July 30th, 2010

“The fault”, dear Brutus, “lies not in the stars…but in ourselves”, Its’ the truth! It’s the simple secret to investments. Those who continue to seek the magic program, magic charts, gurus, the tea leaves…etc. will eventually come to one realization…they’ve been had. The secret of investing lies within you.

In the 90’s I loved Hewlett Packard and started building a position. Sold covered calls. Over the next few years as the company pre-announced shortfalls and the stock went down I bought more. And more. Finally, one day it hit a new all tine low and I could not stand the pain any longer. In disgust I sold all the position and was momentarily relieved only to witness to my horror that I had sold at precisely the low. From there Hewlett went straight up for the next five years. And…I don’t know which was more painful…the trip on the way down or the trip up without me.

It was 1987. I had recently sold a successful restaurant enterprise, had lots of cash and was filled with optimism, confidence and perhaps cockiness. Looking back it was all foolish hubris built on a foundation of shifting emotions. So, I built a sizable portfolio of synthetic stock. I was enamored with my own sophistication. I could do complicated transactions. And there was fuel to the fire…the market for most of the year went up. My synthetic stock portfolio was making a profit and I was giddy. Then there was ‘Black Monday’ of October. Stocks were cut in half, my short puts were exercised and I had to make the long trek to Dean Witter with a $125,000 plus check to cover. I was immobilized and traumatized. Sold out my entire portfolio. And…was out of the market for the next five years. I can still feel the pain…market down with me and up without me.I remember in the lobby of Dean Witter on that fateful day an older guy came in and said “I gotta buy something, I don’t know what, but something”.  I could have killed him.

When the bubble burst…I was there. When the Asian Flu infected the market I was there. When the Tai Baht cratered I was there. When the real estate market collapsed I was there. Desert Storm, the gas lines of the 70’s, short term interest rate at 20%, inflation run amok, mortgage rates at 10% plus…Yep, I was there. Don’t get me wrong…I made money on the way up, but always got caught with the exogenous event was blindsided with the rest of the lemmings and the fall was blind and instantaneous.

I read books, read charts, poured over financials. The result was always the same. That unforseen event. Trauma, and selling at the wrong time with that sick feeling.

One day, some years ago I read a book suggested by a man whom I admire, Ron Insana. The book was an old book, Extraordinary, Popular Delusions and the Madness of Crowds, written by Scottish journalist, Charles Mackay in 1841. It took a bit of an effort just to remember the title. I read Ron’s own books on trends and bubbles too. Then I looked at myself, my personality, my make up. What forces me to do the things that I do in a repetitive way. How do I navigate around my own built in pitfalls. And…those pitfalls only appear when extreme pressure is present. That pressure becomes insurmountable only when the great risk comes into clear focus. That is…when all are in a free fall with the rest of the lemmings…yep, over the ledge.

I had taken the general strategy of investing…’buy low and sell high’, and reversed it. This, by the way, is common amongst investors. It’s only the savvy who are able to buy when all are running from investments and selling when the lemmings are gathering in a que. But to be able to buy when the world is seemingly falling apart one must be in a strong position both psychologically and financially. That is, he must have sold into strength and have plenty of cash. And…I yearned to be, if only once, in a big cash position when stocks are in a free fall.

After much soul searching and analysis I came to one conclusion…for me! At those particular junctures in the market when a calamity happens I was taking too much risk. I simply could not handle the risk. All was great during normal market fluctuations and would go on merrily for a time but at downward extremes that risk intolerance would be exposed forcing me to do the opposite of what my objectives dictated. But…how much risk is appropriate? That is the question which requires much analysis and introspection. With too little risk one is never able to achieve the gains required. Too much risk reverses the investment strategy. I suppose trial, losses and error is one way. Unfortunately, that has been my experience. It’s been painful. But…I don’t know any other way. No one is born with a meter that measures risk tolerance. Wouldn’t that be nice! Look down on your left wrist and there is a meter that says, ‘this human unit tolerates this amount of risks and these are the vehicles which are appropriate’. No such thing! At the incept all are optimistic and wish to realize big gains. The bigger the better. Who worries about the downside? So, the cycle begins. And each cycle has new lemmings.

Risk tolerance is my key to investing.I know what mine is. That’s the secret. From there I found the vehicle which matches my risk tolerance. And…for me that vehicle is the S&P 500 Spyders (SPY). Jim Kramer says that these type of funds won’t give you the appropriate type of returns and that he can do better with individual stocks. Probably so! But…he’ll be the first to agree about my concept of risk tolerance. Jim’s risk tolerance is much greater. And…he also deals with other people’s money. I believe that it’s different when ‘it is your ox that’s getting gored’. So, I invest all my portfolio in the SPY. I know for certain that it will never go down to zero. For me that’s an important risk tolerance concept. You see, I’ve owned Washington Mutual that went down to zero, PG&E down to six, JDSU down to two, and many other Enrons. My Spyder will perform at the market rate. Now, what to do to spike the performance? I sell one year out of the money leaps to generate and extra 5%+ and that’s cash. Now I have five percent of my portfolio to invest in something else…more risky.

I use stochastics to determine the timing to sell leaps. At the proper time I will choose a leap ten percent out of the money and sell when the long term stochastics is over 80 and beginning to crater. The worst that can happen is that the market goes up beyond my parameters and at year end my Spyders will get called away and I end up making fifteen percent on my portfolio. If the market stays relatively the same or goes down then I use the five percent cash to buy an individual stock when the long term stochastics are below 20 for that stock. Thus far, I added Intel and Norfolk Southern to my portfolio and have purchased back the SPY leaps at market lows…so I’m now in a position to sell the leaps again for this year when the stochastics give me the signal.  And this will give me more cash to choose another stock.

 But how do I know that this is truly the correct vehicle for my risk tolerance? For me, I’m certain. I owned the SPY during the worst market since the great depression. That is March, 2009 when the SPY hit the satanic mark of 666. I held firm and never gave it a second thought. I knew that my relative position in the market was safe. I don’t think that in my lifetime there will be a market which will negatively eclipse that market of March.

So, there you are ‘Dear Brutus’! I’ve found my vehicle…now, go find yours!



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