I approach risk like a typical client does – a loss of my hard-earned money! Most financial plans and investment sales presentations present risk as volatility. Volatility is essentially how much an asset wags around the average return of that asset. If I was a short-term trader, volatility is a very appropriate measure of risk, but I am not. Ironically, as a market operator, I should be looking for volatility not shunning it. Large deviations or dislocations create opportunity. Generally, any of the sales presentations or "financial plans" where "risk" is a measurement are generally worthless for long-term guidance in my opinion. Risk is not something that can really be measured. This is not a science. There are no "laws of finance." There is no gravity in the stock market. Just how low is low? If a stock goes up by 50% or down by 50%, which one is riskier? Is one more volatile then the other?
The way the stock market works, as stated above, I'm skeptical that risk can be measured statistically. Therefore, let’s at least create a framework where we can identify whether we should be packing a Winter parka! (Note: You can also refer back to Lesson 6.) At this time we need to identify two areas of risk. We either take the red bill or the blue pill. One pill gives us the truth and the other keeps us in the illusion. This is where we separate "information" risk from "price" risk.
Let me state that all decisions in the stock market involve risk. There is even risk in doing nothing. Price is simple. It is there in your newspaper and on your computer screen. It is a fact. The stock price does not lie. We want information in order to base our decisions on. Here's the thing, in our quest to reduce "risk" by gathering more information or possibly waiting until the tone of the information improves to justify the investment - it is probable the price has moved higher. If so, then we have done nothing but increase our price risk. In our attempt to reduce information risk, we have increased the only risk that really matters, and that is price risk. The chances of the stock going down has in fact increased not decreased. At the market bottom, the news is bad (high information risk) and price is cheap (low price risk). As price increases, the stock is already discounting all of the public and non-public (insider) information into the current price. This is why stocks always top on good news and bottom on bad news. The key takeaway is that price does a much better job forecasting the news than the news does in forecasting price! When you begin to focus on what risk is most vital to your financial well being, I am confident your investment success will improve.
Happy Returns!
P. Franklin, Jr.
April 27th, 2017
All opinions and estimates included in this communication constitute the author’s judgment as of the date of this report and are subject to change without notice. This communication is for informational purposes only. It is not intended as an offer or solicitation with respect to the purchase or sale of any security. This information is subject to change at any time, based on market and other conditions. Any forward looking statements are just opinions – not a statement of fact.
Investing may involve risk including loss of principal. Investment returns, particularly over shorter time periods are highly dependent on trends in the various investment markets. Past performance does not guarantee future results.