Tuesday, February 28, 2006

Hedge Funds - High Risk

There are many types of Hedge Funds.

Originally hedge funds started as a way to control market risk. Most folks agree it is almost impossible to guess where the markets will go tomorrow. At least honest folks agree.

There are a million ways to make money in the markets - and all of them are short lived and hard to find.

Some money managers decided to hedge their risks - buy companies they liked - fade (sell short) companies they didn't. This theoretically would allow them to make a profit and avoid loss regardless of market direction.

Hedge funds
were touted as wealth defense.

Very few true hedge funds were created and then survived. Investment managers soon discovered they could structure a hedge fund around regulation - huge profits for investment management then assured success of the name hedge fund.

There are now thousands of hedge funds. Statistics on their success have a decided survivability bias, even stronger than the regulated mutual funds..

Bill and Martha go to Vegas, Bill lose money all week, and Martha beats the odds and has a big win one day. If you remove the losses - as many people psychologically do - they were big winners. If you have enough
Bill and Martha teams - a few will be big winners for many years in a row.

Say you start the year with 3000 hedge funds taking huge leveraged risks. Five hundred hedge funds win big and start attracting hot money. One thousand hedge funds do horribly and close or merge. The 1500 hedge funds in the middle languish and wait for next year. Of course when money managers look at the cash made by the top 500 hedge fund managers - you will have more than 1000 new hedge funds for the new year.

survivability bias looks at the above information and says we have more hedge funds than last year - and the older funds have done fantastic. Avoiding the math, the huge overall gain is largely due to the losing hedge funds disappearing totally or merging themselves into a "successful" hedge fund.

Lets look at the top 500 hedge funds in the above example. Next year assume 100 have a great year, 100 are so bad they close or merge, the other 300 can still brag on their "results since inception." The top 100 managers paychecks and egos are now huge. Continue and after 5 years you will have a few wealthy "superstars of finance."

You could do the same. Maybe that's how Hillary made a hundred thousand in the commodities market and only "invested" once. The broker could have two opposite future accounts opened and leveraged them to the hilt. One account went up $100, 000.00 while the other account went down a similar amount. Surprise - Hillary had the one that "earned" 100k.

The next view of hedge funds is less charitable. The first notice of this type of scam I am aware of is in a book recommended by almost every top investor, advisory, or speculator - Confessions of a Stock Operator.

The latest version of the scam will be in tomorrow's email.

The way con artists can do the same thing is to send out 200,000 emails telling about their "new" program. 100k emails will recommend going long in Soybeans and 100k emails will recommend going short. Half of the recommendations will have big gains and receive a new email - half recommending going long in pork bellies, half of the emails recommending short. After two wins money will start to come in for "investment" in the program. Repeat to the "winners" and the cons are an expert with a great track record according to the "lucky recipients of the offer." Rinse and repeat.

It's a bit like being an economist: if you can't guess right - guess often.

Today almost all hedge funds share one characteristic - high unhedged leverage. Those that blow up will not be around to taint next years graphs of hedge fund returns.

My opinion is derivatives will probably cease to exist in their present form after they are blamed for the next depression. In the interim they are frequently tools of excess leverage that are hidden behind the doors of many huge banks. These banks are counter-parties to largely unregulated hedge funds and overly creative corporate and government finance departments.

This derivative balloon will not end well.

Those that claim nothing has gone wrong since LTCM are like the fellow that jumped off a fifty story building. As the jumper passed each floor folks could hear him saying; "so far so good - so far so good."

Consider the above before you invest in a hedge fund.

The graph a hedge fund shows you is of them as a small percentage survivor, the past is definitely no assurance of next years results. An "unforeseen catalyst" may cause devastating losses.

Heck if it was foreseen the hedge funds would have prepared for it. Bad things will continue to surprise in the future.

Here is a repeat of an important speculation rule that greatly applies to investing in hedge funds:


Life is not linear.

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  • Monday, February 13, 2006

    We Need Government Assistance

    A cry for government help from those that need it most.

    Its for the good of the country - for the good of the people. A statement like this and a following rant would normally be on my A Sovereign Speculator pages.

    This time I read a well written page over at the
    321 gold site. 321 gold and their sister site 321 energy have interesting speculation information, and occasional insight pieces like A Tale Of Two Railroads.

    I by no means agree with all the insight pieces
    321 gold lists, but I will read and consider the ones that are not bombastic. (I dislike reading name callers - and anyone that shouts "always, should have, never, every instance" and offers no balance or proof for their slanted opinions)


    Larry LaBorde wrote a short and informative historical piece that has significant application to current world events.

    Take the minute or two required to read A Tale Of Two Railroads.

    I'm sure that even though Larry LaBorde does not shout out conclusions, you will be see his point, and give it fair consideration.


    Your world view is important in your understanding of speculative markets.




    All markets are speculative markets.



    .

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  • Sunday, February 12, 2006

    Finger On The Speculation Trigger

    You always pull the trigger without having complete information.

    An Investment is a long term bet based on incomplete information.

    A speculation is an indeterminate term bet based on incomplete information.

    Information will always be incomplete - even after the fact.

    With an investment you first discover an opportunity that you think exists. Next you may discuss it with a broker to find a good way to put money behind your conviction. Then you wait and watch as your chosen vehicle raises and falls.

    With a speculation, when you pull the trigger and enter the trade - you have a good idea of when and how you will exit the trade. If the trade does not work as anticipated - if there is a loss - you will probably get out quickly.

    With an investment it is buy and hold. Most investors will hold until their emotions get too high. They will either sell when the price drops enough to seriously depress them or has risen enough for them to feel good about a victory. With this emotional criteria they tend to let losses run and grab at small profits - they lose overall.

    A speculator should understand before they enter how they will know if they were wrong about the market or the timing. Speculators seek to protect themselves from large losses by pulling the exit trigger quickly. The other side is to hold on to profitable positions - giving themselves maximum opportunity for large gains.

    When you hear of a big winner in a speculation - it was not that one speculation that made them successful. If they stay successful they will cut losses short and let profits run. This is done most frequently by planning your exit points before you enter.

    That large speculation win is the symbol of many victories comprised of cutting losses short. Protecting your chips so you can win big when you are right is a major victory also.

    The exit point does not have to be a number, in fact for profits it probably won't be a number.

    • Pull the trigger to enter your speculation only when you have a way to judge quickly if you were wrong
    • Pull the trigger to exit the speculation as soon as you know your reason for entering was an error.
    • Stay in a profitable speculation as long as the reason to pull the trigger in the first place remains valid. If that changes - consider exiting the trade.
    • Pull the trigger and exit when your target for the move is complete - and - your analysis shows the trend is about to end.
    • Buy the book before the speculation - know the rules and tricks relevant to that particular market before you commit.

    If pulling the trigger is determined by emotions, the investor has probably made a mistake.

    Our emotions tend to reflect the emotions of the herd. The herd is right for short periods in the middle of a trend - but emotions are not high there.

    The herd is wrong at extremes - emotions will be high - wrong choices will be made. The defense to emotions is to, as much as possible, eliminate emotions as a trading criteria.

    An old speculation rule states this quite well.


    Plan your trade - Trade your plan.


    .

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  • Thursday, February 09, 2006

    On Vacation

    I should be back about February 20.

    You will probably enjoy the five page article on speculation rules developed over decades; check the preamble here.

    Another article, this one on 8 steps to acquiring financial freedom, is also with reading.

    Enjoy life, I'll be back soon.


    .

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  • Financial Fairy Tales -- #2

    Today's fairy tale: hold investments for the long term - everything will work out.

    If we all just believe -- Tinkerbelle will come back.

    It makes a great story --but is you retirement tied to wishful thinking -- do you just need to believe?

    Those that use this lovely fairy tale to sell investments leave out a lot of the details.

    Details hidden by fairy tales like these and the (reality they hide):

    • stocks always come back (even if it takes fifty years)

    • its different this time (its always different - but trees still grow - die - and fall)

    • the government knows how to control the economy (never has - never will)

    • this is a safe blue chip investment (blue chips are still gambling chips)

    • buy the dips (great in a bull - disaster in a bear)

    • buy more and your average price will be lower (think how many shares you can get at a penny each - just before they go to zero)

    • the price is down due to profit taking (who makes a profit on lower prices?)


    Keep the belief in fairy tale endings for the fairy tales.

    Think for yourself.

    Markets do not always come back - within your lifetime. Even countries and societies eventually fail.

    Mere investments are burning matches - don't hold one too long. Don't try to get that last 10%, look instead for a new speculation that has just taken off.

    Use that pixie dust to fly with a new trend.


    If you are to live happily ever after - prepare for sudden and long term change.


    .

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  • Wednesday, February 08, 2006

    Elliott Wave Internation Free Week Starts Today

    A quick note - this EWT free week is worth exploring - go take a look.

    Look at the excellent and free - Elliott Wave tutorial - while you are there.

    Here is their e-mail writeup. All I have done is embeded the link they had as a cut and paste.

    Enjoy!



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    Allan

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  • Financial Fairy Tales -- #1

    Fairy tales of the financial type tend to have unhappy endings.

    There is a lot of financial advice that sounds wise - but is the equivalent of nibbling on the witches' gingerbread house.

    Our first fairy tale: -- "Don't put all you eggs in Little Red Ridinghood's basket."

    The advice, based on the old math based
    Modern Portfolio Theory, is to diversify into ten or twelve unrelated investments depending on portfolio size.

    If we were to pick ten investments - our first three choices will probably outperform the extra seven put together.

    The realty is that wealth is usually made by concentration, and preserved by diversification.

    Using that guidance it would seem appropriate to put all your eggs in one basket - and then watch that basket very carefully.

    We can use Red's basket after all.

    If your basket seems at risk - protect it. Cut your losses short by getting out of risky trades quickly.

    Once you see a profit - let it grow. Don't be quick to exit with a small profit. As long as the reason you entered the trade is still valid - stay in the trade. Don't however let a profit become a loss - get out if you risk damaging your original clutch of eggs.

    If you are already wealthy - you don't need me to tell you to diversify - just do it.

    Diversify over time to maturity, over asset classes, in different countries; and any other way you can imagine.

    Then send me a check for my good advice (and what big eyes I have).

    We can then share that happy ending.

    Allan

    .

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  • Tuesday, February 07, 2006

    Economic News From A Non- Economist -- Good

    Economists exist to make weather men look good.

    An old economist saw is since you can't guess right - guess often. Then they can point at a guess that came close and say something like " I told you last August that the number would be down."

    Who is worse than a weather man and an economist?

    A politician of course. They both guess and lie. It doesn't matter what they said last August - they will still claim to be right.

    With that knowledge, what would you say if I told you that I read articles by a fellow that is both a congressman
    and someone that understands money.

    I have a hard time believing it too.

    Representative Ron Paul is well worth reading. The fact that nobody in Washington, R or
    D, seems to appreciate him is a very good sign.

    Give Ron Paul's recent article A Real Washington Scandal a look.

    This read is a taste of real economics.

    .

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  • Monday, February 06, 2006

    Book Review - Market Wizards - Jack D. Schwager

    Market Wizards is highly recommended reading if you speculate.

    There are two other books also:
    The New Market Wizards and Jack D. Schwager's new book: Stock Market Wizards. Go ahead and buy all three of them - once you read one - you will want to read the others.

    Schwager understands markets and traders.
    Market Wizards is a series of interviews with top traders / speculators that have had remarkable runs of success.

    You will want to read the interviews several times. The
    Market Wizards books can be re-read as short vignettes. After the first read through they are great to leave next to your favorite chair.

    What you will notice are consistent speculation rule themes that run through most of the interviews:

    • keep losses small

    • let profits run

    • limit exposure to correlated investments

    • if in doubt - get out

    • don't try to capture the first or last 10% of a move
    - and a whole bunch more good advice. Notice advice derives from most of the interviews.

    You will learn as much from the exceptions to speculation rules as the repetition.

    Knowing when to break a speculation rule is an important bit of knowledge -
    Market Wizards provides some fine insight into that subject.

    You may also find yourself drawn to one style of investment - that alone can save you tons of cash and years of time.

    I'll insert one of my own speculation rules here:
    always buy the books before the speculations.

    Market Wizards in not one writer's opinion on markets, it is the opinion of the few who have learned how to succeed on a grand scale.


    Market Wizards is a compilation of great advice from great traders.

    .

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  • Saturday, February 04, 2006

    Speculate In What You Know

    For years Warren Buffet avoided investing in technology stocks.

    There is plenty of money to be made in areas you understand. If you buy diamonds on a street corner you will probably end up with cut glass. That gold brick you are offered is probably a lead bar with a thin plate of gold, or maybe even paint.

    That leaves you with two choices.

    Invest in what you know -- or learn about what you want to speculate in.

    This brings up an obvious question, what about expert advice?

    If you already are conversant in the asset class, expert advice can help point out new opportunities you might have missed.

    Even experts will be wrong - if you do not know why you are in a speculation - you won't know the right time to close your position.

    Perhaps you have done well on the long side of stocks, but now feel the short side may make sense. You have some basic skills and knowledge, study to fill in your knowledge.

    If however you see opportunity in gold, soft commodities, or currencies and have not played futures markets before -- don't.

    At least don't play them until you read some books and understand them. Always read the book before you play the speculation.

    When you enter new markets keep your size small, increase size slowly, studying the whole time.

    First and foremost - speculate in what you know.

    Later learn some tools in other areas.

    Don't make speculations in areas you don't understand.

    You can't win if you don't play.
    You can't play if you lose your chips.

    Stick with games you know, be very careful about entering new ones.


    .

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  • Thursday, February 02, 2006

    Elliott Wave International "Free Week" Is Coming

    This will be your chance to review current Elliott Wave thinking - at no charge.

    The free week will start 8 February 2006.


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    Keep your losses small - let your profits run. That is a speculation rule. Elliott Wave International's free week may demonstrate techniques that allow you to profit from this rule.


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    Take the free Elliott Wave tutorial - prepare for all the free reports during the free week.

    .

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