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MANAGING RISK

Jeff Saut’s weekly letter has some excellent insights on the oft overlooked world of risk management:

Well, perhaps the best way is to emulate some of the trading principles used by the pundits of yesteryear who beat the stock market no matter the emotions and mechanics of the institutional herd. For instance:

Bernard Baruch – Some 70 years ago, he would research a stock, buy it, and then each time the stock rose 10% from his purchase price, buy an additional amount equal to his first purchase. If the stock began declining he would sell everything he had bought when the drop equaled 10% of its top price …

Baron Rothschild – His success formula was centered on the famous quote attributed to him – “I never buy at the bottom and I always sell too soon.” …

Jesse Livermore – This legendary speculator profited enormously by calling the various 1921 – 1927 advances correctly. In 1929 he reasoned that the market was overvalued, but finally gave up and became bullish near the top in the fall of that infamous year.

He quickly cut his losses, however, and switched to the “short side.” Livermore listed three major points for his success:

1. Sensitivity to mob psychology

2. Willingness to take a loss

3. Liquidity, meaning that stock positions should not be taken that cannot be sold in 15 minutes “At the market” …

Addison Cammack – A stockbroker from Kentucky who swore by the two-point stop-loss rule. “If you’re wrong,” he said, “you might as well be wrong by two points as ten.” He followed this method successfully and was one of the few bears to make a fortune on Wall Street and keep it …

Interestingly, all of these disciplines have one thing in common. They all adhere to Benjamin Graham’s mantra, “The essence of portfolio management is the management of RISKS, not the management of RETURNS. Well-managed portfolios start with this precept.”

Managing the “risk;” what a novel concept, but unpracticed by many investors. To be sure, typically when portfolio values start to erode investors seem to chant, “It’s time in the market not timing the market; or, it’s a strategic not a tactical strategy.” Such mantras cost S&P 500 index investors more than 50% in portfolio value from the October 2007 high into the March 2009 low. However, if that same index investor “listened” to the cautionary signals the stock market was flashing in November 2007, and hedged that “long” index portfolio for the downside, the loss would have been less than 10%.

Source: Raymond James

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