Tag Archive | risk

Even Advisors are promoting better Risk Management – Down Markets Matter!

SmartStops comment:  We couldn’t agree more!  It is exactly why we brought this service to the marketplace.

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http://www.onwallstreet.com/video/?id=2679576&page=1

Look at the money protected by SmartStops recently on AAPL, CMG, NFLX etc.

Nowhere to Run: The Correlation Bubble

SmartStops Comment:: Indeed, Beta and correlation approaches are not enough to manage risk in today’s markets. However we have somewhere for you to run – to intelligent self-adjusting risk methodologies that the SmartStops optimization engine offers.

Originally published at Seeking Alpha: http://seekingalpha.com/article/815851-nowhere-to-run-the-correlation-bubble

Fundamental analysis of “buy and hold” companies is a quaint, Warren Buffetish notion that probably works in the long term. But as Keynes said, in the long term we’re all dead. The big risk in today’s über-correlated markets is systemic shock. One can practice due diligence on a company and buy at a reasonable valuation, but if global markets collapse the next day and don’t recover for years, one has paid a lot in opportunity cost. In other words, tail risk is not reflected in fundamental analysis.

Fundamental analysis is valuable so long as the basic fabric of capital markets remains intact. In an insane world (where U.S. Treasuries and German Bunds are considered “risk-free”, of infinite rehypothecation, where MF Global’s John Corzine walks off with $200M segregated assets, of the London Whale, LIBOR, Goldman’s muppets, regulatory capture of SEC and Fed, U.S. / China animosity and the dollar’s loss of world reserve status) it’s unlikely that business-as-usual will continue without a disruptive bout of creative destruction.

Precisely when and how it will occur is anyone’s guess, but, unfortunately, old school techniques like cross-asset class and regional diversification have lost their glimmer. Just as socioeconomic disparity is partitioning the globe into lords and serfs, so too has the market been divided into polarized castes of highly correlated risk-on assets and (scarce few) risk-off havens.

Position Sizing: Key to Maximizing Returns

In a time when market volatility and equity preservation is of utmost importance, determining the correct number of shares to buy, or “position sizing”, is key to maximizing returns and minimizing risk.

The common investor generally doesn’t spend much time thinking about how many shares to buy or how significant of a position to take.  Instead, most investors use a common methodology of trading the same number of shares each time, which usually translates to a specific dollar amount.  Other, more sophisticated investors, opt to allocate a certain percentage of their portfolio value to a specific position. Following this train of thought, a new position in a portfolio of $100,000 would transcribe either a $10,000, or 10%, investment or a usual position of 50 shares.

Although these methods may work for some, using the volatility of a specific portfolio is likely to be the most effective decision tool.  Measuring a portfolio’s overall volatility enables an investor to decide on what percentage of that portfolio he is willing to risk losing on the new position.  This methodology is better explained through the following example. Read More…

A New Risk Indicator To Sidestep Market Downturns: Is It Better Than VIX?

By Chris Georgopoulos, originally published on 11/14/11

Without question the most popular model to predict market crashes is the VIX, commonly referred to as the “Fear Gauge,” a market index that measures the implied volatility of the S&P 500 index options. Its concept is quite simple, when the uncertainty and fear among investors rises, they commonly run to the S&P 500 options to either hedge or speculate. The increased interest in the options usually leads to higher premiums and as the premiums increase so does the VIX. However, predicting the future isn’t 100% accurate, most of the time it’s not even close. Every forecasting model has its flaws and the VIX is not an exception. There are many problems skeptics have found with the VIX such as; its population study is limited to only the 500 stocks of the S&P 500 and” {the} model is similar to that of plain-vanilla measures, such as simple past volatility” (Wikipedia). A blog post on sensibleinvestments.com summarized the VIX as “simply an indicator of actual volatility in the market but one that is very sensitive to changes in actual volatility particularly if it is on the downside.” Is there a better way?

An elementary statistics theory states that the larger the population size, the greater the likelihood that the sample will be represented. If markets are graded by the performance of popular indexes such as the S&P 500, why limit a forecasting model’s population to only 500 stocks? The economy has become global; interactions from every corner of the world’s businesses affect every other business. If there is a model that forecasts market direction, should it limit itself to just the largest companies? As for only using a month or two of short term option premiums to garner a prediction, as the VIX does, it seems to limit itself to only a single variable. Instead of short term options premiums and limited samples what if we could measure real-time individual stock trend alerts on thousands of domestic and foreign stocks and ETFs? Or simply what if we analyzed the micro components (every stock) to develop a macro forecast of the market based off trends and risk?

By studying the history of risk alerts from SmartStops.net, an intelligent risk management service, two proven alternatives to the VIX were found. SmartStops.net has developed their own proprietary risk model that monitors the trends and risks to over 4,000 of the most popular stocks and ETFs. If the risks grow on any individual investment SmartStops.net alert their subscribers with both long and short term exit triggers. However not only do these alerts help individual and institutional investors manage specific investment risk, the reviews of the alerts themselves have predictive capabilities. By back-testing every alert that SmartStops.net has issued from their inception versus the S&P 500 performance, there is proof of this and the results speak for themselves.


There have only been 7 days for which the amount of Long-Term Exit Triggers (stop alerts) as a percentage of every stock and ETF covered by SmartStops.net has been over 20%. The subsequent market action of the S&P 500 has averaged a negative return for the time periods of 1 week, 1 month, 3 months, 6 months and a year. The 6 month average return is over -7% and when examined from the absolute lows of the S&P 500, the returns average over -19%. If you remove the knee-jerk market reactions caused by “Flash Crash” on 5-6-2010, the returns are even lower.
Another metric offered by SmartStops.net is their SRBI(tm) (SmartStops Risk Barometer Index); this index measures the current percentage of stocks and ETFs that are in “Above Normal Risk” state (ANR) divided by the 100 day average above normal risk percent. By definition, a stock that is listed ANR experienced a risk alert as its last SmartStop alert identifying a downtrend. Conversely, a stock that is listed in a “Normal Risk State” experienced a reentry alert as its last SmartStop alert indicating trading strength and an upward trend. Back-testing historical SRBI data since inception shows that the repercussions to the market when the percentage of downtrends increases to over 40% of all stocks and ETFs covered are profound. Below you will see that there have been only five occasions where this has happened. In each case the S&P returns for the following year were all negative.

Is this a better way?

Before a concrete conclusion can be determined, the predictive capabilities of the VIX must also be analyzed. Read More…

NETFLIX Investors – Did you Protect Yourself?

NETFLIX , NFLX, drops but SmartStops keeps investors and traders from major losses.

This is why Risk Management and Protection are a must in every investor and trader’s arsenal.   SmartStops triggered its short-term protection for Netflix at $74.13 at 9:32AM.  NFLX closes at $60.28 today, 7/25/12.

In the most recent Netflix downtrend SmartStops saved its clients  $42.46 per share!  

See chart at: http://www.smartstops.net/PublicPages/SmartStopsOnDemand.aspx?symbol=NFLX

 

In Defense of Market Timing – a study that will shock you!

SmartStops comment :  As we dig up other studies we’ll add to article.  

Missing Best and Worst Days in Stock Market 1984-1998

 The article was originally published in 2008.    

SmartStops  comment  on 08/4/11:    Markets have dropped 9% in last nine days with the whole debt ceiling “show” going on in U.S.  government.   Do you think you needed to have given back your gains?   Think again!

Market timing is the art of making investment decisions using indicators and strategies to observe and determine the direction of prices. Many believe that market timing involves predicting the future, when in reality, the goal of market timing is to participate in periods of price strength and avoid periods of price weakness.

The general investing public has been told that market timing is a high risk proposition. Most of what has been written about the topic focuses on its failure and the risk investors take when trying to time the market. A typical study focuses only on the negative consequences of missing a few particular up days in the market – calculating the negative financial impact of missing those days and concluding that attempting to time the market is foolish. The biggest fallacy with these studies is    Read More…

Chicken or Egg? Risk Tolerance as a Driver of Financial Success

SmartStops would like to draw your attention to this article’s statement:    Overall, by taking more risk Bill can expect to be significantly better off.    As SmartStops will remind you, you can take on more risk by ensuring there is constant active oversight for it.  See other articles on that subject.   

 published originally at:  Advisor One by Geoff Davey, FinaMetrica

Many studies have shown that risk tolerance correlates positively with income and wealth. The correlations are not strong, usually around 0.3, but they seem to be universal.

There is a temptation to think that higher income and/or higher wealth lead to higher risk tolerance. However, there is always a danger in trying to read a cause and effect relationship into a correlation. To know for sure we would need to conduct a longitudinal study measuring risk tolerance, income and wealth as we went along.

Failing that, we can conduct a thought experiment. Suppose that Bill and Bob have different appetites for risk. Presented with a choice between taking a certain $100 and a 50/50 gamble of winning $0 or $X, Bill will take the gamble when X is $250 but Bob won’t take the gamble until it reaches $300. Looking at any single $250 gamble choice, Bill has a 50% chance of being no worse off than Bill.  However, if Bill and Bob are presented with a series of such choices, the longer the series runs the more certain it is that Bill will finish up better off than Bob. With a series of 10, Bill has an 83% chance of being no worse off than Bob and by the time we get to a series of 100 that chance has increased to 98%.  Over 10 choices, Bill will finish with $1,000 but Bob could expect to have $1,250, though he may have nothing or $2500.

Now suppose that Bill and Bob both started with a kitty of $1,000 and that rather than the choices being framed from a base of $100, they were framed from a base of 10% of the kitty at the time. For 10 choices, Bob’s kitty grows to $2,593 but Bill’s grows to an expected average of $3,260 and 62% of the time will be greater than $2,590. At worst Bill will have $1,000 and at best $9,300.

Overall, by taking more risk Bill can expect to be significantly better off.

So how does this relate to real life? Clearly, life’s choices are rarely as simple as in our example and rather than a series of identical choices we face a series of mainly different choices where there are usually more than two alternatives—and those alternatives will often include the possibility of losses. Further, the range of outcomes is often not clear and they must be estimated rather than calculated. Finally, we may make cognitive errors in assessing the situation and in identifying and evaluating the alternatives.

As we know from experience, risky choices take many forms and occur in different contexts including employment, borrowing, insurance and investment. For the riskier alternatives to be considered there would be a commensurately greater expected reward, but this will come with the possibility of an unfavorable outcome. The more risk tolerant amongst us will need less of an incentive to take the riskier alternatives. If we continue that pattern over time, all other things being equal, we should finish up better off.

So my hypothesis is that risk tolerance is a driver of financial success rather than the converse.

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