Plan Ahead. Updating your portfolio vs the use of stop-loss orders.

May 11, 2010

In portfolio management, the term strategic is code for long-term.   The term tactical is used as a way to describe a strategy that is shorter-term, such as a portfolio adjustment based on seasonality.  

So for example, you may want to own the India Fund (INP) in a strategic long-term sense --- though you may be underweight on a tactical/short-term basis etc…  Or you may not care about the Gold ETF (GLD) long-term but you see a tactical opportunity in it now --- something we have highlighted recently.

We know that you can greatly improve your Sharpe Ratio by employing some relative strength strategies to your ETF investing.  One of’s primary strengths is allowing users to easily test various overweight/underweight methods.  Our relative strength application ‘updates’ on a pre-defined date -- we do not use stop loss orders.   The ‘stop’ is in effect the next update period.   We view this as a far superior method as it removes the emotional nature of the markets and keeps you from acting on whipsaws, like we saw last Thursday. But the primary benefit of this framework is that it keeps you focused on the bigger picture -- and it is global asset allocation that ultimately drives 90%+ of your portfolio returns. Is your portfolio positioned correctly as of the end of each quarter?   Is it positioned correctly at the end of each month?   You can of course update your portfolio during any day – but hopefully, you are doing this in accordance with a larger strategic plan.

If you plan ahead and watch your overall volatility, you can sleep at night knowing that you have the Sharpe Ratio on your side.  Over the long-term, the relative strength models will find markets that go up ---- and good portfolio management will limit your drawdowns.  If instead you recklessly buy a list of securities and have no idea what your portfolio volatility even is --- then you are going to be placed in some very difficult situations.  The key is to plan ahead of time.   Hopefully, our models and backtests can aid you in this thought process and help you find some good reward-risk situations to overweight.   

On Monday, the market gapped up a very large percentage on the nearly 1 trillion Euro bailout.  Importantly, this followed a very significant correction in European stocks.  This is the kind of thing that is a more technical aspect of tactical portfolio moves.   Indeed, vicious short squeezes should be viewed as the norm after sharp market corrections, like that experienced in Europe. This is the very definition of volatility.  

Precious metals --- Gold (GLD) and the precious metals ETF (DBP) are the thematic leaders of the market now.  Be on guard regarding your overall portfolio as volatility has surged – but keep your tactical trades in line with your strategic ideas and you will consistently be updating your portfolio with the best reward-risk situations.   Combined with intentionally keeping your volatility low, your Sharpe Ratio will rise – and this should be your ultimate focus.

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