Time to Revisit Portfolio Risk Management
Time to Revisit Portfolio Risk Management
In 2007, I wrote about the importance of managing risk within your investment portfolio. When considering what investors have gone through over the past 18 months it seems appropriate to revisit risk management as a component of a sound portfolio. While I have always been a student of "what can go wrong with an investment,' in my dealings with investors, this question is often an overlooked consideration. Candidly, I blame my industry for this as we have propagated the commonly held beliefs that you should "be in it for the long haul" and that the markets simply go up over time. While the former statement is true in the sense that monies you commit to the capital markets should be long-term in nature due to the inherent volatility of markets and the latter statement is historically true in that the markets have gone up over time (although this is not guaranteed to continue in the future), it is worth considering how to protect your portfolio when things go wrong.
In my previous column I suggested that, at the core, markets are driven by supply and demand. This is to say, when there are more buyers than there are sellers, the price of stocks will go up. Conversely, when there are more sellers than there are buyers, the price will go down. At its root, the market is driven by Economics 101: supply and demand. If you can subscribe to this premise, then it suddenly begins to make sense why it's possible to own a company that has a strong balance sheet, good earnings, high profit margins and a defendable product niche, yet the stock goes down in value. On the surface, from an intellectual standpoint, it simply makes no sense for a good company to go down in price. We've all found ourselves asking the question, "this is a good company and their earnings are great, why is the stock going down?" The answer is simple, you may own a great company, yet at the current point in time you also own a bad (losing) stock. Again, if a good company goes down in price then you can conclude that there are more sellers than there are buyers. It's really that simple. Granted, there may be a multitude of reasons unrelated to the company that is causing people to sell the stock, however, the bottom line remains that there are more sellers than there are buyers. Thus, the stock declines in price.
So the million dollar question becomes how can an investor determine whether there are more buyers than there are sellers? While some investors rely on one or two supply/demand indicators, we all recognize that no indicator by itself is correct 100% of the time. With this in mind, it may make sense to create a series of indicators from multiple disciplines in order to attempt to determine which direction Wall Street is leaning at any given point in time. There are numerous disciplines - which are considered technical analysis tools - from which to analyze the current supply/demand dynamics in the capital markets. Further, some disciplines are more suited for an intermediate term market posture while others are best suited for a shorter-term stance. With respect to short-term indicators, they may be useful in determining entry and exit points on any given stock or pooled stock investment. The following is a list of some of the more popular technical indicators:
A. Bar Charts.
B. Point and Figure (PNF) - in particular of the New York Stock Exchange Bullish Percent Index.
C. Stochastics.
D. Moving Averages - simple and exponential moving averages.
E. Bollinger Bands.
F. Moving Average Convergence Divergence - commonly referred to as MACD or "Mac D".
G. Trendlines.
H. Relative Strength.
For a detailed description of these indicators simply search the Internet by the indicator's name or visit your local library.
No matter what form(s) of analysis you subscribe to your goal should be to find a methodology that provides a logical and organized way of recording the supply/demand relationship of any stock or pooled stock investment you own. Bear in mind, no methodology is the Holy Grail nor does any discipline offer a perfect Crystal Ball. However, what you can seek to achieve is a process by which you can potentially increase your odds of success and develop a discipline by which you can act upon when things go wrong - managing risk - with any particular investment you own. For as sure as day follows night, at some point things will go wrong (witness the Fall of 2008!) May I also suggest that if you currently work with an advisor (financial advisor, broker, insurance agent) that you inquire with them to determine what their discipline is with respect to managing risk.
As we enter the second half of 2009 now would be an excellent time to consider using some of the aforementioned indicators as well as reevaluating your investment game plan. Toward the goal of assisting you in developing a game plan, you might consider using mine as your template:
Step 1: Market Analysis - is the market conducive to growth of my capital?
Step 2: Sector Analysis - determine which sectors of the market are conducive to growth.
Step 3: Fundamental Research - review the fundamentals of any investment you are considering to answer the question of "what to buy."
Step 4: Technical Research (Indicators) - using fundamentally sound investments (Step 3) utilize your indicators to determine "when you should buy."
Step 5: Risk Management and Follow-up - constantly monitor your portfolio. Have a plan for when things go right and most importantly, have a plan if things go wrong.
As we know, nothing in the capital markets is ever certain - especially in the current environment - so it is critical that you and/or your advisor have an investment game plan that is well thought out and continually monitored. Good investing!
DOUGLAS J. ADLER, AAMS®, WMS
Senior Vice President, Investments
Raymond James & Associates
Member NYSE/SIPC
1400 Abbott Road, Suite 100
East Lansing, MI 48823
Office: 517.332.4081
http://WWW.DOUGADLER.COM
In 2007, I wrote about the importance of managing risk within your investment portfolio. When considering what investors have gone through over the past 18 months it seems appropriate to revisit risk management as a component of a sound portfolio. While I have always been a student of "what can go wrong with an investment,' in my dealings with investors, this question is often an overlooked consideration. Candidly, I blame my industry for this as we have propagated the commonly held beliefs that you should "be in it for the long haul" and that the markets simply go up over time. While the former statement is true in the sense that monies you commit to the capital markets should be long-term in nature due to the inherent volatility of markets and the latter statement is historically true in that the markets have gone up over time (although this is not guaranteed to continue in the future), it is worth considering how to protect your portfolio when things go wrong.
In my previous column I suggested that, at the core, markets are driven by supply and demand. This is to say, when there are more buyers than there are sellers, the price of stocks will go up. Conversely, when there are more sellers than there are buyers, the price will go down. At its root, the market is driven by Economics 101: supply and demand. If you can subscribe to this premise, then it suddenly begins to make sense why it's possible to own a company that has a strong balance sheet, good earnings, high profit margins and a defendable product niche, yet the stock goes down in value. On the surface, from an intellectual standpoint, it simply makes no sense for a good company to go down in price. We've all found ourselves asking the question, "this is a good company and their earnings are great, why is the stock going down?" The answer is simple, you may own a great company, yet at the current point in time you also own a bad (losing) stock. Again, if a good company goes down in price then you can conclude that there are more sellers than there are buyers. It's really that simple. Granted, there may be a multitude of reasons unrelated to the company that is causing people to sell the stock, however, the bottom line remains that there are more sellers than there are buyers. Thus, the stock declines in price.
So the million dollar question becomes how can an investor determine whether there are more buyers than there are sellers? While some investors rely on one or two supply/demand indicators, we all recognize that no indicator by itself is correct 100% of the time. With this in mind, it may make sense to create a series of indicators from multiple disciplines in order to attempt to determine which direction Wall Street is leaning at any given point in time. There are numerous disciplines - which are considered technical analysis tools - from which to analyze the current supply/demand dynamics in the capital markets. Further, some disciplines are more suited for an intermediate term market posture while others are best suited for a shorter-term stance. With respect to short-term indicators, they may be useful in determining entry and exit points on any given stock or pooled stock investment. The following is a list of some of the more popular technical indicators:
A. Bar Charts.
B. Point and Figure (PNF) - in particular of the New York Stock Exchange Bullish Percent Index.
C. Stochastics.
D. Moving Averages - simple and exponential moving averages.
E. Bollinger Bands.
F. Moving Average Convergence Divergence - commonly referred to as MACD or "Mac D".
G. Trendlines.
H. Relative Strength.
For a detailed description of these indicators simply search the Internet by the indicator's name or visit your local library.
No matter what form(s) of analysis you subscribe to your goal should be to find a methodology that provides a logical and organized way of recording the supply/demand relationship of any stock or pooled stock investment you own. Bear in mind, no methodology is the Holy Grail nor does any discipline offer a perfect Crystal Ball. However, what you can seek to achieve is a process by which you can potentially increase your odds of success and develop a discipline by which you can act upon when things go wrong - managing risk - with any particular investment you own. For as sure as day follows night, at some point things will go wrong (witness the Fall of 2008!) May I also suggest that if you currently work with an advisor (financial advisor, broker, insurance agent) that you inquire with them to determine what their discipline is with respect to managing risk.
As we enter the second half of 2009 now would be an excellent time to consider using some of the aforementioned indicators as well as reevaluating your investment game plan. Toward the goal of assisting you in developing a game plan, you might consider using mine as your template:
Step 1: Market Analysis - is the market conducive to growth of my capital?
Step 2: Sector Analysis - determine which sectors of the market are conducive to growth.
Step 3: Fundamental Research - review the fundamentals of any investment you are considering to answer the question of "what to buy."
Step 4: Technical Research (Indicators) - using fundamentally sound investments (Step 3) utilize your indicators to determine "when you should buy."
Step 5: Risk Management and Follow-up - constantly monitor your portfolio. Have a plan for when things go right and most importantly, have a plan if things go wrong.
As we know, nothing in the capital markets is ever certain - especially in the current environment - so it is critical that you and/or your advisor have an investment game plan that is well thought out and continually monitored. Good investing!
DOUGLAS J. ADLER, AAMS®, WMS
Senior Vice President, Investments
Raymond James & Associates
Member NYSE/SIPC
1400 Abbott Road, Suite 100
East Lansing, MI 48823
Office: 517.332.4081
http://WWW.DOUGADLER.COM
