August 6, 2015
The No. 1 Way to Reduce Risk
in Your Portfolio... Legally
By Tom Vician, CMT
How to maximize gains while minimizing risk is the quintessential investing query. But while significantly reducing risk is possible (as I'll show you in a minute), you cannot remove it entirely.
Investors may seek out the "Holy Grail" -- a trade with a high return and no risk -- but in reality they're just shifting risk.
For example, people who illegally trade on insider information can take huge positions and make an enormous, nearly "guaranteed" reward with seemingly no risk. In reality, the market risk has shifted to a legal one. If caught, the trader faces the potential disgorgement of those profits and incarceration. The same is true of fraud such as Ponzi schemes like the Bernie Madoff hedge fund scandal.
Risk remains -- just in a different form.
Law-abiding investors must accept that risk and reward are inseparable. The good news is that maximizing return and minimizing risk is possible using a trend-following system. Or should I say, it is possible when you learn to overcome the emotional difficulties which often stand in the way of profitable trend following. In my 20 years of managing money, I've found this is the key to success in the markets.
Shortly after graduating college, I did an apprenticeship with Ed Seykota, one of the first traders to use a computerized trading system. During that time, I learned the fundamentals of successful trend following and applied technical analysis, and I helped him develop a relative strength/price momentum trading system.
Over the next two decades, I've honed my craft and earned the designation of Chartered Market Technician (CMT). The trend-following system I use today in my premium advisory, Alpha Trader, is based on a proprietary indicator known as the Alpha Score and is designed to spot stocks on the verge of a breakout.
If you'd like an overview of how my system works, you can view this presentation. But today, I want to discuss the importance of sticking with a trend-following system through thick and thin. The way to do this is to find the right balance between risk and return for your personal temperament.
The key is to find the sweet spot between taking on enough risk to merit a sizeable reward, but not so much that you can't get back in the saddle after inevitably falling off.
If you fail to cut your losses short, one or two gigantic losses can wipe out your investment account. However, a long string of "regular" or "normal" losses can be just as devastating if they become so untenable and disheartening that you stop following the system.
In order to maximize returns, we have to keep pulling the trigger on a successful long-term system, even when things seem bleak. This is the only way to ensure we capture the next big winners when the market turns.
Capturing one big trend can be all it takes to put an account back in the black and make your year. But failing to pull the trigger means potentially missing it.
In an effort to help my Alpha Trader subscribers select the right amount of risk, the picks are broken up into 10 different portfolios:
Each portfolio can hold up to 10 stocks a piece, so the overall Alpha Trader portfolio could hold up to 100 stocks at any given time.
Traders don't need to purchase every stock I recommend to get the benefits of a trend-following system though. Alpha Trader uses a wide variety of strategies to meet the two biggest needs of individual investors: diversification and market-beating returns. This lets traders pick which portfolios best suit their risk tolerance.
To maximize returns, though, investors need to pull the trigger on all the trades recommended in the portfolios they follow. This is the only way to ensure they will catch the next big winner, because we only know in hindsight which ones will result in the highest returns.
My system is delivering when it comes to finding huge price moves across all of its portfolios. The table below highlights the biggest winners from each.
As you can see, the return on any of these is large enough to make up for a string of smaller losses. But if a trader fails to stick with the system and instead picks and chooses which stocks to buy, they may end up missing out on the stocks that could make their year.
Executing a trend-following system is not easy. Every trader has let their emotions get the better of them at one point or another.
The first step is selecting a successful long-term system like the Alpha Trader system. My system is based on an indicator that has been independently verified in peer-reviewed academic journals to deliver market-beating returns.
A landmark study conducted exhaustive back-tests of various fundamental and technical triggers to identify which, if any, were predictive of future performance.
It demonstrated that one indicator -- the one the Alpha Trader system is based on -- outperformed all others and consistently beat the market by a huge margin. Between 1926 and 2009, the market turned $10,000 into $38 million. But this indicator turned $10,000 into an astonishing $572 million.
To get the details behind the trend-following system I use in Alpha Trader to minimize risk while making huge returns, follow this link.
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