Risk Reduction Strategy - Why I Will Not Copy Traders With Big Gains and Risks - Applying Graham: Chapter 1
There is a lot of wisdom about value investing in the book „The
Intelligent Investor“ by Benjamin Graham. The first chapter of this book explains the difference between a speculator and
an investor. An investment operation is one which, upon thorough
analysis, promises safety of principal and an adequate return.
Investing consists of three elements:
The current portfolio is inspired by the trading strategies of this book. Therefore I decided to apply a risk reduction strategy on the portfolio. This risk reduction strategy includes the following actions of the last weeks.
Keep in mind that once you lose 95% of your money you have to gain 1,900% to get back to where you started. To further explain what that means we show a practical example with slightly modified data (to ensure to keep the data anonymous) from a popular investor with thousands of copiers on Etoro.
In the year 2015 we start our simulation with 10000$.
03/2015: 5,01% 10501
04/2015: -24,02% 7978,66
05/2015: -1,30% 7874,94
06/2015: -3,63% 7589,08
07/2015: 1,80% 7725,68
08/2015: -8,55% 7065,13
09/2015: -0,55% 7026,28
10/2015: 6,15% 7458,39
11/2015: 35,10% 10076,29
12/2015: 4,22% 10501,51
Annual Result in 2015: 5,015%
You can clearly see that the trader needed a gain of 35,10% to get back to where he started because he lost 24,02%. Also there was no crash in the stock market or crisis in 2015 to explain the huge loss. We therefore assume that this trader was involved e.g. in a lot of speculation with high leverages. With such a portfolio you had only 3 months where you could get your money back while there were 7 months where you could only get out of this portfolio with losses of your capital. When there is a stock market crisis of cause we would expect something like this to happen but in 2015 everything was ok on the overall stock markets.
The book of Graham tells us that operating on margin is speculating not investing. In my view and as I understood that book this is primarily because you risk a total loss of your capital when the stop loss is triggered so you cannot build up your wealth continuously this way.
This portfolio will therefore not include any copies of popular investors with a trading history that looks like the shown example. The transition to unleveraged stock investments will continue into the long term future of this portfolio minimizing further risks involved.
Graham also introduces two types of investors. The defensive investor avoids losses and wants to achieve freedom of effort as well as avoid the need to make frequent decisions. The enterprising investor (active, aggressive) who devotes time and care in selection of stocks and invests quite a lot of time and effort into his more frequent decisions.
Some active speculation was done in the beginning of this portfolio but this portfolio will become more of a defensive investor portfolio for the long term future. The speculation was primarily done to get the 5% back that you loose net worth when transferring money from and to Etoro (2 x 250pips on the EUR/USD rate). After the SegWit2x fork event of Bitcoin there will be a decision on Bitcoin and further Bitcoin speculation when there is more insight on the Bitcoin's future technology.
- You must thoroughly analyze a company, and the soundness of its underlying businesses, before you buy its stock
- You must deliberately protect yourself against serious losses
- You must aspire to adequate, not extraordinary performance
The current portfolio is inspired by the trading strategies of this book. Therefore I decided to apply a risk reduction strategy on the portfolio. This risk reduction strategy includes the following actions of the last weeks.
- Changed the goals for this portfolio from a monthly 6% performance to an annual 15-20% performance.
- Transition from leveraged investments to unleveraged investments for the S & P 500 index and KHC stocks (also saves the financing costs).
- Profit taking of the Bitcoin speculation before SegWit2x
- No hedging activities with high leveraged CFDs on the EUR/USD forex markets in the future (like they were done in the past) although there is a lot of risk involved as currently all investments are in USD in our portfolio.
Keep in mind that once you lose 95% of your money you have to gain 1,900% to get back to where you started. To further explain what that means we show a practical example with slightly modified data (to ensure to keep the data anonymous) from a popular investor with thousands of copiers on Etoro.
In the year 2015 we start our simulation with 10000$.
03/2015: 5,01% 10501
04/2015: -24,02% 7978,66
05/2015: -1,30% 7874,94
06/2015: -3,63% 7589,08
07/2015: 1,80% 7725,68
08/2015: -8,55% 7065,13
09/2015: -0,55% 7026,28
10/2015: 6,15% 7458,39
11/2015: 35,10% 10076,29
12/2015: 4,22% 10501,51
Annual Result in 2015: 5,015%
You can clearly see that the trader needed a gain of 35,10% to get back to where he started because he lost 24,02%. Also there was no crash in the stock market or crisis in 2015 to explain the huge loss. We therefore assume that this trader was involved e.g. in a lot of speculation with high leverages. With such a portfolio you had only 3 months where you could get your money back while there were 7 months where you could only get out of this portfolio with losses of your capital. When there is a stock market crisis of cause we would expect something like this to happen but in 2015 everything was ok on the overall stock markets.
The book of Graham tells us that operating on margin is speculating not investing. In my view and as I understood that book this is primarily because you risk a total loss of your capital when the stop loss is triggered so you cannot build up your wealth continuously this way.
This portfolio will therefore not include any copies of popular investors with a trading history that looks like the shown example. The transition to unleveraged stock investments will continue into the long term future of this portfolio minimizing further risks involved.
Graham also introduces two types of investors. The defensive investor avoids losses and wants to achieve freedom of effort as well as avoid the need to make frequent decisions. The enterprising investor (active, aggressive) who devotes time and care in selection of stocks and invests quite a lot of time and effort into his more frequent decisions.
Some active speculation was done in the beginning of this portfolio but this portfolio will become more of a defensive investor portfolio for the long term future. The speculation was primarily done to get the 5% back that you loose net worth when transferring money from and to Etoro (2 x 250pips on the EUR/USD rate). After the SegWit2x fork event of Bitcoin there will be a decision on Bitcoin and further Bitcoin speculation when there is more insight on the Bitcoin's future technology.
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