Risk Management 02 (Aug 15 - Dec 25)

[winston]

The Most Reliable Way to Reduce Risk in Your Portfolio By Dan Ferris

This is my favorite way to reduce risk...

It's an asset that isn't priced in a large, liquid market. There aren't millions of people trading its option value back and forth millions of times a day. It has no expiration date. And you aren't locked into buying or selling at a particular time.

It's a "call option" on any asset you like, with no pricing constraints, and no erosion of value over time.

The option I'm talking about is cash.

And in today's essay, I'll show you why holding it is the easiest way to eliminate three types of risk in your portfolio...

You don't have to time markets to have plenty of cash on hand at the right moment. You just value equities...

In Extreme Value, when our bottom-up, one-at-a-time research approach fails to turn up a new bargain, we're effectively saying investments are too expensive and there's little value to be found in the market. In that kind of environment, holding cash is more desirable than spending it on expensive stocks that may have limited upside potential left.

Cash is what you stick with when you can't find a great idea.

It avoids the two risks we care about most and the one we don't care about much at all, but which most investors are obsessed with...

One of the benefits of holding cash is the lack of market risk.

The risk most investors are focused on is market risk, the risk that their stocks and bonds will be quoted at lower prices, reducing the value of their accounts. That's a rational fear for most investors, who are prone to selling out for big losses at market bottoms in a panic.

You'll never see your $1 of cash quoted at any price but $1.

For investors buying stocks in the U.S. with U.S. dollars, small fluctuations in the value of the dollar relative to other currencies won't make much difference and won't damage the option value of cash. Finding great ideas should cancel out the effects of inflation.

During the financial crisis, money market accounts were quoted below $1, but that's because they weren't holding cash in its purest form. They were holding derivatives that proved illiquid and volatile during a financial calamity.

I remember contacting brokers back then and telling them not to sweep my cash into a money market account, as is the standard practice at most brokerage firms every night.

A second benefit of holding cash is the lack of valuation risk.

Valuation risk is the risk of paying more than the asset's true value.

Most people who buy stocks today are likely exposing themselves to valuation risk. Facebook, for example, is a popular name that generates plenty of free cash flow, $4.4 billion of it over the last four quarters. But its market cap is $289.5 billion, 66 times free cash flow. It's hard to believe Facebook is worth that.

I'm willing to bet there's more valuation risk there than most investors currently believe. Even the best business is a terrible investment if you pay too much.

When valuations fall to more reasonable levels, anyone who paid too much for Facebook will lose money... and anyone who waited in cash will be ready to seize an opportunity to buy a cheap, fast-growing cash-gusher.

A third benefit of holding cash is the lack of fundamental risk.

Fundamental risk is the risk of a permanent reduction in intrinsic business value.

Many investors are exposing themselves today to fundamental risks by owning difficult businesses like electric car maker Tesla.

Tesla is a new company with flashy products and a charismatic CEO. It experiments in a highly competitive, low-margin, capital-intensive industry with no prospects for generating a profit any time soon. It makes expensive cars that don't run on the cheapest, most abundant transportation fuel on the planet (gasoline).

Tesla also contains what superinvestor Warren Buffett might call "cat risk," or catastrophe risk – the risk that the whole enterprise will fail. That happens to brand-new, unprofitable businesses all the time. I bet if Tesla turns profitable, the market will give it a much more rational valuation than the current eight times sales.

Look at other big car companies... Toyota trades at 0.8 times sales, Ford at 0.4 times. Even if you love Tesla, be patient. If you're right about it, it's highly likely you'll get it cheaper one day.

We try to avoid valuation risk by recommending stocks that are extremely undervalued, have competitive advantages and good balance sheets, and generate large amounts of excess cash flow.

By avoiding stocks and implicitly recommending cash, we eliminate most valuation risk. A sudden reduction in the value of your cash would require a massive overnight currency shock, something nobody could anticipate, that would not be preceded by any warning signs or steady drops in the value of the currency. That is highly unlikely to occur. Your $1 of cash will still be worth $1 when you wake up tomorrow.

Holding cash is by far the easiest, most reliable way to reduce risk in an equity portfolio. The more cash you hold, the less risk exposure you have. For most investors, holding a lot of cash seems like a mistake or a copout.

If it is a mistake, you will only pay for it with the unearned value of a lost opportunity. You won't pay for it with the loss of capital. It's guaranteed you'll lose some opportunities by holding cash – that's just the cost of the option value. But you won't lose money.

Cash is a strategic asset that can be unleashed on any asset you desire. Its option value is substantially greater than the intrinsic value of Treasury bills or cash-savings accounts. If you don't understand that, you may behave impulsively and take on valuation risk or fundamental risk.

Be confident. Be patient. Hold your cash proudly. Brag about it at cocktail parties. Don't deploy it until you find a good business that's undervalued and not likely to stay that way for long.

Source: Daily Wealth

[winston]

How to Avoid Becoming a Boiled Frog By Adam O’Dell

I recently explained why many investors become “boiled frogs.”

Namely, they focus on the S&P 500 index rather than its individual components.

They’re also slow to prepare for a down market. They wait until the market has already lost 20%, the official definition of a bear market, before trimming down their exposure. By then, it’s already too late.

So today, let’s talk about a better way…

It starts with a simple concept: adaptation is the key to surviving change.

I learned the intimate details of this truth as a biology major in college. But even non-science types should be familiar with this idea thanks to Charles Darwin’s quote:

“It’s not the strongest species that survives, nor the most intelligent. It’s the one that is most adaptable to change.”

Politicians get criticized for changing their opinion on a topic, as if conviction in one’s beliefs is more important than anything else. But scientists are required – by the ethics of their profession – to change their minds, theories and research actions when new information comes along. Even if it makes them look like a “flip-flopper.”

Naturally, as an analyst, I side with the modus operandi of the scientists.

After all, the stock market doesn’t pay anyone for their opinions or convictions. It only pays investors for being on the right side of the prevailing trend. And because that trend is constantly changing, investors must adapt constantly or else go the way of the dodo.

So when I designed Cycle 9 Alert three years ago, I made certain it would be able to adapt to a variety of (constantly changing) market conditions – bullish, bearish and all the shades of grey in between.

At the time, I realized I had two options for ensuring my service could play both sides of the market. One was an “All or Nothing” approach. This would have involved a simple rule like this:

Gravity. Relativity. Thermodynamics. Now, the Stock Market.

The scientific method has unlocked many of the world’s most cryptic secrets. And now, someone has effectively applied the scientific process to the markets.

If the S&P 500 index is in a bull market, consider only bullish positions.

If the S&P 500 index is in a bear market, consider only bearish positions.

This approach has the advantage of being clear and simple. But it’s imprecise and unable to adapt quickly and efficiently.

This is where we find the frogs slowly boiling in water. You see, the stock market doesn’t flip from a bull market to a bear market in an instant.

Instead, the process is agonizingly slow. And the change comes about in a slippery way – so it’s difficult to detect it’s happening, until after it’s already happened. It’s why the frog doesn’t jump from the pot… and why many investors hold hemorrhaging stock portfolios for far too long.

This chart proves my point…

See larger image

Here, I’ve plotted what percentage of the nine U.S. stock sectors were in a bullish trend over each of the last 12 months.

Twelve months ago… all nine sectors were bullish.

Ten months ago… eight out of nine were bullish.

Five months ago… seven out of nine were bullish.

Four months ago… only five out of nine sectors were holding a bullish trend.

And then, a month ago… all nine sectors were in a bearish trend!

That’s what a pot of slow-boiling water looks like. And that’s why I engineered Cycle 9 Alert to have a more advanced adaptation mechanism – rather than a rudimentary “on/off” switch based on an aggregate stock index, or an arbitrary definition of a bear market.

At the risk of mixing analogies, Cycle 9 Alert’s adaptation mechanism works much like a mountain bike.

Mountain bikes don’t have just two gears – one for flat terrain, and one for steep inclines. Although that bike would work just fine for me here in Florida, where a single-speed beach cruiser does the trick, I certainly wouldn’t take it to the Colorado ranch that my wife and I visited last year. The mountains were insane!

Most mountain bikes have between 21 and 27 gears. This gives the rider much more flexibility – to quickly and efficiently adapt to subtle changes in terrain and incline. Instead of simply gearing the bike for either “flat” or “mountain” terrain, the rider can better adapt to all shades of grey in between.

Cycle 9 works much the same. We aren’t limited to just two “gears” – 100% bullish or 100% bearish.

That’s because, instead of applying my trend-following rules to an aggregate stock market index (i.e. the S&P 500), I apply them individually, to individual sectors and stocks. This looks like:

If <this particular stock> is in a bullish trend, consider a bullish position.

If <this particular stock> is in a bearish trend, consider a bearish position.

This construction gives us unlimited access to the market’s shades of grey – when it’s neither 100% bullish, nor 100% bearish. And it allows us to gradually adjust our positioning since, as the chart above shows, market conditions change gradually, not instantaneously.

Source: Dent Research

[winston]

How to Protect Your Money from Everything the Market Will Do in 2016

By PETER KRAUTH

Source: Money Morning

http://moneymorning.com/2015/12/14/how- ... /#deeplink

[winston]

How to Reduce Your Risk in the Market By Jeff Clark

Most people say options trading is risky.

Novice traders often don't take the time to learn the right way to use options. They jump right in thinking, "I got this." They gamble, blow up their accounts, and then walk away penniless and swearing off options forever.

Even experienced traders sometimes get caught up in the allure of fast gains. They over-leverage their positions – take a bigger position size than they should – and then take a hit. All the options traders I know, including myself, have blown up their accounts at least once.

But it's not the option that's risky. It's the strategy. And when used the right way, options are far less risky than trading stocks.

Let me explain...

Most people use options the wrong way. Most people use options to increase leverage... to get more "bang for their buck." In other words, most people use options to increase risk.

That's wrong. That's the exact opposite of what options were designed for.

The options market was created so investors could reduce risk. Options allow investors to hedge their positions... and to risk much less money than they would if they bought a stock outright.

Let's say you want to buy stock in Company X. It trades for $10 a share. You could put up $1,000 to buy 100 shares... But you can control the same amount of stock with one option contract. You can buy a contract for, let's say, $50... and leave the other $950 in your account.

If Company X's stock goes up, you'll make money. If the stock goes down, the most you'll ever lose is that $50. That's a 100% loss... but it's a lot less than potentially losing 20% or more of the $1,000 you would risk if you bought the stock.

This is a simple example. And it's the simplicity that proves my point. Options allow you to risk much less and profit just as much as you would buying stocks.

But that benefit disappears if you over-leverage the trade and take on a larger position with options than you would otherwise take with the stock.

That's the biggest mistake most novice options traders make. Instead of replacing a 100-share purchase with one call option (an option that gives you the right – but not the obligation – to buy or sell a particular stock at an agreed-upon price at a set time in the future), they take the entire amount they would have allocated to the stock and buy a much larger position with the options.

Rather than buying one call option for $50 and leaving the remaining $950 in the bank, novice traders take the entire $1,000 and put it into buying more call options.

They end up buying 20 call options to try to get more bang for their buck. What would have been a 100-share purchase has turned into control of 2,000 shares. Instead of using options to reduce risk, they've increased their risk 20 times.

Losing 100% on an over-leveraged trade would be a disaster. And it's why most folks think options trading is dangerous. But it's not dangerous if you trade options the way they were originally intended... as a way to reduce risk.

Limit your options exposure to control just the number of shares you would normally purchase. Leave the rest of the money in the bank. Then it won't be so bad to lose 100% on an option trade. It will almost always turn out better than what you could have lost on the stock.

In tomorrow's essay, I'll walk you through a real-world example of using options to lower your risk in the market. I'll also show you how to use options to increase your potential returns.


Source: Growth Stock Wire

[winston]

10 reasons why you need an offshore bank account today

by Nick Giambruno

Source: International Man

http://thecrux.com/10-reasons-why-you-n ... k-account/

[winston]

The Art of Survival

By Adam O’Dell

“The art of survival is a story that never ends.”
~ Irving Rosenfeld (in American Hustle)

One of the first lessons I learned about life, and myself, emerged on the tennis court.

Like many kids, I grew up playing sports… soccer (briefly), basketball (more briefly)… and many years of baseball and tennis.

And at the apex of my preteen growth spurt, I found myself still playing tennis with a “juniors” racquet that my parents and coaches were equally vying to rip from my tight grip.

The pleas were well-founded: “It’s too small.” “You’ll get more power from a bigger racquet.” “Adam… it’s time to move on!”

There wasn’t anything particularly special about that racquet I wouldn’t give up. It was lent to me by my dad’s best friend. It was well-worn.

But it was my racquet. My first, and only. And it felt so comfortable… like an extension of my arm.

Every other racquet I picked up just felt foreign and awkward.

I can’t actually remember the tipping point… when I finally caved and retired the “toddler racquet” (as my dad would jest). But I did fumble through a few weeks of practice getting acquainted with my new, properly-sized equipment. Eventually, it too began to feel comfortable in my grip.

And it gave me the power and reach I needed to take my game to the next level… state championships and all!

Switching racquets was definitely the right thing to do, but…

…it sure didn’t feel good.

Let’s face it: humans are creatures of habit.

Knowing a bit about biology (my undergrad major), I realize there are evolutionary advantages to creating and executing habitual behaviors. This M.O. allows us to be more efficient with routine tasks, even paving the way for multitasking. Doing things we’ve done many times before helps us operate with confidence, which is a key to success.

But there’s also a detrimental side to habits. They prevent us from adapting to change.

We’re all aware “Change is the only constant.” That’s true in science and the evolution of species. And it’s also true in free markets.

In fact, the ideas of change, evolution and adaptation are central to Adam Smith’s view of free markets. Smith, the 18th century pioneer of economics, saw competition as the force that drives businesses to perpetually innovate… to adapt to an ever-changing business environment.

This system ultimately creates value for all. Businesses that can’t adapt to changing conditions die… and we’re better off without them. While businesses that do adapt thrive, offering better products and services at cheaper prices.

With all that in mind, let me ask you a personal question: When it comes to investing, are you still holding on to your “toddler racquet?”

For decades, it worked just fine to take a comfortable approach to investing. That involved buying a mix of stocks and bonds… and holding for the long haul.

And after years of success with this simple method, I fully understand that investors find most other strategies foreign and awkward… just like that new, properly-sized tennis racquet felt to me at first.

But, if you find yourself holding tight to old habits… you’re not adapting.

Financial markets are truly global these days. So looking only to the U.S. stock market for wealth-building strategies makes little sense.

Until recently, gaining access to foreign markets, let alone commodity and currency markets, was difficult for the average retail investor. Hedge funds traded them. But only institutional and high-net-worth investors could afford the fee structure and minimum investment levels these funds required.

The ETF (exchange-traded fund) has changed that.

The $2.3 Trillion ETF Market

Just as mutual funds revolutionized the investment landscape in the 1970s, the growing popularity of ETFs has generally been a win for retail investors.

ETFs give retail investors access to markets and sectors that were previously cost prohibitive. And they give investors the ability to trade in and out of positions instantly, with only a click of the mouse.

The Investment Company Institute publishes an annual Fact Book on industry trends. All 294 pages of this year’s report can be freely accessed here. There’s also an infographic by Kurtosys.com, which boils the data down nicely: The Growth of Exchange-Traded Funds.

One portion of the infographic shows the growing number of ETFs introduced… and the investment assets they’ve garnered:

See larger image

Of course, the mere existence of ETFs doesn’t mean investors are automatically or properly diversified. In fact, the full infographic shows that a whopping $444 billion was concentrated in U.S. large-cap stock ETFs last year. That’s nearly twice the size of the next largest category: bond and hybrid ETFs.

For true diversification, you have to take a page from the hedge fund playbook.

Diversification… Precisely When You NEED It

I take issue with Wall Street’s traditional definition of diversification. True: small-cap stocks typically perform better than large-caps in bull markets, and worse in bear markets. True: utilities stocks and technology stocks perform differently during different phases of the business cycle.

That’s why the theory holds that a diversified basket of stocks should be less volatile than an all-eggs-in-one-basket approach.

But during bear markets, stock correlations rise dramatically. That means that most stocks — more than 80% typically — will fall in lock-step during times of turmoil.

It’s cruel. Just when investors need the protection that a diversified approach should afford… diversification — at least in the traditional sense — fails them.

The lesson from this is simple: you have to look outside the stock market for true diversification.

A perfect example of this took place in 2008 when the S&P 500 lost 38%, yet the Newedge CTA Index, which is a proxy for a true diversification strategy, produced a solid 13% gain.

That performance was possible because, as stocks were tanking, non-correlated markets were surging.

The Japanese yen jumped 19%...

10-year Treasury notes gained 22%...

And platinum surged 45% between January and March…

Of course, since early 2009 U.S. stocks have been the best game in town — some would say the only game in town — against the backdrop of the Fed’s punch bowl of monetary stimulus.

But now, stocks have started to stumble.


Source: Dent Research

[winston]

Is It Time for Investors to Panic?

by Alexander Green

Source: The Oxford Club

http://www.investmentu.com/article/deta ... pLWsxV96M8

[winston]

A simple way to reduce your portfolio risk today...

by Alexander Green

Source: Oxford Club

http://thecrux.com/buying-this-asset-to ... nd-beyond/

[winston]

What Investors Can Do When Markets Are Volatile

by Kenneth Kim

The stock markets are currently volatile. So, what might you consider doing (and not doing)? The answer: it depends.

Source: Forbes

http://www.forbes.com/sites/kennethkim/ ... f303b3db2d

[winston]

Here are 7 ways to protect yourself from what’s about to happen…

by Porter Stansberry

Source: Stansberry Digest

http://thecrux.com/porter-stansberry-th ... ke-action/