Conquering the Seven Faces of Risk (eBook)

Automated Momentum Strategies that Avoid Bear Markets, Empower Fearless Retirement Planning

Scott M. Juds (Autor)

eBook Download: EPUB

2018 | 1. Auflage
258 Seiten
Bookbaby (Verlag)
978-1-5439-3170-9 (ISBN)

Infos

Risk is not a one-dimensional problem cured by a single dose of diversification. It's a multidimensional problem, and diversification's passive risk reduction is only just the start. At least since Markowitz developed Modern Portfolio Theory 65 years ago, risk has generally been measured as the standard deviation from average return. However, Behavioral Economics (and even the dictionary) say risk is really about the loss of value, which is quite different from volatility. Risk has at least seven unique faces, including (1) Single-Stock Risk, (2) Market Volatility, (3) Bear Market Crash, (4) Momentum Loss, (5) Backtesting Deception, (6) Strategy Hired/Fired Late, and (7) Retirement Savings Will Not Be Enough. The elephant in the room for the majority of people facing retirement is a serious retirement savings shortfall - which makes their most serious risk about earning sufficient returns. Fortunately, a Royal Society Fellow, a National Medal of Science winner, and a trio of Nobel Laureates have laid the foundation for active risk reduction and forever changed the game. This book intends to shake the very foundation of the sleepy momentum mono-culture that seems happily mired in decades-old, simplistic, risk models that not only fail to treat momentum as the multi-faceted problem it is, but also fail to consider fundamental signal processing methods (older than Modern Portfolio Theory) that reduce the 'random walk' part of the signal and improve the probability of making a better investment choice. The good news is two-fold: (1) the book's principles and methods are described in a manner most ordinary investors will easily grasp, and (2) while it is truly complicated under the hood (like my car), software tools make it easy to drive. So, buckle up, turn the page, and let's go for a ride!

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Risk is not a one-dimensional problem cured by a single dose of diversification. It's a multidimensional problem, and diversification's passive risk reduction is only just the start. At least since Markowitz developed Modern Portfolio Theory 65 years ago, risk has generally been measured as the standard deviation from average return. However, Behavioral Economics (and even the dictionary) say risk is really about the loss of value, which is quite different from volatility. Risk has at least seven unique faces, including (1) Single-Stock Risk, (2) Market Volatility, (3) Bear Market Crash, (4) Momentum Loss, (5) Backtesting Deception, (6) Strategy Hired/Fired Late, and (7) Retirement Savings Will Not Be Enough. The elephant in the room for the majority of people facing retirement is a serious retirement savings shortfall - which makes their most serious risk about earning sufficient returns. Fortunately, a Royal Society Fellow, a National Medal of Science winner, and a trio of Nobel Laureates have laid the foundation for active risk reduction and forever changed the game. This book intends to shake the very foundation of the sleepy momentum mono-culture that seems happily mired in decades-old, simplistic, risk models that not only fail to treat momentum as the multi-faceted problem it is, but also fail to consider fundamental signal processing methods (older than Modern Portfolio Theory) that reduce the "e;random walk"e; part of the signal and improve the probability of making a better investment choice. The good news is two-fold: (1) the book's principles and methods are described in a manner most ordinary investors will easily grasp, and (2) while it is truly complicated under the hood (like my car), software tools make it easy to drive. So, buckle up, turn the page, and let's go for a ride!

Textauszug

Introduction

“Necessity is the mother of invention.”

– Unknown

One time-proven stereotype of engineers is that they will likely first break off the knob before reading the instruction manual for a new piece of equipment. But the problem doesn’t stop there. The engineer also feels compelled to fix the knob before proceeding. It’s what they do. To me, there’s nothing strange about that. It’s precisely what spawned the development of SectorSurfer, AlphaDroid, and finally, this book.

Since failure drives necessity, and necessity drives innovation, one might ask: “What is the root cause of the failure that caused the necessity?” Although financial sufficiency during retirement years is one of the most important things to get right in life, there were no “Retirement Investment” classes offered in high school or in either of the two universities I attended. Planning 40 years into the future apparently isn’t as important as getting a job to support a family on an entry level salary. We’re left to figure out investing for ourselves – while attending the School of Hard Knocks. And, that leads me to the backstory….

In 1980, the small electro-optics company I worked for had no 401k plan and its profit-sharing plan, although interesting sounding, had no profits to share during my first 3 years of employment. In fact, because many felt it was counterproductive as a company benefit for either attracting or holding employees, some young, rogue, unnamed engineer who was newly being included in middle management, led a campaign to terminate the plan. In hindsight, it is likely that insufficient patience resulted in cutting off potential upside even though there never was a financial downside.

I eventually started my personal investment efforts in 1983 when I received a bonus check for $3,900. While it was burning a hole in my pocket, I resolved that it was high time that I start investing in something – but what? The business section of the newspaper seemed superficial, and of course, there was no Internet. So, off I went to the Seattle Public Library to research the problem and hopefully ensure a wise decision.

After reviewing numerous newsletters and piles of highly detailed Value Line stock analysis reports, I concluded that the field of possibilities must first be narrowed – and to me, that meant I had to decide what was going to be “the next big thing.” I quickly (naively) dismissed electronics and computers as already having had their great runs, thus leaving little chance for continued outperformance. However, emerging biotech companies were kicking butt and clearly had only scratched the surface. I quickly identified the three best performing/trending companies over the prior year: Amgen, Genentech, and Monoclonal Antibodies (later merged into Quidel), and opened a Merrill Lynch account. I stood proud of my astute investment process and decision.

I soon found myself obsessed with tracking them at least a few times a week. After about 6 months they seemed to be doing reasonably well – two were up a bit and the third was sinking a bit. Then one Sunday I took a cross-country flight to Atlanta for a business conference and couldn’t check their prices until late Wednesday. I was flabbergasted to find Monoclonal Antibodies had fallen from $24.00 per share to a paltry $2.40 per share in the space of 2 days. A primary patent of Monoclonal Antibodies had apparently been successfully invalidated by an adversarial heavy-weight drug company, which in turn crushed the company’s valuation. I immediately knew I had just completed my first investment course in the “School of Hard Knocks.”

Something had to change – I couldn’t possibly monitor the news for such events coming out of left field while holding a full-time professional job. Furthermore, the meaning of “single-stock risk” became clear and needed a solution. It seemed obvious that mutual funds were the answer. Not only do they inherently eliminate single-stock risk through broad diversification, but they are managed by full-time professionals who can look out for and handle such problems. Henceforth, it would be professionally managed mutual funds for me!

It wasn’t long before I found a copy of the annual Money Magazine listing of mutual funds and selecting a pair of the better performing funds seemed the obvious, smart, and responsible thing to do. Certainly, the mutual fund managers who proved their skills over the prior year or so were the guys to bet on for the coming year…a skilled craftsman is just not going to lose his skills, tools, and supply of good information very quickly. I selected the two best looking ones and split the value of the remaining biotech stocks between them. I could now confidently go on with life knowing I had nailed my retirement savings responsibility. Like clockwork, I added another $2,000 to my IRA every January and checked Money Magazine for the best two Merrill Lynch mutual funds and split the account funds between them. What could go wrong?

I vividly remember retrieving the annual report for my Merrill Lynch account from the mailbox in January of 1991. As I opened it on my way back to the house, I was thinking, “Hmm, contributing $2,000/year for 7 years would be $14,000 invested, and the account balance in the report says I have only $13,900.” Meanwhile, the S&P 500 had doubled over the same period. I would have been better off to put the money under my mattress! That was my second lesson from the School of Hard Knocks. Again, I had to change the game.

I read no shortage of newsletters. Each had great reasons why they were right, but there certainly was no consensus. I dutifully watched the CNBC talking heads. They managed to have eight simultaneous different opinions. In fact, it is their job to present all the possibilities and alternatives. There rarely is consensus, which means these guys are all just a soap opera. But, I admit that I enjoy watching them anyway.

It eventually occurred to me that my coffee mug really was right. “If the nation’s economists were laid end to end, they would point in all directions.” It took me years to realize that this is a fundamental truth about market equilibrium. If there were not an equal number of buyers and sellers pointing opposite directions, the market would quickly adjust to make it true.

I listened carefully to my financial advisor, who hypnotically repeated, “Diversify and Rebalance…Diversify and Rebalance.” To me, that sounds like “if I own a little bit of everything I could achieve precisely average performance? Average? Was that my goal? Would that make my mother proud?

With no apparent value in newsletters and talking heads, as a good engineer, I wondered, “What about the data? Does recent market data hold clues for future prices? In other words, “Do price trends exist?” I knew if I could get some data and do a few experiments I could answer this question.

In 1992 I bumped into one of the FastTrack ads in the Wall Street Journal and subscribed. I used it to export 3 years of data for 11 Fidelity mutual funds to this Quattro Spreadsheet from the good old DOS days. I set up a few equations and multiplier coefficients to calculate monthly trend correlations and used them to select the best fund to own for the next month. The years 1989, 1990, and 1991 were quite different from one another, so if there was any set of coefficients that produced good returns over all three years it would seem to be reasonable confirmation that trends exist in market data.

It was not difficult to find a set of coefficients for weighting recent past data that produced trend signals predictive of next month’s return. The experiment produced impressive returns – about 40% for all three years 1989, 1990, and 1991. I was pumped! It was clear that trends do exist in market data. A trend is the measured byproduct of the momentum something has – i.e., trends are caused by momentum. By its very definition, “trend” means that some property measured in the recent past will continue (at least to a degree) into the near future. Since future price movement is what we all want to know, extracting its trend from noisy market data becomes a top priority.

This was the defining moment in my life regarding how investment decisions should be made. Still, I knew this spreadsheet was too cumbersome for daily use and could never be a truly practical solution. Furthermore, I knew there were many other popular indicator algorithms that I would have to evaluate and hundreds of other mutual funds that I also must consider. But, what’s life without a project? As an electronics engineer with a strong electro-optical signal-processing background, the task of extracting trend signals from noisy market data actually sounded like fun. Applying my engineering skills to solve my investment problem? What could be more fun than that?

It’s said that “to a hammer, everything looks like a nail.” So, perhaps “to a signal processing engineer, everything looks like a signal-to-noise ratiot3 problem.” Whether or not the tool is a match for the problem is eventually made obvious by the outcome. The importance of signal-to-noise ratio to performance is well illustrated in my two U.S. Patents identified below, both of which are about signal detection in the presence of noise. The first of them relates to an optical industrial sensor about the size of a farmer’s index finger that must reliably detect weakly reflected signals to ensure automated factory machines...

Produkt-Details

• Erscheint lt. Verlag: 15.4.2018
• Sprache: englisch
• Themenwelt: Sachbuch/Ratgeber ► Beruf / Finanzen / Recht / Wirtschaft ► Geld / Bank / Börse
• ISBN-10: 1-5439-3170-7 / 1543931707
• ISBN-13: 978-1-5439-3170-9 / 9781543931709