If you want to explode your portfolio returns a way of doing this is by learning how to ride stocks that are on the big momentum waves but doing it in a very unemotional and controlled environment. This will help you maximise the trend potential.
A simple and naturally occurring analogy is that of an ocean wave that breaks and subsides. You jump on (enter) the wave when it breaks, ride it as long and hard as you can, and get off (exit) before it subsides. That’s fun and very satisfying.
Explosive trends have mesmerised and taunted investors for years as stocks propel themselves ever higher. Getting on them and off them at the right time is the tricky bit. The perceived safety of diversification to try and capture these stocks is a fall-back strategy that only ever really generates average returns primarily because the losers drag the strategy back to average. Don’t lose heart, let’s now focus on the big winners.
Research completed on ‘wave’ trading over a 16-year period has exposed an interesting if not confronting outcome. Using a methodology of ‘conviction’ portfolios‘ that focus on a smaller set of stocks has provided superior results.
How do you find them, how do you run with them, and when do you get out of them before they turn nasty, so you keep those hard-earned profits? For this conundrum I offer a solution.
There are periods when stocks bloom and in characteristic fashion they surprise us all. Stocks propelled by perceptions of what might happen in the future nearly always exceed our expectations because humans can and will believe almost anything.
This period of euphoria rarely lasts however, and like a wave that breaks, it runs, but then it (always) subsides. The same effect repeats itself.
That period of excessive price euphoria, or momentum, is our target. To use our emotionally driven minds is rarely the best way to capture these stocks and in reality, a robot could do better given some basic trading rules. So, let’s test that theory.
Real examples: ALU more than doubled its price in 2017/18, A2M nearly quadrupled its price in the 15 months to April 2018. And more recently FMG increased 59% from Jan 2019 to March 2019. Annualised out that’s about a 240% return. These are big rallies which have all been robotically controlled with ‘break out and catch the wave’ entry techniques and money management exits.
There are examples across the market of this type of stock behaviour as stocks blow the valuations out of the water and capture our minds. I don’t profess that we can get all of them and we don’t need to – just some. This process is also not without periods of adjustment as no system is perfect but over time the accumulated profits have more than compensated for this. See Graph B below
The strategy used for this type of stock selection is driven by systematic process driven analysis to enter a position, while the exiting of position is executed and controlled purely by a risk management process. It is robotic of nature. i.e., if this happens, I do that, and if that happens, I do this. This is a systematic methodology that helps us more efficiently capture the major portion of excessive price moves.
That’s a good thing because emotional tradingthat occurs during market surges often doesn’t exit the market as a good risk management process must. The ‘hang on it’ll get better’ disease has no cure. You have to change your ways!
This process plays a numbers game of selection which quickly discards the weak and runs with the strong. Based on basic rules of investing that follows a process, and then testing various portfolio sizes i.e. number of stocks held, based on trading signals over a period of 16 years, it reveals that smaller conviction portfolios do this best because we place bigger bets on the winners. As our bias is always to winners this approach magnifies that effect.
I have tested various portfolio sizes over various market capitalisation groups from the top 200 ASX stocks with a selected 100 stock group yielding the optimum results. The results vary but the best come from the smaller conviction portfolios of just 5 stocks. See graph below based on a top 100 selected group and a smaller midcap 50 group.
Or to look at the top performing 5 stock portfolio based on the Top 100 universe another way:
Graph B: benefits from the compounding effect
So rather than trimming the edges of mistakes as a diversified portfolio does it seems it also trims the edges of the winners by spreading the risk too far. What we want to do is leverage the winners by placing bigger bets on them and riding them hard, but at the same time not losing the objective of still keeping capital safe.
What are your thoughts on how best to manage and run a portfolio of stocks?
The majority of stocks underperform the index – fact. They provide average returns and by holding them put a drag on portfolio results and this is primarily what index managers do. As stocks go higher, be it miners or banks, their large market capitalisation dominates index moves and masks the lower capitalised big performers. It also means index fund managers need to hold more of these big stocks in your fund, and when they eventually go down, which they always do, you go with it. This aspect of index fund management needs to be properly addressed because it causes unnecessary capital decimation and means they follow indices down and miss the big moves by being underweight lower capitalised top performing stocks. Why the obsession with the index?
The attraction and challenge of the stock market is the lure of the dollar and the stocks that offer these riches. Some investors have found a way to capture and ride these profitable waves. Stockradar’s methodology of selection and stock management quickly discards the weak and runs with the powerful.
https://stockradar.com.au/wp-content/uploads/2019/05/EXPLOSION.png7201080Richard Lie/wp-content/uploads/2018/03/logo.pngRichard Lie2019-05-22 17:13:492019-07-08 16:52:24Exploding myths and your portfolio returns
https://stockradar.com.au/wp-content/uploads/2019/04/puzzle-1487340__340.png7281028Richard Lie/wp-content/uploads/2018/03/logo.pngRichard Lie2019-04-01 15:40:112019-07-08 17:02:26The Price and Volume relationship is fundamental to price analysis
A share price is at the mercy of market sentiment and investors are often affected very much in their decision making by such emotions as anchor bias, and other such like confirmation, information, loss aversion and hindsight biases.
Definitions of these are readily available on the web and are recurrent examples of why investors make trading or investing mistakes and I discuss this in my YouTube videoMy 5 top tips for success on the stock market.
So, using the example of PGH above I would think now many previous investors are somewhat shy (anchor bias) of investing back into PGH. Righty so maybe but you might remember the ‘emoji guide to investing I showed in last week’s Radar Newsletter (25/1/19) demonstrating the fact that the key to consistently successful investing is to be poised and maintain a balanced perspective no matter what the market is doing.
Looking through the haze
Right now, PGH investors are suffering but realistically having halved in price back to its initial starting price at listing and is now showing potential demand at this support level the stock must go on the radar again of starting to look valuable and having to potentialfor a turn back up. Not that I want a long-term investment because that’s not how I play the stock market, but these points can often be scrambling points when a change of sentiment can take hold and trigger all sorts of portfolio rebalances, short position exits and fresh ‘value’ buying etc. Looking at the stocks afresh with clarity and perspective can be hard because of our biases but that’s what we need to be able to do.
Focus on your own style
My style of trading and investing is looking for those types of investor changes that can trigger sharp price moves and new trends to capitalise on. PGH and many other stocks are currently in this position and over coming weeks I will point you to a few of these opportunities that this falling market has now delivered.
Bull or Bear?
Whether the ASX/200 rises of falls from here is to a large degree irrelevant when assessing individual stock performances. Yes, a rising market offers more opportunities and a falling market less, but still opportunities always arise in any market and this one is no different. Are we in a correction phase or beginning a new wave higher? That is always the eternal question. Don’t even try and answer it because you can’t and it’s simply a major distraction. Keeping a clear head is vital.
How to play it
Smart stock investors always remain poised and have the ability to have good perspective without biases and emotions. This will help your success rate immeasurably.
https://stockradar.com.au/wp-content/uploads/2019/02/bias1-1.png8001028Richard Lie/wp-content/uploads/2018/03/logo.pngRichard Lie2019-02-14 14:44:402019-07-08 17:20:59Biases, Perceptions and Poise.
https://stockradar.com.au/wp-content/uploads/2019/02/cool.png8281028Richard Lie/wp-content/uploads/2018/03/logo.pngRichard Lie2019-02-05 15:13:122019-07-08 17:23:18Sharpening your trading and investing psyche