Pillars of Success
INVESTING PRINCIPLE #1 -- RELATIVE STRENGTH IS THE CORNERSTONE OF YOUR SUCCESS
Relative Strength is about being in the right global market (Domestic,International, Emerging Markets). For example, when global markets decline, it’s best to have bearish positions on non-U.S. equities. Drilling down a bit, Relative Strength is also about finding the best way to invest in something. If we want to own the broad U.S. equities market, do we stand to profit more, or risk less by investing in…
Large-Cap Growth Stocks ($10 billion + market cap)...
Large-Cap Value Stocks ($10 billion + market cap)...
Mid-Cap Growth Stocks ($2-$10 billion market cap)...
Mid-Cap Value Stocks ($2-$10 billion market cap)...
Small-Cap Growth Stocks ($2-$10 billion market cap)...
Small-Cap Value Stocks ($300 million - $2 billion market cap)
Finally, Relative Strength is about finding the right sectors of the stock market. Some people mistakenly believe a bull market causes all sectors’ stock prices to advance. They say “a rising tide lifts all boats”. In truth, each sector is its own mini stock market within the broader one. Financial stocks may be up 25% for the year at the exact time Oil stocks are up 10% and Tech stocks are down 15%.
To outperform the broad market benchmark (the S&P 500) we do look to diversify... BUT we do so among the top 4 - 5 sectors.
INVESTING PRINCIPLE #2 -- USE OPTIONS TO GET THE MOST OUT OF YOUR TRADES.
The market is never an "either/or" ecosystem. Securities don’t just advance OR decline. They can advance slowly, quickly, or moderately...
And they can decline slowly, quickly, or moderately.
And of course they can stay where they are by trading sideways.
There are strategies that best suit each of these scenarios. If a security is advancing, but slowly, you can find an options strategy that will generate a higher return than you'd get by simply owning the stock. Likewise for securities that are heading up quickly or heading nowhere at all.
INVESTING PRINCIPLE #3 -- USE OPTIONS TO LOWER YOUR RISK.
Most people think the secret to making a fortune in the markets is to win more trades than you lose. The real secret is to employ strategies that let you profit more when you are right than you lose when you are wrong.
As a simplified hypothetical example, the most common strategy that we use might allow us to gain 10% if a security gains 10%, but only lose 9% if the security loses 10%. More importantly, if there is a catastrophic event (a "black swan") that causes a security to collapse by 30%, 50%, 80% in a day or two... this strategy caps losses at a fixed percentage, say 15% of the total position value.
Many pundits say catastrophic events situations like that are incredibly unlikely. But we wouldn’t advise jumping out of a plane even if there were only a 0.01% chance that the parachute wouldn’t open!
My point is: This sort of protection is critical if you want to avoid scenarios where it becomes too difficult to regain your capital. Remember, if you take a 50% loss, you'll need to make 100% just to get back to where you were.
INVESTING PRINCIPLE #4 -- TAKE POSITIONS THAT ARE BULLISH AND BEARISH
Once again, the market is not a "bull/bear" world.
True, there are times when you are one or the other. But then there are times when you'll want to have both bullish and bearish positions on.
An example of this might be when U.S. equities are outperforming emerging market equities by a large margin. You might have half of your portfolio in bullish positions on, say, four of the strongest U.S. sector ETFs...
While simultaneously having the other half invested in bearish positions on four emerging market ETFs.
INVESTING PRINCIPLE #5 -- ACCEPT THE FACT THAT SOMETIMES YOUR ACCOUNT WILL HAVE LITTLE TO NO MARKET CORRELATION
Most people are programed to think “up market good, down market bad”. But as we just said, we aren’t obsessed with the direction of any particular financial market. Instead, we're focused on finding situations with the highest probability of success.
As also mentioned, we aim to hedge the account by being bullish and bearish on semi-correlated markets (e.g., bullish on the U.S. stock market while bearish on the Australian stock market).
Believe me, it's a great feeling when the market you're familiar with is in decline... and you're one of the few avoiding the decline (and even profiting from the event!) And on the flip side, if your account happens to be down while the market you’re familiar with is advancing (and most people you know are celebrating) it can be frustrating to say the least. Nevertheless, at times your account will be out of step with the wider world. That's just the way it goes.
It's always a good idea for people who use hedging strategies to take a long-term view. That's because, without question, their account will go through advancing periods and declining periods. We believe our approach (Relative Strength) is superior over the long haul. That said, it pays to remember that it isn’t a commonly used methodology. For that reason, we shouldn't expect our periods of success to line up perfectly with those of investors who take a different approach.
INVESTING PRINCIPLE #6 -- CASH IS GOOD
When you’re in cash, your risk is minimal (basically, inflation). Thus, if we can match the stock market’s performance while having our capital in cash for half of the year, we actually did better than "the market." That's because all major risk was off the table 50% of the time. If we can beat the market while having the money invested only half the time, well... that’s phenomenal. We made more while taking much less risk.
Sitting in cash, especially while it seems the rest of the world is having a profit orgy, is extremely difficult for most humans. The fact remains, it pays to exercise patience.
After all, Cash is a trade too. Every asset holds value relative to another asset. Relative to a dollar, your television may have declined in value over the past five years even if you never used it once. But relative to that same dollar, Tom Brady's football jersey might have advanced in value so it can later be exchanged for more dollars.
Like art, stocks, gold or real estate, dollars are just another place to store value.
Thus, if your investment account was 100% in cash while the equity market declined by 50%, then, relative to the equity market, your cash doubled in value. You can now exchange your dollars for twice as much of that same stock market as you could have done prior to the market's decline.
The six principles above are among the most important I've ever learned.
I hope, by sharing them with you, that I can cut some time off of your journey.