David Fabian | Apr 16, 2015 06:48AM ET
Risk management has become a buzz word in the investment business with little real world application over the last several years. The need for stop losses, hedging, strategic asset allocation, and other counter-measures to traditional market cycles has been overridden by a “buy the dip” mentality. Active investors have been conditioned to wait for a little speed bump and then race into the fray with extra cash to buy up stocks and ETFs.
It’s no wonder that this strategy has worked so well considering the big moves in volatility futures along with other greed/fear indexes. A 2-year look back at the CBOE Volatility Index (VIX) versus the SPDR S&P 500 ETF (ARCA:SPY) shows just how quickly investors go from bullish to bearish.
Every rally is met with skepticism, while every dip is quickly hedged with options, cash, or a flight to quality. This happens within a matter of days or weeks and the ship always seems to right itself in a very swift manner.
Risk managers have been punished under this regime as recency bias overrides the best intentions of those that remember how quickly things can change. 2008 seems like it was barely more than a dream, as we plow to new all-time highs on a regular basis and celebrate the confidence that the Federal Reserve has bestowed upon us.
As a trend follower and sensible money manager, I have been participating in the strength of both stocks and bonds through a variety of low-cost ETFs. Nevertheless, I understand that one day the music is going to stop without notice and everyone will have to find a chair, lest they risk falling solidly to the floor.
Trends can often last far beyond reasonable expectations, which is why I never try to call market tops and bottoms. I would much rather err on the side of caution (in both directions) by focusing on the price patterns relative to long-term moving averages. That way I am able to participate in the upside with the knowledge that I will have to one day step aside to avoid big losses.
During this period of relative stability and good will in the markets, I believe it’s prudent to refresh your risk management plan along with establishing sound trading principles in your portfolio. That way you aren’t caught off guard and making decisions under pressure when cycles change – and believe me, they will change one day.
The following are some thoughts on managing risk in your portfolio:
No matter what your methodology for the market may be, doing some of this analysis may help shed light on weak spots in your portfolio.As always, having a disciplined approach and implementing it decisively will produce superior investment results.
Disclosure: FMD Capital Management, its executives, and/or its clients may hold positions in the ETFs, mutual funds or any investment asset mentioned in this article. The commentary does not constitute individualized investment advice. The opinions offered herein are not personalized recommendations to buy, sell or hold securities.
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