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« Who is Overconfident? | Main | ETF Update: Time for Big Banks? »

February 14, 2010



Smart investing includes risk management. For each stock, bond, mutual fund or other investment you purchase, there are three distinct risks you must guard against; they are business risk, valuation risk, and force of sale risk. In this article, we are going to examine each type and discover ways you can protect yourself from financial disaster.

Business risk is, perhaps, the most familiar and easily understood. It is the potential for loss of value through competition, mismanagement, and financial insolvency. There are a number of industries that are predisposed to higher levels of business risk (think airlines, railroads, steel, etc).


Mike C -- My writing has attracted a number of system developers. I have my methods for reviewing. Very few ideas pass the tests.

One thing I do is take the system and test it on a different time period and using different choices than did the developer. This is about as close as you can get to a real-time test.

The result is a method that combines strong sector picking in good times and goes to inverse ETF's and other choices when times are bad.

The filters and time frames are much discussed, and the average investor can improve results with these methods. Readers will appreciate your citations (which I have seen) but I did not want to seem to endorse any particular approach.

Thanks for your suggestions.



Ron -- Nice additions. Thanks for sharing with us!



Zardoz -- I'll need a new way of explaining this concept!



Mike C

"There are some simple solutions for those who are afraid of a repeat of 2008.

I had some reader questions after last week's update, wondering whether asset allocation models had triggered. Mine have not. The "correction" is still relatively small when compared to the recent gains.

We watch the asset allocation carefully for clients, and the indicators are closer to a conservative stance, but not there yet and certainly not short.

The average investor can try to do this at home. There are plenty of ideas online.

I think many including myself are rightfully afraid of a repeat of 2008 because at least from my vantage point it is very difficult if not impossible to ascertain whether we have a bonafide economic recovery with its associated typical multi-year bull market, or whether the "recovery" since the Mar lows is just a result of governement stimulus and a potpourri of government and Fed programs.

Given that set of circumstances, it does seem like a position of cautiously long equities with one finger on the PLAY DEFENSE button is the optimal position.

You mention there are plenty of ideas online. Given the importance or minimizing another 2008 type drawdown, perhaps this is something where it might be helpful to share some specifics with regular readers of this blog without understandably giving away the store or anything proprietary that clients pay for. What specific metrics or quantitative indicators are you using to trigger more conservative asset allocations.

I'm sure you are aware of the 200 DMA/10-month moving average indicator which is very popular. Mebane Faber's paper tops the charts on this indicator, Random Roger often mentions it, and Bespoke mentions it here:

I know that I and most likely your other regular readers would be interested and appreciative in some more specifics here in terms of what you use.

ron glandt

Some of the best indicators of S&P trend.


Baltic Dry Index

Constant maturity swap

0ther economic indicators of value....some surprises!

Ron Glandt


>> black swans are not found in herds.

Yes they are! but I take your point anyway.

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