The questions have really piled in the last couple of days so I'll try to address some of them in this post and then share a little bit of wisdom/philosophy imparted to me by someone I have tremendous respect for.First up is a theme in the comments from Friday's post about the people in government not be intellectually equipped to know how to fixit (hello Oscar Rogers). The financial services industry owns some of the blame (you can decide for yourself how much), certainly they are more equipped than the politicians but they don't know either. If they did know it would have never unraveled and they would still be shaking that same moneytree today.
To the extent that getting the housing market (mortgages, prices, all of it) to start getting healthy is important; we know time can fix it, just not how much time. The various plans will either shorten the time, lengthen it or not matter at all and we will be left to contemplate whether the money spent was worth it. Ditto with employment.
One reader asked about the PIMCO Stock Plus Short Strategy Fund (PSSDX). It is an inverse fund that is mostly owns debt to collateralize being short SPX futures. The biggest drawback for me would be a lack of access during the day. This has mattered before (for things I have done with SDS), may matter again so I would rather not be hampered in that manner but that's just me.
From yesterday's post;
One reader said when a client trusts you or any one else with their wealth,(-)20% or simalar returns should never happen. So a couple of things with this one. Usually advisers set expectations. Hire a guy who is a DFA person or otherwise an indexer and he will tell you that the market cannot be timed so you will own the market (assumes proper asset allocation) which means occasionally you will go down a lot.
I tell clients that when the S&P 500 goes below its 200 DMA we will begin to take defensive action with the goal being to go down less (ie miss a chunk) than the full brunt of the bear. No guarantees but that is the goal. A more aggressive defensive strategy might go down close to nothing.
I would ask the commenter if down 20% should never happen, what is acceptable to you, how do you do it and do you understand the risk you take in trying to deliver to that expectation? If you take clients to 100% cash after a 5% decline, what if that 5% decline was the bottom, when do you get back in? If you take clients to 50% cash after an 8% decline what happens if the market then drops another 60% (you'd be way below the down 20% at that point)?
One reader left an instructive comment about his father-in-law with portfolio problems and that the father-in-law is considering some sort of go for broke gambit. The situation probably arises from a lack of defensive strategy, improper asset allocation or both. The reader also believes his in-laws did not educate themselves properly.
One reader thinks I am too nice of a guy not to have some compassion for those whose lives get screwed up through the fault of others. Losing a job or getting sick can be dreadful events but can happen to anyone at anytime. The people in these circumstances seem to be a target of the plans.
I got laid off once, knew it was coming way ahead of time and built up a warchest in case I needed it--so I have walked in those shoes. In addition to having a warchest I was also willing to take a job at a retail store (but something in the industry came along) because that is what was needed to not go too deep into the warchest. For about ten months from 2003-2004 I was in between my last job and hiring on where I am now and I did logging, digging, put a roof on a garage, other handiwork and some paid firefighter work to supplement having only a couple of clients because that is what needed to be done.
I reject the concept of fault of others. Occasionally we get tested, we can blame others or we can pull ourselves up and do whatever it takes. For anyone living below their means doing whatever it takes is much easier. All of that and I didn't even touch on the economic failings of this sort of bailout.
One reader asked for an update on my belief that the market would bottom in Q2 2009. The way I manage accounts it doesn't really matter whether a call like that turns out to be correct or not. No matter when things bottom it is a good bet stocks will turn up before the economy does. There obviously can be variance in the lead time of equities. In December 2009 the recession will be two years old (if it is still a recession then). Two years is a long time for a recession, not record breaking obviously. To think the economy could bottom in December, January or February is not ludicrous (Roubini said 2010 when he was on CNBC with Taleb). So a six-eight month lead time for equities is not ludicrous either. It may turn out to be wrong of course but that was thinking behind Q2 2009. I would add that even if my timeline is anywhere close to correct that does not mean the US will be the best investment destination.
I was wrong about the magnitude of the bear market; cutting in half twice in a decade is an incredibly long shot. Now that we are so low the reader says he thinks the market is in the despair phase. He notes I did not see the market going much below the 750-800 (it still hasn't) and wonders if I think the increased uncertainty means that we will go lower.
Hopefully I have been clear that I have opinions but concede anything can happen. We know that uncertainty peaks at the bottom. As a microcosm, when it looked like the banks were going to be nationalized mid-day Friday things started to really meltdown; the banks are done. I don't know where the bottom will be. I have been saying for months that I thought the market would continue to stumble along the bottom (if anyone knows who originated that saying, please leave a comment) without going meaningfully below the November low. So far that has been correct. Now that we are close to the low it is only logical that people would be more worried about it breaking the low. Maybe that will happen but the more important thing to me is that demand for equities is unhealthy so I remain defensively positioned.
Now for some wisdom imparted to me. In past posts I have mentioned my 77 year old neighbor who supplements his income with all the backhoe work he wants (getting paid $60/hour to drive a big tonka toy is appealing to most men on some level). He is also a firefighter. Yesterday was pack test day (three miles in 45 minutes wearing a 45 lbs pack, because the station is at 6300 feet and the road is a hilly we go a little less). A bunch of us went out and did the hike but we were one pack short for my 77 year old neighbor to go in the first group. So when we got back he went out but since he was the only one left to take it I went out with him (I did not wear the pack the second time). He did it four and half minutes slower than I did, yapping the entire time--77 years old.
In the middle of the conversation he said "I can put up with a lot of bullshit from someone who is willing to work hard." I think that circles back to pulling yourself up as discussed above.
37 comments:
Roger,
Great post as always. I especially like your idea of not blaming others. It certainly feels good temporarily to blame others for our situation, but ultimately it increases the feeling of helplessness and keeps us from moving forward. I always think of the Buddhist belief when it comes to blaming others. If you want to understand your present, look at your past. If you want to see your future, look at your present.
Nice commentary today. I especially liked how you addressed some of the questions and observations. Of course, no one can know the optimum portfolio in advance and most strive to limit the downside and maximize the upside. Hopefully we can all share without being rudely criticized by the one or two know-it-alls who post regularly here. Constructive criticism in a respectful manner is what is all about.
Have a great day.
It certainly feels good temporarily to blame others for our situation
this is a crucial point about the psychology of so much of this that I did not think of. really a multi-facet idea.
thank KK
thanks anon
During the long bull market rise all analyst got burned calling corrections, until no analyst survived their predictions. Now a new generation and the market is going into a long term decline, and many analyst are calling for a correction, a suckers rally. It is not happing. I see lots of equities that are dirt cheep and they are still declining. If you believe that something is worth owning then buy it or stay away from it. Gold, can you eat it, no. I do not know what you can do with it. There are stocks today that are paying 10 to 12% dividends yet UBS, Credit Swiss are calling to sell such ownership. What a crazy world. I feel, not so sorry if UBS a credit swiss go down to zero. How can you trust such institutions when two years ago they asked investors to purchase bank, insurance and financial stocks.
Everyone should look at the bigger problem, understand the scale.
I hope by now, everyone realizes this has now become a triple circular negative spiral.
Spiral A:
1. Jobs are lost
2. Product Sales go down
3. Companies retrentch
4. Jobs are lost.
Spiral B:
1. Jobs are lost
1. Home sales & prices go down
2. Bank balance sheet goes down
3. Credit dries up further
4. Home sales & prices go down
5. (Home related) Jobs are lost
Spiral C:
1. Credit dries up further
2. Companies retrench
3. Jobs are lost
4. Sales plunge
5. Companies balance sheet weakens
6. Credit dries up further
This is no longer a simple case of a price correction anymore. It has legs. it can reinforce on its own. This is what's feared as the deflationary spiral.
But realize, this spiral *IS REINFORCING* and can run to ruinous results for everyone! Nobody is immune, even renters and job holders on supposedly "immune" industry, goldbugs and even if you're off the grid and have your own food and bomb shelter, you are not immune!
Doing nothing is not an option.
This can absolutely spiral down. What is the absolute floor you ask? The absolute floor is when everyone has nothing to lose. WW 2 era or the Great Depression. That's the "floor" where the spiral stops naturally.
Think about this next time you wish for the spiral to resolve on it's own. Be careful what you wish for, for you may get it anyway. Any actions may prove futile anyhow.
A lot of people still think this is a regular recession and there will be cyclical bounce and rebound. An almost cult like subscription to "there is a rebound" idea. Which is why the best action is to sit back and let it resolve on its own... I'm sad that this train of thought reveals that these people do not realize the depth of this rabbit hole.
I know the anger at the irresponsible people who caused the problem. I am angry! But that time is past. These "first line" irresponsible action has now ignited the big fire of devastation. Undoing that irresponsibility won't bring things back. Trying to punish, for morality, justice or any other reason won't stop the spiral. Looking at how to stop the spiral is what we all must do.
Who knows if the anything *CAN* be done to prevent this down crash, if everything we do will be futile, but "doing nothing is not an option" is indeed the correct philosophy to deal with such devastation.
Anon 8:59, very interesting comments. I wonder if you would kindly share what specific measures you are taking since as you say "doing nothing is not an option."
"I would ask the commenter if down 20% should never happen, what is acceptable to you, how do you do it and do you understand the risk you take in trying to deliver to that expectation? If you take clients to 100% cash after a 5% decline, what if that 5% decline was the bottom, when do you get back in?"
That commenter wasn't me. But that style is very close to what I do.
So my answer to "when to get back in" is
12 rolling year long positions, one started each month (1/12th of the total fund value). If any one position falls 5% below the original start date price (capital value only) then the proceeds from that position sit in cash until the 12 month time stop date.
Like having 12 positions, one started each month and each with a time-stop of 12 months and a stop-loss of 5%
I used to use guaranteed stops, but since around 2 years ago I now use cheaper alternatives.
http://www.crestmontresearch.com/content/market.htm "if an investor can avoid the losses, it takes only 30% of the positive gains to match the market."
In many ways this has commonality with a Taleb like investment style.
Clive I find that to be interesting and a million miles from where i am coming from which is of course ok.
I am not sure if what you do is far more sophisticated or far less sophisticated than what I do but I commend you for having sought out something that is outside the lines and presumably fits well with your tolerances and/or thresholds.
I have posted here before saying that to me, the underlying value of an investment is not as important as the earnings the investments themselves throw off. The question becomes where to direct new cash.
As a farmer, I have used the analogy of real estate values versus the income from the farming operation. They really are independent of each other. The only connection being real estate as collateral to finance the farming operation.
Perhaps I am unique in that I consider myself to have an infinite time horizon. Thoughts anyone?
Anyone else here get slapped with a 50% increase in the subscription price of the WSJ? I love the paper, but $360/yr, yikes. FWIW, I get the paper early in the morning and read it throughout the day...I have no internet access during the day.
Thanks Roger. I appreciate my comment wasn't a reflection of your intended point.
I used to proclaim that style many moons ago - in the days of CIS dial up board postings. Lead a horse to water and all that... I stopped in around 2002, and those that might have listened likely carried low losses through both the 2000 and 2002/3 crashes (as they would have done through the more recent crash).
I've no formal financial qualifications, and use the style purely for a private family fund that I manage. With over a decade under the belt however it feels that I've gained enough experience to that of a doctorate in the subject.
Personally I found no real benefit in measures such as the 200dma crossover and some years back just resorted to using a simpler time based diversification based approach.
As you say fits well with my tolerances and/or thresholds - as its my only source of bread and butter.
Best regards.
Seeing miscreants and ne'er-do-wells rewarded as if they were prodigal sons returning home rankles, no doubt. It is easier to imagine people receiving assistance as miscreants or careless rather than hard-working and unfortunate but the truth is that in the absence of direct, personal knowledge we can not separate the wheat from that chaff and therein lies the rub with "I can put up with a lot of bullshit from someone who is willing to work hard."
In the absence of direct knowledge we consider it a sign of carelessness or unwillingness to work hard if people readily accept assistance, if they allow themselves to be bailed out they lack pride which means they are probably unworthy; the evidence they are worthy naturally involves refusing the assistance offered. The logic is viciously circular, a double-bind, a Catch 22: Damned if they do and damned if they don't.
To add to Anon 8:59's point then, I've studied the Great Depression a bit and one its most striking features, to me at least, was the general lack of broad, overt evidence of the damage being done: Families hid in their houses or pretended to go to work, ashamed to admit destitution; soup kitchens, bread lines and labor cattle calls were in back streets, not out on main avenues in plain sight; most people were still working in some way at least part of the time but nearly a quarter of the working force of the country was on the move, job hunting; hobo jungles were hidden at the edges of towns.
That was then, this is now, but anything that smacks of a deflationary slide bothers me more than the prospect of inflation, at this point in time anyway.
FWIW I hated the way the bailouts were designed and implemented before Bush left office and I don't care for much of what I am seeing now -- for gods sake place Citi into receivership and get it over with -- but there are some elements such as the program to mitigate or support mortgages the public already owns as a result of the Bush era TARP purchases that seem promising because they at least attempt to address the underlying asset problem rather than the problem of derivatives connected to that asset (several orders of magnitude larger) or the insolvency of institutions that hold those derivatives (such as zombie banks).
Perhaps that's why we are getting so much noise about how 'bad' and 'unfair' Obama's mortgage mitigation program is: The bankers don't like it because it means less money going into their hands and the Republicans don't like it because of the Catch 22 noted above or, more cynically, because it might actually do some good.
To Anon 9:41, the Farmer, in a serious deflation your produce drops below the cost of production, your debt becomes more expensive to carry because a dollar is worth more and you couldn't borrow more even if you wanted to because your land is now worth less than the debt, your dividend paying assets go bankrupt or default. I don't believe an infinite horizon would be desirable in that scenario; otherwise, not a bad perspective.
The farming analogy actually shows a direct connection between asset value and earnings in the "modern" world that I hadn't thought of.
Make an assumption that you fund operations each spring using loans and not from cash (interesting long term comparison there, of course - dad's old school way of farming vs. brother's way of farming). In a way, that makes you exactly like some suburban family that bought a McMansion and used rising real estate prices to fund a lifestyle.
If some land crisis comes along and the bank is no longer able to determine a value for your land, they won't make you the usual loan and now you can't fund operations.
Farmer guy here.
Most farming operations are financed by placing a lien against crop revenues. I for one am very careful to make sure all my loans (haven't needed one since 1991) are non-recourse, so again land values matter very little to me. There are a multitude of government farm programs and crop insurance products that protect against catastrophic crop losses. Most lenders are comfortable with this. The main insurance product is a crop revenue protection product which protects against a combination of poor yields and low prices. By the way, the premium is heavily subsidized by the U.S. taxpayer, thank-you very much! Many believe it is in the nation's best interest to have cheap food available to the populace.
I personally self-finance. The return on the investment from farming far exceeds anything offered by Wall Street. I assume this is true with most businesses. Wealth is created in commerce, wealth is preserved in investment schemes.
Land speculation has pushed the value of land past the ability of a farmer to acquire new land and pay for it with farming. Land acquisition therefore requires some degree of leverage or someone with deep pockets. This along with high estate taxes are why were are seeing a shift from small family farms to a farming industry of tennant farmers and investor landowners. Don't know if this is good or bad, but it is what it is.
As to dvidends or interest payments going to zero in diversified index funds, well we'll have lots more to worry about. You're talking Mad Max scenario.
Hope I haven't put everyone to sleep. Thanks for the feedback all, keep em coming.
RW, I really enjoy your posts. Well done!
Clive,
I find your method fascinating, thank you for sharing.
A few questions if possible:
1. What do you invest the positions in - is it a market-wide fund such as SPY or do you go narrower/ international?
2. What do you do when a position finishes 12 months without being stopped out? do you sell and reinvest or just adjust the stop-loss limit?
3. Any data you can share about long term performance?
Thank you Roger for hosting this very interesting discussion, as always.
SA
Hi SA.
You can backtest the idea relatively easily. If for instance you run against the Dow historical prices I suspect you'll see something like around 35% of cases not being stopped and each such case averaging around a 25% gain including dividends.
For stopped cases generally over the longer term you might assume that the income generated from dividends/cash-interest counters the loss.
I personally use a 50/50 to 75/25 like virtual stock/bond index (home-grown type thing) and run against that. I try to blend a range of holdings to lower the volatility, looking for pairings of individuals that might have one up as the other is down type of thing. The lower volatility generally means that you hit more winners (run the full 12 months without being stopped), but each such hit achieves a lower gain (smaller gain per hit). Overall the totals are little different to that of a more volatile fewer hits but larger gains per hit type underline holding.
If a position runs the full 12 months to the time-stop then I just add (or reduce) to realign the exposure to the then indicated exposure amount and set the new time and stop-loss triggers to the appropriate levels at that time - so in effect a roll-over with (usually) a slight modification.
As per the link in my previous comment, avoiding most of the downside means that you only have to capture part of the upside to achieve comparable returns to buy-and-hold. Over the longer term I anticipate matching or possibly even bettering buy and hold, but that is all very subjective. The volatility is lower than B&H so over some periods it relatively under-performs whilst (typically during a Bear) it outperforms.
Taleb uses a small speculative position, the bulk in low risk. This style uses a speculative play on the whole, but cuts out to low risk after a relatively small loss. As I said before the two style are pretty similar in many respects.
I'm UK based so realising some capital gains in a single tax year can be a good thing as we get a yearly capital gains tax allowance over here. I also try to 'trade' within a tax free based account as much as possible.
Thanks for expressing an interest.
Best regards.
Sorry for posting more than a fair share, but to add to my previous comment
Generally much of the exposure is mathematical such that the method provides an overall amount of exposure at any one time from across the collective, so actual trades are relatively small and not that frequent. That exposure is driven by market prices levels at any one time, rather than being predictive.
For the lower cost stop-loss method I hinted at in the first posting - I use end of day price levels and inspect the current days intra-day low. If that low is below a stop-loss level then I close out that position, even if the price has subsequently rebounded back up above the stop level. Over time the collective average of all such stopped cases tends to be very close to the target stop-loss level. Just that some individuals will have gapped below the target stop level whilst others are closed at above the stop-loss level.
This avoids having to place open market orders which can get taken out, and avoids having to pay a premium for guaranteed stops.
I too am fascinated by Clive's system and would like to hear some performance #'s on it over a long period - either from Clive or anyone else with good back-testing resources.
Testing it 'by hand' would be daunting - but I will if I have to!!!
Prescott Wayne
Prescott Wayne??
The reader I met at the bottom of the grand canyon a few years ago? How've you been?
I do also hold some core buy-and-hold stocks. From my observations if you use for example the Dow historical monthly prices and measure all possible 5 year or longer periods annualised returns then you'll see something like 6.3% (capital only). Typically dividends = cash = inflation and that average uplifts to around 9.8% e.g. around 3.5% income benefit.
You might use that dividend as the indicator as to whether stocks are relatively cheap/expensive and likely see yields range from 2% up to perhaps 5%. The 9.5% longer term return is only achieved if you buy and sell at around fair price level e.g. when yields are perhaps 3.5% to 4%. If you buy when yields are high (at peaks) and sell at a trough then you'll perhaps only make 5% p.a. as a result of lower dividend income and prices moving against the tide.
If you buy at a trough and sell at a peak then you'll benefit both from a higher yield and from the tail-wind that can uplift longer term returns to 16% or more.
With current UK FT100 yields at around 4.8% I'm nearing a point where I would consider adding to my long term buy-and-hold core. Presently however I don't feel comfortable with making such a migration just yet and suspect that dividend values might decline.
I'd rather miss an opportunity rather than adding to my core at what later turns out to be relatively high price levels. I suspect that a few years down the road there will potentially be some high government bond/gilt yields to be had. That will likely be my add-to-core point time.
Clive: Curious about your stop-loss method: On average, how close does it come to your 5% loss target? Do you ever experience successive months where you are stopped out (more than one portfolio segment in cash until end of cycle)?
"in the days of CIS dial up board postings" wouldn't mean the old CompuServe Investor's Forum would it? I used to sysop there.
Hi Prescott
For a quick and dirty test
Drag down Dow monthly historical prices from yahoo into Excel
http://tinyurl.com/c64jd6
Sort the prices by date
In Cell I2 paste
=IF(B2*0.95< M I N(D2:D13),1,0)
In Cell J2 paste
=IF(I2=1,E13/B2,"")
Copy and paste I2 and J2 downwards towards the end of number of row
Average Column I values and average Column J values and you'll see something like 37% hit rate (column I) and 19.6% average gain per hit (column J - which is capital
value only). In a hit year you also get to keep the dividend so on average its
37% years gaining perhaps 23% = 8.5% simple average.
PS had to expand out the Excel Minimum command in the above text (put spaces between each letter) in order to get the comment to be accepted. Weird.
Hi RW
Over the longer term my average stopped case is pretty well exactly 5%, just a marginal fractional percentage point difference.
Yes I do get successive months stopped out. Using the 37% hit rate as an example from the previous comments typically they'll cluster into sets of hits and sets of misses. Using a less volatile underline holding such as a blend of stocks and bonds helps smooth that out to some extent.
I can't recall actually posting to CIS forums as such, although I probably did (I'm about 5 years older than Roger, so the brain cells are starting to fade). I mainly used to post to a dial up BBS system that had FIFO I think it was called (shared between other BBS's) setup - and if I recall correctly CIS was used more for exchanging private messages.
Just seen a type in my 1:25 posting
"If you buy when yields are high (at peaks) and sell at a trough then you'll perhaps only make 5% p.a. as a result of lower dividend income and prices moving against the tide."
should have read "If you buy when PRICES are high" (i.e. when yields are low).
Roger, Thank you for responding to my request yesterday for an update on a possible Q2 2009 upturn. Perhaps "discouragement" is a more fitting description than "despair" for this phase. I choose to remain optimistic, not in hope of a swift recovery, but of our ability to recover in time.
On the topic of dividends, and related to the "10-year roundtrip to nowhere" for major averages, I'm curious what importance you place on dividends as a component of total return. I've seen charts which indicate dividends are responsible for 50% or more of long-term equity performance. There's an argument here for staying fully invested through downturns to collect dividends, and managing risk by putting on hedges rather than going to cash. You've mentioned using SDS as a hedge, but as I read it you also do some selling at a drop below 200DMA. In your experience, what's the value to doing both vs. hedging alone?
thanks
Roger:
This is indeed the Prescott Wayne you met near Phanto Ranch in Grand Canyon on rim-to-rim day 2006.
I'm doing well, thanks. I'm living in Mystic, CT where I moved to be CFO for a friend starting a plastics distribution business. We are doing pretty well, but it is a difficult time in this industry (any industry) - gotta watch those receivables and credit risk like a hawk.
I still read the blog regularly and enjoy it - your low kwy and common sense approach is refreshing.
down 40% for the market and i think the value of an extra couple hundred basis points in yield for the portfolio becomes less important. ditto if the market were to go up that much. i've kept some yielders and also used SDS. I did both because that's what I thought was best overall.
Hello Clive,
Thank you for the additional information, it makes the method even more appealing to me.
The problem with Taleb's scheme is that it assumes you can do wonders with the small speculative part of your portfolio - which I definitely can't, not on a sustainable basis. Without this "miracle" Taleb's system does not work.
Your scheme, on the other hand seems very feasible.
I can see why you would need to add a bond component to smooth out the ride since in a period like now where volatility is large - you risk being stopped out even in periods which, in general should complete the cycle.
I am sure that the 5%-sell rule should not be tempered with but what do you base your Stock to bond ration on?
Many thanks,
SA.
Interesting comments from Tom Drake today:
http://twocents.blogs.com/weblog/2009/02/back-to-2003.html
US eyes large stake in C, nationalization continues
http://online.wsj.com/article/SB123535148618845005.html
Roger,
I believe either here or at GF you indicated that you own gold. I was curious why you would one an asset for clients that has no true real rate of return on a long term basis and in lieu simply hold bonds and tips?
From my perspective, diversification is about avoiding uncompensated risk. What's left is risk "worth taking," or risk that you expect to be paid for taking. This doesn't work well, however, unless the underlying holdings have something to compensate you with - earnings, dividends, interest.
Adding absolute funds, gold, cash under the mattress can all reduce volatility, but so can plain old bonds/TIPS. At least the latter pay you something for holding them.
Bear funds, etc. rely on making directional bets and then trading effectively to capture a diversification-effect return, which has as much to do with random chance as anything else.
At some point, we have to come to terms with the fact that risk and return are related. You can't really expect one without the other. Avoiding risk is avoiding return.
i view gold as insurance...how's it done?
There's tons of research showing that commodities like gold, though having zero real return in the long run, reduce volatility and boost return slightly when they are added to a portfolio in small quantities.
I'd point you to the Journal of Financial Planning site, but their search function doesn't really work.
Hi SA
The 5% stop level is by no means a rigid requirement. I just use that level as it's around the income level that I believe can be made in total in the average year, such that overall the worse case should be break-even year.
A problem with this style with just a stock based underline holding is the 'dry' years as I call them. Prolonged periods of zero gain.
Splitting into a core B&H (for income) of stocks bought at relatively low prices and the stop-loss style helps smooth that out.
As does using a lower volatility underline holding for the stop-loss style such as a Stock/Bond virtual Index.
For that virtual I use a Robert Lichello's AIM style (or more strictly an adaptation of such that can extend into some moderate leverage at very low stock price levels).
There's a commercial www.signalpointinvest.com crew that run an AIM like style in much the same way as I do (except being UK based mine is more atuned to the UK domestic market).
Hi SA
Scott Burns' http://assetbuilder.com/Investing/inv_evolution.aspx style might be another reasonable US alternative as the underline virtual.
The bottom line is that it is a form of portfolio insurance.
If you have say a $500k house and a $500k stock investment then many will typically insure their house, but not their portfolio.
We each have our own risk/reward tolerance/expectation, the stop-loss style is just my way of meeting that for me and provides the downside loss protection that I'm comfortable with.
Roger uses SDS based on the 200dma for such protection. Personally however I see that as being selective short term insurance cover application only, such that you could be caught with no insurance. I prefer a more continuous protection, year in, year out.
Relative to the original amount invested, if a stock doubles in price then thereafter for every 1% change in stock price the value changes 2% relative to the original investment amount. Equally if the stock price halved then for every 1% change in stock price the value changes 0.5% relative to the original value.
Which is somewhat akin to buy-high, sell low.
To install a more constant risk you need to reduce exposure as prices rise, increase exposure as prices decline - which is akin to buy-low/sell-high.
You can create a snthetic PUT Option by starting with a relatively small short position (or no short), and add to that short as prices decline, reduce the short as prices rise. Which is something along the lines of what buy-and-hold does (and/or Roger's use of SDS). The counter party to that trading action is in effect selling increasingly more Puts the further prices decline - but potentially capturing the premiums from such should prices rebound back up.
Another factor to consider is that a 12% simple average with a 20% standard deviation will provide the same compound average to that of a 10.7% simple average that has a 10% standard deviation.
If buy-and-hold were the Eutopia then likely daily trade volumes would be much lower. As daily trading tends to be high (something like 100%+ yearly average stock churn if I recall correctly), then obviously buy-and-hold is favoured less than that of addressing variable risk/reward.
Collectively there is no one simple single best style. Accordingly I try to hold a bit of exposure to each.
The stop-loss, AIM and diversification each have their own individual characteristics that collectively blend together in a manner that provides the overall qualities that I personally desire.
Clearly globalisation has led to higher class correlations. Investment style diversification goes some way towards reinstating an element of low correlations.
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