Risk and Opportunity; Investing is analogous to war
One needs to understand the difference between a battle and a war. You can lose several battles but still win the war, or win many battles and still end up losing the war. It comes down to how much damage you incur as opposed to losing or winning the battle. If you minimise the damage, you can lose several battles in a row, retreat and regroup and come back and win the war.
Bullish and Bearish cycles are akin to battles fought in a War
Each cycle should be considered a war, and as long as you win the war, the individual battles are meaningless. The mass mindset focuses on each battle, students of mass psychology focus on the war.
When it comes to investing one can experience extended periods of success, where the markets do exactly what they are supposed to do, but the equation must balance and sooner or later the market will go through a phase of turbulence. In these turbulent times, like the current one, we will experience more losses, but when the turbulence vanishes, the win ratio and the percentage in gains will be far higher than experienced during the phase of turbulence. Until October we had a remarkably long winning streak.
Every bull market goes through one shakeout (strong pullback phase)
One never know when that will occur exactly. A shakeout is not the same as a market putting in a long-term top. This is done to get the masses to alter their perception. The big players need someone to sell these stocks to before they cash out. The masses eventually buy this strategy, and when they do, the top is usually close at hand. Once again, look at Bitcoin, everyone was happy when it traded past 10K, they turned ecstatic when it broke past 15K and then they assumed that nothing would hold it back.
During this shakeout stage, it is essential to have stops in place and deploy one’s money at different intervals. Nobody can change this order. No one can tell with certainty when the markets will experience a stronger than normal pullback because this market is as manipulated as they come; after 2008, free market forces ceased to exist. However, if the trend is positive, then those pullbacks have to be viewed through a bullish lens.
The following inferences are therefore possible:
In times of risk, the masses seek to take on more risk as opposed to taking on less risk. The masses beg for the opportunity to buy low and sell high, but when the moment finally arrives (and the risk factor is much lower) they baulk, and their argument is always the same “it is different this time, the market is going to crash, and we need to bail out”. However, they never put forth the same argument when the markets are racing upwards, and analysts all over the place are issuing insane targets such as $1 million, and they now assume the next stop is the sun or another galaxy. Instead, the next stop is usually “hell”.
Run when the Masses Turn Euphoric
When the masses believe they have found the next best thing to white bread, its time to head for the hills. Case and point Bitcoin. Throughout its fall, the masses remained bullish, and despite the heavy beating it has already taken experts are still issuing insane targets even now when Bitcoin is trading below 5K, which means that Bitcoin the odds of it hitting 3K are far higher than 15K.
Imran Wasim, a financial analyst at AMSYS Group, told News BTC he was far from downbeat, predicting cryptocurrency will become “more mainstream” in 2018. https://bit.ly/2DZs7fo
Bitcoin Price Forecast: Tim Draper Predicts Bitcoin Will Be Worth More Than $100,000.
Llew Claasen who is the executive director of Bitcoin foundation recently stated that he expected Bitcoin to hit $ 40,000 by the end of this very year. He further added that 90% of the cryptocurrencies will actually fall. https://bit.ly/2FHTVX0
Tom Lee, co-founder of Fundstrat Global Advisors, lowered his year-end target to $15,000 from $25,000 — still well above where the cryptocurrency was trading on Friday.
A key driver was bitcoin’s “break-even” point, the level at which mining costs match the trading price. That level is down to $7,000 from an earlier estimate of $8,000 for the S9 mining machine by Bitmain, according to Fundstrat’s data science team. Based on that, Lee estimates that fair value for bitcoin would be roughly 2.2 times the new $7,000 break-even price. https://cnb.cx/2BhvnQD
Alexander V. van Dijl, Financial expert:
At the beginning of this year I predicted a bitcoin value of 150.000. While that seems like a lot today, I believe some firm price movements will take place in the (very) near future. Something big will happen, perhaps a large retailer will accept bitcoin, perhaps adult advertising will accept bitcoin as payment. Something big will happen that will cause the price to skyrocket again. 150.000 is my prediction for January 1st
Eric Brown, Founder and CEO of Aliant Payment Systems:
My Bitcoin price prediction for 1 January 2019 is $23,000.We were practically at this price once, and we know what it takes to get it back there. We are very much in the infancy of this type of currency, and as technology grows, so does the value of the currency. The future is technology and Bitcoin is the currency of that technology.
Sam Russell, Co-Founder / EVP Strategy and Innovation at WORBLI:
If the fundamentals on Bitcoin positively change in September with the upcoming proposals for an ETF approval by the SEC, we can expect buying pressure to increase pushing price up to previous market structure highs of $11,400 testing resistance in that area. Should that happen, Bitcoin would effectively change in trend. My guess — 17,000 USDhttps://bit.ly/2wJoUu8
The sensible thing to do is to implement a strategy that works both in good times and turbulent times, and that is what we are doing.
Courtesy of Tactical Investor
Random Views on Risk and Opportunity
The First Risk and Opportunity in Active Investing
What is the most significant risk in quant (and all active) investing today?
The First Moment (the mean)
The Second Moment (under-estimating tracking error)
The Third Moment (skewness, left tails, crash risk)
Mis-specified risk model (hidden factor biases, factors ‘eating’ alphas)
Sub-optimal portfolio construction methodology (error maximization)
Higher than expected transaction costs
Individual stock risk
Quants typically chose 2, 3, 4, 5 and 6.
In my view, the most important risk in active investing is #1: The First Moment.
This is the no-alpha risk = strategy does not outperform the benchmark = the long-term mean <=0
The lack of alpha in the industry is not news, and many are trying their best, but I believe the reason more effort is not producing better results is because we are trying to solve the alpha risk as an engineering problem rather than an architectural one.
Today’s quants are already very well equipped to deal with risks 2 through 7. These risks have engineering-friendly convergent solutions. 50 years ago, some of these other risks might have been at the top of my list, but after decades of advances in these areas, these risks are much less problematic than the First Moment Risk (as a side: in total portfolio mandates from the asset owner’s viewpoint, Crash Risk #3 is still very much alive and real). Full Story
What Is Opportunity Cost?
Opportunity costs represent the benefits an individual, investor or business misses out on when choosing one alternative over another. While financial reports do not show opportunity cost, business owners can use it to make educated decisions when they have multiple options before them.
Because by definition they are unseen, opportunity costs can be easily overlooked if one is not careful. Understanding the potential missed opportunities foregone by choosing one investment over another allows for better decision-making.
How to Calculate Opportunity Cost
The formula for calculating an opportunity cost is simply the difference between the expected returns of each option. Say that you have option A, to invest in the stock market hoping to generate capital gain returns. Option B is to reinvest your money back into a business expecting that newer equipment will increase production efficiency, leading to lower operational expenses and a higher profit margin.
Assume the expected return on investment in the stock market is 12 percent over the next year, and your company expects the equipment update to generate a 10 percent return over the same period. The opportunity cost of choosing the equipment over the stock market is (12% – 10%), which equals two percentage points. In other words, by investing in the business, you would forgo the opportunity to earn the higher return.
Opportunity cost analysis also plays a crucial role in determining a business’s capital structure. Full Story
Use The 50-Day Moving Average To Pinpoint Opportunity Or Risk
An ax can be either a useful tool or a dangerous weapon. In stock charts, the 50-day moving average has a similar dual nature.
The 50-day moving average takes a stock’s prior 50 daily price closes and averages them. Do this every day in an upward-trending stock, and you’ll get a line on a chart that runs below the stock’s price bars while smoothing out the jumps and buckles.
The line serves a startling number of uses. When a stock is basing, a cup base with more than half its bulk above rather than below the line is a sign of health. Another sign of a stock’s strength: a flat base that finds “support” at its 50-day line.
What is support? Institutional investors often use the 50-day or 10-week line as a reference point, stepping in to add shares to their positions when a stock pulls back to the moving average. This buying creates upward pressure — or price support — to help keep the stock’s prices above that moving average.
This is why rising stocks often rebound from their 50-day lines, turning brief pullbacks into follow-on buying opportunities. It is also why 50-day and 10-week moving averages tend to cradle advances that can run across many months.
On the dangerous side, a rallying stock that collapses below 50-day support in heavy volume is often sending a sell signal. Once below that line, institutional investors may use the 50-day line to mark a sell level. Full Story