# The Portfolio MYTH-----Do you need to change your thinking?



## tech/a (25 March 2017)

Its becoming more recognised, I've seen it mentioned by a few now.

While portfolios are designed to minimize risk they *certainly don't maximize profit*.
I think this is true for Technical/Fundamental/and Systematic traders.

*I've changed the way I trade stock. Its taken 8 mths.
*
In some part as a throw back from trading futures for a few years now.
Individual issues develop a life of their own. Take enough time to study it and you'll see its consistent. So what's changed my thinking.

(1) I find it easier to anticipate the movements of one/two max issues--- than 10 or 20.
(2) I can make decisions quicker for entry/exit and trade management.
(3) I can take a larger risk on one/two max--- rather than 10 and get a better bang for buck.

( This has taken time to perfect but I have had up to 60% of my allocated funds (to small caps) in one issue during a day of trading. Yes I hit and run but often still hold the original.
Just one part of a vastly altered trading plan---*designed specifically* to trade 1 or 2 issues).

(4) I can at times take on far more risk while still minimizing longer term (O/N) risk.
again better bang for buck.

(5) Much easier to manage.
(6) I think its a necessity if you wish to adjust with the times.
(7) There are opportunities everywhere and they are black and white--they trigger or fail
very quickly and with the risk mitigation skills learned while trading the DAX/FTSE they are
easy to trade---more reliable---slower!!--than Futures.
(8) Many of the runs are long and returning well over 5 sometimes over 10R.
(9) I rarely drop more than 1-2% on a losing trade and only 2 times have I dropped my initial risk in its entirety .
(10) Theories are easier tested. And prospects quickly found.

(11) Its *MORE PROFITABLE (On money invested)
*
(12) Lastly its bought the *FUN BACK!*


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## galumay (25 March 2017)

It makes sense for those reasons for a trader, I believe there is some cross over for investors too.
From an investing point of view it avoids di-worsification and requires less effort and time to fully understand the businesses I am invested in.
The big commonality is higher returns if the decision making is sound.
I suspect its highly dependent on one's strategies and processes to support them.

I have reduced the number of businesses I am invested in and consolidated my portfolios to some extent. I am mindful of Buffett's suggestion that we treat it like a punch card,

 "I could improve your ultimate financial welfare by giving you a ticket with only twenty slots in it so that you had twenty punches - representing all the investments that you got to make in a lifetime. And once you'd punched through the card, you couldn't make any more investments at all. Under those rules, you'd really think carefully about what you did, and you'd be forced to load up on what you'd really thought about."


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## DeepState (25 March 2017)

If you are awesome, you don't need diversification. Spreading yourself too thin can reduce the degree to which you are awesome. That's true.

The average SMSF portfolio has less than 10 stocks in it.  I suppose most of us are either awesome (everyone is special!) or have very limited bandwidth (everyone has ADHD), or have no idea what we are doing.  ... It's hard to say which.... or is it?

If fun is your objective, do what makes you happy!

Now, please remind me, how many stocks does Berkshire hold? Or, for traders, Rennaisance Capital?


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## galumay (25 March 2017)

DeepState said:


> Now, please remind me, how many stocks does Berkshire hold?




I believe Warren & Charlie have both made the point aboiut how hard it gets when you are as incredibly successful as they have been. Nothing much that is true for the rest of us really makes sense on the sort of scale they have to operate on! 



DeepState said:


> or have no idea what we are doing. ..




Thats the one that resonates with me!


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## tech/a (25 March 2017)

*If fun is your objective

Fun is a bi product of doing something well.
Anything
Business 
Sport
Marriage
Friendships.*


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## DeepState (25 March 2017)

galumay said:


> I believe Warren & Charlie have both made the point aboiut how hard it gets when you are as incredibly successful as they have been. Nothing much that is true for the rest of us really makes sense on the sort of scale they have to operate on




How about what they were doing, say, 40 years ago....(accessable via Chairmam's letters via BRK site if interested). Anyway, it's rather more than 10. And that's when they had a lot more flex than today.


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## barney (25 March 2017)

tech/a said:


> *I've changed the way I trade stock. Its taken 8 mths.
> *
> ( This has taken time to perfect but I have had up to 60% of my allocated funds (to small caps) in one issue during a day of trading.      *designed specifically* to trade 1 or 2 issues).
> 
> Lastly its bought the *FUN BACK!*




Its interesting to hear you think this way tech and it reinforces what I finally discovered about 3 years ago.  Your new rules in Post 1 are very similar to what turned my trading from "I probably should give this up" ... to, "I'm doing OK" ..... 

As you know, when taxation becomes a consideration, you trading is improving lol ....

As for the fun aspect .... I'm not quite to the fun stage yet but I understand your sentiment .... i am hoping for "fun" to develop over the next couple of years


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## DeepState (25 March 2017)

In the land of ASF, everyone had enough but there was a debate about the myth of portfolio diversification that needed to be settled.  The population of 2000 has equal skill but there are differing views on the matter of diversification. The town is split in to two camps.  Camp Awesome held portfolios which had half of the effective diversification of Camp Timid.  Think of this as equally weighted portfolios of 10 stocks vs equally weighted portfolios of 20 stocks where the stocks are similar in characteristics individually.

After a year, the results are in.  Of the top 10 Hall of Fame list, nine are from Camp Awesome and only one is from Camp Timid.  They all do book and speaking tours and the township became convinced that concentrated portfolio management was definitely the way to go as the very best investors overwhelmingly preached it.

One curious kid, a child of Camp Timid, walked around the town a month later and was looking at a huddled mass of unfortunates eating cat food.  This was strange because the town of ASF had enough only a little while ago.  Crime was low in ASF, so he approached them.  Nine out of ten of them, it turns out, were from Camp Awesome.  No one asks them to share their thoughts on the matter of portfolio diversification though and their story goes unheard.

Meanwhile, the bulk of people in Camp Timid go on to live their quiet lives with some being tempted to move to concentrated portfolios by spruikers of how that it how they got so rich.    Those who were Awesome remained forever convinced that this is the way to go because the super-stars almost always invest that way.....

The child never developed a sense for investments.  He went on to create a cat food company and became very wealthy.


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## galumay (25 March 2017)

DeepState said:


> How about what they were doing, say, 40 years ago....(accessable via Chairmam's letters via BRK site if interested). Anyway, it's rather more than 10. And that's when they had a lot more flex than today.




We are probably dragging the Duck's thread OT a bit, but...two things, he said 20, which is rather more than 10, and he wasnt saying thats what BRK did, he was advising groups of college students about the approach they might take to investing.

EDIT - We wrote the last 2 posts concurrently, lovely story DS, the concluding line is gold! Prompts me to repost one of the best quotes by a recently departed mate of mine, I had been making a long winded and intense point in debate within a critical negotiation, and concluded by making the point that there is more than one way to skin a cat, my old mate John looked up, rubbed his eyes as if waking from a stupor (induced by my rambling), and noted, "Yep, and the cat doesnt like any of them."


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## tech/a (25 March 2017)

*The child never developed a sense for investments*
And he probably doesn't learn Morse code either.

Poor analogy D/S

Would you feel as strongly if a futures trader
Argued that trading futures (1 or 2) are potentially
More profitable and easier than trading a portfolio of
Stocks. I'd agree with him.

I suggest those interested investigate the idea which is not
Mine alone ----- further.

Buffett became filthy rich from 1 great company and one
great decision.
Berkshire Hathaway.

20 and 10 is still quite diversified portfolios
2 v 20 is vastly different in content and management
So they should be.

*Black and White really*


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## DeepState (25 March 2017)

galumay said:


> We are probably dragging the Duck's thread OT a bit, but...two things, he said 20, which is rather more than 10, and he wasnt saying thats what BRK did, he was advising groups of college students about the approach they might take to investing.




Hi Galumay

In the world of stocks, if the assets are material to you, I don't have any problem with something like 10-25 stocks, depending on what they are.  T/A did not advocate 10-20, he said:

_(1) I find it easier to anticipate the movements of one/two max issues--- than 10 or 20.
(2) I can make decisions quicker for entry/exit and trade management.
(3) I can take a larger risk on one/two max--- rather than 10 and get a better bang for buck._

So, going into ultra concentrated holdings.  He never mentioned BRK, but I raised it because Buffett is often quoted on the matter.  And yet, he held portfolios which were more diverse that many might think when mentioning 'diworsification' amongst many wise things he has said.  Interestingly, Buffett says Jack Bogle is truly the awesome one in the latest annual.  Bogle founded Vanguard...the doyen of diversification.

So, this concept of hyper concentrated portfolios keeps coming up and it keeps coming up because the best outcomes are often derived from it.  Whilst often expressed as skill, it is a statistical matter that they will be at the outliers and it will appear like skill to be emulated because the spoils go to the victors...and cat food eaters don't write books.  The natural outcome, if people are not aware of 'availability bias', is to believe in concentrated portfolios and the whole loop tightens with vast outcomes for a few and a wide and silent group for whom it did not work out.






galumay said:


> EDIT - We wrote the last 2 posts concurrently, lovely story DS, the concluding line is gold! Prompts me to repost one of the best quotes by a recently departed mate of mine, I had been making a long winded and intense point in debate within a critical negotiation, and concluded by making the point that there is more than one way to skin a cat, my old mate John looked up, rubbed his eyes as if waking from a stupor (induced by my rambling), and noted, "Yep, and the cat doesnt like any of them."




Nice one.  Given two options, find the third!


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## rb250660 (25 March 2017)

I take it you are talking about discretionary trading right?

I'd hate to have 60% of total funds in some POS low cap stock that suddenly goes into a trading halt to raise capital after a recent big break out. So typical! Or someone decides to fly planes into building while you were sleeping.


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## DeepState (25 March 2017)

tech/a said:


> *The child never developed a sense for investments*
> And he probably doesn't learn Morse code either.




Actually, the kid did learn morse code.




tech/a said:


> Poor analogy D/S



How so?  Perhaps the town isn't actually called ASF?

Do the extreme outcomes from investments not come from those who take the greatest risks more often than not?  Does extreme upside not get celebrated and emulated?




tech/a said:


> Would you feel as strongly if a futures trader
> Argued that trading futures (1 or 2) are potentially
> More profitable and easier than trading a portfolio of
> Stocks. I'd agree with him.




If that was the trader's skill set, that's fine.

It's about risk deployment.  If DAX/FTSE is all he knows, that's fine as long as the risks are contained.  If he actually knows how to trade a stack of futures markets and has edge in general, it's not such a great idea.  He'd be better off deploying risk slightly more broadly. 

There is a possible argument, which you have made, that focus increases edge.  That's viable.  But your edge had better degrade very rapidly to sustain the argument of ultra-concentration.  The kind of degradation that would mean a person just can't concentrate on much at all...which makes investing/trading rather dubious.



tech/a said:


> I suggest those interested investigate the idea which is not
> Mine alone ----- further.
> 
> Buffett became filthy rich from 1 great company and one
> ...




You are writing this seriously aren't you.  I suggest that those interested might read this statement and consider the efficacy.  If not apparently absurd, read again given BRK is essentially an insurance company bolted on to an investment portfolio that can be replicated by a mutual fund whose stock counts would be >20.  Ridiculous.



tech/a said:


> 20 and 10 is still quite diversified portfolios
> 2 v 20 is vastly different in content and management
> So they should be.
> 
> ...




Yes, I'm sure that it appears black and white.  In which case, there is probably a problem somewhere.


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## tech/a (25 March 2017)

You have made an assumption
But at times yes.
If I see something running like a flooded river I'll 
Hop on and off in the one day just as I do when
I trade futures.
Nothing irresponsible


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## tech/a (25 March 2017)

rb250660 said:


> I take it you are talking about discretionary trading right?
> 
> I'd hate to have 60% of total funds in some POS low cap stock that suddenly goes into a trading halt to raise capital after a recent big break out. So typical! Or someone decides to fly planes into building while you were sleeping.




60% of trading capital not nett worth


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## rb250660 (25 March 2017)

I just changed the position sizing on one of my mean reversion strategies to trade 50% of capital on each position. I don't know why I didn't think of this sooner to maximize my gains. Never mind the draw downs. Look at those annual returns! YOLO!


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## DeepState (25 March 2017)

What particular assumption are you referring to Duck of Awesomeness?  That's great, like Connor McLeod of the clan McLeod (Highlander).  Except he truly was immortal.


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## rb250660 (25 March 2017)

tech/a said:


> 60% of trading capital not nett worth




Oh so you diversified????


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## DeepState (25 March 2017)

rb250660 said:


> I just changed the position sizing on one of my mean reversion strategies to trade 50% of capital on each position. I don't know why I didn't think of this sooner to maximize my gains. Never mind the draw downs. Look at those annual returns! YOLO!



 Awesome RB.  Can I be like you?


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## barney (25 March 2017)

galumay said:


> It makes sense for those reasons for a* trader,* I believe there is some cross over for *investors* too.





Not sure whether this thread will end well but i think the bottom line is likely related to whether punters are long term "investing" or short/medium term trading ..... big difference!!


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## rb250660 (25 March 2017)

You can be whoever you want. That's what is great about life right!?


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## DeepState (25 March 2017)

barney said:


> Not sure whether this thread will end well but i think the bottom line is likely related to whether punters are long term "investing" or short/medium term trading ..... big difference!!




This is actually a very important point (not kidding).  Can you please expand on what you are thinking here?


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## rb250660 (25 March 2017)

Seriously though, if the risk to the downside is managed anything is possible.

On the other hand I look to diversify by trading multiple strategies that are not correlated to each other. None of them hold any more than 10 positions and certainly trade different time frames. I think beyond that you are wasting you capital if you think you are diversifying. You'll find that even with 10 positions if mining for example is going off, half of your holdings are probably mining stocks, why hold another 10?

My comments of course depend on your trading style.


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## galumay (25 March 2017)

DeepState said:


> and the whole loop tightens with vast outcomes for a few and a wide and silent group for whom it did not work out.




Yep, i got the analogy! I think that Buffett is right both ways, as long as you understand the context. He was pointing out the 20 slots thing to try to get people to more carefully consider where and how they allocate capital, I think he would be the first to concede that he and Charlie are outliers and what he recommends others doing very often is entirely different to what they have done. I also think his enthusiasm for the Bogle approach is based on his conclusion that the vast majority of people are psychologically unsuited to active investment - in which case a highly diversified portfolio (like index trackers), works best. 



DeepState said:


> In the world of stocks, if the assets are material to you, I don't have any problem with something like 10-25 stocks, depending on what they are.




Around 15-20 seems to suit me, I think it would be variable based on how much time I am able and prepared to devote to active portfolio management - currently that number fits in with the rest of my life activities.

While I appreciate and understand your comments about the heuristics that lead to people to believe that the best results are achieved with "hyper concentrated portfolios", the opposite is also the case with many similar biases leading to people frequently and loudly arguing that hyper diversification is essential and anything less is a path to ruin! Like most things in life, the reality probably lies somewhere in the middle, some of the time, for some people!


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## DeepState (25 March 2017)

Yep. So each of your individual trading strategies is run pretty tight....but you run several.  So, at least in my book, you're not running a portfolio of 1-3 stocks.  Perfectly legit.

Agree also with the management of downside risk.  Rule #1.  Which is the reason behind my question to Barney.

I understand that a position is being advocated by T/A s to deploy the same quantum of capital, that had been invested in some equity portfolio that is meaningful to the person, into a very small number.  On the face of it, subject to revelation of why this is only really a part of a wider - diversified - arrangement, that's got some hairs on it.

If the assets are just punting BS loose change, then do whatever...it doesn't matter....but the advice should probably state that the situation is such that the proposition doesn't matter anyway.


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## OmegaTrader (25 March 2017)

I think the answer to the debate is what ever gets the best results in the long term.

Those results should take into account return, risk, availability of opportunities and time taken for the trade/investment return to be realised.

The strategy that has the best return measured at the same time frame for the given risk and appropriate for your capital level.

Easy to say after the fact, finding out the answers is the hard part. Ones personal situation often tends to cloud the situation as well to fit in with the ingrained lifestyle and attitudes/beliefs.


The rest is hubris and the proverbial gorilla inside beating the chest. 

my limited two cents


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## barney (25 March 2017)

DeepState said:


> This is actually a very important point (not kidding).  Can you please expand on what you are thinking here?




Hi DS .... I really believe that every Trader's personal circumstances dictate their bias as to what is the "best" way to trade/invest.

"Best" of course is a relative term ..... So many variables have to be considered .... My circumstances are likely so far detached from what yours or tech's may be that I don't think anyone can discount the possibility that "all" our systems might still be both profitable and "correct" for our own personal circumstances (repeating myself, sorry)

I think Galumay's point that you can skin a cat in many different ways is the best way to describe it ..... 

Normally I would feel sorry for the cat, but trading/Investing makes the cat fair game ... lol 

I really think that the potential direction that this thread could end up taking is likely a non event based on the fact that some people like "Tabbies" and others like Burmese/Himalayan crosses  Cheers.


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## galumay (25 March 2017)

OmegaTrader said:


> I think the answer to the debate is what ever gets the best results in the long term.




I am going to be contrary here, I dont think you can say that, because as DS points out its very likely the very best outlier results will come from an ultra concentrated portfolio - in fact logically the best result will come from a single holding - whatever company is going to have the highest % increase in share price over the time period.

The point is to be very wary of any absolutes, whenever I hear someone saying, "there is only one way..." or "the best way is certainly..." I become wary!


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## DeepState (25 March 2017)

barney said:


> Hi DS .... I really believe that every Trader's personal circumstances dictate their bias as to what is the "best" way to trade/invest.
> 
> "Best" of course is a relative term ..... So many variables have to be considered .... My circumstances are likely so far detached from what yours or tech's may be that I don't think anyone can discount the possibility that "all" our systems might still be both profitable and "correct" for our own personal circumstances (repeating myself, sorry)
> 
> ...




Thanks.  There certainly is much room for wiggle in this, between the extremes of one stock and 2,000 stock portfolios.

I was curious about your time frame assertion.  I think it matters, but wanted to wait for you first.

I think "best" is: doing whatever has the highest chance of getting what you want (taking in to account the pain and suffering for not getting it).  This includes consideration of how likely you are to survive the journey to that point in addition to your skills and aptitudes.  If your neural net can handle it, you can also allow for 'fun' in this journey...not kidding.

There are situations where a single stock portfolio makes sense.  They are uncommon.  These would include options market makers.  Traders sometimes get in to the zone on a single futures contract...which is where this gets interesting.

If you used to punt around in a portfolio of 20 stocks and now argue to deploy that capital in to just 2 stocks, the trade-offs in skills required to achieve this outcome are the stuff of fiction if that somehow is to be regarded as even best-er-er.

However, it is entirely viable if you cut your portfolio risks in a way which accommodates for the concentration now being taken.  If you do this, on the basis that deep focus gives you greater edge (and may even help you hold through tough spots because knowledge gives you comfort and confidence), all is good.

If the outcomes just aren't material to you, as previously mentioned, then who cares - the alternatives basically merge.  But if they are then it takes a special idea of what constitutes best to suggest a 2 stock portfolio is a responsible way forward for the prior assets.  I suspect that T/As account really doesn't matter that much for him.  In which case, do whatever makes you happy...just don't take it as useful general advice for those who's situation requires more careful consideration.


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## tech/a (25 March 2017)

Seem to have hit a raw nerve 
So we have two no's and 1 interested
To the question of course


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## galumay (25 March 2017)

I dont think you have hit a raw nerve, its healthy discussion isnt it? 
I think everyone is interested, otherwise why would we engage?


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## Quant (25 March 2017)

If your diversified portfolio doesnt beat the total return index why do you even bother with a portfolio . Many times i think diversifying stock holdings isnt reducing risk , its likely just burying it . If you arent proactive managing risk why dont you just do it the easy way with an index etf/derivative


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## galumay (25 March 2017)

Quant said:


> If your diversified portfolio doesnt beat the total return index why do you even bother with a portfolio .




What leads you to the conclusion that some/all posters in the thread are not going to return better than the relevant index with their portfolios?



> If you arent proactive managing risk why dont you just do it the easy way with an index etf/derivative




I dont quite understand what you mean by this statement. I guess there would be many varying opinons about exactly what risk is and how/if it should be managed. Not sure how you link that with passive index investing. (which has its own specific risks IMO.)


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## OmegaTrader (25 March 2017)

galumay said:


> I am going to be contrary here, I dont think you can say that, because as DS points out its very likely the very best outlier results will come from an ultra concentrated portfolio - in fact logically the best result will come from a single holding - whatever company is going to have the highest % increase in share price over the time period.
> 
> The point is to be very wary of any absolutes, whenever I hear someone saying, "there is only one way..." or "the best way is certainly..." I become wary!





*If you are not trying to get the best results what are you trying to do???*

hahahah

Read what I said.

*Proof is in the pudding end of story*

If you have two strategies. The same risk, the same return per year,the same time spent per week and both applicable to your amount of capital with abundant opportunities available at your level of capital.

One has 17% p.a return trading one asset and  one has 12% p.a return trading 20 assets.

17%>12%

Now if the 17% was day trading and 12% was buy and hold and you work full-time, then that is a different story. Now time and opportunity cost of time and lifestyle choices come into play.

However ceteris paribus 17% is always better than 12%

That is what I was referring to. You could switch the scenario as well etc.

If an investor/trader has the experience and toolbox to employ multiple strategies. He/she just employs the best strategy .

He does not think oh I will take 12 % instead of 17% just because Ideologically I like diversification  and vice versa of course. Oh statistically holding one stock will show this or that. Just go for the meat.

What works for him to get the best risk return profile. What works to make the most money in the long term for him. He cares about money not ideologies. 



It never changes, 17% will never be better than 12% no matter how hard one beats their chest.


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## tech/a (25 March 2017)

Quant said:


> If your diversified portfolio doesnt beat the total return index why do you even bother with a portfolio . Many times i think diversifying stock holdings isnt reducing risk , its likely just burying it . If you arent proactive managing risk why dont you just do it the easy way with an index etf/derivative




Yup


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## galumay (25 March 2017)

OmegaTrader said:


> Read what I said.




I could say the same to you! You have basically completely failed to comprehend the point I was making about your statement that, 

"I think the answer to the debate is what ever gets the best results in the long term."

Maybe I didnt explain it clearly enough.

Your response just seems to introduce more unsupportable generalisations. In fact people are continually trading higher returns for the perception of reduced risk. Ask anyone who practices portfolio rebalancing or chooses an asset class like ETF's. 



> If you are not trying to get the best results what are you trying to do???




I realise the best results are beyond my skillset, picking the company that will have the biggest increase in share price over the next 20 years is not something I have any confidence in, so i trade off the best possible return for less risk and accept that I will make a lower return than the absolute outliers.


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## barney (25 March 2017)

DeepState said:


> Thanks.  There certainly is much room for wiggle in this, between the extremes of one stock and 2,000 stock portfolios.
> 
> I was curious about your time frame assertion.  I think it matters, but wanted to wait for you first.
> 
> I suspect that T/As account really doesn't matter that much for him.  In which case, do whatever makes you happy...just don't take it as useful general advice for those who's situation requires more careful consideration.




DS,  I totally respect your opinions and to be honest, I suspect you are likely so far advanced of my own meager trading exploits that I perhaps shouldn't even be conversing with you

In saying that, i also totally understand what tech/a is on about in his initial post ...... Tech runs a very successful business and (I assume) trades as a pastime to create a small passive income ...(Much like my $1 punting system I use on the TAB to pass the time when the markets aren't open lol) ... Disclaimer ... I generally lose over the medium/longer term

That being the case, every persons reason for trading, and their strategy for trading is totally independent of someone else s situation ..... 

My assumption ... Tech really doesn't even need to trade ... He probably does it because a) He can ... and b) He has proven he can!!

Personally,  I still trade because I lost a small fortune about 12 years ago and I am determined to "make it up" to my family for screwing up so badly!!  .... Last 3 years using a similar strategy to what tech suggested in post 1, lets just say my results have been ...... pretty good

The interesting thing is ..... that Tech's newfound plan in post 1 are very similar to my own realization even though *we are living totally different worlds *........ 

I really have no idea of what I am trying to get at,  other than the skinned cat scenario  It's late and I'm babbling ... hopefully you get my drift Cheers.


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## DeepState (25 March 2017)

OmegaTrader said:


> It never changes, 17% will never be better than 12% no matter how hard one beats their chest.




...that's unless the risk in the 17% asset is high beyond a certain point.  If, some time in the future, cash was at 12%pa and this other asset was a stock/portfolio with (a properly assessed) 17% expected return in any given year but risk (say std devn) of ~35+%pa, you'd actually do worse investing in the higher expected return asset or portfolio of assets.

This happens because a loss of 10% requires a higher gain of around 11% to make up for it.  This feature makes a full investment in to a risk asset produce a lower long term return than might be imagined from just saying it should surely be the 17% figure, extrapolated forever. 

This is not chest beating, but an example that a reduction in diversity really does come at a cost.  That's fine to bear if the stocks you own have a high enough expected return to make up for it and the discomfort/risk-to-mission for doing so.  As mentioned before, it can be argued that concentration increases your expected return...but will it do it by enough?


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## galumay (25 March 2017)

barney said:


> DS, I totally respect your opinions and to be honest, I suspect you are likely so far advanced of my own meager trading exploits that I perhaps shouldn't even be conversing with you




dont sell yourself short mate, while I totally agree with your opinion of DS, thats exactly why we should be conversing with him - and be grateful he shares his views and thoughts. 

Its late here too, and I should know better than to get into these sort of in depth discussions while trying to watch the rugby! (Go the Sunwolves!)

Its invaluable to have ones ideas and thoughts challenged by those who think differently - sometimes I suspect my desire to learn what people are thinking and why comes across as patronising or arrogant, but that is not my intent.

Anyway, back to the rugby, and goodnight!


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## skyQuake (25 March 2017)

tech/a are you advocating simply kelly betting a small cap momo system? 
And is the single digit number of stocks a function of low signal generation rather than an enforced rule


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## barney (25 March 2017)

galumay said:


> dont sell yourself short mate
> Anyway, back to the rugby, and goodnight!




LOL   Cheers M8 ... and good luck with the Rugby


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## OmegaTrader (26 March 2017)

DeepState said:


> ...that's unless the risk in the 17% asset is high beyond a certain point.  If, some time in the future, cash was at 12%pa and this other asset was a stock/portfolio with (a properly assessed) 17% expected return in any given year but risk (say std devn) of ~35+%pa, you'd actually do worse investing in the higher expected return asset or portfolio of assets.
> 
> This happens because a loss of 10% requires a higher gain of around 11% to make up for it.  This feature makes a full investment in to a risk asset produce a lower long term return than might be imagined from just saying it should surely be the 17% figure, extrapolated forever.
> 
> This is not chest beating, but an example that a reduction in diversity really does come at a cost.  That's fine to bear if the stocks you own have a high enough expected return to make up for it and the discomfort/risk-to-mission for doing so.  As mentioned before, it can be argued that concentration increases your expected return...but will it do it by enough?





What you can't bring in another strategy out of left field .

If cash is better go in cash.
If long term buy and hold diversification is better diversify.
If trading day trading one futures contract is better , daytrade.

Go where the money is and where you competence is. Each to their own.

That is my point and all I know. Enough arguing I think 

goobly goopie goo in my brain

gg

bye


----------



## luutzu (26 March 2017)

I always thought investing is about buying stocks you figured are selling below its value; sell when you think it's way above its value or when you find a better opportunity.

Don't get cocky and put all your capital into the one or two stocks in case the future turns out badly or you're wrong. Other than that, repeat the first step and diversify into new industry if you can.

So it's either I went to the wrong school or not being paid by the hour to look smart.


----------



## howardbandy (26 March 2017)

Greetings --

Post # 1 of this thread.  Tech/a is correct.  End of thread!!

I have this view of trading versus investing.  
... Investing.  I buy something (always long, never short), call my lawyer, and have instructions for the disposition of that item following my death written into my will.
... Trading.  I buy something (or go short), anticipating that I will exit that position sometime.  The time might be in hours or days, or perhaps years.  But I do not expect to hold it for the remainder of my life.  This gives me an incentive to consider in advance what might cause me to exit the position and be prepared to do so.

Re Warren Buffett.  
Mr. Buffett is described as being an investor.  True, he does buy assets intending to hold them forever.  But he acts more like the CEO of a conglomerate corporation than an investor.  Consider the market drop in 2009.  Mr. Buffett's portfolio (Berkshire Hathaway -- lost more than 50% from previous high equity to low, and took over five years to recover.  Holding through drawdowns of that magnitude is an act of faith, not of reason.  1929-32 saw similar drawdowns.  It took over 20 years and reconstruction from a world war to recover.  What if the investor / trader needed the funds during that period or simply found a better use?  True, he made great choices and is wealthy.  But in large parts because of randomness and of luck.  I do not look to him for guidance or inspiration in trading.  Or even in investing.

Best,  Howard


----------



## craft (26 March 2017)

howardbandy said:


> Greetings --
> 
> Post # 1 of this thread.  Tech/a is correct.  End of thread!!
> 
> ...




If you are running a trading business than your money is working capital in that business. To that extent, I don’t have an issue with Tech’s proposition that a business that only concentrates on the most profitable product line at any one time can maximise profit (potential). For me the missing word in his post is potential.


Focusing will flatten and widen the distribution of potential outcomes so yes you can get a great result – but the distribution has two tails not only the upside tail.

How do you make sure you get the top end of the distribution and not the bottom end?  Imagine where you may finish in the distribution for example getting caught in some nasty future price gap shock with everything on the line?  Just focussing won’t tell you where in the distribution you will end. Diversifying as a strategy also doesn’t tell you where you will end up in that resulting distribution of possible outcomes but it does narrow the distribution thereby eliminating the worst of the bad outcomes.


So focusing opens profit “potential” but at the cost of “actual” downside protection. Perhaps that’s a trade-off that makes sense for a business if you are doing it with your eyes wide open. Especially if the trading capital in that business only represents a small part of your wealth.


But in-between a trading business with minimal wealth tied up in the working capital of that business and Howards definition of investment lies a huge expanse of wealth management/creation options for which the opening post in many instances is not good advice.


----------



## galumay (26 March 2017)

howardbandy said:


> Post # 1 of this thread. Tech/a is correct. End of thread!!




I can only assume that is some sort of attempt at humour. 



howardbandy said:


> I have this view of trading versus investing.




An interesting if rather odd view! 

(thats 2 absolute statements already, my radar is on high alert.)



howardbandy said:


> I do not look to him for guidance or inspiration in trading. Or even in investing.




Now, why doesnt that surprise me?! 

I think I can see why you have such a polarising effect on people, Howard!


----------



## DaveDaGr8 (26 March 2017)

One of my quotes that i have written down is

"Put all your eggs in one basket and watch the basket".


----------



## tech/a (26 March 2017)

98% of people do as everyone else does
98% of people achieve as everyone else does.

Being in the 98% is nice and safe a feeling of belonging.

Some of us take every step we can to move away and do things
Differently to the 98%

Ridicule is common place.
I've seen it in all walks of life.
From here
To business
To Property 
To ultra events ( sporting )


----------



## DeepState (26 March 2017)

tech/a said:


> 98% of people do as everyone else does
> 98% of people achieve as everyone else does.
> 
> Being in the 98% is nice and safe a feeling of belonging.
> ...



So are you proposing an extreme process just to be different, or otherwise derive more fun for the relative uniqueness? Or is it because it can actually be expected to produce better outcomes from a perspective of genuinely improving a monetary outcome that really does matter to someone?

If you need to be different, call yourself awesome, or wear a pink tutu at a fun run...go for it. Variety is great!  If being different involves strapping yourself to a Korean missile, it's still something 98% of people wouldn't do. But...maybe some people, even the average ones, can appreciate that being different for its own sake doesn't make any effort in that regard a sensible one.

Also, apparently, ridicule is not reserved for those at the extremes.

In the population of ASF/retail SMSF, having a well researched/plausible, well considered, appropriately diversified (as opposed to neccesarily highly diversified) portfolio would fall well in to the wings.  It's the punter garbage which makes the bulk. Which, I have said, is fine if it's just for fun.


----------



## tech/a (26 March 2017)

DeepState said:


> So are you proposing an extreme process just to be different, or otherwise derive more fun for the relative uniqueness? Or is it because it can actually be expected to produce better outcomes from a perspective of genuinely improving a monetary outcome that really does matter to someone?




In finding a way that is different to what the majority do/think or put in place in areas where I'm looking for an edge or a uniqueness what I do and have done can be seen by most as extreme---they wouldn't do it!
Yes I expect better outcomes if I don't get out of the box I won't find something different with the "POTENTIAL" of above average results.



> If you need to be different, call yourself awesome, or wear a pink tutu at a fun run...go for it. Variety is great!  If being different involves strapping yourself to a Korean missile, it's still something 98% of people wouldn't do. But...maybe some people, even the average ones, can appreciate that being different for its own sake doesn't make any effort in that regard a sensible one.




One mans stupidity is another's brilliance.
In 96/98 when we purchased 10 4 bedroom houses Friends took great joy in ridicule
Those same friends look for advice in 2003/4 
Being different is acquired and definitely not for those who reside within the masses.



> Also, apparently, ridicule is not reserved for those at the extremes.




Apparently 



> In the population of ASF/retail SMSF, having a well researched/plausible, well considered, appropriately diversified (as opposed to neccesarily highly diversified) portfolio would fall well in to the wings.  It's the punter garbage which makes the bulk. Which, I have said, is fine if it's just for fun.




You have narrowed the field.
With very few gaining more than a benchmark index and with even fewer capable of trading a reasonable sum to a worthwhile profit, encompassing testing research trial and error ( forward testing ) and most importantly trade management and risk mitigation then they are best suited to the masses---it won't be their fault.

Labelling everything outside of convention as garbage is ignorant in itself.   
Your smart enough to know daring to be different isn't as simplistic as you are trying to make it.
Not everything needs to be complicated and available exclusively to the educated of this world
Even Ducks can be awesome.
After your condescending analogy---I made it so.
Now that's fun!!


----------



## DeepState (26 March 2017)

tech/a said:


> In finding a way that is different to what the majority do/think or put in place in areas where I'm looking for an edge or a uniqueness what I do and have done can be seen by most as extreme---they wouldn't do it!
> Yes I expect better outcomes if I don't get out of the box I won't find something different with the "POTENTIAL" of above average results.




In seeking to improve, changes are made.  In order to be better, you have to be POSITIVELY different to those who did worse.  In obtaining outsized performance, outsized difference had to occur.

My assertions only relate to whether those outsized differences, like a 2 stock portfolio, actually made any sense.  I agreed that focus can improve outcomes.  I assert that the improvement in prediction that arises from concentration of effort needs to be huge for your assertions to make sense.  That level of huge is virtually implausible unless there is something very odd going on.

You seem to think I object to difference.  I don't.  I was/am regarded as unbelievably extreme in what I do.




tech/a said:


> One mans stupidity is another's brilliance.
> In 96/98 when we purchased 10 4 bedroom houses Friends took great joy in ridicule
> Those same friends look for advice in 2003/4
> Being different is acquired and definitely not for those who reside within the masses.



If that choice was well informed, then it was an excellent one.  If it was a punt, then the outcome was the result of a big punt and you should receive the kudos that comes with it and not be offered the kudos for being genuinely well informed.

I note you bought 10 houses (presumably with leverage)...but only want 2 stocks in a portfolio.





tech/a said:


> You have narrowed the field.




Apart from retail/SMSF, the only other major categories of investors are institutions.  Apart from highly specialised situations, none would keep their jobs if running 2 stock portfolios.  I was doing you a favour by keeping the field narrow.




tech/a said:


> Labelling everything outside of convention as garbage is ignorant in itself.



I agree.  Yet labelling everything which is conventional as garbage is also ignorant or demonstrating an insatiable need for attention.



tech/a said:


> Your smart enough to know daring to be different isn't as simplistic as you are trying to make it.
> Not everything needs to be complicated and available exclusively to the educated of this world
> Even Ducks can be awesome.
> After your condescending analogy---I made it so.
> Now that's fun!!



The quote I responded to espoused difference for its own sake as a favourable thing and disparaged the 98%.  I found that simplistic and highlighted that not all difference is favourable.

There is nothing more complicated going on here beyond saying that if you used to have a, say, 10-20 stock portfolio but now choose to deploy that in to a 2 stock portfolio, you need to have some pretty awesome increment in skills arising from focus .... or, the sum of money involved is actually irrelevant to you.  None of that requires much education or experience to understand at all.  Howard can give you the maths if you like, using assumptions as would be required for a trade as opposed to a close-you-eyes forever type of investment.  You clearly trade.

The term Awesome wasn't actually directed to you.  It related to overconfidence, which is a widespread phenomenon amongst investors - leading them in to concentrated portfolios and other trading activity which defies logic had they known their true abilities.  So, if you wish, you can feel free to furl up your protest.

This is fun.  When at dinner, if duck is on the menu, 98% of the time, I eat it.  Next time, I'll do something different as a tribute.


----------



## Quant (26 March 2017)

Buffet is held up as the god of investing and no-one is suggesting he hasnt exploited circumstances brilliantly but we must be aware that the markets today are hugely different to the time Wazza made  his ultimate returns  and therefore what worked for him while SPX rose from 65 to 1500 during 1975 to 2000  is'nt neccessarily as relevant in todays world
I think reading this book gives a bit of insight into what i believe to be the foundations of a proactive road to wealth in the investment type scenario  , Trading is required and dealing with risk is required . There are no easy answers and a sweet spot needs to be established . Trading specs is fine and can realise great returns at certain times but scalability , liquidity and the position in the cycle make it as risky as anything ( probably riskier ). It can be a piece of the puzzle sure but it def is'nt a stand alone answer . Ultimately the best returns will come from an adaptive methodology as markets are very dynamic so thinking should also be dynamic .  Good luck to all


----------



## tech/a (26 March 2017)

DeepState said:


> In seeking to improve, changes are made.  In order to be better, you have to be POSITIVELY different to those who did worse.  In obtaining outsized performance, outsized difference had to occur.
> 
> My assertions only relate to whether those outsized differences, like a 2 stock portfolio, actually made any sense.  I agreed that focus can improve outcomes.  I assert that the improvement in prediction that arises from concentration of effort needs to be huge for your assertions to make sense.  That level of huge is virtually implausible unless there is something very odd going on.
> 
> You seem to think I object to difference.  I don't.  I was/am regarded as unbelievably extreme in what I do.




You don't seem to be a crowd member particularly if you like duck. Its too rich for me.





> If that choice was well informed, then it was an excellent one.  If it was a punt, then the outcome was the result of a big punt and you should receive the kudos that comes with it and not be offered the kudos for being genuinely well informed.
> 
> I note you bought 10 houses (presumably with leverage)...but only want 2 stocks in a portfolio.




It was to me a no brainer I could finance 100% and rent would cover it well over the repayment.
Rinse and repeat---The 3-500% profit was right place right time

2 stocks
Quick turn over I can invest the price of a home in a click of a mouse and sell it just as quick
I can trade sizable sums.





> Apart from retail/SMSF, the only other major categories of investors are institutions.  Apart from highly specialised situations, none would keep their jobs if running 2 stock portfolios.  I was doing you a favour by keeping the field narrow.
> 
> 
> 
> I agree.  Yet labelling everything which is conventional as garbage is also ignorant or demonstrating an insatiable need for attention.




Not doing that --- just making a point which most can see.


The quote I responded to espoused difference for its own sake as a favourable thing and disparaged the 98%.  I found that simplistic and highlighted that not all difference is favourable.



> There is nothing more complicated going on here beyond saying that if you used to have a, say, 10-20 stock portfolio but now choose to deploy that in to a 2 stock portfolio, you need to have some pretty awesome increment in skills arising from focus .... or, the sum of money involved is actually irrelevant to you.  None of that requires much education or experience to understand at all.  Howard can give you the maths if you like, using assumptions as would be required for a trade as opposed to a close-you-eyes forever type of investment.  You clearly trade.




Yes but a more pressing issue is on my door step--FOOTY gotta go.



> The term Awesome wasn't actually directed to you.  It related to overconfidence, which is a widespread phenomenon amongst investors - leading them in to concentrated portfolios and other trading activity which defies logic had they known their true abilities.  So, if you wish, you can feel free to furl up your protest.
> 
> This is fun.  When at dinner, if duck is on the menu, 98% of the time, I eat it.




Oh
I gladly accepted it.


----------



## tech/a (26 March 2017)

Quant said:


> Buffet is held up as the god of investing and no-one is suggesting he hasnt exploited circumstances brilliantly but we must be aware that the markets today are hugely different to the time Wazza made  his ultimate returns  and therefore what worked for him while SPX rose from 65 to 1500 during 1975 to 2000  is'nt neccessarily as relevant in todays world
> I think reading this book gives a bit of insight into what i believe to be the foundations of a proactive road to wealth in the investment type scenario  , Trading is required and dealing with risk is required . There are no easy answers and a sweet spot needs to be established . Trading specs is fine and can realise great returns at certain times but scalability , liquidity and the position in the cycle make it as risky as anything ( probably riskier ). It can be a piece of the puzzle sure but it def is'nt a stand alone answer . Ultimately the best returns will come from an adaptive methodology as markets are very dynamic so thinking should also be dynamic .  Good luck to all
> 
> 
> View attachment 70505




Who mentioned Specs
You can trade anything.


----------



## Quant (26 March 2017)

tech/a said:


> Who mentioned Specs
> You can trade anything.





tech/a said:


> ( This has taken time to perfect but I have had up to 60% of my allocated funds (to small caps)




I dunno


----------



## tech/a (26 March 2017)

Quant said:


> I dunno




Clearly the idea isn't limited to Small caps
I personally have had 60% on a single stock during a single day

You could easily do that with a blue chip

Same principle


----------



## DeepState (26 March 2017)

howardbandy said:


> I have this view of trading versus investing.
> ... Investing.  I buy something (always long, never short), call my lawyer, and have instructions for the disposition of that item following my death written into my will.
> ... Trading.  I buy something (or go short), anticipating that I will exit that position sometime.  The time might be in hours or days, or perhaps years.  But I do not expect to hold it for the remainder of my life.  This gives me an incentive to consider in advance what might cause me to exit the position and be prepared to do so.




This is curious. You've said this before.

An investment is something you buy with the full intent never to sell it in your life time.  I'll take it one step out and say that you don't expect dividends from this at all (like, say, BRK*), just to make this a super duper long term investment with literally infinite duration...just for this discussion.

Firstly, it implies you never need the money tied up in this stock during your lifetime.

Secondly, from the outset, you have no intention of ever reviewing the position again.  You buy and talk to your lawyer. If you have an ability to value a company or gauge its prospects over a time frame that is less than your presumed lifespan, you actually choose not to bother using this from the outset...which makes me wonder on what basis the original decision was made.  If you have no skill whatsoever and just bought something random and then accept that any decision from then on is essentially random, it might make sense to hold it forever....if you don't need the money.  Set and, eventually, completely forget.

In your lifetime, there is no practical difference between making this investment and investing in dig shot. Except the alternative to stock is possibly more humorous when written in to a will and sends a different message to the bequeathed.

If you had any skill and were trying to leave some wonderful gift to the next generation, you'd use what skill you had to make sure this was as best handled.  This would include keeping an eye on it in case there was a better way to deploy the value during the remainder of your lifespan....unless you didn't really care about that or felt your time was better spent elsewhere.

So, these 'investments' are rather curious.

They would be undertaken by people who have no idea what they are doing or, otherwise, know but can't be bothered from the outset as a positive decision....and definitely don't need the money.  In such cases, outcomes are irrelevant and a single stock portfolio is totally fine.  Pick any stock you like.

I really can imagine that things like a house, or works of art...things with values that fluctuate but where you own them to enjoy them...do fall in to this category of investment.  A share of BRK?  Not so much.

--
*whom I know you do not particularly respect on the grounds of those outcomes being a lucky draw. It certainly can't be absolutely disproved.


----------



## kid hustlr (26 March 2017)

Surely there's a direct correlation between how 'good' you are and how diversified you should be.

I'd trust DS, Craft or T/A to manage a smaller basket compared to my taxi driver for example


----------



## tech/a (27 March 2017)

kid hustlr said:


> Surely there's a direct correlation between how 'good' you are and how diversified you should be.
> 
> I'd trust DS, Craft or T/A to manage a smaller basket compared to my taxi driver for example




Doesn't make sense
I was under the impression people placed stocks in a portfolio 
Because they expect a capital gain in share price.
Sure some are selected for dividend returns but none for anticipated 
Falls
So if you select 20 stocks I'd have thought you'd have to be a lot
Better at selecting stock than people who pick one or two.

My findings are more about selection/watch lists /trade management/ position sizing
Compounding/pyramiding than being right.

There is a lot more behind the statement than changing your view from 10-20 stocks to 1 or 2


----------



## kid hustlr (27 March 2017)

tech/a said:


> Doesn't make sense
> I was under the impression people placed stocks in a portfolio
> Because they expect a capital gain in share price.
> Sure some are selected for dividend returns but none for anticipated
> ...




I guess I meant the cab driver who has no idea should buy the index, whereas has someone who has a proven track record of beating the market with a specialised methodology should do that.

Enjoyed the thread, hope it continues.


----------



## Wyatt (27 March 2017)

Certainly in trend following, buying a reasonable no. of different stocks increases your likelyhood of owning most of the stocks that go on to outperform and may make up for the large no. of losers or non performers.
If you could go straight to these performing stocks , that would be nice but unrealistic, While it has been mentioned by market wizards that winning stocks, tend to go up right from the get go, backtesting suggests tight stops decrease returns.
To be able to make money holding just 1 or 2 stocks, you really must be at the screen full time, hunting the high liquidity action, willing to jump in with size and do a bit of line wiping, hang your nuts out in the breeze and pin your ears back. We've all seen it, but that is not for everyone. Unless your algo is that esquisite

Is the answer momentum, value or high octane day trading?


----------



## tech/a (27 March 2017)

> Post # 1 of this thread. Tech/a is correct. End of thread!!




I think it's done


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## odds-on (27 March 2017)

I personally do not see the issue with holding only a couple of stocks in a portfolio as long as one is aware of the potential distribution and willing to act accordingly.

Most super-investors seemed to be highly concentrated/leveraged in their early years. There are probably numerous others who were similarly concentrated/leveraged over the years but lacked the luck/skill/timing so eventually blew up. This is worth thinking about a lot before going down the concentrated/leveraged path.


----------



## tech/a (27 March 2017)

Wyatt said:


> Certainly in trend following, buying a reasonable no. of different stocks increases your likelyhood of owning most of the stocks that go on to outperform and may make up for the large no. of losers or non performers.
> If you could go straight to these performing stocks , that would be nice but unrealistic, While it has been mentioned by market wizards that winning stocks, tend to go up right from the get go, backtesting suggests tight stops decrease returns.
> To be able to make money holding just 1 or 2 stocks, you really must be at the screen full time, hunting the high liquidity action, willing to jump in with size and do a bit of line wiping, hang your nuts out in the breeze and pin your ears back. We've all seen it, but that is not for everyone. Unless your algo is that esquisite
> 
> Is the answer momentum, value or high octane day trading?




You know
The long term investment type threads I see here with 20 or so stocks all show a good number with massive drawdowns.
I've often wondered why they just keep holding regardless of how wrong they are!

Your back test statement can you qualify that?


----------



## odds-on (27 March 2017)

DeepState said:


> How about what they were doing, say, 40 years ago....(accessable via Chairmam's letters via BRK site if interested). Anyway, it's rather more than 10. And that's when they had a lot more flex than today.



What about 60+ years ago? 75% of net worth in GEICO.


----------



## Wyatt (27 March 2017)

tech/a said:


> The long term investment type threads I see here with 20 or so stocks all show a good number with massive drawdowns.




Yes it is the age old problem with trend following, definitely interested in your concept, monitoring just a few stocks gotta be easier than 15-20 and I guess you would have low market exposure.
As a highly respected and active member of ASF, i would love to see some of your backtesting and do please keep the ideas flowing. 

Speaking of holding on, my backtesting suggests monthly rebalanced portfolios tend to increase win % and lower D/D. A bit like Radge's US momentum system

http://bettersystemtrader.com/037-cesar-alvarez-studies-stop-losses/


----------



## DeepState (27 March 2017)

odds-on said:


> What about 60+ years ago? 75% of net worth in GEICO.




Well, that's true.  He was also 21 yrs old and had a total asset base of $20k at the time. 

Do you think that situation represents a sensible thing for others to emulate for meaningful investment?  It certainly worked for him.


----------



## howardbandy (28 March 2017)

Deepstate may mis-understand my point.

The distinction between investing and trading is, to my point, that investing is locking up the funds "forever."  An example might be buying a property that will be used for a family estate.  Or buying a company, such as a winery, planning to manage it as a business "forever."  These are very infrequent.  I do not have any.    

Any transaction where I expect to reverse it during my lifetime -- maybe in years, maybe in days -- is a trade.  Even other real estate transactions, such as buying a house to use as a residence or an apartment to manage as rental property, are trades.  Stocks of companies I do not manage are clearly trades.  

My point is that, for those who follow quantitative principles, trades are entered when the rules indicate that there will be profit, and exited when the rules indicate there are better uses for the funds.  The rules create a model.  When applied to a tradable issue, they create a system.  The system has risk and profit potential.  All such systems are alternative uses of funds.  By normalizing risk, profit potentials can be compared.  And the funds allocated to those with the highest profit potential.  

This thread is about portfolios.  Continuing on with my point, portfolios consist of several issues held simultaneously.  Each of them has its own risk and profit characteristics.  My recommendation to identify those separately and use the funds for the best rather than for the average.    

Best,  Howard


----------



## Sir Burr (28 March 2017)

tech/a said:


> So if you select 20 stocks I'd have thought you'd have to be a lot
> Better at selecting stock than people who pick one or two.




I run a couple of large position number systems and backtesting them with just 2 positions reduces profits substantially and increases drawdown moderately.

In my case I "think" it's simply not having the *opportunity *of picking up some nice trades while only selecting two. Maybe you can pick those nice trades, who knows 



Wyatt said:


> monitoring just a few stocks gotta be easier than 15-20




I'm not sure if this thread is about daytrading, EOD or investing but if EOD pressing the Explore button in Amibroker where it exports to a CSV. Send via the DDE spreadsheet to IB makes no difference in time between 1 or 100 positions.


----------



## tech/a (28 March 2017)

Sir Burr said:


> I run a couple of large position number systems and backtesting them with just 2 positions reduces profits substantially and increases drawdown moderately.
> 
> In my case I "think" it's simply not having the *opportunity *of picking up some nice trades while only selecting two. Maybe you can pick those nice trades, who knows
> 
> ...




I have absolutely no doubt that that would be the case.
In a systems test scenario you are waiting for the test parameter cycle to do its thing.
From my own trading in real-time my findings are as follows.

(1) Each selected trade must have a buy trigger.(In futures there are obviously sell triggers). Many never trigger.

(2) I want selected stock to move in my direction immediately.
If it does I move the stop (a fixed technical point generally at the bottom of a pattern)
the distance of the move in that day.(I use fixed $ value for the initial buy)
Ill keep doing that until I reach B/E at that point I only look at expected target or technical signals of
stalling or stopping for evaluation.
This leads to quite a few B/E Trades.
Very rare full loss of initial stop as I raise the stop if the move is against me after a triggered buy.
So I do have turn over pretty quickly before nailing one that goes.

(3) Most stops are between 1.5-.5 % when hit OR at B/E if it takes off and turns.
*This I believe is a key.* On Average it is quick to kill off accumulated losses with a good win or two.
Similar to Peters methodology in some respect but much quicker on stops and moving of them.

(4) Once in profit and at B/E Ill let it run and add aggressively if it triggers another setup and this can be
from an anticipation off a single bar. Ill only hit it for that day or to a target (*Within that day---another key I think*). Leaving the
initial trade to run its course--targets or technical pattern for exit, including stagnation.

You do have to be on top of it particularly in the initial phase and if your hitting it. I have real time at my desk and on the phone.
Mind you I miss quite a bit (Timing) as I do my day job---I have an understanding boss.

My findings ----


----------



## odds-on (28 March 2017)

DeepState said:


> Well, that's true.  He was also 21 yrs old and had a total asset base of $20k at the time.
> 
> Do you think that situation represents a sensible thing for others to emulate for meaningful investment?  It certainly worked for him.



It depends on your objective. It does provide an example of how to compound capital. Just got to pick the right stock.


----------



## DeepState (28 March 2017)

odds-on said:


> Just got to pick the right stock.



Yep.  That's what all of this comes down to.  If you actually could pick the right stock with high confidence...you don't need much diversification.  Actually, scrub the confidence bit and replace that with ability.

Also, you don't need much diversification if buying 'lottery tickets' where no other means exist to achieve your aims or otherwise you really don't care what the outcome is.


----------



## tech/a (28 March 2017)

Trade enough setups reject enough 
And you'll find a lot of right stocks.

If your really interested read the above 
If you have no interest.Happy with what
You now do.

Return to village.


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## DeepState (28 March 2017)

howardbandy said:


> Deepstate may mis-understand my point.




Thanks for the clarification.  



howardbandy said:


> This thread is about portfolios.  Continuing on with my point, portfolios consist of several issues held simultaneously.  Each of them has its own risk and profit characteristics.  My recommendation to identify those separately and use the funds for the best rather than for the average.




So, for a situation there there is even a low (but strictly positive) degree of aversion to loss and even high predictive ability (say, Info Coefficient of 0.2 at monthly interval), how many stocks might appear when the universe is the ASX 200 or S&P500?  And signals are available on the full cross-section.....

Would it be 2?  Or closer to 20+


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## DeepState (28 March 2017)

tech/a said:


> Trade enough setups reject enough
> And you'll find a lot of right stocks.
> 
> If your really interested read the above
> ...




So...I am interested.  Which is why I am fielding alternative viewpoints.  Just that I also check the maths to make sure 1+1 actually does equal 2, and not 15 as sometimes claimed or imagined.

Trade heaps of setups, reject heaps, there will be heaps left, some of them will be good ideas?  And, if by chance, some of them go up and you lock to breakeven, it's amazing how hit rates go up!

That's all true.  Of course.  It actually is.  Now...where is the flaw in that argument that leads to a belief that this amazing investment ability is real?  Howard would know.  And, if you've read all his books, you'd also know.



tech/a said:


> Return to village.



Don't like your ideas actually tested by someone with evidence and a knowledge of how this stuff works for real?  Thought you might be more awesome than that.


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## Quant (28 March 2017)

The people with the answers to this will never give the keys to the palace away . An edge is only an edge until the masses see and use it  . The Howard way is the key , statistical patterns in the market exist and the inefficiencies allow these patterns to exist and be exploited . Now i can claim this is factual and all the usuals will demand evidence . The thing is a smart operator keeps the keys to the palace in his pocket so really this whole thread will continue to go in circles  , Its possible to beat the index by 100% year in year out with some very basic strategies and not go outside the top 50 stocks with only approx 50% time in market . Mean reversion allows this exploitation  , you just need to find the patterns  . The more stable companies are actually the easiest ones to exploit . No-one with the answer is going to share it is basically the point i'm making  . Circles is the best you can expect   ..  good luck to all


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## craft (28 March 2017)

DeepState said:


> Yep.  That's what all of this comes down to.  If you actually could pick the right stock with high confidence...you don't need much diversification.  Actually, scrub the confidence bit and replace that with ability.
> 
> Also, you don't need much diversification if buying 'lottery tickets' where no other means exist to achieve your aims or otherwise you really don't care what the outcome is.





Considering everything we know for certain relates to the past but every decision we need to make about risk relates to the future. Unless your second paragraph applies scratch ability and go back to a "special" kind of confidence.

Its amazing how many traders on the internet think /act as thought they are the trading equivalent of Alex Honnold - hopefully they don't have too much on the line when they discover they are not.


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## DeepState (28 March 2017)

Quant said:


> statistical patterns in the market exist and the inefficiencies allow these patterns to exist and be exploited . Now i can claim this is factual and all the usuals will demand evidence .




I accept this as a fact without further evidence required from you.  The question proceeds as to whether, even in this instance, we need to reconsider the portfolio myth.  That is the question the Duck posed in the header.  I have posed the question to Howard with a scenario that most strongly favours the response of a concentrated portfolio.  If the coefficient were much higher than 0.2 (and I have not even asked about frictions to trade - so this is net of frictions), you'd be trading so well that ASIC would be watching.



Quant said:


> Circles is the best you can expect   ..  good luck to all



Let's shrink the circle.

Duck says two stock portfolios.  I agree in certain situations.  These include complete indifference to the outcome or risk seeking behaviour (likes thrill).  An alternative includes having insufficient skill to meet a target saving level and thus resorting to highly speculative behaviour.  This is a lottery ticket, and it is rational in this situation.  So it may be fine for duck and many others.

So let's talk about something less trivial, where this stuff actually matters.  Someone who lives off this stuff or where the assets and how they are invested has a material impact on them.  What then?  Two stocks? Even if you can generate 100% per annum via statistical reversion (which does exist and is the realm of HFT and leverage) these portfolios are very diversified.  The individual edges are tiny.  Your get these results by diversification across stocks and trading very frequently...and applying leverage.

In this much more narrowed situation, where the evidence load has been dropped to ankle height, what is your view about the portfolio myth?  I want to know because this is my situation.  I care and I am never happy about what I do and very much like to find where my assumptions are wrong...but arguments to such ends need to actually make sense.  It took me five years to unlearn what University taught me in many areas (some time ago now...I'm not a freshie).  Maybe the importance of diversification is another one of these.

Or, have we now devolved in to "Just 'cos" in which case...yes, good luck to all...this has been fun and useful in that context alone.


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## Quant (28 March 2017)

DeepState said:


> Duck says two stock portfolios. I agree in certain situations. These include complete indifference to the outcome or risk seeking behaviour (likes thrill). An alternative includes having insufficient skill to meet a target saving level and thus resorting to highly speculative behaviour. This is a lottery ticket, and it is rational in this situation. So it may be fine for duck and many others.




Im all for small portfolios but in the case of say 2 stocks id much favour indice trading . My idea is a small universe to follow , know them well and deal with them as dynamics change , i primarily follow top 50 as they are stable , less prone to unexpected movement and they have very distinct cycles/patterns/price imbalances that have high probability . I look for what WILL happen , im not looking for lotto wins just a heap of 10-20% moves inside a basically 4-8 week time frame , i wont put all my money in a one position but i may put up to 30% depending whats available  . I look for predictability , top 50s over shoot down and up , identifying when the downs and ups happen is the mean reversion bit , just look at say a 120 day rolling range in top 50 stocks , thats the available range to exploit



DeepState said:


> So let's talk about something less trivial, where this stuff actually matters. Someone who lives off this stuff or where the assets and how they are invested has a material impact on them. What then? Two stocks? Even if you can generate 100% per annum via statistical reversion (which does exist and is the realm of HFT and leverage) these portfolios are very diversified. The individual edges are tiny. Your get these results by diversification across stocks and trading very frequently...and applying leverage.




lets be clear im not saying 100% returns just > 100% indice outperformance with NO negative years and no leverage  , with leverage that 100% return is doable but as we know that double edged sword is what explodes accounts . Can only speak for myself but the edges arent tiny



DeepState said:


> In this much more narrowed situation, where the evidence load has been dropped to ankle height, what is your view about the portfolio myth? I want to know because this is my situation. I care and I am never happy about what I do and very much like to find where my assumptions are wrong...but arguments to such ends need to actually make sense. It took me five years to unlearn what University taught me in many areas (some time ago now...I'm not a freshie). Maybe the importance of diversification is another one of these.




The portfolio myth , its not a simple answer , markets change and are dynamic , in recent time very much so  . Investors refer to Buffet a lot and looking at BRK in the greatest bull run from mid 70's to 2000 the results are spectacular and not so much since 2000 . Now sure Buffet beats the index return by 100% but he does so with 50% drawdowns , not accepatable in my world and obv easier to deal with not owning 10% of the market . Buy and hold is a flawed approach in todays world and having 30 stocks isnt ideal , people bury the risk and dont deal with it and that is crazy . Its hard work getting the right strategies and i would never say its easy but it is doable . Dealing with risk is mentally easier with a smaller portfolio as you are basically forced to do it . If you arent accurately proactive buy an index and beat the majority of funds , you cant rely on luck . Mediocre methods get mediocre returns .. old cliche but it really applies ...  dont confuse a bull market with genius , its the **** years that seperate the good from the bad .

We are very lucky here in OZ with the high div paying stocks and tax laws that create " events " ... slight hint  fwiw   ... good luck to all

Quick addition with the right strategy avoiding the 50% dd with even just a breakeven (although i still think positive results are doable under these circumstances )  you are 100% ahead of market right there with the cash/ability to exploit to explosive runups that occur after such events , the 10-20% 6 week returns turn into 20-40% briefly  ( year or 2 )  FWIW i blew up my account spectacularly  during GFC , best thing that ever happened to me, lead me to where i am today  , making sure that never happens again  . Time in market is risk and while the market/stock is retracing/flat its time to do something else with that coin

 You only want to be in the market when something happens , you learn that pretty quickly as a daytrader and it applies to ANY timeframe

I now have strategies that even in GFC returned very solid returns . these strats test positive back to 2000 with incredible expectancy and accuracy


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## DeepState (28 March 2017)

Cool.



Quant said:


> Im all for small portfolios but in the case of say 2 stocks id much favour indice trading . My idea is a small universe to follow , know them well and deal with them as dynamics change , i primarily follow top 50 as they are stable , less prone to unexpected movement and they have very distinct cycles/patterns/price imbalances that have high probability . I look for what WILL happen , im not looking for lotto wins just a heap of 10-20% moves inside a basically 4-8 week time frame , i wont put all my money in a one position but i may put up to 30% depending whats available  . I look for predictability , top 50s over shoot down and up , identifying when the downs and ups happen is the mean reversion bit , just look at say a 120 day rolling range in top 50 stocks , thats the available range to exploit



So, in significant part, does portfolio concentration arise from signals actually firing?  For example, you might have 2-10 signals firing at any given time and hence the portfolio concentration varies.  That's totally fine.  However, does that mean that the portfolio invested amount varies with the number of signals as well?  eg. you put less in the market when only two stocks are active than when 10 stocks are active?  That would represent a very reasonable response to longitudinal signal construction of the type you have described (at least I think).



Quant said:


> lets be clear im not saying 100% returns just > 100% indice outperformance with NO negative years and no leverage  , with leverage that 100% return is doable but as we know that double edged sword is what explodes accounts . Can only speak for myself but the edges arent tiny



I presume you are long-only on stocks.  Your time frame for reversion is much longer than I had imagined.  It is normally extracted for periods of less than a month and largely much shorter than that.  Either that, or it is long term reversion of the 3 year variety.  Nonetheless, I am not questioning your alpha.



Quant said:


> Dealing with risk is mentally easier with a smaller portfolio as you are basically forced to do it .



Can you please expand on this?  This looks important to your perspective.  



Quant said:


> We are very lucky here in OZ with the high div paying stocks and tax laws that create " events " ... slight hint  fwiw   ... good luck to all



You need to watch for the offshore market activity now who don't get credits.  They are increasingly crushing the trade before ex. That is their way of playing this arb.


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## Quant (28 March 2017)

DeepState said:


> You need to watch for the offshore market activity now who don't get credits. They are increasingly crushing the trade before ex. That is their way of playing this arb.



Yes correct , something im aware of and has been the case as long as i can remember , i never hold into EX div  or report for these very reasons , in fact under the right circumstance ive been known to short stocks pre report , obv certain parameters required  , i dont short stocks often though


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## Quant (28 March 2017)

DeepState said:


> Can you please expand on this? This looks important to your perspective.



in a 30 stock portfolio with lets say equal weight a stock going to zero is a 3% hit to portfolio , in a 10 stock port its 10% obviously , you cant bury the risk , you are made to deal with it and thats a positive thing imo . Now we get index correlation on 30 stocks that we dont deal with the risk and by the time we panic the drawdown is 30% ( hypothetical numbers )  diversification is useless in deep index drawdowns


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## DeepState (28 March 2017)

Quant said:


> in a 30 stock portfolio with lets say equal weight a stock going to zero is a 3% hit to portfolio , in a 10 stock port its 10% obviously , you cant bury the risk , you are made to deal with it and thats a positive thing imo . Now we get index correlation on 30 stocks that we dont deal with the risk and by the time we panic the drawdown is 30% ( hypothetical numbers )  diversification is useless in deep index drawdowns



Totally fair point.  If we rely too much on statistical arguments on diversification, then we will be inevitably disappointed when the diversification benefits vapourise just when we need them. Although we can allow for these effects by using 'stressed' matrices in port con for example.

Can I take you up on that 'can't bury the risk'. Just because I have more at risk doesn't necessarily make me a whole lot better at managing it.  Though some have argued that focus increases ability to generate return and, probably, understand risk better, the extent to which this occurs in practice is not normally very large.  So, beyond putting stops etc. are you inferring that we somehow are able to be more aware of risks and doing smart things which we would not otherwise do?  And, net, this gets a better outcome?  Using a ten stock portfolio vs, say, a 30 stock one as comparisons for concrete examples (feel free to use others though).


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## Quant (29 March 2017)

DeepState said:


> Can I take you up on that 'can't bury the risk'. Just because I have more at risk doesn't necessarily make me a whole lot better at managing it. Though some have argued that focus increases ability to generate return and, probably, understand risk better



Well a skill set is obviously required to deal with the risk and goes without saying a skill cant be gained/improved if you dont use/ strategize it . My theory is the smaller portfolio in a way forces you to go down this  road . Also having a small universe allows you to be more active and knowledgable on the stocks you buy .  This is why i prefer large caps  , not so much smoke and mirrors  and the times to deal with unexpected results is very very low  , this is part of why i wont hold into reports  , this is when risk is likely announced . Give me the easy money anyday over the maybe money


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## DeepState (29 March 2017)

Quant said:


> Well a skill set is obviously required to deal with the risk and goes without saying a skill cant be gained/improved if you dont use/ strategize it . My theory is the smaller portfolio in a way forces you to go down this  road . Also having a small universe allows you to be more active and knowledgable on the stocks you buy .  This is why i prefer large caps  , not so much smoke and mirrors  and the times to deal with unexpected results is very very low  , this is part of why i wont hold into reports  , this is when risk is likely announced . Give me the easy money anyday over the maybe money



OK. So it is mostly true that, if you have a stack of stocks, almost any reasonable weighting produces a half-decent risk outcome.  You don't have to think.  However, if you are aware of risk, you have to go at it pretty hard when individual positions matter.  Very sound.  I agree.  Beyond about 15-20 positions and, you've done the thinking, portfolio risk gains from further diversification is pretty limited in absolute terms...but still very present if index relative.

Can I take it that you aren't in favour of a two-stock portfolio but find something like 10-20 appropriate (if fully deployed)?  You are clearly risk aware.  That's still punchy but if drawdown won't smash your lifestyle, and your horizon is long, and you don't answer to anyone else...it's about right for most people in that situation..I think. Unless the whole lot is in specs etc etc.


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## howardbandy (29 March 2017)

DeepState said:


> Thanks for the clarification.
> 
> So, for a situation there there is even a low (but strictly positive) degree of aversion to loss and even high predictive ability (say, Info Coefficient of 0.2 at monthly interval), how many stocks might appear when the universe is the ASX 200 or S&P500?  And signals are available on the full cross-section.....
> 
> Would it be 2?  Or closer to 20+



Greetings --

The idea is to develop systems for one issue at a time.  Each system trades one issue long/flat or, if you wish, short flat -- but short systems are harder to develop and many people do not / cannot go short.  

At each evaluation and management period -- which I recommend to be daily -- update all the systems and compute the CAR25 for each of them based on the "shadow" trades that they would have taken.  Following safe-f, use the available funds to take one position based on the one system that has the highest CAR25.  If the highest CAR25 of all the systems tracked is $20 bills under the mattress, remain flat for that day.

Best,  Howard


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## ducati916 (29 March 2017)

Morning chaps,
A couple of links for you:

http://blog.alphaarchitect.com/2017...cker-of-all-time-buffett-or-lynch/#gs.bg6Rej0

https://www.ifa.com/articles/what_about_active_managers_have_beaten_market_still_need_alpha_charts/

jog on
duc


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## ducati916 (29 March 2017)

Chaps,

With regard to the original question:

If you are day-trading, entry/exit within 1 trading session, you can still be 'diversified' even if you only ever trade the ES contract (example).

So you in this scenario would have capital of $50K. You have a couple of options:

(a) you take a single trade for the day, using 100% of your $50K (and any margin that you may qualify for), and exit for a profit/loss before the close; or

(b) you have the same $50K, but, you will enter any number of trades in a given trading session, closing flat at the close. In this scenario you only allocate a % of capital to any given trade.

Option (b) is a diversified 'portfolio' in that you have a trigger (expectancy) for opening a trade and closing that trade if another signal (stop) is triggered. Your expectancy is that there will be winners and losers, but overall, you will over time (day, week, month) be profitable. You are diversified in that you will have X number of trades on any given day.

Option (a)'s expectancy should be much higher than Option (b) as you are only taking 1 trade (no diversification). If you have a high success rate, this is obviously a very profitable strategy.

Anything other than a 'day-trade' is (in my book) an investment, as, when the market closes and you can no longer place a trade to exit/hedge your position, you are vulnerable to 'news', whether that is for 2 days or 20 years.

To my mind, the lower your diversification in this scenario, the more risk you are assuming.

With ETF's, you can have a single position to manage, but with an already built in diversification. You will give up the rocket ship, but you won't be caught by the liquidators announcing entry to your stock either.

jog on
duc


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## DeepState (29 March 2017)

howardbandy said:


> Greetings --
> 
> The idea is to develop systems for one issue at a time.  Each system trades one issue long/flat or, if you wish, short flat -- but short systems are harder to develop and many people do not / cannot go short.
> 
> ...




So a single issue at any time with allocation at 'safe-f'?  One stock portfolio (or cash)?

The concepts of diversification at the portfolio level come from time diversification and also from stochastic, Bayesian, position sizing to control risk exposure.



howardbandy said:


> Greetings --
> Post # 1 of this thread.  Tech/a is correct.  End of thread!!




So this was the literal perspective.  Yes, it seemed strange for you to write something you didn't actually mean but it seemed so out of step with conventional belief I wasn't sure quite what to make of it.

----

This is very divergent which is absolutely fantastic to find.

Let's say TraderX has a preferred habitat consisting of the universe of stocks in the ASX 200 + Russell 2000.  TraderX is able to generate 1000+ candidate longitudinal signals in each of these 2,200 stocks.  These need not be using the same functional form (albeit with different parameterisation).  You can think of it as 2,200x1000+ candidate signals.  This is, after all, machine learning within an information rich dataset at reasonably high frequency.

Let's make a huge assumption that TraderX has investment (ok, trading, for this conversation) insight.  In other words, those signals actually have a basis for prediction and are not formed via extensive mining of random or uninformative data.  Each is genuinely believed to have true predictive ability, albeit time-varying.  

Out of 2.2million+ signals, we only choose the best one to invest in for that day??  Would the second best signal (which would have been the best had not some freak of nature actual found the better one) not be valid at all?  Signal #1 has valid forecasting, but signal#2 to 2,200,000+ have no validity? Yes, some will be short selling etc, but let's not move to the edge cases yet.  Surely one of 2.2million signals will pick a buy for one stock even if that signal might be #10 on the day...Signal ranked 10 of 2.2million is given zero weight?

If signal #1 has scaled 'merit' of 100%, even if signal #2 (on CAR25) has 80% scaled merit and signal #3 has 60% etc... All key risk features and curve characteristics would improve for compiling these in to a portfolio and weighting in a way that makes sense...say using safe-f for a portfolio of these particular signals in some sensible way.

If TraderX has produced 2.2million candidate signals and is skilled, it would be the most unbelievable situation for them to believe there was literally only one idea that was worth investing in that day and lob their entire risk tolerance on to it.


So..unless the humble CAR25 is some magic filter which finds the one valid needle that day out of a veritable haystack, whose composition changes from hay to needle and back in a non-linear way by the day, I must be misunderstanding another heterodox concept.  Can you please clarify what that is on this occasion?

The process is undeniably optimal if the insights are random but risk can be estimated in that it cuts transactions costs vs other portfolio oriented alternatives for a given risk tolerance.  However, I think your ambitions for it are much higher than that ('towards best').


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## InsvestoBoy (29 March 2017)

DeepState said:


> So...I must be misunderstanding another concept.  Can you please clarify what that is on this occasion?




From my understanding of what Dr Bandy is saying:
You have a stable of systems that exploit different patterns and market regimes.

Over the intermediate term one market pattern or regime becomes dominant, and the system that exploits that will float to the top. I doubt the systems are allocated to a single stock, probably a ranking of stocks that match the regime best or a broad ETF or futures contract (which is already a portfolio, NO FOOLING).

So on any given day you are likely "investing" into the same signal that you did yesterday or the day before that (and probably the same signal tomorrow).

e.g. if buying ES on 2 day closing low and selling on the first up close is profitable, then you will be doing that until another regime becomes dominant.


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## DeepState (29 March 2017)

InsvestoBoy said:


> I doubt the systems are allocated to a single stock, probably a ranking of stocks that match the regime best or a broad ETF or futures contract (which is already a portfolio, NO FOOLING).
> 
> So on any given day you are likely "investing" into the same signal that you did yesterday or the day before that (and probably the same signal tomorrow).
> 
> e.g. if buying ES on 2 day closing low and selling on the first up close is profitable, then you will be doing that until another regime becomes dominant.




That's more reasonable in my view, yet Howard's own words (which are usually very accurately chosen) say: "Following safe-f, use the available funds to take one position based on the one system that has the highest CAR25"

One system.  One stock.  Yes, that stock may be a diversified ETF.  I imagine that the process is also intended to be applied to individual stocks and is more generally expressed or applied for such processes or trading across a universe of indices.  So, one instrument selected for one system for full risk exposure, per day.


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## howardbandy (30 March 2017)

DeepState said:


> That's more reasonable in my view, yet Howard's own words (which are usually very accurately chosen) say: "Following safe-f, use the available funds to take one position based on the one system that has the highest CAR25"
> 
> One system.  One stock.  Yes, that stock may be a diversified ETF.  I imagine that the process is also intended to be applied to individual stocks and is more generally expressed or applied for such processes or trading across a universe of indices.  So, one instrument selected for one system for full risk exposure, per day.




Greetings --

Deepstate is stating my recommendation correctly.  To reiterate the process:

1.  Use the analysis of the price history of a list of potentially tradable issues to determine the risk, profit potential, and liquidity of each.  Issues that pass those filters become candidates to be traded.  They might be individual stocks, individual futures contracts, ETFs that are made up of some group of issues.  This is the activity of the "data prospector."  No rules (no model) have yet been applied.  Independent of any possible rules, some data series are untradable due to high or irregular volatility, others are not worth trading due to low volatility.  The individual issues can be given a score to rank them.    

2.  One at a time, pick a trading candidate and develop a model (a set of rules that identifies probably profitable trades and issues orders to buy and to sell) that trades that single issue long and flat.  Or short and flat, but not both in a single model.  For stocks and equity ETFs, identifying good signals to be short is more difficult than to be long.  Patterns preceding price rises are different than patterns preceding price falls.  Do not ask your model to try to identify both and keep them separate.

The process of system development becomes the process of fitting a model to a single data series.  It is during this process that we discover whether there are identifiable and persistent signals in the data that precede profitable trades.  Not every candidate data series that the prospector gave a passing grade to results in a tradable system.     

Use the scientific method.  Examine historical data looking for patterns and fit the model to the data, giving the best in-sample fit.  Test the model on data not previously used in fitting (validation).  The test produces a set of trades that are the best estimate of future performance.  Ignore in-sample trade results -- they have no value in estimating future performance.  Using the best estimate set of trades, compute metrics giving the maximum safe position size (safe-f) and estimate of compound annual rate of return (CAR25).  If this one-time validation shows satisfactory results -- that is a value of CAR25 that is higher than risk free use of the funds -- move the system to trading where it will be managed by a trading management model.  

Develop as many such systems as you wish.  Each has its own safe-f and CAR25. 

3.  The trading management model uses trades as its input and has safe-f and CAR25 as its output.  The model is based on Bayesian analysis and sequential learning -- learn from the most recent data, adjusting your view as new data is received.  Begin with the best estimate set of trades for any system under consideration.  Trade, or paper trade, that system producing real trades if real money was used or shadow trades if paper traded.  Add the new trades to the best estimate set, reducing the weighting of older trades as new trades are added.  Safe-f and CAR25 will change.  The change represents changes in the data series.  We cannot know whether these are random and within the distribution we began with, or "regime change" coming from a new and different distribution.  We act as if they are true indications of distribution shift in the signals coming from the data.  Recompute safe-f and CAR25 at every evaluation -- probably at the close of trading every day -- and sort the results.  The system to trade next is the one at the top of the list.  That is, trade the one system that has the highest risk-normalized CAR.  Take a position guided by safe-f.  To trade at any position size higher than safe-f risks drawdown that exceeds your tolerance.

Diversity comes from having multiple systems, each of which trades a single issue, available for trading at the next opportunity.  As conditions change, risk changes, safe-f changes, CAR25 changes, leadership of the list changes, and the system that is being traded changes -- or, at least, could change.

The portfolio is a portfolio of systems, each trading a single issue with its own set of rules -- rather than a portfolio of issues traded by a commonly applied single set of rules.  In terms of modern portfolio theory and the efficient frontier, the chart is one dimensional -- CAR25 along a line -- rather than two dimensional -- risk (typically standard deviation) on one axis, return (typically CAR) on the other.  The method I recommend has normalized the risk, so risk is the same for all system.  The other dimension is return and that is CAR25.

Best regards,  Howard


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## craft (30 March 2017)

howardbandy said:


> Greetings --
> 
> Deepstate is stating my recommendation correctly.  To reiterate the process:
> 
> ...




In summary, it appears you are describing continuously changing to the system with the best historical risk adjusted return.


How different is that from continuously changing to the fund manager with the best historical risk adjusted return? The inclination to chase return seems ingrained to human nature so plenty of historical data on the success of such strategy exists. The evidence of its success is overwhelmingly negative.


Obviously you are talking changing systems not fund managers, although given fund managers are normally pretty sticky to one system /strategy this distinction may not be so great.   And the rate of changing systems you advocate may be greater than what has been studied in the Phenomena of chasing historical fund manager returns.  I would like to see any ex-post evidence you can provide that your twists on this human trait to chase historical returns will produce results opposite to the body of evidence that already exists?


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## howardbandy (30 March 2017)

craft said:


> In summary, it appears you are describing continuously changing to the system with the best historical risk adjusted return.
> 
> 
> How different is that from continuously changing to the fund manager with the best historical risk adjusted return? The inclination to chase return seems ingrained to human nature so plenty of historical data on the success of such strategy exists. The evidence of its success is overwhelmingly negative.
> ...



Hi Craft --

Yes.  Use whatever model currently gives the best prediction of future performance, as measured by metrics appropriate for the application.  This is the central principle of sequential learning and adaptive management.  Credit scoring, self-driving cars, paper machine operation, etc.  And trading.

There are variations of changing mutual funds and exchange traded funds that do work when rapid switching and short holding periods are allowed, easy, and inexpensive.  

The literature describes rotational systems, often based on mutual funds.  Working with different fund managers complicates use of traditional mutual funds.  Mutual funds try to avoid customers rapid switching in and out, often imposing early-termination fees to discourage it and overwhelm whatever profits are made.  

It isn't risk adjusted long term historical return that is most useful to switching -- it is recent trade performance.  Day-by-day.  Simplistic models may not work at all.  There must be reasonable assurance, through use of sound modeling and simulation techniques, that the model applied to the data series does identify profitable patterns.  Not all data series qualify.  Not all models work. 

The literature I have seen that describes historical fund manager performance and the value of chasing it uses long lookback periods, long holding periods, and no scientific method.  The conclusions are, as you say, disappointing.

A technique that does work is to use the mutual funds to generate signals, then take the trades in individual stocks that are highly correlated with the funds.   

But more generally, and to what might be more useful for those of us trading, what is the best technique?  

If individuals are to consider historical performance at all, there are several considerations.  The time frames to use -- what lookback period and what holding period?  What performance metrics to value -- good recent performance, or poor recent performance?  What set of rules -- how to identify patterns that precede profitable trades / switches?   

Best,  Howard


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## DeepState (30 March 2017)

howardbandy said:


> Greetings --
> 
> Deepstate is stating my recommendation correctly.  To reiterate the process:
> 
> ...



Thanks for the detailed explanation Howard.  It's good to see your thinking laid out here so clearly.

FWIW, I believe that this is actually a trend signal in disguise if the fitting periods are anything like a slightly front weighted 3-12 month period. I won't go through this because, as Quant has suggested, anyone who wants this can do their own work.  Not having seen any you have produced, I am confident that this method would work in backtests and across different markets if applied to stocks in broad universes, but less so for diversified ETFs.  It would work for commodities and FX. I agree with separating long vs short signals in this case, for stocks but not others.

If producing a great long term risk adjusted return is the aim, the filters to a single stock holding at any given time require an extreme process which essentially assumes that only the 'best' signal of the day has any validity.  The underlying belief systems to support that are not reasonable in my view.

The process also makes no allowance for frictions which, depending on the portfolio of systems and their characteristics interacting with the universe of instruments, can destroy an absolutely enormous amoutn of value.  For example, a universe of 200 stocks and an infinite number of rules will spit out one which tells you to buy something.  The chances of that same something being in place the next day are very low.  Let's say we trade once in 2 days.  Brokerage of 0.1% each way.  That's 126 round trips.  20+% per annum erosion on a fully invested portfolio (yes, you have a safe-f and this changes, but the idea is here).  And that is if you take zero spread or slippage.


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## DeepState (30 March 2017)

howardbandy said:


> Greetings --
> 
> Deepstate is stating my recommendation correctly.  To reiterate the process:
> 
> ...metrics giving the maximum safe position size (safe-f)...




I really like this aspect of your process which calibrates nominal exposure to risk tolerance and has the additional/associated benefit of volatility stabilisation if the estimation method is valid.


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## howardbandy (30 March 2017)

I hear and understand the attractiveness of long holding periods, low system maintenance, low transaction costs, lower tax rate.  Fund managers such as John Bogle (Vanguard funds) and the like recommend this technique -- but they have vested interest in keeping funds in positions to ease their management.  

My caution is that the period from 1945 to 2000 is probably far better for long term holding in terms of high reward and low risk than we can expect in the future.  If that is repeated, we want to participate.  If the future is different -- higher volatility, more efficient markets, significant markets drops -- then we need to have procedures that indicate that risk is increasing and, if possible, ways to profit from changed conditions.

Risk normalization and dynamic position sizing is one such technique.  To illustrate, begin with a list of the trades from a series of long term holdings.  Note the intra-trade mark-to-market daily high and low equity.  Compute the risk of that one equity curve.  Form the distribution based on that set of trades and compute the probability of drawdowns of various levels.  You will find that risk to the funds exposed to the market is much higher for long term holding.  In order to hold risk of the trading account to a reasonable level, some funds must be kept in reserve.

Whatever risk the system has Will Be experienced by the funds exposed to the market.  We cannot avoid that.  Holding some cash in reserve is what keeps the risk to the trading account reasonable.  

But, the funds held in cash earn very little, so overall rate of return is lowered.

Then compare with more active trading -- accurate trades with short holding periods.  Normalized for risk, more active trading is safer and more profitable. 

Best,  Howard


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## DeepState (30 March 2017)

howardbandy said:


> accurate trades with short holding periods.




Is the application of CAR25 the alchemist required to convert mostly noise into accurate signal?  With an accurate signal, net of frictions, anything is possible.

Certainly a weaker outlook for equity returns (which seems to be continually defied, just like the edict that bond yields surely can't go negative), lowers the bar for alpha strategies.  However, the bar is still there and remains a challenge that 90% will not make in the next 3 years.  Add a frictions hurdle of 20%+ on deployed funds and you have a definition of an epic hurdle for a signal to overcome just to break even.  Cash could easily turn out to have been the better strategy...or being a broker.

Which still leaves the question on portfolio diversity at any given time (as opposed to through time) somewhat unanswered.  Unless the candidate signals are so wild that they switch in and out of predictive ability such that only one exists at any given time and that CAR25 is capable of finding it with some accuracy, this approach is not deploying risk and taking in to account the skill in selecting candidate strategies being filtered for maximum effect - where I am assuming skill exists for the sake of argument.  If skill does not exist, as mentioned earlier, it doesn't matter except for saving frictions...so you glide in to the ground more gently than would be the case applying a portfolio approach under the assumption that skill existed in the first place at any level.


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## howardbandy (31 March 2017)

Hi Deepstate --

To my thought, the procedure is pretty clear and pretty much all trading system developers have the requisite domain knowledge.    
... Development:
1.  Use the data prospector to curate a list of potential candidates.
2.  For each candidate, attempt to develop a long / flat trading system using the scientific method.  The model is rule-based, uses state signals, marks-to-market daily, is looking for trades that are accurate, frequent, and hold a day or two.  If a traditional trading system development platform is being used, an oscillator with a fast cycle works.  Pick any one, since at that rate, all are equivalent.  Or some other indicator of your choice that will give about 50 signals per year.  
3.  Also attempt to develop short / flat systems, but there will be lower success.
... Trading:
1.  Bring data up to date and evaluate all the systems daily, computing safe-f and CAR25.  If the one with the highest CAR25 has a score higher than a risk free account, take a position using safe-f portion of the account.
2.  As the jingle says -- rinse and repeat daily.

Still one system at a time, one day at a time.  

Volatility was one of the characteristics examined by the prospector.  When he or she passed it originally, volatility was acceptable.  If it increases at a later time, dynamic position sizing will identify that and lower safe-f and the CAR25 score, moving it down the list of those available to be traded.

If AmiBroker is being used, I have published several models that work.

If Python / machine learning is being used, I have published one decision tree model showing that it replicates the traditional platform.  Also examples of about ten alternative models that can be applied with little change to anything.  And suggestions for additional predictive variables.  

Modeling experience and skill become more important here.  The magic sauce, whose recipe developers of machine learning trading systems will hold close, is which additional predictor variables are useful, what steps are taken to create stationary data, and what data preparation is used.

Best regards,  Howard


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## ducati916 (31 March 2017)

howardbandy said:


> My caution is that the period from 1945 to 2000 is probably far better for long term holding in terms of high reward and low risk than we can expect in the future. If that is repeated, we want to participate. If the future is different -- higher volatility, more efficient markets, significant markets drops -- then we need to have procedures that indicate that risk is increasing and, if possible, ways to profit from changed conditions.




In that time frame there have been two periods [in the US] of extended high volatility and sideways movement. The first 1965 - 1985 and the second 1999 - 2014.

That is one period of 20 years and the one period of 15 years, within your 72 year time frame, which is more or less, 50% of the time.

If this period is considered a good period with regards to risk/reward  and the future could contain higher volatility, which changes risk/reward for the worse, then '_we need to have procedures that indicate that risk is increasing and, if possible, ways to profit from changed conditions_'

It would seem that you advocate more frequent trading [shorter signals]. Correct me if this is not the case.

I would argue that for many retail traders, this is simply not the way forward. Intra-day and daily price moves are simply too noisy.

jog on
duc


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## DeepState (31 March 2017)

howardbandy said:


> Hi Deepstate --
> 
> To my thought, the procedure is pretty clear and pretty much all trading system developers have the requisite domain knowledge.
> ... Development:
> ...



Howard, it's not the broad process mechanics that I am questioning.  Though, thanks for writing it out again, and in more depth, to shed more light.

Ultimately, this is another process framework with a range of parameters upon which the success and failure of an effort will rest.  In broad terms, I agree with the concepts used in risk deployment.  There is merit in checking for performance in a recent period in the belief that regime rigidity is a feature and might help with prediction in that environment.  CAR25 is a selection criteria and is a reasonable one.

None of these will save you from throwing garbage at it.  And, if the skill of the operator is what differentiates the winners from losers, it was so before this approach was conceived and remains so.

The main question I have relates to portfolio construction.  This is a thread where a strong statement about 2 stock portfolios was raised.  In my view and in my experience of seeing and participating deeply in professional money management of the real and hedge variety, this is unsupportable for situations outside of play money.  And that's fine if so.

Yet, you came along and seriously expressed support for a 1 stock portfolio.  And it is this I wanted to explore.  Your proposition is 1 stock at any given time consuming the full risk allocation.  You will appreciate that the position is an extreme one, but you are a man of serious intellect where statements seem to have rationale, even if we might reasonably disagree on those merits.

So, I say to you that, even under the framework of CAR25 and safe-f, you would be better off holding more than 1 stock at a time.  Yes, your current process only selects the best CAR25 over some horizon using all sorts of permutations along the way as may be codified.  End of the day, Howard Bandy: 1 stock...full risk deployment on safe-f.

I do not think I am misunderstanding you when I say:

+ Surely, if you had a million well chosen signals feeding in to a soup of algos over a range of instruments, and their merits, however obtained, were ranked first to last on any given day...that you would feel that only one was valid.  Yet, that is what the system does.

+ If signals other than the one ranked one have any merit given the skills of the operator, others with lower rankings also have solid expectations.  Let's say that these signals are issuing a BUY on some other instrument so there is no overlap. These are currently not used in the Bandy System.

+ By not using signals which also have solid expectations and allowing for portfolio effects, you will produce worse risk adjusted results than otherwise achievable.  If the operator is skilled at selecting candidate signals for ranking, that would be a huge information loss.

+ By putting all weight on the 'best' only, the system actually produces a risk-adjusted outcome which is far from best in a portfolio sense.

Reasons why you would not do this include:

+ A trivial case of where the inputs are known to be garbage and no algo to screen them can convert garbage to alpha without finding a latent factor via the screening alone.

+ You literally believe only one of the candidate signals in the primordial soup truly had positive expectation.  This would justify full risk deployment on this one instrument on the one signal on this particular day.  Whist things may be non-linear in life and require special techniques to identify the underlying order, this kind of binary, first is right and the rest is junk for today, outcome is wildly unreasonable in my view or a sign of a highly unstable set of candidates where identification of merit would already be highly tenuous.

Comment sought:

1. Do you think that only one signal, that chosen as 'best' by the process for a given day, has merit in terms of positive expectations? That the rest have absolutely no merit at all on the ranking criteria beyond that placed first? 

2. If the screening criteria does rank in a way which helps us order the merit of signals and others are also somewhat valid, why should this information not be used and result in these signals combining in to a portfolio setting, given an aggregate safe-r equivalent (adjusted as required for whatever you like to get this estimate) and then deployed in to the market.  More than 1 stock at a time.

Regards

DS


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## howardbandy (1 April 2017)

DeepState said:


> Comment sought:
> 
> 1. Do you think that only one signal, that chosen as 'best' by the process for a given day, has merit in terms of positive expectations? That the rest have absolutely no merit at all on the ranking criteria beyond that placed first?
> 
> 2. If the screening criteria does rank in a way which helps us order the merit of signals and others are also somewhat valid, why should this information not be used and result in these signals combining in to a portfolio setting, given an aggregate safe-r equivalent (adjusted as required for whatever you like to get this estimate) and then deployed in to the market. More than 1 stock at a time.




Earlier in your post you suggest there might be a million well chosen signals.  My view is different.  There might be a dozen or two.  The data prospector tests each candidate data series for its inherent risk and profit potential and liquidity.  Most fail.  A few dozen pass.  These are the ones that become candidates to have models applied to them.  Assuming that every one of those data series does have persistent and detectable patterns that precede profitable trades, there are still not many of them.

Then to your questions.

1.  Assume that there are 20 systems that have passed validation and are being followed each day.  CAR25 is the risk-normalized profit potential of each.  Immediately remove from consideration for today's trade any that have a CAR25 below risk free.  There might be days when none remain, but assume there are two.  (The math works for any number.)  ABC has CAR25 of 15, XYZ has CAR of 9.  Each has its own safe-f -- assume they are both 1.00, meaning that all funds can be used to buy shares.  The account has $100,000 available.  Our choice is whether to buy $50,000 worth of both ABC and XYZ, or $100,000 worth of ABC.  Splitting the funds used drops the CAR25 from 15 to 12 -- 0.5*15 + 0.5*9.  Yes, put all the funds into the single best alternative.

Anticipating a followup question.  Yes, there will be fluctuations and we have no assurance that the results will match the estimates.  Those fluctuations apply to all.  If there was some reason to expect that XYZ was the better use of funds, that reason is either: subjective, in which case and all bets are off; or objective, in which case the model should be refit to take the new information into account, possibly raising the CAR25.

2.  Does the example I used in responding to question 1 give enough to answer?  The CAR25 of any portfolio is the average of the CAR25s of the components.

This process is repeated daily.  When conditions change, CAR25 changes.  The rankings change.  Tomorrow's choice might be different than today's.  

Best,  Howard


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## howardbandy (1 April 2017)

ducati916 said:


> It would seem that you advocate more frequent trading [shorter signals]. Correct me if this is not the case.
> 
> I would argue that for many retail traders, this is simply not the way forward. Intra-day and daily price moves are simply too noisy.




Yes, I definitely recommend frequent trading and short holding periods.  The research is compelling.  I have written about this extensively.  My mantra is:  trade frequently, trade accurately, hold a short period, avoid serious losing trades.  

I recommend using daily data, using state signals (compare with impulse signals), forecasting one day ahead, and managing daily.  Managing daily means mark-to-market daily, measuring equity highs and lows on daily prices, and being willing to change position for the next one-day holding period daily.  

Your question suggests perhaps using less frequent management or longer data bars.  I have not been able to develop any system that passes validation using weekly, or longer, bars.  Those that have come close to passing have much lower CAR values than systems using daily data and holding a few days at most.  It is up to the trader whether he or she is willing to ignore intra-trade changes in equity between management activities.  I recommend being willing to ignore intra-day changes, but not intra-week changes.  Mark-to-market each day at the close, being able and willing to either: continue the same trade for one more day; close out the existing trade and change to a new position for one day; close out the existing position and remain flat for one day.  This is the sweet spot of having a life other than trading, but actively managing trading. 

I do not necessarily advocate use of intra-day bars and creation of systems that regularly trade more than once per day.  Intra-day systems are an order of magnitude more complex than end-of-day systems.  Complications include acquiring and managing historical and real-time intra-day data; a greatly increased number of data points when modeling; need to monitor the market during the period a trade is active, perhaps issuing cancel and replace orders; increased cost of commission and slippage.  For the intra-day models I have created, two trades per day is the sweet spot.  

The model fitting process takes volatility and noise into account.  If the volatility is too low, there will not be enough profit potential.  If it is too high, there will too much risk.  Both of these are reflected in CAR25.  The purpose of the model is to detect patterns that precede profitable trades -- the signal among the noise.  If there is too much noise or if the signal is too low or changes too rapidly, the system will fail to pass the validation tests and will not be a candidate to trade.    

Best,  Howard


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## howardbandy (1 April 2017)

DeepState said:


> + A trivial case of where the inputs are known to be garbage and no algo to screen them can convert garbage to alpha without finding a latent factor via the screening alone.



Assuming the model is rule-based.  If inputs are garbage, then they contain no persistent patterns that precede profitable trades.  If there is no signal to find, the model might fit itself to whatever noise is present, but the validation tests will fail and the system will not pass on to trading.


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## howardbandy (1 April 2017)

DeepState said:


> + Surely, if you had a million well chosen signals feeding in to a soup of algos over a range of instruments, and their merits, however obtained, were ranked first to last on any given day...that you would feel that only one was valid. Yet, that is what the system does.



Yes, that is what the process does.  It is designed to do that.  It is the best use of funds.  The expected final equity after some period of using this technique is highest.

However many systems there are that have passed validation, even granting that there might be a million, each has its own CAR25 score.  Assume any number of them have scores that are higher than the score of risk free use of the funds.  Day by day, pick the highest one.


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## howardbandy (1 April 2017)

DeepState said:


> If signals other than the one ranked one have any merit given the skills of the operator, others with lower rankings also have solid expectations. Let's say that these signals are issuing a BUY on some other instrument so there is no overlap. These are currently not used in the Bandy System.




When the conversation moves from rule-based to subjective, estimates of future performance fade into the unknown.  You are correct that they are not used in the procedures I recommend.  

If an experienced trader prefers to continue with subjective methods that have worked for him or her, I recommend they do that and ignore me.  If a newbie is considering trading system development, and thinks subjective judgement has some value, I recommend beginning with Daniel Kahneman's book, "Thinking, Fast and Slow." 

For everyone, please pay attention to the increasing ability of machine learning / artificial intelligence techniques.  They have already surpassed humans in almost all fields.  They are already being used by the largest trading houses.  Systems based on subjective judgement of individuals, particularly individuals without extensive expertise, will have a hard time competing.


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## DeepState (3 April 2017)

howardbandy said:


> When the conversation moves from rule-based to subjective, estimates of future performance fade into the unknown.  You are correct that they are not used in the procedures I recommend.
> 
> 
> If an experienced trader prefers to continue with subjective methods that have worked for him or her, I recommend they do that and ignore me.  If a newbie is considering trading system development, and thinks subjective judgement has some value, I recommend beginning with Daniel Kahneman's book, "Thinking, Fast and Slow."
> ...







howardbandy said:


> Yes, that is what the process does.  It is designed to do that.  It is the best use of funds.  The expected final equity after some period of using this technique is highest.
> 
> 
> However many systems there are that have passed validation, even granting that there might be a million, each has its own CAR25 score.  Assume any number of them have scores that are higher than the score of risk free use of the funds.  Day by day, pick the highest one.





Howard, I am recombining the two posts because the point I am trying to communicate doesn't seem to be getting through.  Having tried the verbal approach, I am now going in to explicit examples and some maths to be as unambiguous as I can.  In doing so, I will use techniques no more sophisticated than Markowitz and binomial distributions.  These are as close to axioms and the simplest expression of randomness as we are going to find in the world of investments.  I will use examples to lead the process heavily in your favour.  I aim to demonstrate that the requirements for a one stock portfolio to be optimal are unrealistic.


I am not talking about any qualitative override to the system when in flight.  I am questioning the system itself and its recommendations.  I particular, I am questioning the primacy of the belief in one stock portfolios.


Let me roll out some background in relation to a clean example for exposition.


Our trader is a genius.  He models 2 stocks: A and B.  These two stocks are unconditionally distributed as equal likelihood of producing a return of either +1 or -1.  The expected return is thus 0 per day with no prediction on timing of these outcomes. The returns between the stocks are completely independent of each other.  This is a buy-only strategy.  The trader will only position long if he thinks the stock will go up.


The trader, using whatever method, including machine language, produces signals which produce a regime independent predictive ability which is equal for both stocks.  The trader sees both stocks equally clearly. This figure is a daily estimate correlation of 0.3. Utterly heroic for a symmetric strategy and sure path of extreme riches.  It represents a daily hit rate on a signal stock of 65%.  Let's say there are no brokers so I will hand over frictions.


Whatever safe-f is, that allocation will be constant for each of the stocks in isolation.  Let's call that figure 100.  You can have another 100 in cash earning zero in spare because we can't handle the risk of complete nominal deployment.


The expected return on this a stock signal is:

(Prob right x profit – Prob Wrong x Loss) x Trading days

 = (0.65 x 1 – 0.35 x 1) x 252

= 75.6 per annum…vastly better than the buy-hold equivalent of zero.  Utter genius, as mentioned earlier,


Risk can be approximated by standard deviation.  All other distributions like DD can be inferred from this. This is the true distribution, with no errors in measurement. The unconditional standard deviation for any stock is sqrt([E(X^2) – E(X)^2]xTrading Days) where X is the Stock Return

= sqrt([1 – 0.5^2] x 252)

=  13.74 per annum


However, when you are a genius of this level and there is no doubt about that at all because I have removed doubt in this example, you tilt aggressively towards the risk stats that you actually get because you know the market better than it knows itself. This makes it less risky to invest for our trader than another lesser, buy-hold, mortal. In this case, the stdev drops to: 12.06. Do the same calculation but replace probabilities with the predicted outcome (65% right) as opposed to unconditional probabilities of 50%,


So, before a CAR25 is even calculated, which means we don't even care about the regime, a single stock position will produce 75.6 expected return for 12.06 standard deviation per annum.  Forget about buy-hold.  Trade like there is no tomorrow.


As all reasonable distributions that feed into a safe-f are going to be proportional functions of this ultra simple binomial model, I will stick to this figure rather than infer drawdowns or any thing else that might be used at the portfolio level.  We identify this distribution without error. The risk is identical to both stocks and safe-f works out to $100.  Let’s say we left $100 under the mattress because our risk tolerance can’t handle its deployment.


A single stock holding, pick any one and just focus on that, will deliver a return of $100 x 75.6% = $75.6 dollars.  Ignoring rebalance effects to keep this ultra simple.


Now, if we stuck both strategies side by side and ran them both with equal risk deployment (think of this as two separate accounts doing their own thing), the expected return for the combination remains 75.6% per annum.  However, as Markowitz noted in his Nobel paper in the 1950s, there is diversification to be considered in a portfolio.  The portfolio of a 50/50 allocation to the strategies for both stocks is sqrt([w(A)^2 var(A) + w(B)*var(B] x Trading days) where w(x) is the weight to each strategy…0.5 for this purpose.  Var(A) is the square of the standard deviation for each individual strategy… = 12.06%^2.  The standard deviation of the combined equal weighted portfolio is thus 8.53. Remember that these stocks perform completely independently of each other.


Hence, for the same risk exposure, we can put 12.06 / 8.53 x 100  = $141 to work in the trader’s portfolio. This also earns 75.6% so the aggregate portfolio earns $141 x 7.56 = $106.  Once again, I am ignoring rebalance effects….which is even further in favour of a single stock outcome, to be sure.


As would be evident to any student of investment, for any given degree of risk tolerance, a lower risk asset will result in greater nominal assets deployed than a higher risk asset for equivalent returns.  Hence, a 50/50 parallel portfolio of Stock A and B strategies running unconditionally on regime and still side by side, allows more capital to be deployed because of diversification benefits.


As a result, portfolio diversification produces better outcomes all else equal.



“(Single Stock Exposure to highest CAR25 Strategy) It is the best use of funds.  The expected final equity after some period of using this technique is highest.”


To cover off on a comment you made that the ‘best’ produces the highest equity curve, let us assume that the ‘best’ strategy of the two produced an expected return of 76%.  There is no way that a strategy with this ‘best’ return would produce a higher equity curve than the portfolio of the two in an expectations sense.  It would produce the highest equity curve of all single stock strategies.  But that is inferior to portfolios where you have a genius making good predictions on other things which might warrant a little less merit at any given point in time.


Progressing…


With this base, let us now examine what it takes for a process that can differentiate between the potential future success of strategy A and B to justify moving to a one stock situation as has been recommended.


Let me build an overwhelming case in its favour.


The process of CAR25 or whatever conditioning function is to discriminate between Stock A and Stock B strategies assumes the ability to:

1.  Identify regimes

2.  Differentiate the probable return for candidate strategies in the presence of the expected regime for the next 24 hours.


There is no need for me to specify this.  I will assume that the trader remains an utter genius and can handle non-linear maths, specified Deep Thought and codes at the very highest level.  All that and understands investing too.


Further, let me remove immense amounts of uncertainty and tilt this even further to the single-stock case.  I hope it is evident to all that these following settings do not exist.


Signal A and Signal B, the predictors previously mentioned which have been vetted at the highest level through any screen that there is to consider, are definitely regime dependent.  There is no doubt.  There are only two regimes in the market: R1 and R2. The occur cleanly. One or the other, no grey. Any meaningful time period contains these in equal measure. In the event of R1, Signal A has an 80% (more than insider trading by the day) change of success and 50% (no skill) chance in the other regime, balancing out to 65% unconditional accuracy ignoring regime identification.  Signal B has the mirror characteristics.


The question is, how good does CAR25 and other smarts have to be to justify moving from a 2-stock portfolio to a single stock portfolio that is expected to produce the same dollar outcome for the same risk?  How well does this regime identification have to predict in order to overcome the most limited levels of diversification?


For a single-stock solution to make sense, the system must be able to generate more than $106 on the same safe-f.


It turns out that this regime identification success figure needs to be around a 75% hit rate. You need to have a 75% chance of choosing the true ‘best’ model to get this outcome.  All the machinery in the world could not generate a genuine 75% hit rate on regime identification at daily intervals for anything resembling a genuine stock market. 


These calculations, and the 75% hit rate that comes from it, are for an absurd example to support the idea of the primacy of a single stock portfolio. It is only a small step from here to move to a scenario of a single stock which is known to always go up faster than everything else in the market every day. 


This hurdle to a diversified set of signal implementation by this genius becomes more challenging when there are more stocks being examined and the comparison diversified portfolio which maximises whatever return criteria matters to you become harder to beat with a single stock portfolio for any given safe-f.


I cannot find any reasonable basis to support a proposition that a single stock portfolio based on CAR25 or any regime identification process created by hand, machine or combinations thereof would improve outcomes to the level required to justify a one stock portfolio over a portfolio created by someone who has any skill and produced a set of candidate strategies that made sense before being fed in to the CAR25 or other algo to identify the ‘best strategy’ based on regime identification at a one day interval.


Naturally, if we run enough backtests, and use enough techniques particularly those which seek vast non-linear structure, some will show a better outcome arising from single stock portfolios.  However, that’s not the hurdle.  The hurdle is: would you reasonably have expected that outcome before running it.  And..would you reasonably expect that to happen when you let it loose in the wild…. The above suggests it’s a tall order even if there is merit in regime identification and conditioning the candidate signals for this.


Between the one-stock proposal and Duck’s two-stock proposal, I would choose Duck’s. Of course, the case generalises beyond that.



Thanks.


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## craft (3 April 2017)

DeepState said:


> Howard, I am recombining the two posts because the point I am trying to communicate doesn't seem to be getting through.  Having tried the verbal approach, I am now going in to explicit examples and some maths to be as unambiguous as I can.  In doing so, I will use techniques no more sophisticated than Markowitz and binomial distributions.  These are as close to axioms and the simplest expression of randomness as we are going to find in the world of investments.  I will use examples to lead the process heavily in your favour.  I aim to demonstrate that the requirements for a one stock portfolio to be optimal are unrealistic.
> 
> 
> I am not talking about any qualitative override to the system when in flight.  I am questioning the system itself and its recommendations.  I particular, I am questioning the primacy of the belief in one stock portfolios.
> ...



Thumbs up from me DS for taking the time to articulate the portfolio position.

I'm also really sceptical that one day persistence of the best historical return system on a single security will in reality overcome frictional cost and gap risk when applied over a statistically significant population. To my last post around this point. Howard reiterated his theory but forgot to provide the ex post evidence requested.

Clearly some of us are not going to be swayed without some hard evidence. But perhaps those that want to believe the secret sauce lies within more complexity and even smarter artificial intelligence don't need evidence just  a theory/belief to justify continued effort is enough.

Too cynical again - right.


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## Value Hunter (3 April 2017)

http://www.lazardnet.com/us/docs/sp6/3048/LessIsMore-ACaseForConcentrated_LazardInvestmentFocus.pdf

The above is a link to a study which shows that on average a fund managers top 5 picks outperform their portfolio as a whole.


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## Value Hunter (3 April 2017)

In one of his books Peter Lynch advocated that individual investors should own between 3 and 5 stocks. This was because an individual investor only has the time and expertise to understand and follow a limited number of companies.

As for Buffet advocating index funds he said the majority of investors should use them. However those with skill and ability should concentrate is what he advocates. Even Ben Graham in the intelligent investor classified investors as two groups defensive and enterprising. Defensive would be similar to an index fund investor today using a mix of bonds and stock ETFs.

Buffet at one point had 40% of his partnership in American express. Charlie Munger once said that he had 110% of his net worth in one stock (an oil company from memory). 

As for Buffet being diversified in his early years that is because he ran 2 strategies in his portfolio simultaneously:
1) Long term investments such as American Express which were typically big concentrated positions
2) Special situations/arbitrage which needs to be diversified by its very nature. This what caused his portfolios to have a large number of positions.


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## Value Hunter (3 April 2017)

Most people do not have the skill, dedication or temperament to be a concentrated stockpicker. These people can either use a mechanical approach, focus on special situations/arbitrage (not recommended these days do to competing with high firepower computerised hedge funds), or use index funds. Skilled investors should have portfolios which are no more than 10 stocks and preferably 3-5 stocks. 

Even Joel Greenblatt advocates most people adopt a well diversified magic formula approach while a skilled minority pick 3-6 (or was it 5-8?) stocks based on careful analysis.


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## Value Hunter (3 April 2017)

To summarise average investors should buy an index fund of some description. Skilled investors should carefully select a small number of stocks (in my stock portfolio I only own 3 stocks, however I own other assets such as property, commodities, etc). In my 3 stock portfolio one stock compromises over 95% and the other two stocks combined make up the other 5%. So far it has worked out well.


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## Knobby22 (3 April 2017)

Value Hunter said:


> To summarise average investors should buy an index fund of some description. Skilled investors should carefully select a small number of stocks (in my stock portfolio I only own 3 stocks, however I own other assets such as property, commodities, etc). In my 3 stock portfolio one stock compromises over 95% and the other two stocks combined make up the other 5%. So far it has worked out well.




I'm usually around 8 stocks.
I find it too hard if I go anymore.


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## Value Hunter (3 April 2017)

Just FYI for Deep state and anyone else who might suggest my approach might be because I only have play money invested in shares that is not the case even though only part of my total investments are in shares my overall investment (not only shares) portfolio is quite leveraged (no margin loans though) so if my top shareholding went bust my net worth would drop by 80-85% and it would take me many many years to recover.


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## skc (3 April 2017)

Value Hunter said:


> The above is a link to a study which shows that on average a fund managers top 5 picks outperform their portfolio as a whole.




The top performers do better than the average... Isn't that kind of true by definition?


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## minwa (3 April 2017)

Why anyone would want to concentrate in any one stock which could end up like a Lehman or Madoff no matter how rosey any analysis seems is beyond my comprehension. 

Especially if they are a portfolio manager whose sole/majority income comes from it. Why gamble on one stock who is just one rumour/announcement away from dealing a major drawdown to your account beats my senses.


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## Value Hunter (3 April 2017)

SKC you misunderstood me I meant top 5 positions by weighting in the portfolio. In other words the stocks they (fund managers) invest the most money in (percentage allocation), on average perform the best (compared to other stocks in their own portfolio) because they tend to invest the largest sums of money in their best ideas.


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## Value Hunter (3 April 2017)

Minwa which investor do you think is taking more risk?
Investor A) Has an equally weighted portfolio of 7 stocks: one Iron Ore exploration company, one gold exploration company, one oil exploration company, one start up Australian medical cannabis company (with no current crops or land ownership), one high tech startup like Martin Jetpack, shares in Myer and shares in Qantas.
Investor B) 100% of his money invested in a very strong global brand like Nestle (you could easily substitute a company like Johnson and Johnson or 3M in this example).

I would wager that if investors A and B both went into a coma (let's assume they were both 20 years old when they went into the coma) and then one day after 50 years suddenly woke up investor A would most likely have a portfolio of worthless companies which long ago went bankrupt, whereas investor B would have a portfolio worth many times there initial investment.


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## Value Hunter (3 April 2017)

My point is that what you invest in is just as important if not more important than how diversified you are. A soccer team made up of 14 (let's include three substitutes) crappy players will make a crappy soccer team. Likewise a portfolio of poorly chosen companies will perform poorly.

Another example, let's say two investors both living in Greece are investing in 2007 in the share market. The first Greek investor bought an index fund representing the Greek stock market. The second Greek investor set up a brokerage account that could invest overseas and bought shares in Unilever. We all know who would be better of today.


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## minwa (3 April 2017)

Value Hunter said:


> Minwa which investor do you think is taking more risk?
> Investor A) Has an equally weighted portfolio of 7 stocks: one Iron Ore exploration company, one gold exploration company, one oil exploration company, one start up Australian medical cannabis company (with no current crops or land ownership), one high tech startup like Martin Jetpack, shares in Myer and shares in Qantas.
> Investor B) 100% of his money invested in a very strong global brand like Nestle (you could easily substitute a company like Johnson and Johnson or 3M in this example).
> 
> I would wager that if investors A and B both went into a coma (let's assume they were both 20 years old when they went into the coma) and then one day after 50 years suddenly woke up investor A would most likely have a portfolio of worthless companies which long ago went bankrupt, whereas investor B would have a portfolio worth many times there initial investment.




You're using the situation that real world investment have to go into a coma. This is not the case. Most people (hopefully) manage their investments - if they do not, only then is it a coma gamble as you put it.

Investor A with a 25% stop in each stock has much lower risk than investor B with a 25% stop in Nestle. That stop is useless when overnight something happens and Nestle opens up with a drop larger than 25%. In the case of investor A, the most can be lost is 14% (1/7th) vs B all the way up to 100%.


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## Value Hunter (3 April 2017)

Not everybody uses stop loses. I do not use a stop loss (I have different sell criteria based on fundamentals).


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## minwa (3 April 2017)

So ? You still manage it as you just said.

Take away the stop in portfolio A & B and put on a fundamental sell signal - the bottom line risk is the same. 1 is 1 scandal away from massive drawdown the other have a few "lives".

The fact that you can't guarantee nothing major will ever happen to the one stock in a major negative way makes A higher risk. Your research will lower the probability, not eliminate it.


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## skc (3 April 2017)

Value Hunter said:


> SKC you misunderstood me I meant top 5 positions by weighting in the portfolio. In other words the stocks they (fund managers) invest the most money in (percentage allocation), on average perform the best (compared to other stocks in their own portfolio) because they tend to invest the largest sums of money in their best ideas.




I see. That makes slightly more sense. I can't tell, from a quick glance of the paper, how they determined top positions by weighting. I know the 5 biggest positions in my portfolio have performed much stronger than the average... but that's because they were the best performers. They are the bigger positions after their stellar runs, and ongoing validation of business performance means that I increased position size along the way. I certainly can't say that they are my high conviction picks from day one however.


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## howardbandy (3 April 2017)

What a lot of good discussion.  

Most agree that it is better to favor holding a small number of issues.  
... It is hard to monitor a larger number.
... The top performers do better than the average.

I am a little confused by DeepState's scenario (in post 107).  Is this correct:

Two separate models.  One for stock A, the other for stock B.  Resulting in two systems -- A and B.

Each system makes a prediction every day.  The prediction is the direction for one day holding.  A correct prediction -- a winning trade -- returns 1.0%.  An incorrect position returns -1.0%.  Each is 65% accurate.

The systems and their results are independent -- correlation between them is 0.0.

We need a statement of risk tolerance in order to normalize risk.  I use:
We are trading a $100,000 account, forecasting two years.  I want to hold the probability of a drawdown greater than 20% to a chance of 5% or less.

---------

Compare two trading management alternatives:

1.  Trade A (or B) alone.  Each trade will be made using whatever portion of the account is determned by safe-f.  

2.  Trade both A and B.  Profit and loss of both trades are accumulated into a single balance, which is split between the two for the next trade.  Each system is trading half the composite account, at the safe-f of each.

This much is straight forward and can be analyzed.

----------

I am confused about the 0.3 correlation mentioned.  How does it come into play?

----------

There is statement that risk can be approximated  by standard deviation.  That fits the frequentist / modern portfolio theory approach.  

I prefer the alternative Bayesian approach, where we let the data guide us.  That is, form many equally likely trade sequences, compute the final equity and maximum drawdown of each, form the distribution of drawdown, adjust position size to normalize the risk, compute the distribution of final equity, estimate profit potential at the 25th percentile.  

Best,  Howard


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## Value Hunter (3 April 2017)

Minwa another one of the problems with simplistically looking at the number of stocks I'm your portfolio is that it does not tell you much about diversification by itself. For example if you own a company like Nestle or 3M or Unilever you have exposure to a huge number of product lines, countries and potentially currencies. However somebody  that buys a Greek stock market index gets exposed mostly to the problems of the Greek economy. If you buy an Australian index fund you get mainly exposure to banks and resources and the Australian dollar. If you buy Berkshire Hathaway you get exposure to well managed companies across a huge range of industries.

Would you agree that owning shares in Washington H.Soul Pattinson gives you more diversification than owning Telstra and TPG telecom?


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## DeepState (3 April 2017)

Value Hunter said:


> http://www.lazardnet.com/us/docs/sp6/3048/LessIsMore-ACaseForConcentrated_LazardInvestmentFocus.pdf
> 
> The above is a link to a study which shows that on average a fund managers top 5 picks outperform their portfolio as a whole.





The Lazard paper which, in turn, refers to the Yeung paper, is showing that cross sectional momentum works. This result has been published for decades.

Unless someone is really interested, please just accept that the analytical process which backs the Yeung base paper produces a strong lean towards momentum even if fund managers are coin flippers. This assertion is confirmed by their own analysis [P-value of alpha on Carhart 4 regression is far from significant but loads on MOM with P = significant across a whole range of tables in https://www.uts.edu.au/sites/default/files/wp18.pdf].

Naturally Lazard has something to sell and the paper wants to create some attention at a conference.  The paper is actually a thumbs up for momentum, not concentrated portfolios on the basis of generating superior returns from focused stock picking insight.

Predictably, the other paper mentioned is Petajisto which argues that very concentrated portfolios (measured by 'Active Share') outperform.  Let's consider this, Abbott and Costello both own stocks A and C in equal measure.  The benchmark is 50/50 to each.  They are index managers with zero active share. No outperformance.  According to Petajisto, when they trade such that Abbott holds 100% in A and Costello holds 100% in C, their active share shoots to 50% and both are somehow supposed to outperform the index because their active share goes up.  I kid you not.  Anyway, AQR is now at war with Petajisto on this matter.  It's not even worth buying popcorn.

These are routine arguments trying to pull money away from index and quant money.  They are head fakes.


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## DeepState (3 April 2017)

Hi Howard



howardbandy said:


> What a lot of good discussion.
> 
> I am a little confused by DeepState's scenario (in post 107).  Is this correct:
> 
> ...



All good.  I made an error in my example by saying that the portfolio is long only.  We can relax this given it is a binary process.  All the figures actually relate to a full long-short implementation.  The point would still stand if you wanted to restrict to long only or, indeed, short only or a mix.



howardbandy said:


> We need a statement of risk tolerance in order to normalize risk.  I use:
> We are trading a $100,000 account, forecasting two years.  I want to hold the probability of a drawdown greater than 20% to a chance of 5% or less.




You can use whatever works for you.  Ultimately is will come down to the distributions I have pre-specified and are not subject to uncertainty.  The safe-f, for whatever risk tolerance you want to specify is identical for both stocks individually and also for their combination.  The diversification effects will hold.

---------


howardbandy said:


> Compare two trading management alternatives:
> 
> 1.  Trade A (or B) alone.  Each trade will be made using whatever portion of the account is determned by safe-f.
> 
> ...



No.  This is where some confusion seems to arise.  In option 2, you are not trading the safe-f allocation of each.  You are trading the safe-f allocation of the portfolio consisting of a 50/50 mix of strategies A and B.  For whatever definition of risk tolerance you reasonably want, the nominal allocation to this combination of stocks will be greater than the nominal allocation for a single stock alone for any given safe-f.  In this example, the nominal allocation to the portfolio of stocks will be about 1.4x the allocation to either A or B alone (option 1).  This 1.4x comes about due to portfolio diversification gains.  That figure isn't even taking in to account return benefits, only risk [yet more in your favour].

----------


howardbandy said:


> I am confused about the 0.3 correlation mentioned.  How does it come into play?




Don't worry about it.  It is the equivalent of saying 65% hit rate for a binary outcome.

----------


howardbandy said:


> There is statement that risk can be approximated  by standard deviation.  That fits the frequentist / modern portfolio theory approach.
> 
> I prefer the alternative Bayesian approach, where we let the data guide us.  That is, form many equally likely trade sequences, compute the final equity and maximum drawdown of each, form the distribution of drawdown, adjust position size to normalize the risk, compute the distribution of final equity, estimate profit potential at the 25th percentile.




I am making this easy for you so that you do not need a Bayesian estimator, although you can weaken the outcomes if you want by applying it.   I have fully specified the system and revealed its full workings for this exercise, tilting everything heavily in your favour.  Your process, Bayesian or other, requires a 75% hit rate to justify a 1-stock portfolio.

If, in the wild, you have to apply Bayesian estimates and let the data speak, it implies that there is estimation error in play of the type which makes the level of insight required to justify a 1-stock portfolio even more out of reach.


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## minwa (3 April 2017)

Value Hunter said:


> Minwa another one of the problems with simplistically looking at the number of stocks I'm your portfolio is that it does not tell you much about diversification by itself. For example if you own a company like Nestle or 3M or Unilever you have exposure to a huge number of product lines, countries and potentially currencies. However somebody  that buys a Greek stock market index gets exposed mostly to the problems of the Greek economy. If you buy an Australian index fund you get mainly exposure to banks and resources and the Australian dollar. If you buy Berkshire Hathaway you get exposure to well managed companies across a huge range of industries.
> 
> Would you agree that owning shares in Washington H.Soul Pattinson gives you more diversification than owning Telstra and TPG telecom?




Being a diversified company does not eliminate the possibility of a big move against you.

For a 2 stock portfolio, one would not have them both in the same sector so don't see how your example applies. You're using examples of how a multistock portfolio should not be constructed to compare against the one stock portfolio.


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## Value Hunter (4 April 2017)

Minwa, my point was that looking at the number of stocks owned in isolation to other factors does not tell you about the level of diversification or risk.

Deep state I will concede the point to you on the Lazard paper, but perhaps you would care to address my other posts/arguments?


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## Value Hunter (4 April 2017)

Minwa owning an index fund (or 20 individual stocks, etc) does not eliminate the possibility of a big move against you as would have occurred in 2008.

Deep state my essential issue is against the middle ground which is the worst of both worlds. If an investor lacks skill and wants to own index funds that is a prudent decision. If an investor has skill and wants to own 5 individual stocks that is all well and good also. What I disagree with (unless its a mechanical approach) is a fund manager or individual that owns a diversified portfolio with no more than say10% in any single holding and owns say 20-30 stocks. This person should either throw in the towel and buy index funds or trim their portfolio to a maximum of say 4-8 positions. Now I understand some fund managers have too much money too manage and due to size constraints must diversify, but for small funds and individuals I think concentration is the answer.


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## DeepState (4 April 2017)

Value Hunter said:


> Minwa owning an index fund (or 20 individual stocks, etc) does not eliminate the possibility of a big move against you as would have occurred in 2008.
> 
> Deep state my essential issue is against the middle ground which is the worst of both worlds. If an investor lacks skill and wants to own index funds that is a prudent decision. If an investor has skill and wants to own 5 individual stocks that is all well and good also. What I disagree with (unless its a mechanical approach) is a fund manager or individual that owns a diversified portfolio with no more than say10% in any single holding and owns say 20-30 stocks. This person should either throw in the towel and buy index funds or trim their portfolio to a maximum of say 4-8 positions. Now I understand some fund managers have too much money too manage and due to size constraints must diversify, but for small funds and individuals I think concentration is the answer.



Hi VH

I think an industrial conglomerate with dispersed industries inside the banner has inherent diversification in it.  However, Minwa has a point that there are still elements of being part of the same conglomerate which reduces the diversity and exposes the lot to event risk or otherwise diminishes risk relative to stand alone holdings in each of the underlying businesses.  This arises due to commonality of management and, sometimes, financing.

I am not particularly averse to the view that you have outlined regarding 20-30 stocks and use of index funds.  It is quite reasonable and would find support from many quarters.  I think it comes down to a view on loss of focus that comes with holding an increasing number of positions.  Each situation is unique and this might lead to different conclusions between fund managers and individuals depending on their skills, abilities and approach. 

Stock numbers per se are just the most obvious way of talking about diversification, but it is a proxy for some concept of effective diversification.  What is wanted is maximum reward for risk and an appropriate deployment of risk.  To that extent, Howard's approach is taking broad steps in the right direction although I clearly diverge in how that it actually done.  

Although the attention scope of an individual might lead them to invest in only 2 stocks in a truly optimal sense (using everything I have outlined throughout), it might be better for that person to admit that their situation isn't ideal and to outsource if those assets are material to them.


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## Value Hunter (4 April 2017)

Deep state as I stated before in my own stock portfolio (stocks make up around 30% of my total gross assets but I am highly leveraged) one stock is over 95% of the stock allocation. Due to portfolio leverage(no margin loans though) if that stock goes to zero 80% of my net assets (my life savings and a six figure sum which is meaningful to me) will be wiped out. I mangage risk not by diversifying but by:
A) Having a long term horizon and being agnostic of drawdowns (unless the value of the business is permanently impaired)
B) Having strong knowledge of the company
C) Choosing a company with a strong balance sheet, strong earnings track record, good management and a bright future (my own subjective assessment) with diversified earnings streams
D) monitoring the company. If the quality of the business ever detiorates I will likely sell.

I still maintain that somebody holding a portfolio of six speccy stocks to me is taking more risk than someone who has 100% invested in a company like Kraft or Unilever or Nestle or 3M.

Diversification is one tool in the toolbox that can be used to manage risk. Other factors such as the ones I stated above are other tools as are things like stop losses (which I do not use). There are many risk management tools with diversification just being one such tool which is useful in some cases but not the right tool in others.


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## Value Hunter (4 April 2017)

Another point I would like to raise is looking at number of stocks or even the number of industries is just one way to look at risk exposure. You have other ways such as looking at exposure to risk/event factors (e.g. how many stocks in your portfolio are vulnerable to a China slowdown?) 

Another method is to look at story types as Peter Lynch did (Cyclicals, Asset Plays, Turnarounds, Slow Growers, Stalwarts and Fast Growers)


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## Value Hunter (4 April 2017)

Deepstate I think you need to define what you consider risk. I agree with Warren Buffet that risk is the probability of a permanent loss of capital (as opposed to say beta, drawdown, etc). In my methodology risk is to a large extent qualitative and not measurable in a strict numerical sense and rather can be described in a broad manner. Given that is the case how would you define or measure "maximum reward for risk"?

The way I look at is adequacy rather than maximisation. Is the reward adequate for the risk I am taking? Due to having imperfect information and dealing with things which are subjective and difficult to measure I do not think I can be more precise than that. I think maximising is an unrealistic goal.


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## DeepState (4 April 2017)

Value Hunter said:


> Deep state as I stated before in my own stock portfolio (stocks make up around 30% of my total gross assets but I am highly leveraged) one stock is over 95% of the stock allocation. Due to portfolio leverage(no margin loans though) if that stock goes to zero 80% of my net assets (my life savings and a six figure sum which is meaningful to me) will be wiped out. I mangage risk not by diversifying but by:
> A) Having a long term horizon and being agnostic of drawdowns (unless the value of the business is permanently impaired)
> B) Having strong knowledge of the company
> C) Choosing a company with a strong balance sheet, strong earnings track record, good management and a bright future (my own subjective assessment) with diversified earnings streams
> ...




VH, do what you feel is right.  When I debate, it's mostly on the basis of assertions which have been made and the course of logic pursued.  Nothing in what I have said makes it wrong for your to do what you are doing per se.  It is unusual and uncommon. But I cannot say that it is wrong...for you.

I will suggest that the protections in terms of fundamentals are not as strong as might be hoped.  This statement comes from many years in the 1990s when funds management was growing, but not the monolith it is today.  Quant had barely begun to show itself in a meaningful way.  

Manager after manager would espouse risk management in the way you have articulated.  They have almost all been swept away with time.

Focus and strong knowledge doesn't improve predictability very much beyond a point.  I can know everything there is to know about a (frictionless) billiard table and the balls on it.  Not allowing for the planetary motion of Mars will change the outcomes of the billiard ball by enough that my forecasts of motion will be wildly off within a very short space of time.  Billiards is nothing compared to investment.


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## craft (4 April 2017)

Value Hunter said:


> Deep state as I stated before in my own stock portfolio (stocks make up around 30% of my total gross assets but I am highly leveraged) one stock is over 95% of the stock allocation. Due to portfolio leverage(no margin loans though) if that stock goes to zero 80% of my net assets (my life savings and a six figure sum which is meaningful to me) will be wiped out. I mangage risk not by diversifying but by:
> A) Having a long term horizon and being agnostic of drawdowns (unless the value of the business is permanently impaired)
> B) Having strong knowledge of the company
> C) Choosing a company with a strong balance sheet, strong earnings track record, good management and a bright future (my own subjective assessment) with diversified earnings streams
> ...



Is the stock you refer too as representing over 80% of your net worth CCP?


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## Value Hunter (4 April 2017)

Deep state can you provide evidence to support your assertion that fundamentals do not provide strong protection? I would argue that using fund managers as an example is a suboptimal example because of the conflicts of interest and agency costs. The job of the funds managment companies is to maximise profit for themselves not risk adjusted returns for investors. The job of a portfolio manager is to keep his job not to maximise the risk adjusted return to investors.


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## Value Hunter (4 April 2017)

Yes Craft it is, the stock representing 25-30% of my gross assets (and a much higher chunk of my net assets is Credit Corp Group (CCP). And I am happy with it. I know you think it is a risky company but I disagree with your assessment.


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## Value Hunter (4 April 2017)

Some people put most of their life savings in the home they own, some people put their life savings in the small business they own. In either scenario most people will not bat an eyelid. Suddenly if somebody wants to put a huge chunk of their life savings in a single stock people think they are nuts.


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## DeepState (4 April 2017)

Value Hunter said:


> Deepstate I think you need to define what you consider risk. I agree with Warren Buffet that risk is the probability of a permanent loss of capital (as opposed to say beta, drawdown, etc). In my methodology risk is to a large extent qualitative and not measurable in a strict numerical sense and rather can be described in a broad manner. Given that is the case how would you define or measure "maximum reward for risk"?
> 
> The way I look at is adequacy rather than maximisation. Is the reward adequate for the risk I am taking? Due to having imperfect information and dealing with things which are subjective and difficult to measure I do not think I can be more precise than that. I think maximising is an unrealistic goal.




Risk, for me, is not getting what you want from your investments.  This can happen due to permanent capital impairment or the market not being rational (seeing things as you want them to - which may arise from our own delusion) in the period that you care about. Or screwing up. This is often correlated to measures like MDD and standard deviation.  

Although we want maximum reward for risk, all that you can go for is maximum expected-reward-for-risk.  The chances of that particular outcome being the actual best with the benefit of hindsight are remote.


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## DeepState (4 April 2017)

Value Hunter said:


> Some people put most of their life savings in the home they own, some people put their life savings in the small business they own. In either scenario most people will not bat an eyelid. Suddenly if somebody wants to put a huge chunk of their life savings in a single stock people think they are nuts.




Or maybe the primacy of home as a store of wealth hasn't been tested in 30 years....and they are about to find they really were nuts all along.  How many small businesses survive 12 months?


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## Value Hunter (4 April 2017)

Lets say hypothetically you are a family living in Sydney. You buy a house with 80% leverage and move into it (owner occupied). Even if house prices dropped 50% over the next 5 years, assuming that you can still make the repayments and are happy to live in that house, its not the end of the world. In 150 years time when your grandchildren inherit the house it will probably be worth a lot more than what you bought it for and nobody will even remember or care or know about the fact that the price of the house once dropped 50%. 

As for small business just because the business does not survive does not necessarily mean you lost your shirt. For example let's say you open or buy a hostel (the business and the land and building) in Byron Bay. If the hostel does not make money after 12 months you could convert the building into apartments, offices, etc and rent it out. The "hostel" ceased to exist but the assets had alternative use. Also Phoenix companies and dodging taxes and creditors are other factors which obscure small business survival statistics. Another example if you have an internet business with highly quality liquid (in demand) stock, let's say you couldn't turn a profit and shut the business down you could liquidate your stock at say a 25% discount to cost and walk away. A well though out small business should have an exit strategy.


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## DeepState (4 April 2017)

VH, people do lots of different things.  If a financial set back is not the end of the world because your future earnings are your real main asset, great. That doesn't excuse dumb actions. It just makes it survivable.

Extreme risk brings extreme outcomes. 

In a world of securities where fractional ownership is readily achievable and management input is non existent, 'best approch' invested in one or two stocks, even if conglomerates, with significant personal leverage, is not generally appropriate for most. But it may be for you.


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## Value Hunter (4 April 2017)

Deepstate I think we are both in agreement that for the masses (90%+) of investors index funds are the best choice. Personally I like to think I am awesome and do not want to dilute my awesomeness ;-) Time will eventually tell if I am right or not.

By the way I am still interested to hear why you think fundamental factors do not provide much protection (in the context of my post before which stated fund managers are a sub optimal example).


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## DeepState (4 April 2017)

Value Hunter said:


> By the way I am still interested to hear why you think fundamental factors do not provide much protection (in the context of my post before which stated fund managers are a sub optimal example).



Because the knowledge required to achieve those outcomes routinely exceeds our ability to acquire it.  Even Buffett makes major errors on individual positions.


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## Value Hunter (4 April 2017)

Deepstate I remember Buffet once stated that his biggest errors tended to be on smaller investments because you tend to be sloppier when commiting a smaller sum. Besides a mistake does not have to mean a wipe out. In many cases the investment can be exited with modest losses as Buffet has done many times before. If you can provide an example when Buffet suffered major losses on a very high conviction investment (I.e. a big chunk of the portfolio I would like to hear it). Sure sometimes like Tesco he makes a mistake but not on the really big positions (at least not since he took control of Berkshire which was a major mistake).


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## DeepState (4 April 2017)

VH, we can go back and forth on this.  You are convinced that an essentially single stock position in a levered portfolio is right for you.  Good. 

The arrangement wouldn't be appropriate for most. Many financial planners have been fined for advising clients to do what you are talking about or something close to it.   

Whilst you might be better than Buffett, making his examples useful indicators for you, the chances of this being accurate aren't very high.  

People will become very rich, from time to time, doing what you are doing.  For most taking this path, the concept of 150 year outcomes will become more relevant.  Hopefully that's not the path ahead for you, but it absolutely is much more likely than for someone investing their assets in an index fund without leverage.  And that will be so even if you know more about Soul Patts than the management of the company themselves and watch it 24/7.

Hope it works out. Hope for the best and all that.


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## Value Hunter (4 April 2017)

I do not hold Soul Patts but I get your point and thanks for the best wishes. I will let the forum know in 5 to 7 years time how my concentrated portfolio worked out.

There is a lot of intelligent debate in this thread


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## minwa (4 April 2017)

Value Hunter said:


> Minwa owning an index fund (or 20 individual stocks, etc) does not eliminate the possibility of a big move against you as would have occurred in 2008.




I never said a big move can't happen against a basket of stocks. It certainly can and does happen. The probability is just lower than being in a single stock where you are exposed to a 2008 crash AND the individual stock's own risk. Systematic risk + unsystematic risk.

If probability of a market crashing is 10% - you are at roughly at a 10% risk of a large DD.

This rises when you are majorly in one stock. You are exposed to both the above 10% AND the risk of a unexpected poor quarter/scandal/industry risk.

You are exposed to risk no matter what you do, even in cash you are exposed. It's about reducing that risk for most people and being in 1 stock just isn't doing that.


----------



## luutzu (4 April 2017)

Value Hunter said:


> Deepstate I remember Buffet once stated that his biggest errors tended to be on smaller investments because you tend to be sloppier when commiting a smaller sum. Besides a mistake does not have to mean a wipe out. In many cases the investment can be exited with modest losses as Buffet has done many times before. If you can provide an example when Buffet suffered major losses on a very high conviction investment (I.e. a big chunk of the portfolio I would like to hear it). Sure sometimes like Tesco he makes a mistake but not on the really big positions (at least not since he took control of Berkshire which was a major mistake).




Let me summarise all these back and forth for you.

DS is an investment professional. That mean he's very good at making money (for himself) while not having losses (he might cause, of other people's money) landed at his feet.

Hence, a lot of time and brainpower are spent on rocket-science level of maths to, one, make people afraid to ask anything they "don't understand"; two, to justify the spreading of people's money all over the place to "reduce risk". 

For us chumps, if we pick a stock and back it up with our own cash.. and the future turns out wrong, or we've made a mistake. We'd be the one wearing it.

For people in DS's profession, doing stupid thing like that mean a lot of hardwork and you'd get fired or demoted if you or your conviction turns out wrong. Hence, you play smart and diversify the blame.

Since Peter Lynch wrote about how a typical Wall St analyst would rather pick IBM than, say Microsoft, because if IBM goes down, the boss will be asking what the heck is wrong with IBM... if the analyst get clever and pick a newby upstart and it goes down... it's what the heck is wrong with you.

This being the 21st century, computer power being cheap and datasets are all over the place... there's more feathers to play the same game of "I didn't do it".


----------



## Value Hunter (4 April 2017)

Deepstate what is you view on rebalancing? If you had an equally weighted portfolio of 20 stocks and after 5 years one stock went up 100 fold (100 bagger) and dominated your portfolio what would you do?


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## craft (4 April 2017)

Value Hunter said:


> Yes Craft it is, the stock representing 25-30% of my gross assets (and a much higher chunk of my net assets is Credit Corp Group (CCP). And I am happy with it. I know you think it is a risky company but I disagree with your assessment.



Boy I hope you mean you disagree as to whether the risk is worth it rather than disagreeing that risk exists in what they do (running off bad debt ledgers and sub-prime lending), the difficulty of the assumptions that underpin the accounting and how they finance themselves.

Being tolerant to risk is one thing, being oblivious to risk is something entirely different.


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## minwa (4 April 2017)

Value Hunter said:


> I do not hold Soul Patts but I get your point and thanks for the best wishes. I will let the forum know in 5 to 7 years time how my concentrated portfolio worked out.
> 
> There is a lot of intelligent debate in this thread




Best of luck..even if nothing (hopefully) happens to that one stock, still does not make it a good risk-calculated investment. 

Same thing as not using a condom with an infected partner. Odds of contracting are still very low (but much higher than using protection) and you may get away with it, doesn't make it a good decision on a risk standpoint.


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## Quant (4 April 2017)

God there are some shocking Anecdotes in this thread


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## skc (4 April 2017)

minwa said:


> Same thing as not using a condom with an infected partner. Odds of contracting are still very low (but much higher than using protection) and you may get away with it, doesn't make it a good decision on a risk standpoint.




I've been wondering what your tag line "well-known offender" refers to.


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## DeepState (4 April 2017)

Quant said:


> God there are some shocking Anecdotes in this thread



I think the exchange has been electrifying with near religious fervour.


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## DeepState (4 April 2017)

Value Hunter said:


> Deepstate what is you view on rebalancing? If you had an equally weighted portfolio of 20 stocks and after 5 years one stock went up 100 fold (100 bagger) and dominated your portfolio what would you do?



If your view of the 20 stocks is identical in terms of future prospects, then rebalancing to the lowest portfolio risk is the best thing you can do, after taking in to account frictions and tax.  There are all sorts of variations in the specifics, but that's the idea.  It's a provable maths concept which would require really screwed up arguments to countervail.


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## Value Hunter (4 April 2017)

Yes Craft of course there are risks to the company but I think the risk is worth it. I think all of the risks that you mentioned exist and are meaningful but I think you have overestimated the probability of those risks materialising and underestimated the upside potential.


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## Value Hunter (4 April 2017)

Deepstate real life rarely works that way, who can honestly say they estimate the future prospects of all stocks in their portfolio to be equal? Lets assume that your portfolio stocks had unequal (by your own judgement) prospects and that the 100 bagger stock even after rising 100 fold had the best future prosoects ? What would you do then? Ben Graham in his Graham Newman partnership kept the outsized hlidng in GEICO and eventually spun off the holding to shareholders, many of whom continued holding it. So the type of scenario I describe does have historical precedent (the numbers were different but the essence of the scenario was the same).

We know that Buffet said (paraphrasing) selling your best company\stock because its become too important\large in your portfolio would be like a basketball team selling off or firing Michael Jordon to another team because the team had become too dependant on him.


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## craft (4 April 2017)

Value Hunter said:


> Yes Craft of course there are risks to the company but I think the risk is worth it. I think all of the risks that you mentioned exist and are meaningful but I think you have overestimated the probability of those risks materialising and underestimated the upside potential.



You' re possibly right - I do make lots of mistakes with my assumptions about the future, that's why I don't have a one stock portfolio.


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## DeepState (4 April 2017)

Value Hunter said:


> Deepstate real life rarely works that way, who can honestly say they estimate the future prospects of all stocks in their portfolio to be equal? Lets assume that your portfolio stocks had unequal (by your own judgement) prospects and that the 100 bagger stock even after rising 100 fold had the best future prosoects ? What would you do then? Ben Graham in his Graham Newman partnership kept the outsized hlidng in GEICO and eventually spun off the holding to shareholders, many of whom continued holding it. So the type of scenario I describe does have historical precedent (the numbers were different but the essence of the scenario was the same).



Then I would rebalance the portfolio in line with the future prospects as I judge them to be, taking in to account some notion of risk.  To the extent that this portfolio differs to the current one, I would consider rebalancing to the target. Rebalancing is about bringing your portfolio back in to line with objectives and prospects rather than letting the market carry it around. In general, it's a good idea.  Someone will always find a way to screw it up.


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## Value Hunter (4 April 2017)

A concrete example of diversification versus concentration by the same person is the hunter hall funds. The Hunter Hall high conviction trust launched a few years ago hit the ball out of the park with stellar performance by Peter Hall. The fund clearly showcased his ability with the fund sometimes having as few as 5 stocks and at one point (from memory) St. Barbara goldmining was more than 30% of the portfolio. You compare that to other other Hunter Hall funds which were highly diversified and had mediocre performance over the same time frame you can see how the burden of having to pick many stocks dramatically weighed down Peter Halls performance.


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## Value Hunter (4 April 2017)

Craft, maybe you make lots of mistakes with your assumptions because you own too many stocks ;-)


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## DeepState (4 April 2017)

Value Hunter said:


> A concrete example of diversification versus concentration by the same person is the hunter hall funds. The Hunter Hall high conviction trust launched a few years ago hit the ball out of the park with stellar performance by Peter Hall. The fund clearly showcased his ability with the fund sometimes having as few as 5 stocks and at one point (from memory) St. Barbara goldmining was more than 30% of the portfolio. You compare that to other other Hunter Hall funds which were highly diversified and had mediocre performance over the same time frame you can see how the burden of having to pick many stocks dramatically weighed down Peter Halls performance.



Awesome.


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## craft (4 April 2017)

Value Hunter said:


> Craft, maybe you make lots of mistakes with your assumptions because you own too many stocks ;-)



Maybe I make them because I'm just a mere mortal who can not see the future.


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## Value Hunter (4 April 2017)

Deepstate were you being sarcastic?


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## luutzu (4 April 2017)

Value Hunter said:


> Deepstate were you being sarcastic?




Dismissive.


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## Value Hunter (4 April 2017)

Deepstate here is a question for you.

Travel back in time to the 1st of December1989. Let's assume you did not know the future. Let's assume you were a Japanese investor and worker living in Japan. Let's say your work pension\retirement fund offered you a chance to invest your retirement money in option A or option B. Lets further assume you could not rebalance or alter your choices for the next 25 years nd that no money would be added or withdrawn from the funds (any dividends or capital returns would be reinvested though). Option A was a fund replicating the Nikkei 225 and option B was an equal weighted portfolio of Nestle, 3M and Coca-Cola. Which option would you have chosen? Which option was more risky?

The point I am more making is that owning more stocks is not per se less risky than owning fewer stocks. It may or may not be less risky. It depends. You have to consider a wide range of factors.


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## Quant (4 April 2017)

Got 3 key words  " Worst Case Scenario "  thats your risk  , dont make the risk ruin  ...  close the thread


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## DeepState (4 April 2017)

Value Hunter said:


> Deepstate were you being sarcastic?



Refer post #8 for the relevance of "Awesome" and Hunter Hall High Conviction. 



Value Hunter said:


> Deepstate here is a question for you.
> 
> Travel back in time to the 1st of December1989. Let's assume you did not know the future. Let's assume you were a Japanese investor and worker living in Japan. Let's say your work pension\retirement fund offered you a chance to invest your retirement money in option A or option B. Option A was a fund replicating the Nikkei 225 and option B was an equal weighted portfolio of Nestle, 3M and Coca-Cola. Which option would you have chosen? Which option was more risky?
> 
> The point I am more making is that owning more stocks is not per se less risky than owning fewer stocks. It may or may not be less risky. It depends. You have to consider a wide range of factors.




As a Japanese investor...investor...I'd actually see that the banking system was destroyed by the Plaza Accord and buying a market with a PE that can't fit on my scientific calculator screen is not a good idea.  In all likelihood, I would have held Japanese government bonds and cash plus a bunch of global stocks and bonds in some proportion that made sense to me at the time.  I would probably hold some gold as well as my confidence in the entire Japanese monetary situation would have been compromised. 

I am side-stepping your question.  Both A and B are dumb options with which to force me in to a binary decision.


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## Value Hunter (4 April 2017)

So Deepstate based on your above post we are both in agreement that diversification by itself is not necessarily sufficient to create a sensible portfolio , that many other factors come into play. 

My point is that blind diversification without proper thought is not going to magically solve everybody's problems. There are certain specific scenarios where a diversified portfolio may be riskier than an ultra concentrated portfolio. That being said I concede that on average a diversified portfolio is less risky. Are you willing to concede that in certain specific scenarios a diversified portfolio can be riskier than an ultra concentrated portfolio?


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## craft (4 April 2017)

Value Hunter said:


> Deepstate here is a question for you.
> 
> Travel back in time to the 1st of December1989. Let's assume you did not know the future. Let's assume you were a Japanese investor and worker living in Japan. Let's say your work pension\retirement fund offered you a chance to invest your retirement money in option A or option B. Lets further assume you could not rebalance or alter your choices for the next 25 years nd that no money would be added or withdrawn from the funds (any dividends or capital returns would be reinvested though). Option A was a fund replicating the Nikkei 225 and option B was an equal weighted portfolio of Nestle, 3M and Coca-Cola. Which option would you have chosen? Which option was more risky?
> 
> The point I am more making is that owning more stocks is not per se less risky than owning fewer stocks. It may or may not be less risky. It depends. You have to consider a wide range of factors.




VH

How about you flip this question for yourself but make the decision point today, throw into the mix option C) of just owning CCP.  What would you do?

Then jump in your time travel machine and travel forward 25 years and tell us how it turned out.


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## Value Hunter (4 April 2017)

Craft in the scenario you described I would choose option B with the 3 stock portfolio. I am fairly confident Credit Corp will do well over the next 5-7 years but 25 years out is too long to foresee for this type of business. I do not expect to be holding Credit Corp in 25 years time and its the type of company which does not have that sort of huge most and you have to watch carefully for any signs of detioration and be ready to sell, whereas companies like Nestle and Coca Cola and 3M you could be reasonably confident would be worth a lot more in 25 years time.  If however the question was a 5 year time horizon I would choose Credit Corp.


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## Value Hunter (4 April 2017)

To answer the second part of the question in 25 years time Credit Corp could be the biggest debt collection company in the world or it could be bankrupt. I would not be able to tell. 3M, Coca Cola and Nestle with dividends reinvested would all be nominally worth at least quadruple (probably more) what they are today and the Nikkei225 would be higher than it is today but would substantially lag the 3 stock portfolio.

The above is of course just my best guess.

I am curious Craft out of options A, B and C which one would you choose and why?


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## minwa (4 April 2017)

A 3 stock portfolio of across 2 industries that I can possibly live with, 4-5 across 4-5 industries would be much more attractive. Very different to one stock.

You are picking the next few best (in your opinion) which should only slightly under perform your best single pick (assuming your opinion turns out right and your single pick is the best performer) - tiny "sacrifice" to make for a proportional large reduction in blow out risk.


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## DeepState (4 April 2017)

Value Hunter said:


> So Deepstate based on your above post we are both in agreement that diversification by itself is not necessarily sufficient to create a sensible portfolio , that many other factors come into play.



Yes.  Was that not evident?

Did I ever say that diversification in and of itself finds a cure for cancer or would solve the Korean peninsula arms escalation issue?  All I have argued is that one and two stock portfolios require pretty special circumstances to be sensible, let alone heavily levered ones.

These situations do exist, but are very uncommon.  There is no law against it. Hang on. You can get heavily fined for it and fall into significant disrepute if you advise retirees to do it. So maybe there is a law against it.

Inadequate diversification is a problem when better options exist.  But most people, including some seemingly smart ones, would have no idea as to the cost to their wealth or investment mission from inadequate diversification in real life situations as opposed to investments so long term as not to matter in one life-time.



Value Hunter said:


> That being said I concede that on average a diversified portfolio is less risky. Are you willing to concede that in certain specific scenarios a diversified portfolio can be riskier than an ultra concentrated portfolio?




I am willing to concede that I made this statement several posts ago to that effect.



DeepState said:


> Stock numbers per se are just the most obvious way of talking about diversification, but it is a proxy for some concept of effective diversification.  What is wanted is maximum reward for risk and an appropriate deployment of risk.




What matters is risk adjusted return.  Simply put, if you take more risk than you need to for a given view of the world, that's just plain dumb. I'm not going in to the concept of effective diversification any further than to say it is actually the target matter on the risk side of risk-adjusted return (which, for the pedantic, includes a utility function that can be as bizzare and multi-universal as you like so long as someone actually doesn't like losing money in general), as opposed to some magic stock count that solves the world's problems.


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## craft (4 April 2017)

Value Hunter said:


> The above is of course just my best guess.




Awsome



Value Hunter said:


> I am curious Craft out of options A, B and C which one would you choose and why?




None - I hoped by referring the question back to you, you might perceive some things about the futility of hindsight and prediction.


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## Value Hunter (4 April 2017)

DeepState said:


> What matters is risk adjusted return. Simply put, if you take more risk than you need to for a given view of the world, that's just plain dumb. I'm not going in to the concept of effective diversification any further than to say it is actually the target matter on the risk side of risk-adjusted return (which, for the pedantic, includes a utility function that can be as bizzare and multi-universal as you like so long as someone actually doesn't like losing money in general), as opposed to some magic stock count that solves the world's problems.




How do you quantify risk or risk adjusted returns for a simpleton fundamental long only investor? You keep discussing in a way that gives an impression that its some mathematically quantifiable thing that you just plug into a formula. Please break it down with a concrete example in a way that a simpleton like me can understand. To me is risk analysis is a judgement call that combines quantitative and qualitative factors and there is no formulaic or mathematical way of calculating risk.

For example I use my own analysis and judgement, coupled with reference to history, etc to decide how many stocks to own, how much to invest in each, holding period, use of leverage, etc and have no rigid rules. How do you decide how many investments to own, how risky they are, how long to hold, and how much to invest in each? Please provide a concrete hypothetical example explained in a dumbed down way so I can understand.


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## Value Hunter (4 April 2017)

Craft, anytime anybody invests in anything including cash we are making predictions about the future whether implicit or explicit so for you to imply that prediction is futile seems strange. Craft when you pick individual stocks as we all know you do you are implicitly predicting that over the long run the sum total of your picks will outperform the market (if you did not believe this you would have put all of your money in index funds). Or am I misunderstanding you?


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## DeepState (4 April 2017)

Value Hunter said:


> How do you decide how many investments to own, how risky they are, how long to hold, and how much to invest in each? Please provide a concrete hypothetical example explained in a dumbed down way so I can understand.




How do I decide?  It is the outcome of a quadratic optimisation which takes my views about the expected returns on assets or clusters of assets and builds portfolios subject to tracking error or total volatility limits.  These volatility estimates are estimated generally via principal components analysis, and either GARCH processed or Bayesian shrunk to a diagonal matrix, after front weighting, depending on the purpose.  The reasonableness of this is tested against the implied volatility of the market itself and my knowledge of events that might make this inaccurate.  Then, there are hard limits put in to place to prevent corner solutions from dominating outcomes.  These hard limits are often aware of what the stock or the cluster of assets actually does for a living. Where the return outcomes are still subject to strong tail events, I hedge or insure them in some way.  When all of this is done, the stock number and portfolio composition pops out and I put it in to the market.

I own lots of different things, not just stocks.  I would represent the other extreme on the issue of portfolio diversification, but what I do is not normally found outside of multi-strat hedge funds which makes it uncommon from the outset.  I have certain skills and this is how I apply them.

Although I use lots of maths, I also take the radical step of....actually checking if the output makes any sense. Why might the training window not be reasonably representative of the forecast window?

In general, my thinking is strongly influenced by risk parity and risk budgeting concepts, though adapted for my circumstances.

At present, I have no idea about how to explain this simply and don't feel particularly motivated right this minute.  Howard has some ideas for estimating risk for single assets or, otherwise, strategies for trading them.  Perhaps that's a good place to start.


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## craft (4 April 2017)

Value Hunter said:


> Craft when you pick individual stocks as we all know you do you are implicitly predicting that over the long run the sum total of your picks will outperform the market



 When I pick individual stocks I'm trying to beat the market and I monitor and manage how I'm going. But I'm not predicting I will beat it, just giving myself a chance and because I want to do it over the long term I'm not willing to take chances that could kill me financially.

There's no getting around the fact that I need a story about the future to compare reality against as it unfolds - you can't manage if you don't know what your expectations are. But my story's about the future are just bullsh!t fiction based on my judgements from past and present observations- not predictions.

To confuse bullsh!t fiction with predictive ability could lead to excessive risk taking.


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## Value Hunter (4 April 2017)

Deepstate your last post completely went over my head too much jargon and maths for a simpleton like me. Craft you are just trying to rationalize your predictions.


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## craft (4 April 2017)

Value Hunter said:


> Craft you are just trying to rationalize your predictions.



Perhaps, or maybe it's a subtlety that makes all the difference. You may never know.


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## Ves (5 April 2017)

craft said:


> There's no getting around the fact that I need a story about the future to compare reality against as it unfolds - you can't manage if you don't know what your expectations are. But my story's about the future are just bullsh!t fiction based on my judgements from past and present observations- not predictions.
> 
> To confuse bullsh!t fiction with predictive ability could lead to excessive risk taking.



It's a hard realisation to make.

But I think once you've made it,  it's even harder to continue doing what you've been doing.  I know in my case it made me step back from stock-picking a lot.


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## craft (5 April 2017)

Ves said:


> It's a hard realisation to make.
> 
> But I think once you've made it,  it's even harder to continue doing what you've been doing.  I know in my case it made me step back from stock-picking a lot.



Worked the opposite for me. More inclined to go with my best judgement and manage my mis-judged stories out then baulk because I don't feel I have perfect foresight. Sift the gravel out and you get left with the gems.


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## Value Hunter (29 May 2017)

I would like to hear from those who switched strategies from having a diversified portfolio to being concentrated or vice versa. I used to be more diversified when I first started but became more concentrated over time. My returns improved after I became more concentrated.


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## Value Hunter (31 May 2017)

By the way I would be interested to hear from people like Craft and Deepstate, and other respected investors on the forum, hypothetically speaking over the past 5 years would your performance have been substantially better if you had evenly split your capital into your top 3 investments/ideas (top 3 by position size) and eliminated all other positions?


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## Klogg (31 May 2017)

Value Hunter said:


> By the way I would be interested to hear from people like Craft and Deepstate, and other respected investors on the forum, hypothetically speaking over the past 5 years would your performance have been substantially better if you had evenly split your capital into your top 3 investments/ideas (top 3 by position size) and eliminated all other positions?




I wouldn't consider myself a respected investor, as I don't have the years of experience required to show a long-term annualised result. Nevertheless, I'll throw my 2cents in to add to the conversation.


One of my biggest mistakes happened to be one of my largest positions as well. So if split my capital evenly between the three, my record would be horrible.
The more I look at it, the more I find I can't deal (emotionally) with the volatility of a very concentrated portfolio. I have typically held about 8 companies, with position sizes varying from 5% to 18%, and some cash holding.

As an example of the emotional hit, my largest holding basically halved in price (it wasn't my largest holding when purchased. But it did increase by 100% in a year, then subsequently moved back to the purchase price).

All of this of course, relates to returns and volatility. To put it into perspective, my dollar weighted average return has dropped into the high teens, from what was roughly 30%. The problem with my metric of course, is that the first two years of running my portfolio had a capital amount of ~5-10% of current size... So recent gains/losses are overstated, and it should be framed using a time-weighted calculation. Using this, I get about 17% p.a. (as of last night)

Since looking at it in this light, I have decided to increase the number of companies, with an end goal of 12-15, although that may prove to be a little too rigid. I'd also like to be close to fully invested, provided I can find companies that meet the hurdle rate I set.
There would also be some availability bias in this, as I've underperformed a few indexes over the last 6 months. I'm sure if you asked me this question a year ago, my answer would have been slightly different. Not a good thing, and I need to ensure I enforce these rules, whatever the decision.


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## Value Hunter (31 May 2017)

Klogg I dare say your portfolio has not been running for long enough to form a conclusion (on how concentrated you should be) either way.


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## craft (31 May 2017)

Value Hunter said:


> By the way I would be interested to hear from people like Craft and Deepstate, and other respected investors on the forum, hypothetically speaking over the past 5 years would your performance have been substantially better if you had evenly split your capital into your top 3 investments/ideas (top 3 by position size) and eliminated all other positions?



No.

Using hindsight to identify the actual three top performers and then saying what if I had only invested in those three - well then mathematically of course the answer has to be yes - but I can't pick stocks in hindsight. Prospectively I would have probably picked the wrong three - I can't know for sure which ones I would have picked because I am now biased by knowing what has actually unfolded - But if picking only three I seriously doubt I would have picked my best three.

My game is not picking the few best - I don't have those prescient abilities. My game is risk management through position sizing and managing my mistakes out - the best take care of themselves and eventually overwhelm my incompetence. 

My best three over 5 years taken as a snapshot last year is different to the best three for the last 5 years and I'm sure the best three over 5 years when viewed from next year's perspective will be different again - so really, what's the use of your question?


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## Value Hunter (31 May 2017)

Craft. The use of my question is for investors to contemplate by reviewing their portfolios if they had a more concentrated portfolio would they have achieved higher returns? In your case your answer appears to be that you are not sure.


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## craft (31 May 2017)

Value Hunter said:


> Craft. The use of my question is for investors to contemplate by reviewing their portfolios if they had a more concentrated portfolio would they have achieved higher returns? In your case your answer appears to be that you are not sure.






craft said:


> No.





I'm sure!!!!!


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## minwa (31 May 2017)

Value Hunter said:


> Craft. The use of my question is for investors to contemplate by *reviewing* their portfolios if they had a more concentrated portfolio would they have achieved higher returns? In your case your answer appears to be that you are not sure.




Reviewing as in hindsight picking the better performers ? Then of course higher absolute return will be achieved by concentration. It's hard to go back now after seeing the performance to say which you would've picked as the best performer without bias.

Return on volatility/risk which is more important for most managers will be a different story.


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## skc (31 May 2017)

Value Hunter said:


> hypothetically speaking over the past 5 years would your performance have been substantially better if you had evenly split your capital into your *top 3 investments/ideas (top 3 by position size) *and eliminated all other positions?






craft said:


> Using hindsight to identify the *actual three top performers *and then saying what if I had only invested in those three - well then mathematically of course the answer has to be yes - but I can't pick stocks in hindsight.




Craft I think you mis-read Value Hunter's question. 

He is talking about top 3 investment ideas, as measured by position size at the time of buying, for those investors who have different position sizes for different stocks (depending on risks, level of conviction etc).

Not the top 3 performers some time in the future.


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## Klogg (31 May 2017)

Value Hunter said:


> Klogg I dare say your portfolio has not been running for long enough to form a conclusion (on how concentrated you should be) either way.




FWIW it has been running for 5.5years. To determine my emotional response to volatility, I don't necessarily need 10 years. Even three months of volatility is sufficient for that.

As for long term track records, anything under 10 is insufficient, but each to their own


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## craft (31 May 2017)

skc said:


> Craft I think you mis-read Value Hunter's question.
> 
> He is talking about top 3 investment ideas, as measured by position size at the time of buying, for those investors who have different position sizes for different stocks (depending on risks, level of conviction etc).
> 
> Not the top 3 performers some time in the future.



I can't answer it then because I don't position size on strength of idea. I have upper and lower limits for exposure at cost, where things finish up sitting between those two number is driven more by ongoing portfolio management, personal liquidity and stock availablity at desired price etc.


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## craft (31 May 2017)

skc said:


> Craft I think you mis-read Value Hunter's question.
> 
> He is talking about top 3 investment ideas, as measured by position size at the time of buying, for those investors who have different position sizes for different stocks (depending on risks, level of conviction etc).
> 
> Not the top 3 performers some time in the future.



Had a look at what my actual three highest positions at cost was 5 years ago. Answer still is a big No.


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## Value Hunter (1 June 2017)

Yes, skc that is exactly what I meant, thank you for clarifying that.

On that basis where do you stand skc? Would you have done better?


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## skc (1 June 2017)

Value Hunter said:


> Yes, skc that is exactly what I meant, thank you for clarifying that.
> 
> On that basis where do you stand skc? Would you have done better?




No. I don't really adopt vastly different position sizes based on level of conviction. I have 2 broad groups of positions... core and speculative. The speculative ones are like boom or bust type plays... e.g. a PDN which is probably technically insolvent but may have some strategic value. The core ones are the companies that I intend to hold across longer timeframes. If one core position is bigger than another that is purely due to issues like liquidity / order entry etc.


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## peter2 (1 June 2017)

My portfolios are built by accumulating trades that all start with the same amount of risk (eg 1% of available capital).  This creates portfolios with approx 12 stocks when fully invested. Starting with a lower amount of risk (eg 0.7%) creates portfolios with more stocks (upto 16).

To create a portfolio with less stocks in it would mean increasing the initial risk (eg 1.5% or 2%). This would create a portfolio with only 6 - 8 stocks. Reducing the number of stocks further would mean increasing the initial trade risk even more (eg 3% - 4%). I wouldn't be comfortable with this amount of risk (downside exposure) in any one stock (in case of disappointing news). However I could do this using one or more market ETF's.

The question I'm pondering is, would a portfolio with a core ETF position (30-40%) and a lower number of trades (6-8 risking 1%ea) produce the benchmark out performance (higher returns/lower DDs) that I now enjoy.

A strategy that collects winning trades while culling the losers may end up with many stocks but as they're mostly winners does it matter how many there are? It's also more likely to get into a good trade that increases much faster than the index when we start trades in many stocks rather than a few.


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## systematic (1 June 2017)

It's fun to see we're all different.  I'm equal weight with position sizing (due to being agnostic about each selection relative to any other).  I'm also just starting to consider increasing number of positions in the portfolio as I'm not sure I want to continue being as concentrated as I have been thus far.  Doesn't change the philosophy of the plan, just a minor rule change.


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## rb250660 (1 June 2017)

I run 5 portfolios each with 5 positions giving a total of 25 slots. Volatility can be quite high in each portfolio but collectively its been very smooth.

I have only been running this set up for 12 weeks now but things are going well. One of the models I have been trading for years, the other 4 are new.


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## minwa (1 June 2017)

rb250660 said:


> collectively its been very smooth.




Long term sanity this is the way to go.


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## galumay (1 June 2017)

systematic said:


> It's fun to see we're all different.




Indeed! Although I have some in common with you, I too dont have different position sizes - other than a couple of speccy plays that I did allocate much less capital to. I am less concentrated than I now like, I have learnt a lot over the last few years and knowing what I know now I would hold a bigger position in less companies, with more conviction.

I am probably quite different to many as liquidity and volatility are not things I worry about and I dont subscribe to the view that risk can be mathematically and quantifiably assessed. 

My personal portfolio has 13 companies currently held and the SMSF has 23.


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## Triathlete (11 June 2017)

howardbandy said:


> For everyone, please pay attention to the increasing ability of machine learning / artificial intelligence techniques. They have already surpassed humans in almost all fields. *They are already being used by the largest trading houses. Systems based on subjective judgement of individuals, particularly individuals without extensive expertise, will have a hard time competing*.




Are you able to give us some feedback as to what type of returns are possible over yearly periods based on your own results / experience / etc  based on machine learning / artificial intelligence techniques.

Also the amount of trade signals that is usually given to trade over the same yearly period.

Thanks in advance....


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## howardbandy (11 June 2017)

Triathlete said:


> Are you able to give us some feedback as to what type of returns are possible over yearly periods based on your own results / experience / etc  based on machine learning / artificial intelligence techniques.
> 
> Also the amount of trade signals that is usually given to trade over the same yearly period.
> 
> Thanks in advance....




Greetings --

Machine learning based trading systems, such as those developed using python and scikit-learn, differ from traditional trading systems, such as those developed using AmiBroker or TradeStation, in several important ways.
1.  Traditional systems almost always use a model based on decision trees.  Machine learning allows use of any of several models, including decision trees, support vectors, various regressions, neural networks, boosting, ensembles, and others.  Individual decision tree models are easily overfit, leading to poor out-of-sample performance.  When several alternative model techniques are applied to a trading system, individual decision trees are seldom the best performers.
2.  Traditional systems typically use impulse signals (buy and sell that each occur on a single bar and indicate the beginning and end of a trade), while machine learning systems always use state signals (which have a state -- beLong, beShort, or beFlat for the next bar -- for each bar).  Traditional systems can be written so that they use state signals, a technique I recommend even if you do not plan to use machine learning.  Holding period for a trade defined by buy and sell is the number of bars between the buy and sell.  Holding period for a trade defined by states is the number of consecutive states that are the same.  Using state signals requires computation of the next signal for each bar, and encourages daily mark-to-market accounting. 
3.  Traditional systems are based on "compute an indicator, then see what happened after," while machine learning systems are based on "identify a desirable trade, then see what happened earlier."   

I recommend developing separate models for each issue traded.  For a given issue, first develop a model that trades long/flat.  If that works (passes validation), then try to develop a second model that trades that same issue short/flat.  

Pay attention to risk.  Risk analysis applies whether machine learning or traditional development.

Begin with your personal risk tolerance, then measure the risk-normalized profit potential of whatever system you are thinking about trading.  Keep position sizing out of the trading system model -- it belongs in the trading management model.  

I recommend using an objective function that first calculates maximum safe position size based on recent trades (call it safe-f), then estimates the compound annual rate of return (call it CAR25) of that system on that risk-normalized basis.  When risk-normalized, the single best use of funds is the system with the highest CAR25.  Using some of the available funds to trade any other system is sub-optimal use of those funds.

If you want to trade more than a single issue, develop several systems, each trading a single issue, and trade the one that is currently best.  Rotate systems according to recent performance.  

Be wary of creating portfolios of multiple issues, as these are extremely difficult to validate.

The number of signals depends on how the developer (the person) defines the system.  

The sweet spot for a given system is always:
A.  Trade accurately,
B.  Trade frequently,
C.  Hold a short period of time.
D.  Avoid serious losses.

Accuracy should be at least 65%.  Holding period one or two days.  Fifty or so trades per year.  What defines a serious loss depends on your risk tolerance, but the more losing trades and the worse the losing trades, the lower the safe position size and the lower the profit potential.  Prefer to pass potentially winning trades in order to avoid losing trades.

There is a learning curve.

Best regards,  Howard


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## Value Hunter (31 July 2017)

The link below is from a Q&A session with Charlie Munger.

http://www.vgipartners.com/wp-content/uploads/2017/03/February-2017.pdf

If you read pages 13 and 14 Charlie recommends that investors who know what they are doing do not need to own more then 3 stocks.


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## Triathlete (11 June 2018)

DeepState said:


> If the outcomes just aren't material to you, as previously mentioned, then who cares - the alternatives basically merge. *But if they are then it takes a special idea of what constitutes best to suggest a 2 stock portfolio is a responsible way forward for the prior assets*. I suspect that T/As account really doesn't matter that much for him. In which case, do whatever makes you happy...just don't take it as useful general advice for those who's situation requires more careful consideration.




Sometimes having a 1 or 2 stock portfolio is justified if you are using it to trade effectively. The idea is that the cash flow generated from concentrating on this type of portfolio can then be used to build a medium to longer term portfolio if required.....

Currently I trade 1 stock in the ASX 50 using CFDs and have been able to increase the starting capital base 100% in 4 months by trading in and out.

Trading portfolio currently stands at:
15 trades all short trades
11 closed
4 open
win/loss...100%.... previous years 80%-86%
R:R.... 3.6:1

My previous years were also successful trading this way to generate cash flow.

However I will make the point that I only use 10% of my assets to leverage for this type of trading I find I have more focus this way without having to worry about a  larger trading portfolio.


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## JuniorR (11 June 2018)

Triathlete you trade once a week?
Do you trade a specific day &  time in that week?


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## tech/a (11 June 2018)

Short term?

DAX Futures
Periodic when an opportunity arises.

Smaller caps 
Periodic also 
Most weeks it depends on filters 
And on scans along with number of open trades.
Exposure


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## systematic (11 June 2018)

It’s such a case of, ‘it depends’ that I don’t think you can give anyone a concrete rule. It depends what a trader is doing, and indeed what their goals are. 

A systematic or ‘quant’ style takes a basket approach to stocks, relying on averages. By its nature, Munger’s comment doesn’t apply. A quant has no business being a stock picker. I’ve made comments in other threads in the past such as, ‘I’m just not that good.’ A systematic investor is like someone who casts a net in a proven area and overall, it works out to a decent catch. A stock picker is like a fishermen relying on their own special skill, fishing where others aren’t and catching something amazing (can you tell from my poor analogy I’m not a fisherman?). 
If it works out you’ll be king of the world. But I’d suggest it doesn’t go that way for many. 

That’s one of the core philosophies of a systematic approach, in my opinion. It’s saying you’re not a special fisherman and you need a net. 

Just some extra food for thought. And that’s from someone who has struggled with this aspect of systematic trading.


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## Triathlete (11 June 2018)

JuniorR said:


> Triathlete you trade once a week?
> Do you trade a specific day &  time in that week?




I am a Discretionary short term trader using CFD's

No specific day or time.....

I use charts to tell me when is the best time to trade....

I look for specific patterns such as Head and Shoulders ,Elliot wave theory and Timing cycles.....once I can see this clearly it gives me a few things such as:

I know based on the expectation of the "said theory" how far a stock price is likely to move too.....if I know this I can take calculated trades until the stock reaches those prices or until the market tells me I am wrong.

I do not care which stock I trade as long as it is in the top ASX 50 as with using leverage I want to make sure I can get out in a hurry.....

I only require one stock with enough movement (volatility) in a week to make money using this strategy.

I only require to know that the price is going up or down and how far the move is likely because I am only using this *"calculated high risk trading strategy for cash flow only".......This strategy is not for beginners...
*
The money that is made over the year ( hopefully if successful) so far so good over previous years..... will then be split by putting into a medium/longer term portfolio, real estate, bonds and some to increase the trading portfolio going into the next years trading which in turn increases the amount of trading capital using leverage......


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## tech/a (11 June 2018)

The filter switches the method I use on and off.

Allowing long new trades to be taken or allowing open trades to run without new trades being taken, or standing aside. It’s part of the systematic approach.

Fishing in a big sea. All thrown back some quicker than others some with my bait.
Some are missed,the ones I keep aren’t known until on my hook. My net is cast in only the volatile seas best suited to my fishing.

DAX is purely discretionary. It can be often only held for a few minutes when smashing long or short.Once or twice a week I get on one. It takes patience and in the first 2 hrs.


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## Triathlete (11 June 2018)

tech/a said:


> The filter switches the method I use on and off.
> 
> Allowing long new trades to be taken or allowing open trades to run without new trades being taken, or standing aside. It’s part of the systematic approach.
> 
> DAX is purely discretionary.




How many trades does the system allow at any time???


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## tech/a (11 June 2018)

It allows a % at risk—- 20
But that could see a few trades with 2 and three positions.
Rarely more than 5


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## Triathlete (12 June 2018)

systematic said:


> It’s such a case of, ‘it depends’ that I don’t think you can give anyone a concrete rule. *It depends what a trader is doing, and indeed what their goals are*.




+1


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## Triathlete (16 June 2018)

Value Hunter said:


> "for small funds and individuals I think concentration is the answer"




+1


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## Triathlete (16 June 2018)

Value Hunter said:


> Deep state my essential issue is against the middle ground which is the worst of both worlds. If an investor lacks skill and wants to own index funds that is a prudent decision. If an investor has skill and wants to own 5 individual stocks that is all well and good also. *What I disagree with (unless its a mechanical approach) is a fund manager or individual that owns a diversified portfolio with no more than say10% in any single holding and owns say 20-30 stocks. This person should either throw in the towel and buy index funds or trim their portfolio to a maximum of say 4-8 positions*. Now I understand some fund managers have too much money too manage and due to size constraints must diversify, *but for small funds and individuals I think concentration is the answer.*




+1


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## tech/a (16 June 2018)

tech/a said:


> It allows a % at risk—- 20
> But that could see a few trades with 2 and three positions.
> Rarely more than 5




Just to clarify

Rarely more than 5 *stocks held*

Agree V/H + 1


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## So_Cynical (16 June 2018)

Some interesting discussion in this thread, i have recently come to realise that the size of my portfolio is an important factor in its success, i enter new stocks on a rough equal position size ($) basis and have done since day one, the goal was to build a dividend stream via a mix of dividend and growth stocks, buy low sell higher but retain some shares in each div stock and move on.

The Portfolio currently has almost 40 stocks with 4 stocks out performing thus lifting the portfolio return out of the ordinary, take the 4 best performers out and im not doing so well, i have to admit that the big 4 are somewhat random successes, i didn't know at the time of entry i just bought them because i had enough money for a new stock and saw some cheapness and potential.

I have noticed over the years that the top performers in my Portfolio keep changing and surprising, i dont know what the next big thing is so i just keep doing what i have been doing for the last 11 years because it works, one in ten will be a superstar out performer, money management is important.

I add 4 or 5 stocks per year to the portfolio and sell out of 1 or 2 and thats how i ended up with near 40, i should probably trim down to 30 or so, have started to re-balance over the last 2 years so the average position size has grown by maybe 15 or 20%, i have achieved a couple of size milestones this year, its been a hell of a journey.
~


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## Triathlete (16 June 2018)

So_Cynical said:


> Some interesting discussion in this thread, i have recently come to realise that the size of my portfolio is an important factor in its success, i enter new stocks on a rough equal position size ($) basis and have done since day one, the goal was to build a dividend stream via a mix of dividend and growth stocks, buy low sell higher but retain some shares in each div stock and move on.




If it works for you and are happy and comfortable with your strategy keep doing the same..



So_Cynical said:


> The Portfolio currently has almost 40 stocks *with 4 stocks out performing thus lifting the portfolio return out of the ordinary, take the 4 best performers out and im not doing so well*, i have to admit that the big 4 are somewhat random successes, i didn't know at the time of entry i just bought them because i had enough money for a new stock and saw some cheapness and potential.




This is what I was trying to get out....If these 4 stocks were say in the top 50 I would not have had a problem of increasing the position size with some that may not have been seeing any growth.....I know it would be too much for me to stay on top of a portfolio of that many 30-40.....My focus has always been to get rid of any stocks that are going nowhere, usually with a large number of stocks in a portfolio a third might be going up a third might be going sideways and a third would be going down.....

[URL="https://www.aussiestockforums.com/posts/949609/"]The Contents of a Bar[/URL]



So_Cynical said:


> I have noticed over the years that the top performers in my Portfolio keep changing and surprising, i dont know what the next big thing is so i just keep doing what i have been doing for the last 11 years because it works, one in ten will be a superstar out performer, money management is important.




As long as you are happy with your returns that is all that matters.....



So_Cynical said:


> I add 4 or 5 stocks per year to the portfolio and sell out of 1 or 2 and thats how i ended up with near 40, i should probably trim down to 30 or so, have started to re-balance over the last 2 years so the average position size has grown by maybe 15 or 20%, i have achieved a couple of size milestones this year, its been a hell of a journey.




How do you stay on top of 40 stocks.....do you use any type of service or do you do all the research yourself..???


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## bngood (9 July 2018)

Some thoughts...

You don’t have to pick the best performing shares on the ASX for a small number of shares to outperform a diverse portfolio.  You can start with 5 or so and weed out the non performers.

Years ago there was a guy on one of the forums who traded for a living and only traded BHP.  He did really well.  You don’t have to choose a megastar performer to make this work. If you choose pretty well and trade well you will make money.

The good thing about trading a small number of instruments is that you can learn the personality of the instrument.  Well, the personality of the holders and traders of that instrument. You can predict how they will respond to certain price moves or indicators. This can work really well.  

I don’t agree with Quant who said (on 28 March 17) that no one with a successful strategy would give it away.  Just look at fib retracement lines and how well they work on some shares.  They work because lots of people are using that strategy.  I think the more people using a strategy the more it will work.


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