How does the world define that term? Wikipedia's page says, "trade involves the transfer of goods or
services from one person or entity to another, often in exchange for money. A system or network that allows
trade is called a market."
How would you define this term? Again, the world according to Wikipedia says, "Art is a diverse range
of human activities... expressing the author's imaginative, conceptual ideas, or technical skill, intended to be
appreciated for their beauty, emotional power, [discipline or effectiveness]."
We might then describe "The Art of the Trade" as a technical skill that results in the exchange (buy or sell) of
a security in such a way that a client can appreciate its "beauty" or "power" (i.e., contributing effectively to an
AT WT Wealth Management, we have always strived to offer varied investment models in order to meet the
needs of every investor, large or small - ranging from ultra-conservative to ultra-aggressive.
Our current investment models include:
- A globally diversified allocation across a broad spectrum of regions and asset classes, in a rules-based
quantitative strategy available in a variety of risk tolerances (the "Quantitative" models),
- That same diversified and rules-based quantitative suite described above, with the additional feature
that the equity allocation is constructed with "smart beta" ETFs that seek to maximize risk-adjusted
returns (the "Quantitative Plus" models), and
- A variety of highly personalized, Separately Management Account ("SMA") strategies for higher-net-worth investors that blend Core holdings with Sectors & Themes and Culturally Significant Equities
(the "3-Pronged" models).
Over the course of the next year, we plan to produce a series of white papers focused on educating you about
our investment models and the philosophies and trading strategies behind them - the Art of the Trade series.
The information contained in this first paper focuses on the trading techniques employed to harvest and
realize gains that are used in the 3-Pronged models.
To begin on a personal note, one of the many things I love about my job is reviewing portfolios of new clients
when they join the firm. Sometimes I'm examining a self-directed account where the client had been making
their own buy and sell decisions, but decided to turn that responsibility over to an advisor. Other times, a new
client is leaving their previous advisor and I'm examining the buy and sell decisions of another advisor. In either
case it's always interesting to see how an account is allocated, the specific positions owned and the results of
those trade decisions.
In self-directed accounts I frequently ask the client questions about his/her overall strategy; why they own
certain positions; if they are "married" to any of them. The answers can range from "I don't really know" to
"I heard about it from a friend or family member" or "I saw it discussed on CNBC". None of those are really
What I find could be improved in many clients' overall strategy (whether self-directed or professionally
advised) is the plan for how to make a profit on a position and what the expectations were when the trade
was initially made. Was it to own it forever? Was it to double their money? Was it to make 20% and walk away?
This is the art of the trade.
The Reality of Pressing Buy
Every trade should have a pre-planned exit strategy before you hit the buy button. This accomplishes two
- It sets expectations about the anticipated results of the trade.
- It keeps you disciplined - fear and greed are powerful emotions.
Investing is intellectually and emotionally hard. It's very difficult to sell all or part of a position that has doubled
from $25 to $50. The natural thought process is to say, "I'm pretty smart! $100 can't be far off." On the other
hand, it's equally hard to buy more of a stock that you bought at $25 and is now at $15. The natural thought
process then is to say, "I'm a fool! How could I have made such a mistake?" Yet these counterintuitive, and
difficult, choices are often the very ones that should be made.
Many aspects of disciplined investing, or disciplined trading, can be very similar to disciplined gambling. The
inexperienced gambler might walk up to a blackjack table thinking, "if I don't lose too badly this might be fun."
Or, "if I can make enough for dinner I'll be super happy." Most sit down without any plan or exit strategy at all.
The casino loves these gamblers.
In blackjack, you might start with $300 and an hour later have $500. You're feeling great, sipping a cocktail
and making friends with everyone at the table. Forty-five minutes later, you leave the table with just $100, the
euphoria is gone and you mumble under your breath, "why didn't I quit when I was up $200 or at least quit
when I was only down $50?" "Why didn't I set aside $100 of my winnings for dinner?" The reason? No plan. . .
In fact, never even contemplated a plan -- after all, this was supposed to be just "fun".
Trading or investing in equities can be very similar. Selling a winner is the only way to "realize" a gain. If you are
fortunate enough to buy a stock at $25 and have it go to $100, that $75 per share gain is unrealized. It's much
like the equity in your home. It really isn't yours . . . it's just a paper gain . . . until you make a decision to sell and
realize that increase. While a "trade" can be very hard to do in your home, it's incredibly easy in a stock. So a
savvy investor will consider harvesting gains as the stock appreciates. The proceeds from these realized gains
then are available as dry powder to pursue other opportunities, or simply as cash or income.
In SMAs, we generally allocate no more than 2%-4% to any individual equity. The allocation size is based on
account size, investment objectives and tolerance for risk. Say we buy 100 shares of XYZ at $25 - that's $2,500,
or 2.5%, of a $100,000 portfolio. When XYZ gets to $30 per share we sell 15 shares and bring the position back
to its original allocation. Now let's say XYZ goes to $35. We sell another 15 shares to bring the position and
the weighting back down to the original allocation again.
Now, I know, clients will say, why sell 15 shares? What does that do? Well it locks in a realized gain of 20% (or
$450) on the first 15 shares sold and 40% (or another $525) on the second 15 shares sold. We like 20% or 40%
realized gains. We've also controlled the risk that the paper gains might disappear if the stock value declines.
This practice is what we mean by the term "fade trading". Maybe the stock loses some steam and gets back
down to $27 or $25 or even $23. Stocks do go up and down as you know. But we still have realized profit in
the position, because of the fade trading.
How does fade trading relate to blackjack? The same "fading or realizing of gains" strategy should be employed
when in the casino. Let's again say you start with $300 and when/if you get to $400 this time you stick $50
in your pocket and let the other $50 ride on your stack. Maybe you get lucky enough to get up another $100.
Same thing. . . $50 goes in your pocket and the other $50 remains on your stack. Here is the key. When your
money in play gets to $250 (i.e., $50 less than where you started at $300), you are done. The money in your
pocket is never part of the decision making process. You get up, thank the dealer and walk away with $100
in your pocket and $250 from the table for a total of $350. Since you started with $300, you've made a 17%
When You Are Losing
Now let's look at how to handle losing situations - both when buying a stock or playing blackjack - because
those situations do happen. No one ever likes to buy a stock at $25 and then see it at $20 a month later. While
we like 20% gains, as above, 20% losses are no fun. At this point there are two things you can do: 1) Sell out or
2) buy more. Most of the time the professional investor, who still sees fundamental value in the stock, is going
to buy more - after all, a product you like is now "on sale". A professional investor will have done countless
hours of research into an individual stock position. Buying more of that position at $20 per share now should
be looked on as a great deal (when $25 was considered a great entry point just 30 days prior). As above, with
fade trading on the appreciating side, we now are going to maintain our initial 2%-4% weighting as the value
of the stock declines.
Using the example trade from above to illustrate, say we buy the same 100 shares of XYZ at $25 - that's
$2,500, or 2.5%, of a $100,000 portfolio. But in this case, XYZ falls to $20 per share. So we purchase 25 shares
and bring the position back to its original allocation.
This time we know clients will say, why purchase 25 more shares in a loser? What does that do? Well, it drives
our average cost basis on this position down from the original $25 per share to $24. And if our on-going
internal examinations solidify our belief that XYZ remains a buy, we have positioned the portfolio for greater
gains if a turnaround occurs. Through thick and thin, we continue with this disciplined approach until our
research, or our pre-established thresholds, tell us that we no longer like the stock.
Of course, sometimes research does actually tell us that we no longer like the stock. And sometimes a stock
does decline below the pre-established threshold. When either of those things occurs, it's time to make the
hard decision to exit a position and move on.
In blackjack, you shouldn't sit down at the table unless you know exactly how much you are willing to lose. Say
you start with $300 and are OK with a $100 loss. That's 20 $5 hands. (I've never seen anyone lose 20 straight
hands, but I bet it has happened). So if, after a period of time, you find yourself down the $100, you cash out
and walk away with your $100 loss. This does a few things. First, it hasn't thoroughly discouraged you from
ever gambling again. And second, it hasn't eviscerated your will to play blackjack in the future. You can revisit
the table to continue the fight later that day, the next day, or on a future visit.
Without an understanding that losses are part of investing and without understanding one's personal tolerance
to experience a loss, many clients reach a point where they simply want out after a market sell-off. "That's
it, I'm out and I'll never do that again!" I recently sat with one prospective client who liquidated his account
in 2010 and just could never bring himself to decide when was the next time to re-enter the market. He was
magical in talking himself out of pressing buy. That was 9 years ago and the client has sat on the sidelines
while the S&P 500 tripled in value!
WT Wealth Management is an SEC registered investment adviser, with in excess of $100 million in assets under management
(AUM) with offices in Flagstaff, Scottsdale, Sedona and Tucson, AZ along with Jackson Hole, WY and Las Vegas, NV.
WT Wealth Management is a manager of Separately Managed Accounts (SMAs). With SMAs, performance can vary widely
from investor to investor as each portfolio is individually constructed and managed. Asset allocation weightings are
determined based on a wide array of economic and market conditions the day the funds are invested. In an SMA, each
investor may own individual Exchange Traded Funds (ETFs), individual equities or mutual funds. As the manager we have
the freedom and flexibility to tailor the portfolio to address an individual investor's personal risk tolerance and investment
objectives - thus making the account "separate" and distinct from all others we manage.
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In addition to the normal risks associated with investing, narrowly focused investments, investments in smaller companies,
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