I can predict which of your investments are likely to be your biggest winners and which are likely to be your biggest losers. Let’s make some investment predictions for 2015.
All I need is the following three pieces of information about each investment:
- What you bought;
- When you bought it; and
- How much you bought.
That’s all that I looked at for the 40 individual investor portfolios I’ve been studying for the past few months. For each portfolio, I had a list of stocks bought along with the purchase dates and the amount purchased.
Given this information I have been able to predict, with above average accuracy, which investments would turn out to be winners and which would turn out to be losers.
How did I do it?
I’m going to share that with you now … and, most importantly, show you how you can do it yourself.
It’s actually very simple.
For each investment, I look at the volatility level (VQ%) at the time the investment was made and I look at how much money was initially invested. From here I identify two groups of investments.
- LIKELY LOSERS: Investments which have above average volatility AND above average position size are more likely to wind up being losers.
- LIKELY WINNERS: Investments which have below average volatility AND below average position size are more likely to wind up being winners.
Here’s another stunning example of these unfortunate truths impacting real investment accounts.
This particular portfolio lost $36,655 of the original $113,239 of capital over the fifteen year period from 2001 to 2015.
Adjusting the position sizes of these investments for volatility – putting more capital into less volatile investments and less capital and more volatile investments – would have produced gains of $64,372!
If we look at the top 10 worst performing investments in this portfolio we can see that they all had very high initial volatility AND we can see that the average original position size (Original Size Pct) was nearly 4 times what volatility based position sizing would have allocated (VQ Size Pct) – that’s 4.07% versus 1.01%.
Moreover, we can see one particularly awful decision (rank number 6 above) where nearly 25% of the portfolio was allocated to one investment – which ended up losing 90% of its value. That’s a killer.
Now here are the top 10 best performing investments in this portfolio.
We can see that the average initial volatility is 39.86%. That’s still very high but it’s a lot lower than the average volatility of the 10 biggest losers – which was a whopping 60.79%.
Moreover, the average original investment size was only about a third of what would have been allocated by volatility based position sizing (0.68% vs. 1.74%).
So… 4 times the volatility-based size on the worst performers and one-third the volatility-based sizing on what turned out to be the best performers.
Here’s how I would sum up what I’m seeing:
- Investors take bigger than average positions in the stocks that turn out to be their biggest losers. These investments tend to have high initial volatility.
- Investors take smaller than average positions in the stocks that turn out to be their biggest winners. These investments tend to have lower initial volatility.
- Investors typically have one or two absolutely disastrous big losers (where they lose 10% – 25% of their capital in one investment) and zero “disastrously big winners”.
- Volatility based position sizing reverses all of those tendencies.
That, my friends, is the most important observation I have ever shared with you. Frankly, I believe that it’s the most important piece of investment information that any one will ever likely share with you.
How to Predict Your Own Winners and Losers
So, how can you predict for yourself which investments are likely to be your biggest winners and losers starting today?
I’ll show you now. You can do this in all TradeStops member levels.
First, make a new Position View. You can do this from the Positions page of the Positions & Alerts section. I’ve put red ovals around the three important items here:
Clicking on the plus sign that I’ve highlighted above will open up a new Add Position View dialogue. Select just the following three fields for your new view:
Once you’ve created your new view, take a look at one or more of your portfolios through the lens of your new view. Here’s an example:
All that we’re looking at here is a list of stocks, sorted ascending by the current volatility level of each stock (VQ%) and then looking at what percent of the portfolio that stock currently represents.
I’ve highlighted the three lowest volatility positions in green and the three highest volatility positions in red.
Stocks that have high VQ% and above average Portfolio % are more likely to turn into losers for you.
Of the three high volatility investments highlighted above, the investment in AAUKY stands out as being a concern. It is one of the highest volatility stocks in this portfolio and it is the biggest position in the portfolio.
The investment in X (United States Steel) also stands out as a concern. It’s the highest volatility stock in the portfolio and the third highest position size.
If you see any big positions in high volatility stocks in your own portfolio, you might consider reducing your position size. You might even consider investing this new free capital into one of your low volatility positions in your portfolio that has a below average position size.
I know that these findings sound crazy. I don’t even fully understand how to explain them myself yet – other than to say that we have a real knack for over-allocating to our eventual losers and under-allocating to our biggest winners.
If you’ve got thoughts on why we’re so good at focusing on our losers, I’d love to hear from you.
This research, these insights and these tools have been 15 years in the making.
I think that it’s the most important work I’ve ever done … and I think that it can be the most important investing lesson you’ll ever learn,
Richard M. Smith, PhD