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Trading Beta, alpha, risks, and award

Discussion in 'Shares' started by wdongli, 22nd Aug, 2011.

  1. wdongli

    wdongli Well-Known Member

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    Beta, alpha, risks, and reward

    There are two basic types of risks in the market, the systematic and unsystematic risks. In financial text books, the system risks usually are explained as beta and the unsystematic risks are the alpha.

    All of stocks would have be affected by system risks but perform differently to market crash or euphoria. Usually the liquid and high capitalized stock would perform tightly with the system or market as a whole and the illiquid and low capitalized stocks would less changed with the environment.

    There were stocks that continually and substantially outperformed the market as a whole with the same and in some cases less risk. It is my observation that the stocks with high alphas tend to move independently of the overall stock market index and were much more likely to offer better returns going forward than other stocks after system crash.

    There are a few reasons for the better performance of high alpha and low beta stocks in my understanding:

    First, some stocks were fundamentally unsound and were sold short by professionals or even the toughest bargain hunters who bet the stock would go down. When the short sellers began to buy back or stop, the lowest stock prices would be available. These not-so-wonderful or financial distressed companies have been sold on fire, so that their price are highly discounted to their remaining value. Once it happens, sooner or later it would experience an explosive rally if it could hold its remaining value intact. This often happens near short-term stock market bottoms, as we saw in April 2001 and October 2001 when some technology stocks skyrocketed due to short-covering rallies; in March 2009 when GFC crash long enough!

    The second reason for high alpha is due to buying pressure. Institutions and individuals recognize the powerful fundamental performance of a group of stocks and they buy them heavily. As we know, the stock market, like any other market, responds to supply and demand. Increased demand pushes stocks higher and higher relative to their respective indexes.

    The key is to identify the high alpha stocks and get your position after system has pushed all down and before the toughest bargain hunters to trade these highly discounted stocks and don't be distracted by the penny profit. Usually the trader type of bargain hunters would pick the little profit but often than not to see the train leave away from the station. So logically, if you buy you should be sure the discount or margin of safety have been setup unprecedentedly; it should not be the actions based on the feeling but a process to be sure you get the high alpha when system risks have played its most power to force people burn the money on fire.

    A lot of bargain hunters have skills to pick up the bottom but have not business plan to get smooth profit to their portfolio in long term. They tend to be tactic right but strategic wrong.
     
    Last edited by a moderator: 22nd Aug, 2011
  2. wdongli

    wdongli Well-Known Member

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    How to keep the best in hands?

    In market, it is critical that you have your own circle, where you are better than 80% of the people there or work hard to be one who better than 80% of them.

    The logic is simple as that best in the offices and workshops are different from best in the market. To most of men, they just could get acceptable good results when they focus on somethings. Some of market players work both hard in job and market and when these two kinds of jobs conflicts each other, they fail in both!

    Dirty-cheap fishes are completely different animals from beautiful swans. Too many times the market players to deal with swans as they deal with the dogs or deal with dogs as the swans. They doom to be failed!

    We need to keep the best dirty-cheap fishes or swans with high alpha and less negative beta in our home ponds. To get this target, we have to be fairly diligent in determining when reward and risk ratings change. Sometimes you will see a stock rise dramatically in a very short period of time and the risk scores will get progressively worse and we need to sell the stock.

    One of my mistakes since the April is that I failed to be the fairly diligent and sell a few fishes which had shot up due to system bullish sentiment. This mistake brought in terrible results and forced me to consolidate my mind and portfolio in case more damages in!

    So the time to buy, hold, and sell is very important for fishes to change between high and low alpha attribution. One thing is also very important that if system environment changes too much, the alpha of each fish would change definitely!

    Market is not linear system. Don't deal with beta and alpha as linear dependent variables. Sometimes black swans could change the alpha dramatically and you have to get insight for the possible black swans in your circles!

    We should began to sell the high alpha when the alpha becomes lower and lower even though the stocks continued to rise in price because they had become just too volatile to continue to hold. On the flipside, there will be times that a stock gets slammed because of missed earnings or other one-off events and then settles down and becomes far less risky than it was before it fell in price.
     
  3. wdongli

    wdongli Well-Known Member

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    It’s the economy and the market cycle, stupid!

    It’s the economy, stupid.” Bill Clinton rode those four words straight into the White House back in 1992.

    In the market, we could say the similar words “It’s the economy and the market
    cycle, stupid,” market players can ride the phrase straight to large profits by hold their position in the right stocks at the right time, matching their portfolio makeup to take advantage of economic events and market cycles.

    We need to be aware of the trends and cycles that can affect our portfolios, not just to protect ourselves from hurting by them, but also to exploit them for profit.

    ***
    Working the market cycle is something like going for a hike in the high mountain country. One sees beautiful vistas, undiscovered lakes, wildlife, land untouched by development.

    Such a journey offers great rewards. But there are dangers. One needs to be aware of weather patterns and be prepared for changes. One must be aware that wildlife is wild and that bears, mountain lions, and venomous snakes
    are not gentle traveling companions.

    Those who are not aware of the dangers that lurk in the back country are the
    ones who will likely need to be rescued, their travails featured on the evening news. There is little difference between the unaware hiker who gets lost in the woods and the investor who suffers grievous losses because he ignored current market conditions and dangers.

    ***
    Could you see where this bearish market go? If the market suddenly turns to be bullish do you feel surprised? If the market moves in zig-zag could you be sure that you could get a portfolio which have the compensated zig and zag shares to make your portfolio no loss at all?

    We all are affected by the environment and do we know the economy, the business, the best of the best stocks, which has the characteristics to sustain the selling pressure and once the market give any gaps for them they could get them out in trap and fly in the sky again?

    How should we protect us and offense at the worst time to buy in time average way. This time I could not do so since I have to take a defensive position for my portfolio. However if DOW could keep its bullish mood before the end bell, I would be very happy to say I could get my capital losses back even I still could not get the losses of the paper profit back which could have been locked in April.

    I am monitoring the market very closely! Hope market recovers and gold just hold its position. If so I would be alerted for any appearance of new winners so that I could lock some profit and to buy the laggers whose price still have great discount. I would try all to lower the cost so that I could give more chance to my portfolio when the market could move up more powerful later, for example the months after the November.

    Could market act as I hope? Definitely not! So don't hope but never lose the effort to protect the portfolio.
     
    Last edited by a moderator: 23rd Aug, 2011
  4. wdongli

    wdongli Well-Known Member

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    Never overconcentrated

    Market business have three basic functions:

    (i) making money;
    (ii) not losing money;
    (iii) and rebalancing the asset mix when things get out of line and overconcentrated.

    Since I jumped into the market,

    (i) I could make some money times by times;
    (ii) I do lose money;
    (iii) and often rebalance winners and losers until I started losing or losing too much of the paper profit.

    One thing is I didn't know we have three basic tasks for our business. Another thing is I tended to be greedy and over-optimism after some big winning corresponding to my financial base.

    All of these three things don't need high IQ but do need a plan we need to follow. Why did I hold $400.000 paper profit in IT peak time until it became ashes? Why didn't I lock the profit this April?

    I was happy I could sell more than half of BKP. Greed is hard to break down as the fear could haunt us for too long now!

    What will happen ahead? If this is not GFCII, all of losers in the market who refused to sell on fire would get something back. I would change from now and if the recovery is significant enough I would sense the market tightly and sell if I could feel the risks to lose what I have got in paper.

    What's next? I would try all to remember the lessons.

    1. Buy extremely low for margin of safely
    2. Learn to evaluate the value and quality for the best among the best
    3. Toughest capital allocation for no loss portfolio
    4. Lock the profit, clean up the rubbish, and rebalance the portfolio for the lowest cost I can get!
     
    Last edited by a moderator: 23rd Aug, 2011
  5. wdongli

    wdongli Well-Known Member

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    How could you allocate capital wisely?

    Do you want to manage your market business properly including capital allocation? If you want you have to

    1. Face yourself bravely
    2. Try all to knows you, your dreams, hopes, fears, biases, and addictions
    3. Try all to know markets, have perspective, and understand investment value

    I want to face myself. I try to know myself, market, market perspective, and value. However I really don't know enough!

    We don't know enough always but know the peripheral of what I know is most important at any given time.

    No one is really stupid just come to the market for losing the money but every one become stupid times by times. It is true to a nation, such as US, China, Australia, and EU. Otherwise you could not explain why they always do some stupid things and make the market crazy!

    Godspeed and Excelsior!
     
  6. wdongli

    wdongli Well-Known Member

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    The heart of capital allocation

    A serious mistake I made between April and June is that I allowed unbalanced capital allocation of my portfolio. Too much profit came from a few darlings due to the relative market bullish sentiment.

    At its heart, the essence of asset capital allocation is the search for noncorrelation. Let ’ s put it in football terms.

    To win at market service business, we need to have a balanced team. We need to have parts of our portfolio that play great offense when times are good. We need defensive shares that are ferocious protectors of our territory when the economy is out of whack and things are not so great.

    Just as a good football team needs a good kicker to get points after touchdowns and kick field goals, we need some shares that provide steady excess returns regardless of economic conditions.

    ***
    To win, we have to be good at all aspects of the game. A sound asset allocation plan is how we build our team. It is about how we are organized for our warrior service business.

    When we are small and could not allocate capital to cover all of fields, we have to get into the market after it burns the money on fire and the warriors desperately want to sell for relief, which is a risky operation and could be full of some mistakes so that we need the capital allocation based on the market sentiment and always have back up cash reserve to buy lower!

    ***
    Just as a football team starts by evaluating players in the draft, to develop a plan we need to put together an organized current and projected view of you, your goals, your financial circumstances, and importantly, your behavioral
    and personality quirks.

    We have to have a general sense of what certain kinds of shares (such as dirty-cheap fishes, mediocre fishes or dogs, and swans) can and cannot
    do for you.

    Once we have an idea of what we are working with and each player’ s talents and abilities, we need to develop and follow a game plan. We have to develop a
    portfolio of diversified and time averaged fishes and swans so that some of our
    shares tend to be doing well when other assets tend to be languishing.

    ***
    Once the game is under way, we need to look at the portfolio from time to time to see whether we should cut back on some winners that have exhibited rapid growth or judiciously add to other sound shares that have temporarily declined in value.

    A good football coach is always looking at the whole field and paying attention to what can go wrong. So should we. We always need to be thinking about how various kinds of risks can affect our capital, so we can take steps to reduce or offset such risks.
     
  7. wdongli

    wdongli Well-Known Member

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    It can last much longer...

    John Maynard Keynes once said: "Markets can remain irrational for longer than you can remain solvent."

    Quite often, we may buy a little too soon and sell a bit early. At times, much patience is required while we watch our asset and investment decisions play out.

    Patience may be one of the most difficult market playing virtues to practice. Sometimes we need a process to force us develop the patience, calm, and reason you need to achieve success with your decisions.

    Before April, I always thought the correction had been too long. Actually yes it really has taken too long and much longer than my expectation. Since the correction channel of XAO stayed there too long it dragged all of bad news into it and magnify the effect, and lead the world in price into the crash.

    ***
    No crash XAO could not get out from the ruins! It is in this mood and if it doesn't want to get out, no one could stop it. It is not about what market should do but what we should be positioned for a no loss portfolio in worst case. It is wrong to reinforce what we see the market but how we could see all of possible scenarios and put us in the right positions.

    We could not avoid mistakes but we could keep in alert to response properly to reduce the damages. The more stupid we are the more we tend to protect our feeling and biases.

    What could we win in the game of twisting the words, self-bias-appreciation, and pretend to know all and never make mistakes? Garbage in and garbage out since no digestion at all!

    ***
    In times of market turbulence and volatility, you need to keep a clear head and
    make correct decisions. You need to deal with the bouts of panic and euphoria that often occur in financial markets.

    You need to be direct and honest. You need to be knowledgeable about life as well as finance and economics. You need to know yourself. You need to keep your hand on the tiller sailing toward your dreams.

    If you still could not figure out what you need to do just think about how could you drive to your office everyday! There are gems in your thought and operations in driving your car! Don't say you don't do anything but drive only! If you could not get lost you do something roughly right!
     
  8. wdongli

    wdongli Well-Known Member

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    Be a specialist in a special circle

    In the market we need wisdom and expertise for a special circle as start points of market warrior service business.

    So how you purchase, hold, and eventually sell a share which could be anything, can be as important as what you own.

    The way you invest in specific circile tends primarily to be a function of

    (1) how much money you have relative to the shares' minimum purchase amounts,
    (2) how much time and attention you can devote to this circles,
    (3) your experience, and knowledge
    (4) your preferred sources of information and advice for your service business.

    ***
    For example, I enjoy looking through magazines, going to check each shares, and examining the options themselves. However I don't have enough knowledge base due to the limitation of my education and career history. That means I have to reeducate myself; pay more attention to the risk management by knowing what I know or don't know; I need to buy each share with big enough margin of safety while keep the cash reserve in case I make some very silly mistakes; I have to know I could not mistakes free but I have to make each mistake affordable. Every time when I forget whom I am I lost too much even when I intentionally call myself as a full-time market student. Market doesn't care about whom we are or what we do but if we make the mistakes we pay the cost not anyone else.

    I have played the dirty-cheap fishes for 6 years. It is a high probable and high consequent circle. The diversification and time-average with enough cash reserve at worst time are the necessary requirement. The patience for the worst time is the necessary personal trait, which could not be achieved by our mental will but by a completely change in behaviors with a trustful share screening process, highly organized business actions with clearly indirect and direct goal, constantly portfolio rebalance to lower the business cost and lock the profit to get the bottom line profit goal first and then extend the profit for business extension.

    ***
    Worst time for market as a whole and high quality of value which at the negative tail of the probability distribution are all I have to understand roughly right and use cash reserve to buy more for the calculated errors or affordable capital loss for my errors.

    It is the key to know buying the worst is not the goal but just the start! How to get the gut to avoid sell too soon is the most challenging part. I could not use the stop-loss since at the worst time any over paid share at significant size of capital could kill me! It has to be operations in the view of portfolio as a whole. Here it is necessary for me to understand the black swans comprehensibly and have to get the gut and knowledge to allow good black swans to drive some fishes into the sky!

    Has the current bear in XAO made the worst in a 12 months horizon? It seems XAO itself could not say anything about it. How far would EU be worse? How far US would be worse? How far would China be worse? Too many of us like to predict this or that in bubbles or at tipping points! I don't really care about these prediction since everyone could declare the sky would fall down!

    I did feel XAO when its price below 3800, was unable to be worse any more. It simply could not lead this world to go anywhere! Could we believe China is in the process to land softly? Could we believe US would issue more money to put its economy back to the slow but development track? Could we believe EU would keep it up/down in a acceptable range? I thought so but I want to buy some insurance if I was wrong! That is why I held the gold hopeful and try to get the cash reserve at normal level!

    Why did I feel so? I thought I know bargain hunters as a whole. They actually have surrendered in this sale on fire which happened between 2 August - 11 August. Damages have been done! Run panic in ruin? They just could not afford! Could we run under the rising Sun? The question should be answered after you could answer another question: do you believe the Sun would rise in 12 months? If the Sun rises, the genius and bums would celebrate the profit again. Could I hold my position for this new Sun rising? I really feel guilty for my business just because I allowed the cost run and the depletion of cash reserve, otherwise this financial year would be a very bright one!

    The goal strategically is to get no loss or fail safe to the portfolio as a whole. It should be a business which could resort a lot of trivial losses(but the total loss from them must be affordable) and several correct buying could generate vital profit which must be big enough!

    ***
    I know I have chosen a hard and turbulent way. It requires me to build the portfolios based on my own research and analysis about specific fish, market sentiment, and economic conditions. The advantages of this method are that I get to pick everything: where to shop, how much to spend, and when.

    It is important to understand that my success depends on my capabilities and knowledge of everything about my warrior service business. Likewise, my success in achieving solid business results is going to depend on my knowledge of markets and individual stocks.

    Doing it yourself means that the entire burden of putting together a high - quality portfolio falls on your shoulders, and you will have to monitor your portfolio closely. It is logical which is similar to that If you create a beautiful home but then fail to maintain it, you will get trouble sooner or later in your home!

    Between April - June, I failed to follow what I know and started to touch what I didn't know while I was ignorant and arrogant to believe I put everything under my control! A very time I was really stupid! It is not about the knowledge and information but how difficult we could be rational when the market is hot or cold!
     
    Last edited by a moderator: 25th Aug, 2011
  9. wdongli

    wdongli Well-Known Member

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    Learn to love the blood flows in the market!

    One thing is sure that "blood flows when entire flock gets in a flap." Another thing is sure that suddenly our irrational bouts of surging optimism and reckless spending suddenly displaced by an overwhelming sense of dread and recrimination, sparking an immediate austerity drive where everything is offloaded at fire sale prices. I could allow myself to be idiotic when my mind was hot but I could not let my mind frozen by the cold market sentiment!

    We all tend to be hysteric when we face some extreme cases. The mass mass hysteria has sent emotions oscillating almost daily, with dramatic reversals of fortune in either direction. People now just warn each other we are moving into September and October, that cursed time when things really tend to turn ugly. XAO have begun to take wild swings since May, which resulted in XAO claim GFCII price, below 3900 with overly large rises or falls nearly every day.

    However I work very hard to make my mind clear. I do believe somethings are prepared by the market to fight against the run of trade in extremes. If the trend goes too far it would swing back in the momentum which would surprise everyone again. How could market allow every traders with the great information and systems just be rich to follow some simple patterns?

    ***
    Do you know Citi analyst Nick Morton, who has constructed an ''Earnings Surprise Model for Australia'':

    1. The global macro forces have created volatile trading conditions and dragged the broader indices lower,
    2. Then there has been a notable increase in stock-specific volatility, where individual companies have come under attack.

    So the big boys have given up any value concerns but have locked them in some trading strategies based on the outlook statements for many of our top corporates.

    These big boys have been madly selling anything with a faint whiff of uncertainty while simultaneously piling into those reporting even slightly better than expected results or those holding out a glimmer of hope.

    The retail market players could not sustain the wild swings, so that they stampeded out to the exit. In the whips of sale on fire now all just want to get out if they could sell than their minimum acceptable selling price.

    Could they do so for 6 months, 12 months, or years? When XAO has been sold systematically all of these big or little boys would be the losers if they fail to catch the turning point!

    ***
    Who can exactly predict the future? It seems no one is predicting the sky falling down. All of big boys are reluctant to or simply could not provide any guidance for the year ahead, not entirely unreasonable given the outlook for the US, European, Japanese, Chinese, and the global economies. That scares all in the market who just cry for the tip-off every day. So we saw XAO led the world in price to the GFC II.

    That hair-trigger temperament is likely to continue for quite some time. I will sell if anything in my portfolio spike up too much and buy more dogs which have been discounted but have not the chances to recover! However I would keep the total capital in my portfolio intact. If I could lower the cost I should do but I should not sell in panic and on fire!

    What market as a whole think about?

    A survey, which has been tracking shareholder confidence for two years and which has become a reliable leading indicator, suggests investors expect shares to remain weak for months.

    Could the herd be right? In short term such as months, it could be but don't throw the value, if you believe it has been greatly discounted, on the fire!
     
    Last edited by a moderator: 25th Aug, 2011
  10. wdongli

    wdongli Well-Known Member

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    It should be remembered!

    As a full time market student or business man, you should never forget:

    1. Know yourself and be realistic about your strengths and limitations in using investment tools.
    2. Make sure you would be the right person who could use the right tools for the specific market business task at hand.

    We tend to be over general to tell us what we should do. It is fine when you think strategically but it is not enough to win in the market. Don't tell yourself you should be businesslike people in the market only, which is just a start point. You have to put your efforts, time, and full commitment to be a businesslike people.

    It is perfect right we have to be organized, disciplined, analytical, and self-reliant. However if we don't know how to change our behavior for this perfect personality, we would doom to fail in the market!

    ***
    In the end, one of the most important determinants of how you invest boils down to whether you are structuring the asset allocation or whether someone else is doing it for you.

    To me I choose to do all by myself since it is my weakest part in social type of matters. So that I need to devote considerable effort to

    1. act with integrity and responsibility for my own interests,
    2. devote considerable effort and resources toward structuring and executing an appropriate and successful asset allocation for myself, and
    3. be as vigilant as I should be in all respects, from the size of my portfolio to expenses to my changing circumstances over time.

    I have won over myself with knowledge and wisdom, and act based on the correct understanding of the market reality!
     
  11. wdongli

    wdongli Well-Known Member

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    What can be learnt from Steve Jobs?

    Steve Jobs is one of the greatest CEO of his generation and maybe the greatest of any generation. He has transformed that company from near death to the word’s most valuable, at least by some measures. It is understandable how market would worry about the future of Apple. To me I do wonder what lessons I could get from this dramatic change.

    In the past decade and a half, Jobs has created a management template that so few leaders follow. What this management template could be used for our warrior service business?

    1. He axed all the company’s loss-making sidelines.
    2. He cut out all the noise and distraction.
    3. He focused the company on what it did best.
    4. He did one big thing at a time — iMac, then iPod, then iPhone, then iPad.
    5. And he made sure they did it right.
    6. A total focus on excellence in execution.
    7. Nothing flawed. Nothing second-rate.

    What I did in the market? Still don't know things in the market in strategy. Still be distracted by the noises and random signals. Still be in the learning curve. Still try to find excuses for me to be sure I could do my market job in right. Fortunately I want to do one thing at a time. I want to focus on excellence in execution.

    Market playing should be simple really! Do what you want, do what you want best, and do it right! Like most of retail market players, I spend half my time stunned at the incompetence I encounter every day in my daily life, and the other half wondering how a parade of mediocre professionals keep their jobs.

    What Jobs has achieved isn’t impossible. Why don’t nearly all do it?

    Could I make the profit, never lose the profit if it is big enough, and allocate the capital properly for the profit? If I could do so why should I stop loss!