://gestaltu.blogspot.com.au/2012/08/permanent-portfolio-shakedown-part-ii.html

...and Japan too (i.e. a market where stocks have been going down for decades and the economy is in deflation):

http://gestaltu.blogspot.com.au/2012/09/the-permanent-portfolio-turns-japanese.html


----------



## TPI

brty said:


> While I wont change my tune about the dangers of rebal on stock portfolios, I have done a little preliminary research on an area where rebal should ALWAYS work.
> 
> This being in the field of ETFs. Taking any of our long term well managed ETFs, say AFI, MLT, WAM, STW etc




brty, AFI, MLT and WAM are actually LICs (listed investment companies) not ETFs.

STW is an ETF though, but not really actively "managed" as such as it is a passive index tracker.


----------



## sinner

There are different types of risk: idiosyncratic, secondary, systemic. 

Diversifying a bunch of stocks within a sector allows you to harvest volatility differences between stocks in that sector, but you remain exposed to secondary and systemic risk. 

Diversifying a bunch of sectors allows you to harvest volatility differences between sectors in a given (international or national) market, but you remain exposed to systemic risk.

Diversifying a bunch of asset classes allows you to harvest volatility differences between asset classes and does protect well from systemic risk.

In each superior case you reduce overall portfolio volatility versus its inferior at the cost of beta returns, but compensated by low volatility alpha returns (i.e. *high win rate trades* - the US Permanent Portfolio linked above "delivered positive returns over 98% of periods since 1970"). 

If you think about it, it also protects you from bubble risk, as you will never hold your largest allocation for any given investment when the market is rising (i.e. valuations falling) - admittedly this does depend on your rebalancing strategy, whether it's price or time or volatility based.

Here's another blogpost I've posted about before, on the difference between convex and concave trading strategies and when each outperforms 

http://cssanalytics.wordpress.com/2...et-allocation-lessons-from-perold-and-sharpe/


> The first takeaway is that there is no uniform winning strategy in all market conditions. Each strategy has a particular regime in which is it likely to shine.


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## sinner

Turnkey Analyst (http://alpha.turnkeyanalyst.com) has a backtesting tool for some simple and academic long only portfolios going back to 1978. Below I highlight a few different ones:


ew_index == Equal Weight 6 asset class (SP500, MSCI EAFE, MSCI Emerging Mkts, FTSE NAREIT, GSCI, 10Y US Treasury rolling) basket with annual rebalancing to equal weight
ew_index_ma == Above with (monthly evaluation) trend following rule
mom_ma == Above with trend following rule and (monthly) weighting asset classes by momentum
risk_parity_mom_ma Above and weighting classes by both momentum and volatility



In this case I think the results are pretty self explanatory, in this case rebalancing wasn't useful for the GFC (since most of the assets in the portfolio are 'risk assets') but it did a good job of protecting from the tech bubble.


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## sinner

Another similar example which shows protection from secondary risk, SP500 (which is a market weighted index) versus the equal weighted (annual rebalance) CRSP universe (unfortunately this test only goes to Dec 2011)


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## Ves

Thanks Sinner.  The GesaltU blog has made for some good reading when you have linked to it in the past.   This time is no exception.


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## DeepState

sinner said:


> (unfortunately this test only goes to Dec 2011)




Hi.  Popping in quickly. Just want to fill a data hole.  Below is an extract of performance from Fernholz's (Originator of Stochastic Portfolio Theory that went on to become re-bal) firm.  It includes rebal over SP500 that shows modest outperformance for the three years to 31 March 2014 which overlaps the missing data.  

InTech, which has been in existence for 25 years, has never closed a portfolio for reasons of performance so this is all their accounts that were ever formed and had external assets in them. It covers different universes, including global equities and small cap equities. Thus, no selection/survival or hindsight type bias exists in this data. All records are live composites. The firm has ~USD50bn.  Not one single strategy has underperformed buy-hold in the period since inception.  Before advisory fees, outperformance of buy-hold is around 2%pa as previously indicated as indicative for the strategy in general.  Those which had access performance of around 1% per annum were run to tighter bounds, which limits misweighting, and hence called "enhanced".

Given the length of the history, essentially all sorts of market conditions have been encountered. 

Enjoy.




Disclaimer/Disclosure:  I do not endorse InTech, it's officers, subsidiaries or associates.  I have had a sandwich lunch with their CEO and a one course meal with their President of International Division and received Christmas cards and presents of nominal value.  Otherwise I have no financial relationship with them whatsoever.  This is not advice nor a solicitation to invest in these products.  Please do your own work.


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## rb250660

DeepState said:


> I have had a sandwich lunch with their CEO and a one course meal with their President of International Division and received Christmas cards and presents of nominal value.




Who cares.


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## DeepState

rb250660 said:


> Who cares.




It's a joke dude, despite it being factually accurate. 

However, in reality, standards of disclosure have reached the point where meals are itemised and the value of the meals are also disclosed when people are interviewed in newspapers and conflict of interest registers in professional organisations providing advisory services. So given I've been asked about disclosure here and there etc. I went OTT or, more accurately, met those standards.

Personally, I wouldn't care either. It's not like the tandoori chicken wrap ($4) or seafood risotto ($25) were out of this world. Touche.


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