I had a question about Portfolio Management from a Member. I sent him this. It might interest you.
Two processes run side-by-side:
- Stock picking and timing.
- Managing market risk.
STOCK PICKING AND TIMING
Stock picking and timing involves a few basic tenets that you might adopt. They include (and apologies for the simplicity):
- Have a quality overlay. Far better you play in reliable stocks. It reduces risk. I am so over holding smaller companies and risking 20% drops on announcements. Some stocks are very sexy, but when you are running other people's (joint Super?) money, you have to be sensible. That involves knowing the numbers and having a quality or (at the minimum) a market cap threshold you won't go below. That means trying to find (say) the most reliable growth stocks, and a lot of those, in order to reduce risk, end up being larger companies. Going down the market cap scale is fine as long as you are aware of the risk and keep that end of the portfolio in check. The smaller the company, the more research is required. Yes, you can narrow the risk, but it takes more effort. In other words, you wouldn't buy a lot of small stocks when looking after long-term important money, although one or two turbocharged popular stocks, on high PEs and stretched valuations, being priced on future, not current earnings, is very common as a side bet you can lose, just keep the size of the holdings smaller.
- Build a watchlist of stocks you like. You don't have to own every stock, so just put a good list of stocks together. If you don't hold the best-performing stock in the last year, it doesn't matter. Just as long as the stocks on your list suit you. Another way to do it is to list stocks you would avoid and why. Too small, unethical, unreliable earnings, yield too low. You choose. Build a list of stocks that suit you. Growth, income, quality, stocks in an industry you know, like, have a future, whatever. Keep it short. Don't worry about price, it's the inherent nature of the company/stocks that you are interested in at this point. You look at price, timing, charts, later.
- There are too many ideas. Ideas are never a problem. In order to filter them pop a Post-it note on your screen every time half decent stock idea comes up. If it's any good, you will now be aware of it and may end up researching it, may end up putting it on the watch list and may end up buying it eventually. The ideas process has to start somewhere. In other words, you don't need four months of Warren Buffettesque analysis to validate every idea. All you need do is note it and start thinking about it (the antennae are up) and see what comes of it.
- Don't buy stocks just because they make it onto the watch list, only buy them because they are also going up. This is the timing part of the equation, and it is mostly done on trends (charts). There is nothing I like more than finding a quality stock on the watchlist bottoming on the charts. When the market tips over, you should celebrate, not commiserate, because that's when those opportunities flourish, the opportunity to buy good stocks at good prices. We use a lot of charting software that quickly scans lists of stocks and highlights trends and turning points.
- Start small and build - You (the nervous) might emulate many fund managers by pyramiding in and pyramiding out. That involves buying a small holding to start with (especially in smaller companies) and adding to it if the stock goes up, cutting it if the stock goes down. It's a way to limit your risk. Go you good thing. Don't add exposure to a bad thing. Cut exposures when it's going wrong. Some people have trouble with big decisions, especially selling. So make a lot of small decisions. It's easier for the indecisive (most people).
- Watch out for liquidity issues - Some stocks hardly trade. Look at the spread. If there is a big spread and it has low volumes on a daily basis, then it can move fast and a lot. You might not want that. Just be aware of liquidity. If the chart has a lot of straight lines on it, beware.
- Sell stocks that go down. I have been running the newsletter portfolios for years. When you transparently manage a portfolio, you begin to understand that you cannot afford to have big negative performance numbers next to stocks or people don't subscribe. So I learned for commercial reasons to cut stocks that went down. You, too, should be drawn to the poor performers as a risk before you notice the glory of the good performers. Pull the weeds easily. If you can do that, you will find that you end up with a lot of stocks that are going up. After that the job is looking after stocks that go up (nurture the flowers). Stupidly simple, but this actually works. Possibly the most damaging weakness of amateur portfolio management is this rather pathetic inability to sell. I have no emotional attachment to stocks. They are share prices, not love affairs. If they don't behave, get rid of them - you don't need to be waking up to failure every morning. Clear the decks easily. If you can learn to do that, you are halfway there because if picking good stocks is half the game, the other half is not holding the wrong stocks. As a broker, every new client would come to us with a tale of tiny holdings with huge losses against them. Learn to sell.
MANAGING MARKET RISK
As you probably know by now, I believe you can time the market and everyone who says you can't is an inexperienced amateur that has heard too many Buffett quotes or is a financial professional that has an interest in you doing nothing (because they don't have to make decisions but still get your fee).
You can manage market risk by raising and lowering your cash weighting. One of the great advantages of managing your own money as an individual without oversight is that you can go to 100% cash. Something the big funds could never do. This allows you to protect capital in a bear market, whereas most of the major funds have no choice, they have a mandate which forces them to hold the market through thick and thin. They will play with a small cash weighting (5-15%?), but it is immaterial come a big market sell-off. They will never get out of the market in a bear market. You can.
How much cash you hold is a daily debate, and there are no rules. I simply wake up every morning and make a decision. I rarely get scared by the market but will rapidly run up cash levels if I think its going wrong. And reverse it again when the squall is over.
When it comes to running up the cash, I may sell a few stocks outright (the ones that are not performing) but will essentially take the top off every stock rather than stock pick. The main issue is to run up the cash and not get cute about which stocks to do it with.
When it comes to this decision - read the Strategy section - it's what it's all about!
Author: Marcus Padley, Founder of Marcus Today
|
