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Author: globalist2013 Big red star, 1000 posts Add to my Favorite Fools Ignore this person (you won't see their posts anymore) Number: of 35392  
Subject: Hedging a Bond Portfolio Date: 5/10/2013 5:41 PM
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I screwed up majorly today by not paying the least bit of attention to the price for gold. http://stockcharts.com/h-sc/ui?s=IAU&p=15&yr=0&m... That's inexcusable. I should have been in there buying. I could have closed the day with at least a dime a share. But I'll offer excuses nonetheless. Wednesday, I made 389% (ann.) on a Penney's bonds. And this morning, as I marked myself to market, I hit another equity high for the year, which has been happening two to three times a week for a couple months now. When the financial weather is the equivalent of perpetually blue skies, it's hard to turn one's thoughts toward the yet unseen storm clouds coming. But only a fool doesn’t fix roofs and windows while the weather is good, and I have to admit to being one.

I take my bond stuff seriously and treat it like the business it is. Every day, I’m in the market scanning for opportunities. Every day, I’m doing the back-office work I need to do. Every day, I’m trying to push what I know of investment theory a bit further. But I’m treating this trading stuff like a hobby, not a business, and that’s going to bite me in the butt when I need those skills to implement the hedges required to protect capital. I need to be able to put on and take of hedges as intuitively and reflexively as I can do bond longs. Scan, vet, execute. Scan, vet, execute, and then get up the next morning and do it again. I don’t give a crap how many pennies I lose learning how to do it. I need trading skills to be in place so I don’t lose dollars. When markets crash, and they will soon enough, I need to be ready to act fast, accurately, and without fear.

I learned to invest in junk bonds by investing in junk bonds. At first, when I put on a position, I was so terrorized by fear of loss that I was nearly vomiting. More than once, I had to back away from a trade, get my stomach under control, slam through my due-diligence one more very unnecessary time, and then force myself to execute. These days, after long practice, I can trust my judgment and do what needs to be done. Buy/sell/ or back away evokes no emotion. It’s just an intellectual problem. The evidence is there, or it isn’t. Execute or don’t. Makes no emotional difference. It’s just a job that provides a good living.

With the weekend ahead of me, I’m going to try to get my head together, so I can focus on becoming a trader. Monday morning, I execute. Tues day morning, I execute. Wednesday morning, I execute. No more excuses. Either put on the trade, or know the reason why it should be backed away from. Fortunately, long or short makes me no difference. I don’t have that obstacle to overcome. But I am going to have to give some thought about what to use for practice vehicles. I’m willing to chew through some money to learn my craft. But, also, I don’t want to be stupid about it. So I should stay away from leveraged instruments for now, as well as stick with things I can trade commish-free. Fortunately, that still leaves both plenty of choices, some of which I’ve traded before and made serious money with, but failed to follow up as I should have.

That’s my problem, follow through. I can’t do bonds and trade. I’m going have to make a choice, or else fail at both. I’m not going to like putting my bond investing on auto-pilot, because that market has been so good to me. But if today’s chart for the 10-year note is a hint of what’s to come, the switch of effort needs to be made immediately. The storm’s coming, and it’s time to get ready for it.

OK, the preceding was personal. The following isn’t. The goal of Modern Portfolio Theory is ‘efficiency’. That one word sums up its intellectual appeal and its Achilles heel. “Efficient is fragile”, and fragile things break. Murphy’s Law says they’ll do so when it is most inconvenient. Taleb’s Law says they’ll do when it’s least expected and more massively than imagined. Take your choice of laws. Either says the same thing. The normal answer to the opposite of ‘fragile ’ is ‘robust’. But that’s wrong. What is robust is merely less harmed by volatility than that which is fragile. But it doesn’t benefit from it. A true hedge for a fragile position is an anti-fragile one. As a bond investor, there are no easy ways to hedge one’s assets. As has been amply proven, “When markets are under stress, correlations tend toward 1.0”. Fragile assets get destroyed, and robust ones prove not so robust after all. Trying to hedge as big and as diversified a bond portfolio as I have with options would be impossibly tedious and expensive. Last summer’s experiment tested and proved that. The far easier path is leveraged, counter-trend, directional bets put on and taken off as needed. That means superb trading skills. So that’s the path I’ve gotta to walk.

Charlie
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