What is investment and how do you hedge your portfolio?
Trading, is about buying cheap or selling expensive or the other way round. Shorting is abut first selling expensive and then buying (back) cheap. Investment is about buying at the right price and selling to the right price. But what is the right price?
“An investment operation is one which, upon thorough analysis promises safety of principal
and an adequate return. Operations not meeting these requirements are speculative.”
During the COVID-19 pandemic 2020, there has been a market chrash and some volatility, especially in big tech companies. There has been som talk about tail hedging of your portfolio, e.g. tail (of the probability distribution of changes in the stock price) heding. Tail hedging is heding against extreme (most often negative) observations. You don't complain about the insurance premium when your house is on fire.
There is a lot of ways to hedge your portfolio. One general technique is to have gold in your portfolio as a hedge against inflation and market crashes. The easiest way to get gold in your portfolio is to buy gold ETFs (search for best gold ETFs). Another general way is to use bonds as a hedge, but with lowe bond yields, bonds are no longer so interesting. Cash don't give interest, but during market volatility and markedt crashes, cash is definitely King. The VIX (VXN for technology) is a good indicator of when the market is close to the bottom. When the market bottoms out, the VIX is close to a a local top. The dollar index usually increases in synch with the VIX during market turmoil, since investeres regard the USD as a safe haven. You can also buy volatility by buing VIX ETFs and dollar index ETFs. A call option is insurance against not owning a stock while a put option is insurance against owning the stock. Here is a more exotic hedging strategy that is relevant as a hedge as big tech uncertainty.
Thorough analysis is the key word. If you have not done your home work, the analysis is not thorough, it is speculation. Trading may be speculation, but trading by professionals are based on thorough analysis. But the difference between an investor and a trader, is
- The trader is interested in volatility or price swings.
- The (value) investor is interested in identifying undervalued papers.
- The investor is interested in long time real appreciation of his invested capital.
Demolition may be depreciation, but sometimes you have to demolish to rebuild. In the theory of nonlinear partial differential equations, an irreversible solution is a solution that can not be inverted. If you blow up an art museum with paintings of Vincent van Gogh you cannot recreate the paintings. If you buy (good) paintings of Vincent van Gogh and Pablo Picasso, it seems to be investment at nearly every moment of time. They have a tendency to appreciate in value over time.
Dynamic allocation, decide on wave degree and invest with the preferred wave count
in direct or inverse indexfunds. Trade with the preferred wave count.
It has always been said that the easy way to beat the market is dollar cost averaging. Over a long
enough horizon this is right, since the main trend is up. Rebalancing the protfolio is another possibility, but in a
secular bear market, you can rebalance the portfolio down. Benjamin Graham, the famous "Dean of Wall Street"
said that you could beat the market by putting it on autopilot and rebalance the portfolio between 75 % in bonds when
the market was overvalued and 25 % in stocks. A 50 / 50 % distribution in between and 75 % stocks and 25 % bonds when
the market was undervalued. He proposed using index funds since they were cheapest. Some index funds like funds following
the Dow Jones Industrial average are often very inflated in cyclical bull markets, so it may perhaps be best to use other
indexfunds. You may use Dr. Ed Yardeni's measure of the market
sentiment as an yardstick to value the overall market.
In a secular bear market, containing many cyclical bull markets, there is an alternative to the above procedure. The message in the heading explains it. This allocation principle may of course be modified to allocate X% in indexfunds according to the preferred wave count, Y% to the alternative count and Z% to the third count.
To understand the message, you must understand the Elliott Wave principle or the Elliott Wave fractal as it is also called. You find relevant literature in the Elliott Wave Bookstore or by clicking banners to Elliott Wave International on the education sub page. Elliott Wave International also deliver a market news service on the following pages
Visit their new site, elliottwave.net. Read their message there about the next big move in the stock market.
If you are young and have a horizon of 30 years or more, you may combine the two procedures, 50 % to dollar cost averaging and 50% to dynamic allocation.
In his facianting new book, "The wisdom of crowds", James Surowiecki explores a deceptively simple idea: large groups of people are smarter than an elite few, no matter how brilliant—better at solving problems, fostering innovation, coming to wise decisions, even predicting the future. His message is very different from the message of Charles MacKay.
"No one in this world, so far as I know, has ever lost money by underestimating the intelligence of the
great masses of the plain people."
-H. L. Mencken
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