Sunday, January 02, 2011

Battle-Plan for 2011 (strategy shift for a lower-volatility environment)

I'm changing my strategy somewhat for 2011, largely due to reduced volatility in the equities markets.

While volatility should likely rise this month, compared the December lull just ended, I'm moving to a more concentrated approach in my equities attack. I've been formulating this in my mind for several weeks and think it better suited, unless and until volatility heats-up again dramatically.

In recent years, in a more charged environment, I've done well emphasizing reducing volatility in my managed accounts. I employed a steady diet of hedging (playing both sides of the market at the same time, to varying degrees); increasing and decreasing position sizes, more or less in-line with the direction of the market; and using a wide-spread number of positions (a larger number of relatively small positions; sometimes as many as 20 long + short names combined).

This afforded me to push an aggressive growth portfolio and out-perform all averages, but demonstrate lower draw-downs vs. the overall market at the same time (yes, lower gains on occasion...perhaps unavoidable in such an approach).

If volatility rises dramatically, I'll revert in the direction of this strategy again. In the meantime it is going to look more like this:

-Fewer total trades. I will scale in and out of positions still, but with fewer numbers and lower frequency.

-Larger, more concentrated positions. View 10-20% weightings now as normal (down from 5-10%); View 5 positions as typical (5-6 positions on one side of market as maximum and 8-10 positions as maximum if neutralizing or playing both sides of the market/smoothing account volatility).

-Employ hedging strategies accordingly. Employ less hedging in a trending market and more in a choppy environment, but certainly continue to hedge.

-Trade far less in a choppy + low volatility market. Let the machines have the spoils in that environment; take to the sea and rest-up during this period.

The risks of such a shift are that I will be more concentrated and thus post larger swings in performance (account volatility should rise relative to the indexes themselves). If I get the market wrong, it will cost more (as always, but more so in this case). If volatility is running relatively high, I will front-run market direction less and follow a quick-step behind directional turns instead (every high and low is potentially important in a higher-volatility environment). On the other hand if volatility is low, I'll be more keen to front-run direction and/or wait-out more minor directional waves and hold more to the larger trend (resulting in fewer numbers of trades).

There are worse fates in this business than the occasional unnecessary retreat and I remain willing to behave accordingly. But the lower the volatility, in general, the more performance suffers by running to and from every shifting tide. Fewer positions make the dance somewhat simpler to manage and extremely low volatility renders over-trading succinctly ill productive. Ride with the larger trend and hold to your guns in that case; unless or until pressure is clear and adequate your position is on the wrong side of the tracks.

Best trading for 2011 - let's rock and roll!

Follow Centrifugal to fade trades in real time

Total Position: Currently 1.41-to-1 net-short, 76% invested (net-short stance, taken only at the end of session on Friday, expected to be short-lived; unless correction commences out of the gate with the new year; which is not unprecedented).

Currently Long
(according to size): BA (12.1%); CRM (increased Friday, 8.6%); ULTA (7.1%); CENX (5.9%)

Currently Short: AAPL (temporary hedge for now, 20%); (NDX index via long-QID, 10.1%); GMCR (7.3%); CVS (4.9%)
(currently weighting QID at 1.55 x's instead of 2 x's on net-long calculation, based on relative beta of longs vs. qid)

Futures: no current position.

Note: More Battle for Investment Survival lectures to come soon; fast and furious perhaps.

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