INVESTMENT STRATEGIES


 
 

Summary:

Our dynamic investment strategy relies on two approaches that are designed to complement each other, based on market conditions. In an upward trending market we are long growth stocks in a dropping and highly volatile market, funds are automatically re-allocated to our reversion to the mean strategy, which has a favorable risk/return profile during market selloffs.

Basic assumptions underlying our investment approach:

  • The direction of the stock market can’t be predicted
  • Human emotions are the primary driver of stock prices in the short term. The shorter the time frame, the more impact emotions tend to have on investment decisions.
  • Not capitalizing on an investment opportunity with favorable odds is as bad as taking a position when the odds are unfavorable.
  • We apply strategies that have a slight edge in the long run and over many transactions.
  • Pre-set stop loss orders are placed, so that we don’t have to make decisions when the bombs are dropping (market crashing).

We apply two strategies that complement each other.

  1. Momentum-driven, long equity strategy.
  2. Reversion to the mean strategy: selling option premium, larger amounts when volatility is high and odds are in our favor.

The higher the probability of success is for either strategy, the more funds are allocated to the respective strategy. The allocation process is governed by a non-discretionary rules-based standard operating procedures.

The two strategies complement each other. In an upward moving stock market, funds are automatically drawn into the long equity strategy. During a rising stock market volatility tends to be low. Low volatility coincides with low option prices. Hence, most funds are allocated to long stock positions and little to selling option premium. Explained simply: selling options means selling insurance to investors against a dropping stock market. During a rising market few investors are willing to take out insurance against a stock market crash, which means insurance premiums (put options) are low.

So more funds are allocated naturally to CAN SLIM during phases of low volatility in few funds to the reversion to the mean strategy.

As the stock market drops and we get stopped out of our long equity strategy, we allocate more funds to the reversion to the mean strategy. Stock market selloffs almost always coincide with a volatility spike. This means that we receive higher option premiums and the odds of success are higher during a highly volatile market.

The essence of our approach is that there are long term trends, and asset prices tend to over or under shoot such long term trends. Humans are herd animals and tend to make decisions based on the herd. They buy insurance when it is already too late and pile into stocks after the stock market has already been rising for a long time.

In real life, the “herd fallacy” can be illustrated by the occurrence of catastrophic events. After a strong earthquake, homeowners tend to take out earthquake insurance. Shell-shocked by the traumatic event of the earthquake and stories of people losing their houses, homeowners pay whatever insurance premium the insurance ask for. At the same time, the risk of another catastrophic earthquake has lessened, lowering the need for insurance.

For more information on our approach, please contact us. Here are some resources that underpin our investment approach:

  • https://www.investopedia.com/terms/h/herdinstinct.asp
  • The Black Swan by Nassim Taleb
  • Fooled by Randomness by Nassim Taleb
  • The Upside of Irrationality by Dan Ariely
  • Thinking Fast and Slow by Daniel Kahneman
  • Far from Random by Richard Lehman
  • Investors.com and Investors Business Daily
  • How to Make Money in Stocks by William O’Neil
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“Compound interest is the eighth wonder of the world. He who understands it, earns it ... he who doesn't ... pays it.”

- Albert Einstein