Pursuing Geometric or Arithmetic Returns

Hi,

I'm a newbie to this forum, so if this is in the wrong place just shoot me a DM and I'll change the forum.

Based on my understanding arithmetic return is higher than geometric return once the level of leverage rises above such a level that ruin would occur in a single trade using a geometric approach. Therefore, leverage must be constrained below such a level to trade using a geometric approach, while leverage can rise above this level using an arithmetic approach.

Based on this, would it not be preferable to trade using an arithmetic approach if you have access to such a level of leverage?

To clarify:
Arithmetic approach - Not reinvesting profits/losses, making every trade using the same sum of capital.
Compound approach - Reinvesting profits/losses.

Thanks in advance for any responses.

Kind regards,
TypingDog.

 

welcome to InvestChat ,

first off, if it is the wrong place the moderator NORMALLY will move it to a better place ( especially since your post is polite )

now i don't use leverage ( have a margin loan ) and probably don't qualify now that i am on a pension , but in 2011 i would have

using leverage as i understand it incurs some extra costs ( like having a drawdown facility at a back , even if you don'r borrow anything there are still some costs involved having it unused

next do you understand the DANGERS of leverage ( a buddy has a margin loan , and he has has some exciting moments some for the dumbest of reasons , like the market dropping on the same day as the internet is stressed ,)

leverage is great when it is working FOR you , but it can have a nasty temper tantrum ( actually it is the lender having a panic attack )

in the share market i consider myself an investor ( think in long term holdings ) so prefer the compond approach

however in younger days i was a gambler ( on the race-tracks , mostly ) ( very short term )

so stuck to the Arithmetic approach ( in fact the winnings went into a money belt and were not even counted until i was at home at the end of the day ) ( out of sight , out of mind philosophy

what i DIDN'T do was make the same bet every time , i sized my bet ( investment ) on the expected return AND the probabilty of success of that bet

so a small bet on a 200/1 chance , a modest sum on a 10/1 chance and NO bet if the value wasn't there ( even if it was 'an absolute certainty ' )

of course this is an untraditional approach ( which sometimes annoyed the bookmakers )

take care and good luck

in gambling ( trading to you ) i found strict self-discipline was a big asset .

 

Duly noted, thank you.

I have carefully considered the consequences of leverage, having run a comprehensive backtest and forward test to assess its impact.

I'm leaning towards an arithmetic approach as well.

I'm intrigued by your sizing approach, how do you asset the probability of success? What philosophy/theory is your approach based on? (I'm currently using the Kelly criterion)

 

i am not sure i am the best person to ask about sizing given my history ( from contrarian gambler to contrarion investor )

ALSO given the recent RC into banks and insurers , what SHOULD have been 'safe but boring investments , now are much less so

since you are new here a brief biy of my history

until very late 2010 i never though about investing or retiring ( i lived one work shift at a time and as long as i could pay my bills promptly ( i am not the credit card type ) all was good

in 2010 i inherited some money ( and some shares ) enough cash to do something incredibly stupid ( which would have surprised none of my friends ) or enough to use as a base for an income stream when i retired ( 2020 ) , i chose the second option BUT took a big breath and put some thinking into what i wanted to achieve and how to learn to do it ( a BIG difference between a 3 minute horse race and a 10 year share position ) but i DID understand RISK and reward ,

so in the beginning of 2011 i worked out 2 mandates ,
1. i had to virtually DOUBLE my portfolio value ( to yield the required income after 2020 NOT sell out and buy a beach house )

2. AND not lose the money inherited

so i had to create an 'instant retirement income fund ' from scratch to be functional in 9 or 10 years

so i had to take EXTRA risk , but not excessive risk but learn investing strategies and companies on the way

so i decided baby-steps at first (small buys , ) but not always different companies bought

for example i bought VAS 3 times in the same week ( 2 in the same day ) as the market slid and slid ,

but i need $$value grow ( within 9 years ) my pick for that was MQG which slid as low as $20 but in my view would triple in share price ( above $60 by 2020 .). if only all my inaccurate guesses were like that 100% wrong but in a good way

BUT i was buying smallish parcels ( normally under $5000 ) but again and again as value appeared ( i was still working irregular shifts at the time so many orders were guesswork put in early morning ( before even the US markets had closed )

but while i was buying i ALSO kept an eye on the porfolio balance you can't have MQG as your largest holding and think you have an investment portfolio

but it is currently , despite selling down 66% of the holding ( the very large holding of WOW i inherited made one bad choice too many so i sold most of the holding

so now it iis
1. MQG

2 cash ( the proceeds of the WOW selldown that i have parked sensibly

3. BHP ( where a LOT of the MQG profits were parked )

and about another 200 shares , LICs REITs and ETFs ( and by the end or April NO hybrids or bonds )

i use the 'comfort ' measure in holding sizing ( is the holding so big it will disrupt my sleep , SERIOUSLY ) the best example of that ( but not the only one ) was a dabble in a tiny bio-tach/IT stock PME now i bought that @ 16.5c a share and despite being over-valued to blazes on historical earnings just rose and rose , so every now and then i would take some profit off the table until i had sold 95% of the holding ...... PME is my 8th largest holding ( or 7th if you don't count the cash ) as at February 1st this year

had i NOT sold down PME ( or MQG for that matter ) they would have dwarfed the other holdings there are not many shares i would be comfortable with if more than 10% ( by $value ) of the portfolio value ( and MQG or PME are not among those shares , BHP probably but it will have to grow more to get there )

when buying shares i normally like to buy small ( parcels less than $5K ) and often i( itf the price is good )

HOWEVER one error i DID make ( in my opinion ) in my 8 parcels of MQG as it slid lower and lower was i bought a set number of shares every time ( the same number ) i would have been better buying indentical $values ( say , $5K every buy ) but it was my first year in shares ..i have made worse mistakes since , and probably will make more mistakes in coming years

cheers

 

Wow, that's quite a write up. Thank you for taking the time.

That's an incredible history, I'm glad you've been able to grow and progress. I see I have a lot to learn.

 

but question everything you learn , that tiny difference on how you apply the knowledge can make a big difference ( in either direction ) and there are plenty of areas i have avoided that might be awesome for you and your time-frame .

a plan and what you need to accomplish are BIG steps forward ( imo) a bit like going to primary school with a career firmly in your focus knowing what you want and learning how to get there .

another hint is to go back and ask yourself could you have done it better ( even when successful )

not bash yourself up over it but learn from good moves , and the bad ones and the moves you didn't make ( but could have )

these are VERY interesting times to start learning in

good luck