My Investment Philosophy, Objective, Strategy, etc.

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My Investment Philosophy:

My investment philosophy is: stock investing is a competition, participated by millions of people including professionals and amatures alike, all trying to make as much money as possible. In reality only some people can "win", i.e., to beat the market. Just like in any competition, to win consistently and to win big, one must

1. understand how the system works;
2. have a strategy;
3. work hard,
4. take risks and
5. have good luck!

In other words, it takes a lot! So much so that one has to become a (quasi-) professional. In fact he or she has to be a very good professional as 85% of the professionally-managed mutual funds in US under-perform the S&P 500 index!

Of the items listed above, the first two are the key factors that separate a professional from a gambler. Without having a good understanding of the stock market and without a trading strategy, one is in fact either doing "random walking" at the mercy of the volatile market or, to be worse, "random trading" which can be disastrous. In either case, he/she will most likely end up a loser, as many individual investors, myself included, had experienced in the dot-com era.

How the Market Works:

On the market, Warren Buffet said it the best: In the short run, it's a voting machine, in the long run, it's a weighing machine. It's easy to understand the second part ("the weighing machine"), but it is the first part of the statement that is extremely important for individual investors: do not get on the wrong side of the maddening crowd, or you may be crushed!

On Market Efficiency, Random Walk Theory, And Risk:

I don't believe that the market is efficient. By doing extensive researches and using innovated technologies, I believe that one can out-perform the market.

My definition of risk is simply the probability of incurring financial loss and the magnitude of such potential loss if I invest in some company. The stock is the least risky if, based on actual data and careful reasoning, the stock is under valued and/or is showing strong momentum.

My Investment Objectives:

Any strategy depends on the objectives. My objectives are to:

1. produce realistic returns that consistently beat the overall market;
   
• Average annual return of 16.5% vs. 6% expected for S&P 500 in next five years.
  
2. avoids large losses;
   
• Minimum annual return: -20% vs. historical -30% for S&P 500
  
3. bring joy instead of stress to my life.

The strategy also has to be such that it is repeatable when applied on different stocks and in different market situations; Ideally it has to be scalable to work with large funds.

My Investment Strategy:

The strategy that I use the most is a data-driven and adaptive trading strategy.

1. Make every trade based on actual data
   
• No random trading. And No wishful thinking.
• Buy only if the following simple proposition is true: "This stock is most likely going up based on actual data."
• Sell stocks only if the following proposition is true: "This stock is most likely going down based on new data".
2. Simplified decision making:
   
• only try to predict price direction but not price targets nor the time frame for the targets will be reached.
• For the same reason, do not trade options.
3. Hold positions tight as long as the ongoing trend holds:
   
• Most gains are realised by holding the positions for as long as the trend continues. This can last for days or years.
  
4. The loss is minimized by cutting loss.
5. Use hedging to reduce the systemic risk.

Stock Selection:

The strategy above has the following implications when it comes to selecting stocks to go long or go short:

1. Favor stocks that show relative strength against the market or sector it is in. Avoid the laggards.
   
2. Favor stocks that are dirt cheap but shows sign of strengthening.
   
3. Favor stocks that are showing strong up trend;
4. Favor stocks that are dominant in their markets and have pricing power;
5. Favor stocks with predictable behaviors. Avoid stocks that tend to give surprises;
6. Favor companies that only provide one or few products or services that I can more or less keep track of. Avoid those with complex and multiple revenue sources.
7. Favor stocks that are high in liquidity. Avoid those that are thinly traded. Avoid penny stocks.
   

I periodically scan all stocks that are traded in the US to find names that meet my valuation or technical criteria.

Investor, Trader or Speculator?

To me, an investor is a glorified trader. For an investor to be successful, he/she must first be a good trader. A trader can be very successful if he/she does it the right way. An "investor" can loss everything if he/she doesn't trade right.

I don't buy the "investing-for-the-long-term" approach because (1) I believe it is only applicable for investing in diversified funds and (2) that I am not smart enough to identify and value the true long-term winners.

Sometimes I am a speculator too, just to add some excitement to my otherwise dull investing experience, hopeful that I may be lucky. Occasionally I put small amount of money in companies that are under financial stress, i.e., in immediate danger of going under, with hope of being turned around. However I run away quickly if the market doesn't go the way I speculate it would.

I don't do day-trading. However if I realize that a mistake has been made, I may close my positions on the same day, even if at a loss.

On Technical Analysis (TA):

I do use technical analysis to time my purchase and sale, as well as selecting stocks. However I only use several simple TA charts that I can explain. These include moving averages, relative strength and money supply. I also pay attention to several easy-to-understand and simple-to-spot technical patterns, such as header-and-shoulder, cup-with-a-handle, double top(bottom) breakout, etc.

However if I understand the company's business very well or if the investment is for long-term value appreciation, the fundamentals will over-rule the technical signals. In these situations, the long-range TA signals are of more importance.

On Diversification:

There are two ways of diversification to reduce the portfolio risk: 1) put your eggs in many buskets. 2) Put them in one or few baskets, but do take special care of them!

I like the second approach, i.e. , putting a good percentage (>50%) of the portfolio in one or two stocks that I've studies very carefully. And I continue to monitor them closely.

The Past Performance:

So far the strategy has served me well, as shown in my portfolio performance since 2002, the year I started stock investing seriously. Prior to 2002, I traded "randomly" without a clear strategy which, unsurprisingly, resulted in erratic and dismal returns.

The Limitations:

The strategy is not without flaws. It requires active management (read: time and effort). It does not offer enough protection from a potential sudden market collapse (as I am not very good at hedging). And it is not proven very scalable yet.

But still, having a strategy is better than having none at all!

Disclaimer:

No single strategy applies to all people. Invest at your own risk.

[To be updated.]