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Hi Daisy,
Under the basic Stock Trading Riches system, we are rebalancing each individual stock or fund back to a constant value (i.e. $2,000). We don't increase this constant value because we handle growth at the portfolio level.
At the portfolio level, we cap cash at a maximum percentage (i.e. 30%), and then add a new stock or fund with the excess.
So, the idea is that we account for inflation and growth by adding new positions over time.
That being said, increasing the constant value by a percentage each year is an option that could be tested.
Hi Daisy42,
We are rebalancing each stock or fund back to $2,000.
If it is a regular mutual fund, you can buy and sell in dollar amounts. For ETFs or individual stocks, we have to buy or sell by the number of shares (unless using a service like Sharebuilder).
That was a great interview, Tom.
Congratulations!
Because of my book, some popular bloggers asked me to join an interview/panel discussion on money and finance. (I came on a few minutes late).
Here is the interview on you tube:
The story was really entertaining - reminds me of my first job out of college, and the first time I worked on a real world computer project and succeeded - it felt so sweet!
Conrad,
You should write a book or blog - you are a really good story-teller! Your story hooked me, and I can't wait to read the second part.
Praveen
Hi Bob,
I considered buying Facebook at the IPO a contrarian move because the stock behaved differently than the conventional wisdom at the time. From what I had read and from talking to other people in high technology, everyone expected Facebook to soar at the opening.
I know someone, a senior executive at a high-tech company, who placed a limit order at the open to not buy over 55. So, I wasn't planning to buy Facebook at the IPO, but when I saw that it didn't soar like everyone predicted, I decided to buy it.
Because my system diversifies, and each individual position is re-balanced, I feel safe sometimes taking a risk on a stock. I will rebalance my Facebook position at the end of the year. Even with Facebook's performance, I'm currently up 10% in my portfolio.
I don't use any stop losses with my system - other than replace a position if I feel that there is something fundamentally wrong with the company. In my book, I list an optional stop loss rule in the section about customizing my system. It calls for replacing a stock if it declines 50% (or X% - it can be customized) from the initial buy. I state in the section that I don't use this rule myself, and it would have prevented the performance in the AMZN stock example in my book.
Praveen
Hi Adam,
I read Robert Lichello's book on the AIM system in the early 1990's, but I ended up developing my own system because I felt that AIM had several drawbacks:
1. Lichello originally intended for AIM to be applied at the portfolio level. Thus, there would be one portfolio control and one cash. The problem with this is that individual stock movements cancel each other out, thus dampening volatility.
2. While AIM can be applied individually to each stock, I felt, as an evangelist for simplicity and elegance, that this was a bit too clunky and complex - having to track separate controls, safes, cash, etc.
3. I also didn't agree (when trading individual positions) of portfolio control increasing during down cycles, and not increasing during prolonged bull moves.
Note that these views don't mean that I think AIM doesn't work. AIM and the Stock Trading Riches (STR) systems are cousins and any re-balancing system is a good approach to the market.
The basic Stock Trading Riches system is to build a portfolio of many positions. Each individual position is assigned a constant value (which never changes) and is rebalanced once a year. Growth happens at the portfolio level. The portfolio consists of the individual positions and a cash balance. At this level, the system uses constant ratio balancing to have a maximum cap on the cash level. For example, the default value is 30% cash.
If cash builds up over 30%, then the cash is used to add new positions.
So my system is more longer term and closer to investing on the trader-investor spectrum.
Hi Adam,
I tend to use individual stocks more than ETFs with my Stock Trading Riches system (which rebalances positions like AIM does), and the way I protect against deep divers is to think of the position as a "slot" which is currently occupied by the stock.
Then, you can set criteria to decide when to replace it (for example, you could set an absolute stop like "50% below your initial purchase price" or depend on more subjective criteria like loss of volatility or fundamental change in the business).
At that point (or perhaps at the next buy signal), you would completely sell your position in the stock and buy a new stock.
If a position becomes a deep diver, you could still substitute it for a new stock that you believe will appreciate.
As long as you are replacing stock A with the same value of stock B, the formulas won't break.
Praveen
Here is the new Paypal purchase link for the "Stock Trading Riches" ebook:
https://www.paypal.com/cgi-bin/webscr?cmd=_s-xclick&hosted_button_id=B8P3WSC9J4S2L
Hi Bilmer,
I'm sorry about the link being down. I will fix it by tonight (Sunday night) and send out a reply when it is up.
Thanks,
Praveen
I just bought Facebook (FB) to be contrarian because of the way the IPO "fizzled".
I first started to think about buying Facebook because, for the last several weeks, I saw lots of news stories warning against buying Facebook when it went public.
Everywhere I looked, reports and columnists warned how the stock is over-hyped, the insiders want to cash out, people are foaming at the mouth to buy it, etc. The stock would run away at the open and, if you were foolish enough to try and buy it during the first day, you would end up getting burned.
I've learned to be skeptical of all these financial stories.
Then, this afternoon, I saw that Facebook did go public this morning at $38. The stock only opened at $42 (so much for the "frenzied pop"), touched $45, and now is around $40.
Also, the last couple of weeks have been bad for stocks, and it looks like Facebook failed to rally the over all market.
At this point, I don't feel like Facebook is overpriced. I think that, over the next several months, it has a good chance to go up because, as the uncertainty with Greece works itself out, and the markets put it behind and start to recover, individual investors and funds will start to revisit Facebook.
On the other hand, I don't see a lot of room on the downside for Facebook. Google Plus doesn't appear likely to do to Facebook what Facebook did to My Space - at least not yet.
As always, I bought Facebook as a long term investment, and plan to manage the position and harvest it for cash by trading around a core position according to my Stock Trading Riches system.
Here is an interview I did for my book "Stock Trading Riches" on the book site "SellingBooks":
http://www.sellingbooks.com/praveen-puri-stock-trading-riches/
Here is a nugget from the interview:
What inspired you to write this book?
Years ago, I became passionate about stock trading, and spent hundreds of hours and thousands of dollars on books, DVDs, seminars, etc. Those techniques never worked for me and I got frustrated. A light bulb went off when I read a book called “Zen in the Markets.” I decided to focus on the present moment and simplicity, and developed a successful trading system that almost feels like meditation. I love sharing it with others who are interested in trading and investing.
Ev Bogue, "Minimalist Business" interview, part II:
http://simple-trading-system.blogspot.com/2012/03/interview-with-ev-bogue-author-of_20.html
My interview of Ev Bogue, Author of "Minimalist Business", Part I
http://simple-trading-system.blogspot.com/2012/03/interview-with-ev-bogue-author-of.html
My experience has been that successful investing is about finding a simple strategy that works, and then having the patience and discipline to stick with it - even when it is not performing in the short term.
Over short periods of time, randomness has a bigger influence. A lot of investors get impatient, and they then abandon the system and switch to trying something else.
With hedge funds and mutual funds, a lot of it is about needing good short term results to attract new money, so they keep trying complicated stuff to avoid any down performances - this helps keep them from getting good long-term results.
On my blog, I wrote about a book called "The Hedge Fund Mirage", which is critical of that whole industry:
http://simple-trading-system.blogspot.com/2012/02/who-really-benefits-from-hedge-funds.html
Today, the kindle version of my book Stock Trading Riches reached the top 100 on the Kindle Business and Investing best seller list.
The Second Best Performing Chicago Area Stock of 2011 was Akorn, Inc (AKRX), which is based in Lake Forest, IL. Akorn sells ophthalmic antibiotics, dry-eye treatments, and injectable drugs for hospitals.
This is another growth stock. Akorn's CEO, Raj Rai, took over in 2009 (when the stock was below $1) and led a remarkable turnaround - the stock increased 239% in 2010 to $6.07/share, and increased 83% in 2011, to $11.12/share.
Rai turned the company around by focusing on its profitable eye treatments and injectable drugs, selling its money-losing divisions like vaccines, investing in sales, marketing, and R&D, and acquiring factories in India to serve that country's fast growing markets.
Akorn has a lot of room to grow, so it could make a good growth stock purchase, especially at a lower price.
Ulta is the Top Performing Chicago-Area Stock for 2011
The Chicago Tribune recently had an article listing the best-performing 2011 stocks among Chicago area-based companies.
The number 1 performing stock was Ulta Salon, Cosmetics, and Fragrance, Inc. (ULTA). The stock was up 91% in 2011.
Ulta has been called the "Best Buy" of the beauty market. It offers one-stop shopping for cosmetics at every price range, as well as a full-service hair salon.
It is a classic example of a growth stock.
On one hand, some analysts feel it could sell off this year because it trades at 32 times estimated earnings. Also, they may face competition as Walgreens and CVS increase their beauty product offerings, and from women shopping online.
On the other hand, the reason for their success is the fundamental shift of women going from malls to strip malls. Most high-end beauty products used to be bought from department stores. Now, women like the convenience of being able to drive up to an Ulta in a strip mall and find all products in one place.
As a result, Ulta is growing at a fast pace. They currently have 449 stores, and have room to expand - especially on the East Coast and Northwest. They plan to increase their number of stores by 15 - 20% a year until they reach 1,000 stores.
At the same time, they recently experienced a 12.6% increase in sales open at least one year.
In addition, since their stores average 10,000 square feet, they are experimenting with launching 300 square foot stores inside devoted to men's skin care and grooming products.
You can look to buy it on a drop for a GAARP play (Growth at a reasonable price) or buy it now as a growth play. Either way, you could then manage it with the "Stock Trading Riches" or AIM formula to play the fluctuations, and pump money out to enhance your return, while reducing your risk/cost basis.
Hi Adam,
I keep most of the cash balance from my Stock Trading Riches (similar to AIM) portfolio in the AALPX (American Beacon Short-Term Bond) no-load fund.
http://www.smartmoney.com/quote/aalpx/
http://finance.yahoo.com/q/pm?s=AALPX+Performance
Lipper rates it's return as 2 out of 5, but I like that it is rated 5 out of 5 in preservation.
It still had a 3 year average return of 2.44%, and it's never had a losing year, so I think it's good for a large cash balance.
Praveen
Hi 1step,
A reader of my book used my spreadsheet to test my system on the SPDR (SPY) S&P 500 ETF from 2001-2008, and said it beat the index (2.0% vs. 1.7%).
They posted it on Amazon.com, in a list mania:
http://www.amazon.com/Contrarian-Stock-Investing-Systems/lm/RKU02DVM0IS13/ref=cm_srch_res_rpli_alt_2
With systems such as AIM or "Stock Trading Riches", a general index fund such as SPY isn't ideal because the individual movements of the components cancel each other out, thus dampening the volatility.
Instead of investing directly in SPY, you would get better results by replicating the index with multiple funds, such as by sector, or market cap (i.e. small, midcap, etc.) That way, you would be rebalancing each fund. They would be more volatile because the stocks in each fund would be more inclined to move up or down together.
For the past 7 years (2005-2011), I have exclusively used my "Stock Trading Riches" system to manage my portfolio.
While I lagged the market in 2011 (-5% vs. +2.11%), I have beaten the S&P 500 over those 7 years:
Year, Me, S&P 500
2005, +13%, +4.91%
2006, +14%, +15.79%
2007, +22%, +5.49%
2008, -40%, -38.49%
2009, +44%, +23.5%
2010, +22%, +13%
2011, -5%, 2.11%
My portfolio has had a cumulative seven-year return of +57.38% vs. +12.32% for the S&P500.
Today I finished rebalancing my portfolio, as required by the "Stock Trading Riches" system. This involved buying or selling each stock that was under or over my constant value target by at least 10% - so that each stock position was now at the constant value.
This year, I did it in two parts: sales last Friday and the buys today. This was because I now keep the majority of the cash portion of my portfolio invested in a no-load short-term bond fund.
After selling the gainers, I then calculated how much more money I would need to complete the buys, and then placed a sell order for the mutual fund on Friday. Today, the mutual fund sale proceeds were in my account, and I used them to complete the buys.
Stocks can be separated into 4 groups, according to their market capitalization:
1. micro caps - below $300 million
2. small caps - between $300 million and $1 billion
3. mid caps - between $1 billion and $5 billion
4. large caps - over $5 billion
I talk in more detail about market cap analysis in my book "Stock Trading Riches" because it's important for investors to allocate their portfolios among all market caps to provide diversification, avoid cyclical returns, and take advantage of "regression to the mean" (e.g. one market cap segment outperforms another, but then they converge).
Market cap is calculated by multiplying the number of shares outstanding by the share price. For example, if stock ABC issued 6 million shares, and the price of each share is $6, then ABC has a market capitalization of $36 million.
In general, micro caps are new companies that are just hitting their stride. Small caps tend to have their infrastructure in place and are in growth mode. Mid caps are big regional or national companies. Large caps tend to be established multinational corporations.
Stocks within each market cap share important characteristics in the areas such as growth rate, risk, dividends, visibility, and international exposure.
Thanks Clifford, I think that the code you posted might just be what I need to get Excel to do what I want.
Many traders use charts of past prices to trade stocks. They feel that, if the chart makes certain patterns, it can predict what the stock is likely to do in the near future.
One of the problems with chart reading is that pattern recognition is fairly subjective (the human brain likes to organize random data into pictures). One trader may see a pattern where another one doesn't. This makes charting-based trading systems hard to test.
However, studies that have been done using objective definitions of patterns consistently detect no trading advantage. They show that trading on chart patterns are equivalent to buying randomly.
I think that another flaw of chart based systems, which nobody really talks about, is scaling. Chart scaling, in my opinion, is the reason that patterns looks so seductive and accurate in hindsight.
Traders develop patterns by studying charts of big moves that have already occurred. They frequently "see" consolidations and patterns before the big moves.
For example, one pattern is called sideways consolidation - where the market trades almost horizontally in a narrow range. Then, prices eventually "breakout" and make a big up or down move.
The problem is that, after a market's range has expanded, the scaling of the chart changes as well. This scale change smooths out the movements that occurred prior to the big move, and creates the sideways consolidation. Prior to the big move, traders would not have seen the sideways consolidation, because the chart scale would have been different.
Let's assume that the market moved in a range between 10 and 20 for 6 months. The chart would be scaled from 10 to 20, and the chart will show lots of peaks and valleys. After the market moves to 85, the chart now reflects a range from 10 to 85. This compresses the peaks and valleys between 10 and 20. The result is that the 6 months before the move looks like a sideways consolidation pattern.
Unfortunately, you can't trade on patterns that occur after the move.
This is why my trading system does not use charts - only prices. Numbers are objective, and not open to interpretation. I only use charts to find prices for stocks I want to back test using my spreadsheet.
I received an email from a "Stock Trading Riches" reader who had a question about the spreadsheet (it is a free download for people who buy the book, in either format - paperback or kindle).
His spreadsheet question was:
In the "number of shares" column I notice that you are checking for a 10% price change between the current years price and the previous years price. This is ok in Year 1 and Year 2 but in the longer term you are not comparing the current years price to the initial Year 1 price. So what could happen is you could have a steady increase/decrease of less than 10% every year over a number of years (cumulatively > than 10% over a number of years) but none of them will trigger any selling/buying as the price is being compared to the prior year. Was the sheet deliberately designed this way?
My answer was:
What the basic system does in real life is only rebalance if the stock has moved 10% or more from the last time it was rebalanced. So, the spreadsheet should actually not compare the current and previous values, or the current and first. Instead, it should compare the current value with the last value where a rebalance occurred.
I don't know how to do that in Excel. So, I put the 10% check between the current and previous row just in case a value isn't 10% apart. But the best way to use the spreadsheet is to manually exclude prices less than 10%.
So, if the monthly prices were 100, 99, 95, 97, 85,... you would put in 100, 85 in the spreadsheet.
The best trading systems are simple and minimally beautiful - at most, they only use a handful of indicators or formulas, and they implement a simple model of the market.
They don't aim to explain market behavior rigorously and precisely like an economist - instead, the model aims at robustness, where it lets you manage your risk appetite and set the odds in your favor.
The purpose is to give you an edge - like the house has in a casino game. It won't win every trade, but it will have a positive expectation where, over time, you can expect to make more money than you lose, thus letting you build your account over time.
If a trader attempts to develop a complex system that could win every trade, then that is a set-up for failure. As systems get more complex, they have more moving parts - which results in unpredictable interactions and bugs that will eventually cause your system to blow up and suffer heavy losses.
With a simple system, your ego may not be satisfied - it will tell you that you are smart enough to come up with something more accurate, so you will lose less trades - but your bottom line account balance will benefit.
tffdo, you can change the constant value. I plan to do that eventually, because I don't want to have hundreds or thousands of stocks.
It's just that this part is handled manually, by your judgement. It's not a mechanical rule.
Though, you could follow the variation for mechanically increasing the constant value. In the book, this is the optional rule where, if the position has gone up, you can average the new value and the constant value to get a new, larger constant value.
Also, remember that, even though it is simpler to have the same constant value for all positions, you can have different constant values (for example, a large one for an index fund, and smaller ones for individual stocks).
I try to stress that the basic "Stock Trading Riches" system is simple, so it is easy to customize it to suit your personality and risk/reward goals and tolerance.
Running out of cash:
When I ran out of cash (which I did at the end of 2008 because of the big drop), I added more cash into the account.
I could not add enough to rebalance all my positions, so I followed the "triage" rule on page 24 of my book (5th paragraph), which is to raise more cash by selling off the worst performing stocks.
I think is it better to sell off some positions to make sure all remaining ones are rebalanced, then keeping all the positions and having them unbalanced.
This worked because I made a 44% return in 2009 (vs. 23.5% gain for the market).
Hi tffdo,
As Toofuzzy said, the leveraged funds are only designed for short term (day) trading, so they are not good for weekly or longer trading.
Compare the year-to-date returns of the profunds bull (SP500) with the ultrabull (2xSP500) and ultrabear (2x inverse SP500):
http://www.profunds.com/funds/bull.html
http://www.profunds.com/funds/ultrabull.html
http://www.profunds.com/funds/ultrabear.html
The bull YTD is -3.49%
The ultrabull YTD is -10.49%
The ultrabear YTD is -12.72%
As you can see, the longer term returns are not what you might expect because the funds are designed to leverage the daily movement, not the movement over time.
I think part of it is a function of the market cycle. Historically, dividends were a big component in the total return of stocks.
In the 1990's, they became only a small component of the total return, and dividends were out of favor. We were in a raging bull market, and companies were pressured to favor growth over dividends.
Investors were hypnotized by the bubble and said: why should they give out dividends (which were fully taxed) rather than invest that money in growing their market share, buying back stock, or buying the stock of other high-flying companies?
Then, the crash happened, Bush cut the dividend tax in half, and investors pressured companies to pay out dividends.
Since the market has been choppy for the last decade, dividends have returned to their historical place as a big part of investors' total return.
Hi Tom,
I agree about dividends. When I switched from short term trading to long term, it not only eliminated stress and reduced expenses, but I started to enjoy seeing the dividends depositing into my account like a cash register. Cha-ching!!
"Stock Trading Riches" is now available in Kindle format on Amazon.com:
http://www.amazon.com/Stock-Trading-Riches-ebook/dp/B0065CE3VO/ref=pd_rhf_dp_p_t_1
They did a good job in the conversion - I saw that the stock tables and programming scripts display well, and the links are clickable.
You don't need to own a Kindle to buy this edition. You can download free readers for PC's, Mac's, iPads, etc.
Hi tffdo,
Thanks for buying my book! I hope it helps you build a trading system that suits your risk-reward level.
I have exclusively used the basic Stock Trading Riches system on my portfolio for the last 6 years, and I have beaten the S&P 500 over those 6 years:
Year, Me, S&P 500
2005, +13%, +4.91%
2006, +14%, +15.79%
2007, +22%, +5.49%
2008, -40%, -38.49%
2009, +44%, +23.5%
2010, +22%, +13%
My portfolio had a cumulative six-year return of +65.66% vs. +10% for the S&P500.
Of course, my system is flexible and you can use the book's section on rule variations to customize the system. For example, you can increase or decrease the maximum cash percentage at the portfolio level from the basic 30%. You could implement the position growth rule, or the stop loss rule, you could change the rebalance frequency, or experiment with percent triggers.
You can back-test these variations on paper with various stocks and see if they improve the system in ways that make you more comfortable.
On Monday, I bought two small cap stocks: ACME Packet (APKT) and 51Job (JOBS).
As I mention in the market cap section of my book, I try to balance my portfolio across market caps, since companies in the different caps have different risk / reward profiles, and the caps themselves follow different cycles.
APKT specializes in session border controllers (SBCs), which provide control and security at the edges of IP networks that carry voice, video, and multimedia traffic. This is a fast growing company, but volatile stock with quartely fluctuations. The stock was up 104% in 2010, but I bought it now because it fell 50% after it missed it's third quarter estimate (due to a large order slipping into the fourth quarter). I don't mind volatility, of course, since I will manage the position through my "stock trading riches" system.
51Job, based in Shanghai, is the human resources market leader in China. They provide recruiting, payroll processing, and training to companies across 25 cities in China. The stock fell into the $40's after a peak of $70. They have $10/share in cash. According to small cap guru Jim Oberweis, the stock trades for 15 times his 2012 earnings estimate, and has expected earnings growth of 55%.
Investing in management.
The Oct. 10 issue of Forbes had an interview with billionaire growth fund manager Ron Baron.
He listed 4 criteria for investing in a new company. He said many others look at the first three, so the fourth one is especially important:
1. The business must have growth opportunities.
2. The business must be appropriately financed.
3. There should be a competitive advantage (i.e. barrier to others from competing with them).
4. There needs to be a trustworthy leader that inspires people to follow them - who will invest in the business, even if it hurts the short term bottom line.
The example he gave was Ralph Lauren. His European franchisee was doing poorly, and Lauren realized that Europe was the next big market. He had to pay such a high price to acquire the franchisee, that it diluted the stock. In the long run, however, the move paid off.
If interest rates go up, all the people currently piling into treasuries and bonds will get hammered. Bonds will lose value as interest rates rise, because the existing bonds will return less than newer bonds.
Stocks keep up with inflation, so funds will start to increase their allocation of equities.
I think it might be a good idea to start looking for bargains among the companies whose products do well in the early stages of inflationary periods - though I think we have time - at least a year or two. These include agriculture, copper, oil, and uranium.
Some possible examples include Archer Daniels Midland (agriculture), Southern Copper (copper), Cameco (uranium), Titanium Metals (titanium), and Viterra (agriculture). Southern Copper is based in Peru, but the other companies are headquartered in the U.S. and Canada. They are easily available from any broker.
These companies all have the added benefit that, besides protecting you against inflation, they provide excellent hedges against a weaker dollar. This is because they all have substantial foreign product sales and own undeveloped land outside of the United States.
Hi Aim Hier,
I think most of our portfolios peaked a few months ago.
Don't fret too much about buying too soon - making perfect investment decisions is hard - especially under the volatile conditions we are now experiencing. All we can try to do is learn and do better next time.
But since we buy low, I'm sure we will take advantage of this down cycle and our portfolios will hit new peaks as the economy starts to recover.
Hi Aim Hier,
I agree that private business tends to be more efficient and, over the years, government (especially at the federal level) has gotten too large. I also agree that, eventually, the government needs to strive for balanced budgets and eliminating the deficit.
Right now, though, there is a lack of demand and a liquidity crisis. Individuals and businesses are sitting on cash. A lot of people I know who have jobs are overworked. My team at the bank where I work is short handed, but we can't get approval to hire any permanent workers.
I think the Republicans and Tea Party are focusing on a good issue (cutting spending / deficit), but at the wrong time.
I think it will push the unemployment/deflation cycle more if we reduce government right now and push government workers into unemployment and into competition for private sector jobs.
I think it will be less painful if the government waits a couple of years until the private sector comes back and the recession ends. Then, there will be plenty of time to slim down government before we have to worry about inflation.