trade assurance and leverage

[hooligan]

Sometimes I wonder:

instead of trading risky options for high reward,
why not just leverage higher on more assured trades ?

that gets me thinking about . . this conceptual map:

%chance of success
potential gain (range)
potential loss (range)
leverage (using margin, etc)
allocation/diversification

if you have a high %chance of success but low potential gain , you can leverage for better reward.
if you have high %change of success and medium potential gain, leverage can turn an easy reliable play into a big gainer !

what if one used this strategy but employed principled allocation and diversification strategy to spread risk?

[Triplethought]

Sometimes I wonder:

instead of trading risky options for high reward,
why not just leverage higher on more assured trades ?

that gets me thinking about . . this conceptual map:

%chance of success
potential gain (range)
potential loss (range)
leverage (using margin, etc)
allocation/diversification

if you have a high %chance of success but low potential gain , you can leverage for better reward.
if you have high %change of success and medium potential gain, leverage can turn an easy reliable play into a big gainer !

I'd love an example.
what if one used this strategy but employed principled allocation and diversification strategy to spread risk?

[hooligan]

put a little more simply:

why do we ever tolerate risky trades to get high gains

when we could just leverage our most high-confidence trades

?

[AstuteShift]

put a little more simply:

why do we ever tolerate risky trades to get high gains

when we could just leverage our most high-confidence trades

?

Higher gains equals more risk

You are allowed to trade independently and you can use leverage but this should be reserved for an elite trader.

It’s very easy to lose everything.

If you put on a trade and can’t sleep at night then that trade is too much for you.

[hooligan]

Higher gains equals more risk

but that isnt a categorical truth
do we need to decouple that mindset ?

sometimes there are trades that are low risk high reward
(these are rare of course)
low risk low reward
low risk medium reward

the risk of losing on the trade
is not the same assesment as the "risked amount"

it's a matter of various TA and market psych probabilities.

so the idea is to choose trades with the highest win probabilty , the safest trades

and leverage them harder , as a possible alternative to choosing investing arenas with higher reward but higher risk of failure, like options for example, since they have the time component , spread gouging , high competition , liquidity issues etc

just a little theoretical curiosity here

[hooligan]

I'd love an example.

On one trade, you're 90% sure it'll go up from buy level, but it'll only go up 20%, to a targeted technical analysis area.

On another trade you're 60% sure it'll go up from buy level, but it'll go up 50%, to a targeted technical analysis area.

_____

Why not just leverage the trade with 90% assurance harder, so you can make that same 50% but with a higher probability of success? You can use stop losses to protect from loss anyway.

_____

The idea is to separate "risk" into TWO concepts: Assurance , and Risk/Reward

Assurance is how likely the trade is to do what you want it to do.

Risk/Reward is how much you stand to gain or lose based on understanding technical analysis levels.

_____

Then of course you have Leverage, which is how much you invest, or how much you borrow, to put behind the trade.

If you can find high assurance trades, then you can jack up your leverage with less concern.

I never hear anyone discuss this dynamic in the investing world. I feel like it could be put to use lucratively.

[Yodean]

On one trade, you're 90% sure it'll go up from buy level, but it'll only go up 20%, to a targeted technical analysis area.

On another trade you're 60% sure it'll go up from buy level, but it'll go up 50%, to a targeted technical analysis area.
_____

The idea is to separate "risk" into TWO concepts: Assurance , and Risk/Reward
_____

I never hear anyone discuss this dynamic in the investing world. I feel like it could be put to use lucratively.

Leverage aside, I totally agree. I think in those terms all the time, i.e. probabilities of risk vs. reward.

The challenges, from my experience, lie in how to determine the actual numbers, and the specific time frame to which they apply. Mistakes may occur in both trade direction and time frame.

I generally don't believe that the % probability of a trade working out can exceed the 80% - 85% neighborhood - the 15% to 20% includes all sorts of Black Swans, personal blind spots, Fed manipulation, other types of manipulation, etc.

Most trades are likely in the 55% to 70% range, at best.

A few examples:

1) I see gold as mostly trading between $1720 and $2000+ in the next five quarters or so. I assign an 80% probability that I will be "right" in that time frame. Gold is currently around $1780, so if one buys now, that represents approximately a 12% to 13% gain, vs. a 3.3% loss. One may then go about deciding how much to invest with those numbers, i.e. 80% probability of a 12% + gain vs. 3.3% loss. 20% probability of a bigger loss or gain, in that time frame.

2) With small-cap biotech. stocks, I use some version of the following rationale:

-a lot of them have a 50%+ probability of 2x or better in one or two years; but they also have a certain probability of dropping 80% to 90%; so I invest in this sector with these types of numbers in mind;

It's also important to have a way of determining whether you are wrong or not, or whether it's simply variance (i.e. price variance or time variance), and what to do with the asset in question if one is "wrong."

Using the gold example above, if gold drops to $1680, I am not going to be too worried, as it lies within my perceived price variance. However, if gold drops to under $1600, then I will wave the white flag and decide that I am wrong.

Then have a specific execution plan of some sort, which one may alter as "battlefield" conditions change.

Currently, for example, I always have a core gold proxy holding. On top of that, I am buying almost every dip in gold with GLD as long as gold is under $1800; once it goes over, I won't buy any more. If gold drops below $1720, I will likely buy one or more times, then stop buying. If gold drops below $1600, I will take a long, hard look at the financial-political environment at that time and outline a new plan (i.e. just hold, or sell a bit to reduce further risk, or even buy more).

It's also important to look at your entire portfolio and try to estimate the "Risk of Ruin" (ROR). That's the rough possibility that if every trade you make goes south, how much you stand to lose . . . not pleasant, but necessary.

Also consider personal psychological costs/impact:

1) Yes, mathematically it might better or the same to lose 80% to 90% on six trades in a row, but gain 1000% on the seventh trade. However, during the time when you are losing on those six trades, you feel like sh*t and this impacts negatively on other parts of your life, etc.

2) If one looks long and hard at the MIM ("Man in the Mirror"), most investors would likely be willing to sacrifice some gain for less downside volatility. Let's take an extreme example:

You are given a choice, for 2022:

Option A: You have an 100% probability of a 0% to 20% overall gain in your investment portfolio.

Option B: You have a 99.9% probability of a 66% to 666% gain in your investment portfolio. However, there is a 0.1% risk that you will lose 100% of your portfolio.

Which option would you choose, if you could choose from only those two?

[SOL]

Before one can become a winner one must be comfortable with losing. If you think you will win all the time, then you are by default going to lose most of the time. Almost everyone focuses on the upside but never on the downside. There is no free meals, there are just probabilities and for anyone one of those probabilities to lead to success the underlying element is how you choose to deal with risk and loss. If you can't deal with loss then forget about high probability trades

[Triplethought]

Before one can become a winner one must be comfortable with losing. If you think you will win all the time, then you are by default going to lose most of the time. Almost everyone focuses on the upside but never on the downside. There is no free meals, there are just probabilities and for anyone one of those probabilities to lead to success the underlying element is how you choose to deal with risk and loss. If you can't deal with loss then forget about high probability trades

This is a lesson I learned (and am still learning) this year. I literally had no "realized" losses well into the first part of this year. That changed when I lost my nerve and bailed out of USAK options a little too early trying to minimize the loss. In fact, most of my losses this year have been on options, in which the time expires and forces me to "realize" the loss. As for options December/Jan is going to be really bad as we take hits on some of the Trend Blazer options like MKC. I've definitely learned why options are for both the sophisticated and for the investor willing to take some losses to get gains as well.

My problem is I've stopped tracking the ROI and even if I didn't the period you calculate it matters. Do we calculate the entire Trend Blazer portfolio? Or combine that with MU? Also none of us probably trades perfectly according to your instructions (The Peter Lynch problem you've pointed out). I've had periods where I've been very good and then ones where I decide not to invest in a particular play so no one can say "the portfolio did x% this year" with complete authority. We have quite a few underwater plays in the MU portfolio that we hope will eventually turn around. My general sense was last year has been better than how we're doing this year.

I know you track % increase or decrease of individual plays - do you do the same on the whole portfolio over given slices of time??

[DOCLUC]

to Yodean
Thinking, Fast and Slow, coyuld be an interesting book. It explain how risk aversion works, why we take (often) wrong decisions etc etc.
Very interesting. And sometimes funny too

[Yodean]

to Yodean
Thinking, Fast and Slow, could be an interesting book ...

Thanks for the recommendation. Have passed it quite a few times in the bookstores - it looks like now is as good as any to start reading it.

[MarkD]

I believe the risk of options is worth it, along with stocks, as long as the deficits increase. I read the other day (can't recall where as I was in recovery mode) the decarbonization plan will cost US taxpayers $150T in additional new deficits over the next 30 years. Unbelieveable. $5T per year.

[hooligan]

i agree sol its all about the overall big picture. you have to be able to stick with a strategy for it to work out over time. this mindset isn't too hard for me personally.

don't want to come off like i'm complaining about any recent losses or anything. just genuinely exploring these concepts.

i love the markets because its similar to a sport, or chess, or anything where there is a consistent marker of success or failure. the markets tell you how well you're doing.

i think something that would perhaps be a useful measure would be to try and quantify how likely you think a trade will succeed. and then track that over time and see how accurate you are.

example:

take all the trades over a three year period that you thought had a 60% chance of success, and see if the total pool of trades ended up being 60% winners, higher, or lower.

could then start getting at "how good am i at judging likelihood of success?"

i wonder if institutions do this.

[Yodean]

to Yodean
Thinking, Fast and Slow, coyuld be an interesting book. It explain how risk aversion works, why we take (often) wrong decisions etc etc.
Very interesting. And sometimes funny too

@DL: thanks for the recommendation ... I've been sloughing my way through this book for the past few months - about 66.6% of the way through - and it's quite excellent, directly applicable to investing, particularly the middle third onwards. Tedious, time-consuming, and at times boring, but extremely worthwhile read.

Terrific recommendation for those who want to improve their decision-making, both in and out of the markets.