Could you elaborate. FnO approach to hedge an already existing portfolio? Hedge it to protect from an impending crash, or just to extract extra beta?
1 Like
Can you explain how you define risk management?
Is it simply valuation (by whatever method).
Every time before I click on buy button I try to say myself one more time. Have I factored everything that can goes wrong against me? Risk management in standard definition is what can go wrong? Companies have an easier framework to identify risks as they have defined business process. Unless you have a defined a method or process you will not able to know your risks.
Here is my current investment method (you can say subset of investment philosophy). Removing few of them due to privacy. Or else most important oneâs are there.
2017-18 (till Mar 31, 2018) Objective: 1. Trading income supports living expenses 2. Dividend goes to charity 3. Non trading funds (core portfolio +liquid funds) appreciates by 22% plus.
These objectives have to be quantified. Itâs not that difficult. For example if my living expenses is 100, by winning 1 rs per trade 100 times I will be able to reach there. If I can manage 40% accuracy then I need 250 trades in year or 20 per month around. (100 pass, 150 fail). If I target 20% on each trade to achieve 1rs income per trade calculate the capital required.
Now for core portfolio objective: how 22%, because my thatâs my long term performance. Metrics for last 14 years say so. Once I outperform benchmark I would look for higher, my benchmark is aligned to my objective of financial goals. I do not care what mutual fund does. Please do not follow them, or else hand them over money. I have cracked 200% plus trading income in last 2/3 years. External benchmarking is extremely damaging in investment as we do not have all parameters to compare.
Now risks for core portfolio:
-
I need to move from 100 to 122 in this year I.e. April 17 to Mar 18. By end of June 17, 100 has becomes 90! I have to move from 90 to 122 till Mar 18. It becomes 36% recovery in 9 months. Now imagine 100 became 50. To go to 122 in 9 months you will require 144% to achieve, insane act! In short define a tolerance limit which you can recover. My risk tolerance or capital protection is defined at historical average. This meaning the maximum loss I could recover in my entire investing career is 27.54%, I donât keep a stop loss beyond 20%. Now this will kick you out from good stocks, I have been answering these questions. I have no problem in re-enrty. I separate research from execution.
-
Tweak tolerance limit as per performance I.e. play big when you are winning, lie down when you lose. If a stock start performing I give more space to it for play around. E.g. I have a company called Maithan alloys which have 30% capital protection point because price has moved from 45 to 830 now. Trust me good stocks give you 100 chances to add, exit and re-enter. I am not here buy either cheap , rather I want to buy at a price and sell at a higher price than purchase price.
-
To achieve my tolerance limit do I have to a bet size of 10% or 25%? Then my game is over, 4 times I am gone wrong; punched out forever. Currently my risk tolerance is less than 0.15% of available capital. This means if I lose 700 times I am gone forever. Well before market brutally beat me down 700 times I will counterpunch 50 times for sure. I need to make sure 50 counter punches are big enough to get me back to game again.
Note: please search my notes in this forum. Recently I gave example of pyramid with negative risk. Also you will find few other notes how I manage positon size. By the way Maithan have given me 24 pyramid transactions since 2013. I am sitting on 540% negative risk! -
If market conditions goes against me and I am not able to achieve target percentage what are other options available to me. Like say move to safety first like liquid funds. Second look for alternative funds management like PE(SME) etc.
-
If margin will be required to achieve objective do I have a brokerage account which provides me margin. Or say if one broker account goes out temporarily for something what is the back plan I have?
-
In case income comes down drastically what would be impact to my lifestyle and family?
Unfortunately it needs to be customised. Valuation method does not help you to manage your risks, itâs your financial plan has to be intertwined with market feedback. Together it will create performance record.
Itâs like everyday you think what damage you can do to yourself. A lot more than you think!
21 Likes
Suddenly realised about tone of this reply. Where ever itâs written as you I am not directing to you as such. Rather in general sense âweâ; for example âa lot more than you thinkâ in the end. What I meant there we can damage ourselves more than we think.
I hope in interim no one felt bad, in case my unconditional apologies.
3 Likes
Hedge existing portfolio, hopefully have a framework which can help me recover some of the losses on my equity portfolio when the going gets tough.
Donât really see the point in striving for extra beta when we have small caps delivering such out performance anyway. Will never be an option seller, hence capital preservation (the capital which goes into paying the premium while hedging using puts) will always be a challenge
If one purchased ATM puts, then expense is usually around 1% to 1.5%. To adjust the beta of portfolio, you may hv to spend around 2%
This is an every month expense. How do you decide when to start? Once started, and if you end-up having to do it for 10 months, then you hve already spend 20% !!
1 Like
Being in the Options market all the time is a sure way to lose money unless one is really good. The bigger challenge is to know when to be in and when to sit out. Through 2017 I have hardly made 7-8 trades, ended the year at a slight profit due to 2 trades that worked out well within 10 mins the day the Gujarat election results came in.
One needs to have a solid framework to decide when to be in the market - it is more macro and event based than valuation based. Thatâs what I hope to improve on, so far have made some progress but not too much.
Further queries on this I suggest we take it offline through PM, wouldnât want to dilute the thread content here
1 Like
@The_Confused_Consult: Really appreciate your lucid writing! I have one question on above statement. Since this is related to non-trading or core portfolio, why would the risk tolerance be so low? As we have seen in the past, the core portfolio can easily draw down quite a lot in a single year. Why would the core portfolio be touched 700 times in a year?
Apologies if you have explained it in pyramid, will look this up 
Another related question I have is, do you have a mechanism to move funds from core to trading portfolio over long term? IN other words is it your plan to move x% every year from CP to TP, or you plan to let the trading portfolio take care of not only providing living expenses, but also increase year over year to take care of yearly inflation?
1 Like
Here is my submission to your first question, kindly let me know if you need further clarification.
I have four stocks in my core portfolio now:
- Stock A- acquired during 1997-2001, average cost is 41.50 (multiple transactions), CMP is 18964, my current capital protection point is 12500 (around35% from CMP). There is no risk.
- The Stock B and Stock C acquired during 2013-14 are sitting on risk free as well.
- The last Stock D (new entrant in 2017) have 4 transactions so far. 3 out of 4 transactions have been risk free except the last addition.
So basically, there is one transaction where I will lose my original capital if market turned against me and I am able to sell my shares at my protection point. I have calculated risk tolerance as the risk divided by capital invested into core portfolio.
Say I buy a stock X (transaction 1: 100 shares at 100 first and I decided I will sell at 80. So, my inherent risk here is 2000 ((100-80) *100), residual risk is also 2000 ((100-80) *100).
Now assume stock X moves to 140. I changed my selling point to 100. Now my inherent risk will remain same i.e. 2000 ((100-80) *100) but my residual risk becomes Zero ((100-100) *100). Here my risk commitment in transaction 1 which was 2000 becomes zero now. Itâs available for next transaction- transaction 2.
Now imagine same example the current price is 3000. As the stock has move up and making me happy I have decided to give 35% protection to play around i.e. I will sell at 1950. My inherent risk will be same i.e. 2000 ((100-80) *100) but my residual risk would be MINUS 18500 ((100-1950) *100).
I will never add a stock which will increase my initial inherent risk on transaction 1. This means if I have committed 2000 risk on transaction 1, I will not add anywhere if this figure goes beyond 2000. That would be all residual risk combined is either 2000 or less. Sometime this allows me to average down also (rarely I do though), how? Here it is:
Same stock X- after a price of 3000, it fell to 2500. Now my residual risk number would be still MINUS 18500 ((100-1950) *100). Even I commit 2000 additional risk through a new transaction the total residual risk will still be negative.
So, 0.16% is calculated on the POSITIVE (without considering NEGATIVE) residual risk of portfolio divided by capital invested. Now If I add both positive and negative residual risk it is a huge negative. But my selling point are transaction wise (at the time of fall I may sell them at one go, thatâs different), so now one transaction in entire portfolio carries a positive risk for now. For last 8/9 years its been like that.
The 700 times premise was derived from this:
If the market kicks me out from current portfolio I will lose 0.16% of original capital invested. In totality the residual risk would be negative, hence no loss of capital. I extrapolated the fact in 4/5 years old portfolio if I can make a plan where I lose 0.16% then I will survive 700 times with same plan. This argument is flawed to some extent, I concede but with conservative bias. This is how:
- Actually, there is no loss of capital. Though overall risk is negative I am still taking last transaction for risk exposure assuming I will sell the transaction at capital protection point.
But yes, next portfolio construction will get into many more years. It would be difficult to assume to maintain the same level of 0.16% risk again. But considering my residual risk being mostly in single digits across 22 years I extrapolated the number to absolute which of course can be theoretical.
Let us conclude this way, I have to be knocked out many many more times by market before I rap up my belongings here.
No, we will never touch portfolio 700 times in a decade even. 2016-2017 I have added only one stock to core portfolio that to 5 transactions so far.
I hope I could explain to your need, I am answering your next question.
5 Likes
Second question is a tougher one for me to answer, let me try. This is how I do now, please advise me with better suggestions.
-
I calculate freely available capital first before beginning of year (1 April- 31 Mar). That would-be a. trading portfolio value (due to churning of capital it is minimum) b. core portfolio (long term in nature) c. non-equity funds which are not locked (I have some investments in PE/SME which are locked for some time).
-
I prepare annual budget of expenses to best of my abilities including contingency. Say I get a figure of 10 lacs. That means I have to extract 10 lacs from trading post tax effect. With gross of tax say around 12/13 lacs.
-
Next step is I compute how much of capital would be required to generate this 12 lacs trading income:
-
Say my average winning percentage is 10% and losing percentage is 5% with accuracy of 50%. This is not random number, I use previous metrics and do a haircut for conservative approach.
-
This would mean I will lose 50% transactions and gain 50% transaction i.e. accuracy of 50%.
-
I would require 2 lacs trading amount each time for 250 times round the year to achieve an income of 12.5 lacs.
125 winning transactions= (2lacs*10%)125=25 lacs
MINUS 125 losing transactions= (2lacs5%)*125=12.5 lacs
Net income 12.5 lacs
-
Now next step is to determine the maximum blocked capital required to achieve this 12.5 lacs. For this I need a very important number which is average holding period of winner and loser. For simplicity let us assume both are 10 days (winner and loser average holding period). What does this convey? Every 10 days by putting 4 lacs (2 lacs * 2) into two transactions once I can make a. 20000 profit (200000 * 10%) b. 10000 loss (200000 * 5%) or 10000 net profit. There are possibly 200 days I want to engage myself in a year meaning 20 attempts. This means by investing 4 lacs every 10 days I can make 2 lacs a year (10000 * 20). To achieve 12 lacs of trading income I have to investment in 6 stocks at one time. That means 24 lacs maximum capital required. On 12 lacs I make profit 1.2 lacs in 10 days, on another 12 lacs I make loss 0.60 lacs loss. A net profit of 60000 every 10 days, on a 200 day a year average it would be 12 lacs (60000 * 20).
-
Now I know my trading capital requirement. In essence freely, available capital minus maximum blocked capital for trading is available for long term investing. If I do not get right opportunity money stays either in liquid funds or get blocked to PE or some alternate sources. If I get opportunity I keep adding to core portfolio.
Now divergences:
- If the trading income substantially increases. This can happen due to two things:
- Planned trading capital delivered more return than planned.
- Trading metrics running far ahead of core portfolio metrics. It is sensible to accept the verdict and increase capital allocation to trading as itâs winning.
The additional income from trading gets added to freely available capital at year end for next year budget exercise.
Similarly, if I book profit out core portfolio it gets added to freely available capital.
- Now if there are losses in trading portfolio I will never allow myself to trade beyond planned. In fact, I will start reducing my position size, number of transactions etc. This would mean I have to use some funds from freely available capital. The shortfall if any I will create a suspense account to make sure it gets down to zero from trading income in future. I am using the word will as I have not faced this situation, just sharing the plan. Since last 2 years only I am trading.
I sincerely hope this may help in your design. And please do let me know changes you would like to propose. We can take it offline if itâs getting bit personal financial plan to discuss here; though I do not have reservation in sharing as long as our privacy in terms of real number is protected.
Best wishes
7 Likes
I really admire your Risk Management and Capital Protection framework but need to understand more how you execute the same. Suppose Stock X is going below your capital protection point say 80 in this case. How do you execute your sell order? Manually or through Stop-Loss mechanism offered by Trading Systems?
@The_Confused_Consult - Thank you so much for the very detailed response and sharing your thinking.
Put one way, what you are doing is instead of shifting capital, you borrow the risk credits from Core Portfolio to trading Portfolio, right? And when market rewards you more, you simply increase the credits and if market punishes you, you plan to create a suspense account to make good the deficit in future. Very good risk management !
On the first part, you hit the nail on the head of where I was going, i.e. re-construction of the portfolio should market mete out severe punishment. Am I right in thinking that you consider ( or anchor) all transactions to âoriginalâ capital and while this gives tremendous freedom and confidence to buy on the upswing while also protecting the downside, there is somewhere a psychological tenet that my original capital is protectedâŚbut please consider a thought experiment when / if there is ever a situation of hitting the portfolioâs Capital protection points. Then, the recovered capital ( say 20% down from current value) is the starting point of a new portfolio, and the transactions then would be different with a fresh anchor point, or a fresh definition of âzero riskâ and hence also residual risk? If this answer is yes, then what is the outcome if we do this thought experiment today, and recalculate the residual risks? What would it change?
Again, I truly thank your detailed response and certainly something to accelerate my currently primitive methods of âtradingâ, or whatever I call my short term bets 
1 Like
when / if there is ever a situation of hitting the portfolioâs Capital protection points. Then, the recovered capital ( say 20% down from current value) is the starting point of a new portfolio, and the transactions then would be different with a fresh anchor point, or a fresh definition of âzero riskâ and hence also residual risk? If this answer is yes, then what is the outcome if we do this thought experiment today, and recalculate the residual risks? What would it change?
If I try to understand correctly your question we are looking for an answer when we get stopped out before making we start from a zero base. Yes agree and I find it extremely useful in my experiment. This would be my submission:
-
Booking a loss removes all biases and errors you carrying emotionally and financially. I can start thinking in clear mind So in a way demonstration of positive behavioral aspect.
-
When I go next time with a zero again I will be reconstructing keeping risk in mind. I understand 10 year old portfolio can not be replaced in three months by using a new positions. I would rather build gradually again to cover maximum capital allocation than one go.
But I guess where I found beauty is metrics, whether I sell or buy , fully or partially my metrics tell my foot print and that would be:
For trading portfolio: minimum
Average winning margin
Average losing margin
Accuracy percentage
Average holding period of winner
Average holding period of loser
If my winning to losing margin is 3:1 with accuracy even 40% my expectancy is 60%. Now if any of my parameter deteriorates my task would be to cut down risk till the time I find out a solution. That includes even stopping the trading.
For investing portfolio thresholds get changed, instead of 10/15 days holding period it can go to 3 year/5 year. But nature doesnât change.
- if my accuracy is falling then can be research or timing issue. Can be behavioral fall as well.
- if margin is shrinking can be valuation issue, can be timing issue.
I mean when we review metrics quite a bit things will you come out only if we documented a reason why we entered in first place and what was the scenario plan designed and what happened subsequently.
Best wishes.
1 Like
I keep an excel tracker and maintain stop loss manually. There may be 2 risks in doing so:
- We may over ride decision, if I do so my metrics suffer. If my metrics suffer I am out of business. In fact my average loss percentage is way below stop loss level.
- Higher slippage- in my experience slippage is a lesser probability event in long which doesnât jeopardize entire portfolio. If I get continue slippage I tighten stop loss further. Any case metrics again will be hit by slippage which forces me course correction.
Thank you so much & providing lot of food for thought !
This thread is important for some one like me who is not keen on working in a regular job for a firm after some time.This some time is pretty long for me(Around 10-15 years).I have still not decided if equity investing will be my full time career but its definitely one of the options.This time frame is based on the
1.Capital required-I have done certain back of the hand calculations and this corpus i would need is a not a fixed one and it will take some time to finalize it.Its based on factors like inflation,contingency capital,future cash flows and my spending habits
2.Knowledge capital-This is a continous process and in this age of information overload,its not only learning new things but also deciding on the things which i need to retain.This one is difficult to quantify but would check after this time frame,if i am still willing to keep learning and unlearning.
3.Developing the mindset and habits-This is the most important thing which i would be monitoring over this period of time.Having the long term outlook,acceptance of the mistakes, ability to stick to strategies,Being emotionally detached from the investments are a few of the factors i am working on.I have started adding a note to every investment i make which details my sentiment and my rationality for doing it.Over a period of time,i believe this journal would help me a lot to decide if i have the mental attributes to become a full time investor or do other things which interest me.
1 Like
I donât want to upset last few hours of your weekend.
- Please do not plan anything post 10-15 years, no one knows what will happen tomorrow. Plan are born on same day, can be executed on same day. There is nothing called perfect plan. We will learn the rope as we go along.
- There was no capital required to create Amazon, neither Dell computer. Risk, capital, reward everything created in same quadrant. We do not need multiple quadrants in life.
Developing knowledge and habit is an excellent idea, very few maintains a journal. After few years it will give your more information than any book. Please include a metrics and journal review every quarter as self assessment and if possible with some one indepdent as well.
There is no second day to start something which you are contemplating with single vision. Unbalanced and focussed approach will liberate you forever. I will tell you one major difference when you work in one quadrant only despite of all obstacles. One year unbalanced and one sided focus is equivalent to 10/15 years of multi tasking. I do not want to use this word, multi tasking is crap and BS!
Not trying to provoke or pump you, reminds me the years I lost for no reason. Time is very important friend, make a plan which includes time element. Not for investing such as rather any one endeavour we are serious at.
15 Likes
I have decided to continue working at my job till I build a corpus of 20 to 25x of my annual expenses.
Hope to build it in few years.
However, I must confess that the more books I read, the more I realize that there is much more to learn in investing.
In the meantime, I continue to lay low till I get good investment ideas.
âFor all your days be prepared, and meet them ever alike.
When you are the anvil, bear - when you are the hammer, strike!â
-Edwin Markham