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Diversify or Suffer the Consequences

In today’s global investment environment, equities, fixed interest or property from around the world is very accessible. bhp-rioThis means 2 things – some part of the world will always be performing better than another and any investment has a true diversified alternative.

bhp-anzDiversification is measured by the correlated move of 2 investments – for example if BHP changes its value (up or down) there is a high probability that RIO will move in the same direction. So the 2 investments do not offer much diversification, they may vary a little but from the chart to the right similar issues will effect both companies.

A lower correlation would occur between BHP and ANZ being from different market sectors, but still the same fate may be born if the Australian share market is struggling.

A lower still correlation may be obtained with BHP and Microsoft.

An even lower still correlation may be obtained with BHP and Government Bonds or BHP and Property. Both of which have an extremely low correlation of a similar move.

So why is this important? — The object of diversification is to create a robust investment strategy that will not collapse if the wind is blowing  the wrong way. The more assets you have in your investment portfolio that are moving in different directions the safer and more robust your investments will be. This doesn’t necessarily lead to a lower return, especially with the correct rotations and reweighting, but it does lead to safer investments.

 

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Options Writing on your portfolio

One of the things I love about options is that there is nearly a strategy for every market condition.

Rather than using the same strategy accross all conditions which may give you questionable results, tailer made strategies can be used to take advantage of current conditions. One strategy that has been adding a lot of value to shares inside an existing portfolio is Covered Written Calls.

Below is an image showing trades taken on an actual account over the last few months, prices noted are per share in cents. Each trade places cash back into the trading account, when the trade is taken. Brokerage is not considered in this diagram.

Now there is risk with any strategy, understanding how to manage that risk is the secret to being profiatble with any strategy.

So if your leaning towards the risk averse end and you would like to add some value to your return, you do have a few choices.

If you would like some examples or a couple of strategies that may suit your style, please give me a call on 0402 855 800 or shoot me an email to steve.soars@gmail.com

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Averaging Down

Sooner or later we all end up with a losing position on a good quality share, we may feel that we can ride out the slump and wait for the market to regain its former glory. One technique we can use to assist is to average down our purchase price. With this strategy we would purchase another parcel of shares at a lower value effectively lowering the average purchase price of the entire holding.

Lets say we own a parcel of 1000 shares has been purchased shares for $10.00, and the position is worth less than the original purchase – Say $6.00 per share.  Lets assume that no risk management has been applied (because if it was, you wouldn’t be in this position).  Buying another 1000 shares at $6.00 would lower the complete average on the asset to $8.00.

So lets look at the right time and the wrong time to do this. The wrong time is when the market is falling, if you are averaging down into a falling market is very difficult to achieve a good result, because we don’t know how far the price will fall. If the price falls to $3.00 your decision to average down hasnt been a good one. The ramifications of getting this wrong may impact on your positions profitability, it may create an imbalance in your portfolio or in the worst cases give you greater exposure to a dying asset.

A more appropriate time to use this strategy would be to wait for the market to form a support base and bounce – at least in this way the market is moving in your favour again. Try to look at it like entering the position again — does it meet my normal entry criteria, if so its the right time – if not then wait until it does, or forget this strategy.

Ideally averaging down with the market bouncing off a support line and forming a bullish pattern is the time to average down, the stronger the move upwards the more likely you will have a successful trade.

In Short: Don’t Average Down into a falling market, go when the market is rising. Getting this right will give you the ability to lower your original entry price so you may trade out of the position with a profit.

Happy Trading

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The trend is your friend?

Governments around the world did a fairly good job injecting funds into schemes to “kick start” their economies from the lows of early 2009. Eighteen months later we have seen a 50% retracement from the “Bear Market” through 08, with markets gaining ground nicely.

The steam started to come out of the market late 2009, transitioning from a nice bullish pattern into a sideways channeling movement. During this phase we started to see the hangover of the short 09 bullish surge.

Once the AXJO dropped below support at the 4500ish level in May 2010, the market shifted into a downward trend once more.

One of the biggest sayings in trading is “Trade with the trend – The trend is your friend”, the way we identify longer term trend changes is using the peaks and trough positions on the chart.

With that information, we must identify we are again with the Bears. So what do we do with longer term portfolios?

Three choices exist;

  1. Let it run, over the longer term the market will fight its way back to previous levels – provided the shares within your portfolio are sound.
  2. Exit your positions – bank your profits or cut your losses.
  3. Take an opposing positions to offset losses. This is called hedging.

Whatever you choose, make sure you take into consideration all the “pros and cons”.

The trend is your friend? Only if you recognise it and act accordingly.

Happy Trading