I've read a few other things about him and while this may not have been very different it is useful. There are people in this business, and it seems like he is one of them despite what he says, that are willing to really bet big, face the consequences of a big bet gone wrong and then start over from scratch.
The point clearly seems to be about learning from Niederhoffer's mistakes. From there you incorporate what you learn from him into your own investment philosophy. He seems to have been done in by enormous bets with no counter strategy and presumably misuse of leverage in pursuit of those big bets. These things have done plenty of people in and will do so in the future. Students of market history have seen this story play out countless times.
Philosophically this blog is at the completely opposite end of the spectrum or road in rural Iceland as the case may be. I don't ever want to worry about the stock market, client portfolios or my own. Further I don't want clients to worry about their portfolios either. Everyone has different panic points and the dread that goes with watching portfolios values implode is very predictable and I would think more people would make a priority out of avoiding that feeling. Yet somehow people can not envision this when they are placing the trade or trades that put them at risk for this dread.I can remember a few years ago after a lottery ticket biotech stock blew up, a reader left a comment disclosing that this now dusted stock had been 25% of his portfolio. While I don't remember what the stock was I remember him saying something about the extent to which he believed in the company and the regret naturally felt. Given that any stock can blow up (Fannie Mae and WaMu were very blue chip) there can be very little justification for the typical person to make the types of go for broke bets that did in the reader above and Niederhoffer.
What would be your reaction to 25% or more of your money disappearing that quickly? Do you even know what your reaction would be? An even better question would be do you ever want to find out? As I said above some people can exist this way but finding out the hard way you are not one of those people would be an awful experience.
There is nothing wrong with buying a lottery ticket biotech, long shot gold miner or the like; these are perfectly valid things to buy but measuring a wipeout's impact on your portfolio is crucial in this context. If you put 2% on what turned out to be a fraudulent Chinese hair growth company (Seinfeld reference) could you live with that consequence? I think most people could. What about 5% or 10%? At some point is your line in the sand or know thyself number.
This is also true of the overall portfolio and the portfolio's volatility budget. You know how to build a portfolio that is more volatile than the market or less volatile than the market. If every stock you pick is more volatile than the corresponding Sector SPDR then your portfolio will obviously be more volatile than the market.
Most people are unlikley to pick the most volatile stock in every sector, instead there would be a blend of volatile and low octane names to create a mix that can be lived with when things in the market are their worst. From there an investor could increase or decrease their overall volatility.
For example an investor could swap out of the Materials Sector SPDR (XLB) into a much more volatile stock like Silver Wheaton (SLW) the silver (sort of) miner. Assuming the stock is not a fraud (I don't own the name but don't believe it is a fraud either) then the decision about adding the name and volatility that goes with it becomes either a good decision or bad decision based on top down factors for the market and the materials sector and bottom up factors based on SLW's situation at the time in question.
Buying SLW at $19 in spring 2008 on the way to $3.45 (assuming no sell discipline) becomes less of a problem at 3% of the portfolio; it simply becomes a lesson learned not a radically altered financial plan.
6 comments:
This is one reason I advocate ETFs or mutual funds for individuals. Although I am thinking about getting rid of all my mutual funds in favor of ETFs.
SEG
"This is also true of the overall portfolio and the portfolio's volatility budget. You know how to build a portfolio that is more volatile than the market or less volatile than the market. If every stock you pick is more volatile than the corresponding Sector SPDR then your portfolio will obviously be more volatile than the market."
This is fine as a brief introduction, but without taking into consideration the (ever-changing) covariance between holdings, investors may be very surprised by the variance they end up with...
Roger,
A bit off topic but if the "market" closes today for the second day below the 200 day moving average will your discipline have you buying back something like SDS as a hedge to the downside?
we can talk about any action taken or not taken and why tomorrow
There are far more ways to make money in the world than there are people who are willing to execute them at the correct leverage.
I agree with putting yourself in a position where you don't have to worry about the implications of an adverse move in a single stock or the overall market. I think it's significantly easier to build savings over time through cost discipline than through earning exceptional risk-adjusted market returns. I bet the average person would be able to reduce their food expenses by 20% with no deterioration in quality of life, but earning a 20% return in the market is no easy feat.
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