Risk management tactics are both traditional and in presenting Nationally over about 15 years, I heard of a number of non-traditional risk management tactics.
Traditional for traders often involves stop loss orders.
Traditional risk management for long term, passive investors is often DCA – Dollar-Cost-Averaging.
There are a couple of market thoughts that fit into this risk management tool I will discuss today.
- One, is the adage, keep your losses limited and let your winners keep winning. In previous comments I have mentioned to try to keep your losses to a $1.00 of loss for each $3.00 targeted gain. In doing this you can lose two of three trades and still be profitable overall with the one winner out of three trades.
- Another “fact” I discovered years ago, not really an adage, but a truism, is more low price stocks appear in the annual “best performers list each year than expensive stocks appear on the best performer list, no matter the category. By Category I mean S&P 500, NASDAQ or NYSE. Of the top ten in each of the previous categories mentioned, 7 or 8 of the best performers started from under $10. That is where my interest in sub-$10 ideas started. If you want winners and at the end of each year, the majority of the market biggest winners, started from under $10. I am also shrinking the pool of ideas I look at in doing this exercise. That makes my job easier. There are more selection factors in profiling for potential 2X to 10X winners but that is not the subject today.
Here is a very simple way to manage risk and let your winners win.
Ten Under $10 is the model used. Here is a link to the most recent posted Ten Under $10 blog post with names.
- Limit the number of positions you buy. 20 is a good a number to talk about. Now if twenty ideas are from all different industries it is impossible to keep up with this number. But if you focus on industry groups and limit yourself to three or four industry groups then you have a industry model and from that you could buy five to ten of the best industry ideas as a collective. Four industries and five stocks from each industry gets you to twenty names. It would be easy to expand that to even more depending on what is happening in the industry. Let’s use the mining industry. I am giving you a lot of mining ideas. Am I a gold or silver bug. No, I do not think of myself that way. I believe miners are at decades long low valuations and are very healthy financially. High cash flows and low debt. That is why I like Miners. The fact that the world has under invested in miners of all minerals since 2012 or thereabouts, makes them scarce at a time governments are telling the global population, we have to make this transition to All Electric All The Time. Healthy companies, under owned, underdeveloped asset that has been dictated by governments to expand into. Sounds like a winning combination. This concept fits into the risk management grid I share with you.
- The Ten Under $10 is our model. The reason I start with $1,000 per position is simple. If I invest $1,000 into an investment idea, I know exactly how much I can lose. $1,000. If I do 20 ideas and lose $1,000 of the $20,000 invested my company risk. If one idea goes bankrupt to $0.00, it was 5% of the $20,000. That is my stop loss. Perhaps you are more disciplined and willing to sell at losing half the $1,000 position. A $500 loss. Better. In this model, I can manage company risk but not Industry risk. Crypto and Blockchain this past May was Industry risk. So, I should be sure of my wanting to own the industry. This model is about company risk. If I look quickly at a balance sheet and see they have no or low debt, the chance of going to zero is low. I can look at the best of the best in the industry with a quick profile of various company metrics. Again, it increases my probabilities. The illustration is put the same amount into each position that you have assigned similar goal to. In Ten Under $10, I am looking for doubles and more. I have to if my risk tolerance is 100% of money invested. I need enough winners and big enough winners to pay for my losers and be profitable. I have to let my winners win.
- Setting dollar amounts to invest in this risk management model is a good beginning. It is simple to present for teaching and sharing purposes. It is not however, dynamic with your income, growing investment pools or shrinking pool when caught in a bear market. A better metric to use is the same percentage with each new purchase. Decide how much money you will allocate to this model and theme. 2.5% of a company invested in, allows you 40 companies. If you only use 20 companies, it allows you to use multiple units at 2.5% per unit in each of the 20 companies. You decide your own boundaries to fit your risk management profile. Example: Max 10% of your portfolio in any one company is four units max per company. If ten companies are the most you want to invest in adjust accordingly.
- We covered selling on the way up in a previous blog. Scaling out at a percentage of the “remaining’ position allow you to always own some shares. Here is a link to the blog post on scaling out of a position.
I view myself as an Idea Generator. I don’t know most of you, so I don’t know what risk level is appropriate for you or the risk level you want. I have stated a number of time that I am mostly a longer-term speculator. I scale in and scale out a lot of the same positions over time. Rarely do I sell an entire position all at once or buy a position all at once. I look for over-sold industries and stocks that I feel are about to come back into favor. If I am going to work a position for three or four years you can bet, I believe I can get a 4X to 10X return from the position. I take hits from time to time as I am now in Soluna and Galaxy. As long as I think the reward is worth the wait, I will work through the tough times. Yup, I trade a random name from time to time. It is not part of my routine. If I recognize an opportunity, I don’t hesitate to step into it. I don’t look for it as a constant. I also sell call options a lot more than I mention. It is a great way to harvest income.
Use me as I present myself. A Stock Idea Generator and source of information on the stocks I present. With age and experience I am more a profiler of patterns and recognizer of probabilities.
I hope this was of both interest and helpful for you.
The biggest winners of the next Bull market are bought at the depths of the previous Bear market.
Also recognize that there are Bull and Bear markets within the Big Bear and the Big Bull Market.
Written August 31, 2022, by Tom Linzmeier, editor of Tom’s Blog at www.LivingOffTheMarket.com
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