Can a trading strategy ever be considered Foolish?
As a prolific user of non-Foolish tools like stop orders and spread bets, you might be a little surprised to find me writing here. But I believe that these 'trading' tools are not all that incompatible with the Foolish philosophy.
You might also be surprised to learn that I managed to generate a return of 3,000% last year using such methods. More on that later.
How I invest
Like all good Fools, I believe in:
- taking control of your own financial destiny;
- diversification;
- buying undervalued dividend-paying stocks with long-term potential;
- holding investments for as long as possible; and
- putting some money where my mouth is by running a real portfolio using real money.
There are some caveats, of course.
My take on diversification is to establish a large number of embryonic candidate positions over a period of time, rather than diversifying all at once into a (hopefully) perfectly correlated collection of assets that rise and fall for no net gain.
In addition, my value calculation is more likely to be based on a big fall on a price chart than it is to be based on an attractive P/E or PEG ratio. And my ideal holding period is "forever", just like Warren Buffett, but I regard this only as an 'ideal'.
What's a long-term investment?
You are probably aware of the phrase: "A long-term investment is a short-term trade gone wrong!"
It refers to our natural tendency to hold on to an initially poorly performing investment in the hope that it eventually recovers.
My approach to trading-cum-investing turns that phrase on its head. This results in my position trading mantra of "a long-term investment is a short-term trade gone well".
If any of my diverse embryonic positions perform badly, I'm not shy of letting them go with a little help from my stop orders -- just like a trader. But the ones that perform well get to stay in my portfolio for as long as possible, maybe even 'forever', attracting more of my funds and dividends as they go -- just like an investor.
In a nutshell, my approach to 'buying and holding' is to buy like a Trader and hold like an Investor.
On stop orders
What sets me apart from most people around these parts is my use of stop orders.
Stop orders are essential in a leveraged portfolio, so that you can exit a losing position before a 20% loss (assuming 5x leverage) becomes a total wipe-out.
But if the price of my investment rises, then so does the price at which I place my stop order. This allows me to lock-in accrued profits without crystallising those profits prematurely by selling out too soon.
Does it work?
I'll admit that it works rather better in a spread betting account than it does in a regular share dealing account, because there are no fixed transaction charges to overcome by making necessarily large initial investments, and because the leverage helps me to make big gains from small stakes.
Since 'going public' last year, the good news is that in the bull market of 2009 I generated an embarrassingly high return of 3,000% in a modest spread betting account.
The bad news is that subsequently in 2010 I drew down by a maximum of 75% at the worst point, and my draw-down is currently sitting at around 50%. That's minus 50%, so I'd need to double my money just to break even this year! In contrast, the UK market is up 8% this year including dividends.
My own equity curve traces a roller coaster ride, too scary for widows or orphans or those looking for a wealth preservation strategy. But it turns out that fortune has favoured the brave, mainly because I wasn't half as brave as I just made out.
Having taken a meagre £600 up to the relatively impressive £18,000 last year, I didn't then presume to be able achieve another 3,000% increase this year. I re-staked only £1,500 of my original 'winnings', and it's a good thing too, because in doing so I suffered an actual worst case draw-down of only £1,000 (which was a mere 5.5% decline in my accumulated fund).
I wasn't greedy, and I didn't need to be, because this is all about making big gains from small stakes rather than making modest gains on big investments.
Making it more Foolish
My main reason for writing here is to show that spread bets and stop orders need not be the preserve of index- and commodity- traders looking for quick daily profits. It is possible to combine some Foolish and non-Foolish ideas in order to establish and maintain a long-term diverse equity portfolio... with leverage.
The most exciting part is that I believe my results have merely been the result of sound money- and risk- management, rather than clever stock picking.
Imagine what might happen if I incorporated even more Foolish principles, so as to identify the best prospect undervalued dividend-yielding stocks in the first place!
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