A Balanced Portfolio: On The Sense And Sensibility Of Trading

The ‘Sense and Sensibility’ of trading must necessarily reflect the Yin and the Yang balance between the short and longer terms.

If anything in the ancient world the might of Rome was not leveled by the growing complacency and corpulence of a fattening empire. Indeed Rome was undone by her own hand thru the growing incoherency of logistics and gradual disorganization of her once mighty forces thru military reforms and changes in battle tactics. In the world of trading, in recent history, we can refer to a string of stunning collapses starting with the venerable Barings, thru to the mighty Long Term Capital Management, culminating with the resounding collapse of the twin behemoths Bear Stearns and the mighty Lehman Brothers. 

The giants are no longer with us. i can well recall the stunning collapse of Lehmans, a firm with which i had some business in derivatives trading and like all that day we stood aghast that the US government actually stood by and let that institution fall whilst AIG the auto makers and the lot of them walked away with glee! Now where was the fairness of equal measure in that? In the aftermath where I plunged with the collapse of mortgage backed securities but only just withstood the perfect storm to walk away in credit, i took time off from my world of trading and spent 3 months in that great city where history could be witnessed in every nook and cranny as a mesh of interweaving stones and marbles from different periods in time. I refer to Rome and 3 months I spent there in Rome musing amidst the ruins and pausing against the night time silhouette of the Coloseo, reflecting upon the force that leveled this great city in but an instant.  

The trading world will come and go and the wounds will heal and the mighty will lie forgotten and as in the immortal words of Percy Bysshe Shelley - 

Ozymandias

I met a traveller from an antique land

Who said: `Two vast and trunkless legs of stone

Stand in the desert. Near them, on the sand,

Half sunk, a shattered visage lies, whose frown,

And wrinkled lip, and sneer of cold command,

Tell that its sculptor well those passions read

Which yet survive, stamped on these lifeless things,

The hand that mocked them and the heart that fed.

And on the pedestal these words appear --

"My name is Ozymandias, king of kings:

Look on my works, ye Mighty, and despair!"

Nothing beside remains. Round the decay

Of that colossal wreck, boundless and bare

The lone and level sands stretch far away.' 

Percy Bysshe Shelley   -  http://en.wikipedia.org/wiki/Percy_Bysshe_Shelley

By our own hands we become undone and ever one must know thyself lest the notions of fame and fortune, and eventually hubris take place in our souls so that our trading worlds shall rise and  fall  inevitably.

And so.. back to our reality and our time and age....what makes a balance portfolio in the modern world; one which is constantly informative of every natural action across every quarter of the planet?

For myself in my own world of trading my balanced portfolio is a blended mix of fixed income investments, equities and of course futures. But for the average Joe what would be the prefect balance that could balance long term growth with short term gains in a manner that can over-ride the adversities of changes that time shall only reveal?

My balanced portfolio breakdown is as follows:

1. Equities- Penny stocks and their options

2. Fixed Income - Government and corporate bonds with coupon payments

3. Futures contracts

This is a well balanced equation that will balance the short term gains with the long term needs. although this blog is largely devoted to the art of futures trading, in the wider context of things i shall now explain why futures trading must not be the be all and end all of things. The way of life of the trader must compensate the winds of fortune with the solidity of earth; the Yin and the Yang and harmony to anchor the rapid with the slow, the liquid with the solid, the sky with the earth.

In essence my breakdown is as follows:

1. 25% equities trading

2. 25% bonds trading

3. 50% futures trading.

and for the average Joe let us assume the balanced portfolio of $100,000 dollars in size.

1. Equities

I dont like the big stocks on the big board at NYSE and I never have. Ever since the collapse of Enron and the insights into offshore account juggling, swaps and all other kind of exotic instruments have we ever been able to find a single accounting appraisal that could value the net worth of a large company and its own stock? How do we really know how much Apple Inc is worth? How do we really know that the stock price of General Electric is truly fair?

the answer is - we don't.

and that is why i like to shun the heavenly Titans and search the floors for the smaller companies, that are ever more reliable and easily more appraisable, with good growth potential as a long term investment.

Equities I do not trade on a daily basis primarily because i purchase them with a view to hold for 1 or 2 years perhaps. These are the long term sleepers that you must acquire and put them away and allow them time to germinate. However, in saying this, not all small companies will blossom in time and many seeds upon barren lands will become rotten. Indeed the art of selecting long term stocks and cherry picking the few with potential requires a lot of sound judgement. If not then we all would be Warren Buffets wouldn't we?  and of course Warren Buffet now no longer needs to hunt the floors of the investment world for those golden seeds, but way back in his formative years, that is how he started, in analyzing the smaller companies, and this is where every investor should accommodate a portion of his/ her portfolio. Longer term investment in small company equities and penny stocks can become a fascinating subject in its own right.

A penny stock by definition is a stock where the share price is trading under $5.00 per share. These are stocks which are quoted over the counter on the OTC Bulletin Board

as OTC Link LLC and some securities exchanges globally. There are by definition a stock which is not traded actively. Over the last 10 years I have been acquiring these stocks 3/10  have leaped by 70% within a year and 7/10 of my penny stock portfoilo have remained at a modest 5% growth, consistently, year in and year out over time. However, the art of cherry picking the sweetest stocks with such explosive potential is not easy. it requires alot of sector analysis as well as company analysis, which is an art form totally different from futures trading. But as with futures trading, the craft of investment can be learned over time.

Traders are not born, they are made.

Here are some examples how explosive the returns can be - 

But always remember that the equity section of your portfolio must always remain a 'sleeper"

2. Bonds

Bonds again represent the sleeper part of my portfolio. To become an active trader in these type of instruments you really should not start under $100,000.

Fixed income products have always been the least understood and less glamorous of the investment vehicles. Prices in investment grade notes do not move on the same rapid swings that equities and futures can and for that reason they are seen as stable investments particularly preferred by pension funds insurance companies and many other bond funds. 

en.wikipedia.org/wiki/Bond_credit_rating

A perfect mix of bonds would be a balance between government agencies and corporates to present an equitable blend of bond yields.

but of course for investors with larger than $100,000 capital the opportunities in corporate bonds trading are just as exciting as in futures.

For myself personally I relish taking positions in corporate bonds and hedging with options to squeeze the best out of my corporate bond segment which mar carry lower tier investment grade rating. Other bonds like Treasuries and Gilts i am less willing to hedge.

Here is an example below of a current of a corporate bond and just notice how wide the dealers bid offer spread is. Whilst most traders run shy of trading thinly trading stocks or futures or bonds, always remember to look at the complete picture of the portrait because what may seem like danger to one pair of eyes may represent opportunity to another.

www.boerse-berlin.com/index.php/Bonds?isin=DE000A1TNFX0

At the time of writing on this security 8% Peine GmbH (2018) at close of trading on Jan 31st 2014 the bid/ offer spread was as wide as 10%!  Chance or danger to the trained and untrained eye like 2 sides of a coin.

3. Futures

Lets get one thing straightened out right here from the very start. unlike stocks and bonds which are tangible assets, futures contracts are not tangible and therefore they cannot be regarded as investments. futures contracts are essentially - speculative instruments. its as much akin to taking a gamble - I bet the price of the underlying will go up, or i bet the price of the underlying will go down.

Futures are speculative contracts in essence and this must always be remembered lest their very nature come back to boomerang upon you. Countless countless times I have seen people make a success of themselves in equities only to go and lose it all and more in futures and forex. Why? Because there is no one size fits all? its like the difference between composing yourself to the strains of Bach's melodical Air for G or a the startling opening of Beethoven's intense Coriolannus!

there you sit picking your trades, making your gains week after week after week, and then in one sudden moment of madness you are long soybeans or cattle and the market is locked limit down

example reference - Futures mag 2012 April

http://www.futuresmag.com/2012/04/24/mad-cow-creams-cattle-while-hog-prices-look-cheap

quote:  Cattle: Markets fell to limit down today on rumors of another case of BSE (Mad Cow) in the U.S. USDA later confirmed that rumor with a press briefing in the afternoon. A dairy cow, of an unspecified age, was found in Central California with BSE.

When prices move dramatically that is the moment when you are in the eye of the storm; that is the defining moment that sorts out the men from the boys and the only thing that's going to stop you from cracking is your innate primeval instinct for survival because you don't have even 10 minutes to refer to your MACD and Elliots and all other kind of charts

Yes there's money to be made if you can treat futures, which is 50% component of my portfolio - as a creature that commands respect all the time, every minute.

Conclusion - the balance in portfolio building is not easy and it takes time to gather your experiences. From my experience which started in currency trading as a lad at 21yrs, to fixed income and eventually futures trading, it has indeed been a long hard road of education. But the one thing I have learned over my entire career if that what other people may say or think and do may not necessarily be the right thing. Otherwise how come Long Term Capital Management, the mighty bond fund with 2 Nobel prize winners fell?   en.wikipedia.org/wiki/Long-Term_Capital_Management       How come the mighty Lehman Brothers with all their PHD rocket scientists fell flat on their faces? how did genius fail?  http://en.wikipedia.org/wiki/Bankruptcy_of_Lehman_Brothers

The answer to that my friends is what the ancient Greeks labelled as Hubris.

But for our purposes of portfolio building; simplicity is best; the balance between a conservative portion of 50% blended penny stocks and bonds as sleepers, and a 50% component speculative futures contracts as the potential leapers.