1 post tagged “low”

The Importance of Diversity

Two types of diversity are important in portfolio modeling: issue and time.

At the time of this writing, over the 16 years that the Time Overlay models have been published, 1065 specific stock positions have been concluded of which 1016 have been profitable. Although we consider this 95-percent accuracy rate to be acceptable (as we shall see later, it can be improved), some losses have occurred. Even though the probability is very low that an individual stock position will fail to be profitable, the possibility does exist that, if a portfolio consists of only a few stocks, they could turn out to be the losers and the method would result in loss.

Because of this, albeit very low, chance of loss, it is reasonable to reduce this loss possibility to a minimum by having several different issues in the portfolio. In actual market endeavors, over many years of employing the Time Overlay technique, we have never seen an account actually lose money that strictly adhered to the method. However, because the possibility exists, it is only prudent to consider issue diversity.

Of greater importance is time diversity. As you can see in Appendix A, listing the published buy/sell points, several buy indications are generally followed by several sell indications, and so on—an ongoing cyclical process. This inclusion of more than one buy or sell in sequence is by design. We are not primarily concerned with picking exact tops and bottoms in the popularized averages, with our emphasis being on the specific stocks we follow. Our concern with movements in the popularized averages is that these movements will enhance our profit extraction through the buying and selling of specific stocks.

As previous mentioned, there is a constant change in the relative attractiveness of the issues on our Master List. There is no reason for us to buy or sell everything at once. We want to enter the market gradually, expanding our exposure (investment level) over a series of buy indications, providing us time diversity as well as a better chance for issue diversity. When selling, our desire is the same, to gradually reduce our exposure. In other words, since the stocks we are involved with will not all hit their low or high points at the same time, it would be stupid for us to buy or sell everything at the same time.

When buying stock that qualifies for inclusion on our Master List, the lower the price is, the better. Since accumulation (buying) is designed to occur over a series of buy signals, it is possible that a stock can be bought repeatedly as its price descends, and this has occurred. The diversity in this case is by time: same issue, different prices.

In most cycles, the time duration between buy indications automatically provides issue diversity because different stocks will be relatively low- priced during different buying periods. During those buying periods in which stocks tended to duplicate—that is, the same stock was purchased during each buy indication—it might seem reasonable to conclude that the duplication increased risk. The actual results to date contradict this assumption, with the time and issue diversities of equal importance. The same stock purchased at increasingly lower prices reduced risk to the same degree as selecting several different issues.

The results of this technique, to date, also firmly indicate that the amount of diversity necessary to approach median return need not be very great. Only five to six individual positions, diversified by either issue or time, have been shown to almost invariably provide returns ± 5% of the median. This allows the technique to be employed by relatively small accounts.

Because of the careful selection technique of individual stocks, the results to date have repeatedly shown that time diversity is more important than issue diversity. It is more prudent to apply monies to a few stocks at different times than to many stocks at any one time. In fact, overdiversification as to the number of stocks can often be a severe disadvantage in optimizing return.

The important point is recognizing that both time and issue diversity are built into our investment technique. The time diversity aspect is automatic because of spacing the buy/sell points. The issue aspect is also (usually) automatic because the different stock issues appearing to have the best profit potential will generally vary between different buy indications.