What has your hit and miss ratio been?

[DeepState]

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

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



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

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

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

Brty...

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

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

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

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

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

Keep pushing back...

 

[DeepState]

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

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

Dear Bill M

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

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

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

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

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

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

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

Very best wishes to you, sir.


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

 

[DeepState]

I would be interested in your view of averaging down.

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

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

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

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

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

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

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

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

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

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

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

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

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

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


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

 

[burglar]

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

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


It is a most entertaining post.



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

 

[So_Cynical]

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

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

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

-----------

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

 

[burglar]

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

Hi S_C,

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

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

 

[So_Cynical]

Hi S_C,

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

Hey burglar

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

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

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

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

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

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

Conclusions and lessons learnt:

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

 

[sydboy007]

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

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

SGN I sold out near their peak

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

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

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

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

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

 

[DeepState]

1. Now introduce a big loser into your portfolio and your rebalancing exercise turns into a disaster as your constantly taking money from your winners and throwing it at your one big loser.


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

Hi So_Cynical...

Thanks for your post.

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

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

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

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

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

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

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

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

140 trades
Hit Rate 83%
Expectancy 56.24

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

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

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

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

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



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

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

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

Good trading to you.

 

[muir]

Hi guys,

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

Cheers

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

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

Here's what I mean.

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

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

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

Your question never even enters my mind.

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

 

[brty]

Retired Young,

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

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

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

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

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

 

[DeepState]

Retired Young,

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

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

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

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

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

Hi Brty

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

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

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

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

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

Nice to meet you Brty.

 

[DeepState]

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

Brty

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

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

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

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

 

[Ves]

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

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

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

 

[DeepState]

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

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

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

His Ves, nice to hear from you.

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

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

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

The purest theory of rebal goes like this...

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

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

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

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

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

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

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

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

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

 

[Ves]

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

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

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

 

[DeepState]

.

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

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

BTW what's "thought worry"?

 

[Ves]

BTW what's "thought worry"?

It's a typo. Edited.

 

[brty]

Hi RY,

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

From RY....

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

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

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

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

 

[damdin]

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

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

....

Your question never even enters my mind.

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

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

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