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“Sound capital management best practices…”

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Michael,

Before stating this, I’ll say that I’m a person who has always been buy and hold, and does NOT mind drawdowns. I lived through Black Monday, the Internet bubble, and the financial crisis, and generally just bought more when I thought things were getting near their lows (kind of a trend strategy in itself). I never sold and was happy that things were finally getting cheaper. The market has rebounded every time, and I’ve been fortunate to make what I lost and more.

Having said that, today I placed my first trend-based (price only, systematic decision) orders today with lot sizes based upon a defined and more than acceptable risk, and with trailing stops based upon volatility. There was something quite comforting about having a defined maximum risk, I must say. Also, I placed trailing stops on several other positions in my account as a function of volatility as well. All thanks to techniques I picked up from your show.

I think it was James Rohrbach (episode 17) who first caught my attention with a simple question when talking about the market. He mentioned, with respect to buy and hold, something to the effect that after a large drawdown, the market may very well come back. As true as that may be, he asked, “Is sitting through that drawdown the smart thing to do?”

Some of the trend stuff, such as intelligent bet sizing, risk management, etc., is more than just trend following. It just makes sense as sound capital management best practices. Thanks for spreading the word.

Cheers,
[Name]

Thanks!

Where is the Exit Strategy with Buy and Hold?

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Michael,

I’ve been listening to your podcast and really enjoy it. Thank you for bringing different perspectives on investing, and for all the trend followers you interview who are candid about their processes, advantages, and disadvantages. I really enjoy all the interviews, especially those with Jerry Parker.

I’ve got a question: You disparage buy and hold, but is it the same thing as trend following? Charles Dow (in my mind) is the inventor of trend following. He defined primary trends, that could not be manipulated, secondary trends that could be manipulated, and shorter term trends (daily) that are generally random.

When you think about it, buy and hold (in equities) is just a bet on the longest of primary trends, namely, that the market goes up and down, but it goes up more than it goes down. It is divorced from any fundamental analysis, and has a clear entry and exit points: buy when you have funds throughout your working career and sell when you need money for retirement.

Sure, it has more volatility and drawdowns than something like the turtle strategy, but it has bigger gains at times too – trend following can’t match the gains in large bull markets. Thus, a buy and hold person subjects themselves to more volatility and drawdowns to follow a long-term (and hopefully more lucrative) trend, while a Turtle uses systematic trading rules to trade on the shorter – akin to Dow’s “secondary” – trends to reduce volatility and drawdowns, sometimes at the loss of gain but likely with superior preservation of capital.

The only difference is the length of trend one wants to follow. Otherwise, they’re effectively the same. Entry and exit rules, no fundamentals, seeking to ride a trend.

Agree?

Thanks for keeping the trend following torch burning. Keep up the good work!

Cheers,
[Name]

Where is the exit strategy with buy hold?

Pretty big issue to leave out if making the comparison to trend following.

How Does Buffett Make So Much Money? Not How You Think!

Excerpt:

Berkshire Hathaway has realized a Sharpe ratio of 0.76, higher than any other stock or mutual fund with a history of more than 30 years, and Berkshire has a significant alpha to traditional risk factors. However, we find that the alpha becomes insignificant when controlling for exposures to Betting-Against-Beta and Quality-Minus-Junk factors. Further, we estimate that Buffett’s leverage is about 1.6-to-1 on average. Buffett’s returns appear to be neither luck nor magic, but, rather, reward for the use of leverage combined with a focus on cheap, safe, quality stocks. Decomposing Berkshires’ portfolio into ownership in publicly traded stocks versus wholly-owned private companies, we find that the former performs the best, suggesting that Buffett’s returns are more due to stock selection than to his effect on management. These results have broad implications for market efficiency and the implementability of academic factors.

Buffett’s record is remarkable in many ways, but just how spectacular has the performance of Berkshire Hathaway been compared to other stocks or mutual funds? Looking at all U.S. stocks from 1926 to 2011 that have been traded for more than 30 years, we find that Berkshire Hathaway has the highest Sharpe ratio among all. Similarly, Buffett has a higher Sharpe ratio than all U.S. mutual funds that have been around for more than 30 years.

We document how Buffett’s performance is outstanding as the best among all stocks and mutual funds that have existed for at least 30 years. Nevertheless, his Sharpe ratio of 0.76 might be lower than many investors imagine. While optimistic asset managers often claim to be able to achieve Sharpe ratios above 1 or 2, long-term investors might do well by setting a realistic performance goal and bracing themselves for the tough periods that even Buffett has experienced.

In essence, we find that the secret to Buffett’s success is his preference for cheap, safe, high-quality stocks combined with his consistent use of leverage to magnify returns while surviving the inevitable large absolute and relative drawdowns this entails. Indeed, we find that stocks with the characteristics favored by Buffett have done well in general, that Buffett applies about 1.6-to-1 leverage financed partly using insurance float with a low financing rate, and that leveraging safe stocks can largely explain Buffett’s performance.

Don’t trust the legends, verify.

Source: Andrea Frazzini, David Kabiller and Lasse H. Pedersen, “Buffett’s Alpha.”

For those unwilling to think deeply…

Great lines from Seth Godin:

You might not be willing to devote the time and energy to understand how electricity actually works, or the mechanisms of your democracy, or the insights behind irrational decision making. More likely, you don’t want to expend the emotional labor to push through feeling dumb as you dig deep on your way to getting smart.

That’s always been an option. You can just use the tool without understanding it, copy the leader without realizing where she’s going, follow instructions without questioning them.

You can choose to be a cog in a machine you don’t understand.

If that’s working for you, no need to change it.

It made me ponder: trust the Fed, trust buy and hold, etc. If it’s working for you, no need to change it.

Tails
Tails

Buy and Hold Works, But Do You Want It?

Feedback in:

Greetings Mr. Covel,

Meb Faber recently stated on your podcast that buy and hold, value investing, and trend following are techniques of investing that “work.” I was surprised that you did not challenge his assertion. Do you agree with him? If Faber is correct, maybe the reason why is because an investor must select the technique of investing that is best suited to him/her as oppose to selecting the “best” method of investing. Comments?

Regards,
[Name]

Buy and hold works. The question: Do you want that “works”?

That is a personal choice.

Isn’t? I don’t want buy and hold. And of course other strategies work. I have had the likes of Toby Crabel and Larry Williams on my show.

Everyone needs to dig deep and pick what they want in life.

Larry Williams
Larry Williams

Ep. 414: Buy and Hold for 50 Years with Michael Covel on Trend Following Radio

Buy and Hold for 50 Years with Michael Covel on Trend Following Radio
Buy and Hold for 50 Years with Michael Covel on Trend Following Radio

Subscribe to Trend Following Radio on iTunes

Today on Trend Following Radio Michael Covel starts off talking about goal setting for 2016. He reads a 100 day fitness regimen for 2016. The challenge clearly lays out what is expected, and has concrete rules in place. In contrast, he plays a clip form CNBC with a headline that reads, “Stocks to buy and hold for 50 Years.” Michael tears their predictions apart. He says betting on others “current flavor of the day” stock picks are not how you want to plan your next 50 years.

“Top Stock Picks from 2016” is the next article Michael reads from. “Pro Michael Farr shares his best bets for the market next year including oil stocks, healthcare and consumer staples.” Farr starts off by giving an overwhelming amount of fundamental data to back up his stock picks. In the middle of giving his fundamental data however, he acknowledges that he does not have a crystal ball (and is guessing). He then goes on to guess oil prices will be higher rather than lower three years from now. Michael uses his statement as an example of prediction without foundation.

Michael moves on to diversification. If you trade in the direction of the stock pickers he brought on today, then where is your diversification? Research has shown that you need diversification. If you put all your money into Facebook or Chevron, as his market guru examples have told you to do, then where will you be in 10 years if those companies go the wrong way? Put together a diversified portfolio with rules for entering and exiting. Know how much you are going to trade. Have a plan in place so you can be successful.

In this episode of Trend Following Radio:

  • Diversification
  • Goal setting for 2016
  • Crystal ball prediction
  • The importance of rules in goal setting

“We’re going to bet 50 years into the future on idiocracy? That we can all instant message each other and pass photos back and forth, and there will not be any innovation in the future that could not possibly cause anybody or everybody to tune out of Facebook?” – Michael Covel

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The Truth: A Two-Edged Sword

The truth is, almost everything about superior investing is a two-edged sword:

-If you invest, you will lose money if the market declines.
-If you don’t invest, you will miss out on gains if the market rises.

-Market timing will add value if it can be done right.
-Buy-and-hold will produce better results if timing can’t be done right.

-Aggressiveness will help when the market rises but hurt when it falls.
-Defensiveness will help when the market falls but hurt when it rises.

-If you concentrate your portfolio, your mistakes will kill you.
-If you diversify, the payoff from your successes will be diminished.

-If you employ leverage, your successes will be magnified.
-If you employ leverage, your mistakes will be magnified.

HT Howard Marks.

More on stretching the truth.

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