position sizing

[Guest cherzeca]

I think if you do have a large position in a stock, you should have already decided upon an exit strategy. holding forever like Buffett works fine if you own insurance companies that provide you float. the longer you hold a large position the more likely something will go wrong with the stock or the market, and the pain is magnified with a large position. a bull market that increases over time can lull one into complacency, and it is dangerous to be complacent with a large position.

[ourkid8]

I totally disagree, you should only sell when the fundamentals change.  If the business continues to strengthen it's moat and it's fundamentals keep on increasing, why would you sell? I have held CN Rail for well over a decade and plan to hold it for the rest of my life. 

 

I think if you do have a large position in a stock, you should have already decided upon an exit strategy. holding forever like Buffett works fine if you own insurance companies that provide you float. the longer you hold a large position the more likely something will go wrong with the stock or the market, and the pain is magnified with a large position. a bull market that increases over time can lull one into complacency, and it is dangerous to be complacent with a large position.

[LC]

the longer you hold a large position the more likely something will go wrong with the stock or the market, and the pain is magnified with a large position

 

The opposite holds true as well, though. Good companies + time is a recipe for success. Of course, identifying good companies is difficult and needs to be consistently re-evaluated as ourkid8 mentioned.

[coc]

I long ago gave up on using the Kelly Criterion.  That is because according to the Kelly Criterion the size of the bet is determined by the formula:  Edge/Odds = size of bet.  But here's the thing - according to the formula if your Edge = zero, then the size of bet is "Don't Bet!". 

 

If most of us are truly honest with ourselves, do we really have an edge in picking an individual stock vs the market.  Do we think our guess as to where the "missing sub" is located is going to be more accurate and correct than the collective wisdom of a diverse group of actors with money on the line?  Are we really just punters when we think we are experts?

 

The good news is that unlike most gambling games (which are negative sum), the stock market is a positive sum game.  All we need is to go with the market via diversification in a group of 10-15 high quality businesses and we will do fine.  So my recommendation is to put away the Kelly position sizing stuff because if you think you have an edge then you are making big bets that you alone can locate a "missing sub" better than the market can.

 

wabuffo

 

p.s. the USS Scorpion story is also featured in James Surowiecki's "Wisdom of Crowds" book.

 

Serious question, if you feel you have no 'edge' (which is a quantitative concept i.e., better odds than average), why are you picking stocks at all? There would be no point.

[Mohammed Al Alwan]

I read this book written by two NY Times reporters years back called "Blind Man's Bluff" about the Cold War that involved true stories about submarine espionage.  One of the stories involves the USS submarine Scorpion that disappears in 1968 to the bottom of the Atlantic with all hands lost.  This sets off a frantic search by the US Navy to find its lost sub.  All they knew was its last reported position, the path it was on (it was heading back to base at Newport News, VA after a tour of duty in the North Atlantic) and only vague other bits of information.  The area to be searched was a large part of the North Atlantic near the US coast.  It was kind of hopeless that the sub would ever be located.

 

https://en.wikipedia.org/wiki/USS_Scorpion_(SSN-589)

 

So the Naval Officer in charge of the search operation (a kind of Hunt for Red October Jack Ryan type of guy, I guess) comes up with a novel plan.  He doesn't just reach out to experts like other submarine commanders.  He assembles a wide range of folks - some with submarine knowledge, mathematicians, salvage ops men - basically a diverse set of knowledgeable people but not all experts in subs.  He briefs them with all the information and data that the Navy has related to the USS Scorpion's last voyage.  He then asks them to go off on their own, sift through the data and independently offer their best opinion on why the submarine ran into trouble, its speed and its steepness of descent so as to locate where it might have touched bottom.  He makes it interesting by offering a reward and prizes to the winner who comes closest to the actual location if/when the sub is located.

 

The individuals' guesses were assembled on a map and using some fancy math (Bayes Theorem) -- a composite guess of the "crowd" was isolated based on the collective estimate of the group as to where the sub might be located.  The location was not a spot any individual member came up with or picked.  But a search was started focusing on the spot identified by this collective method and five months later the sub was located within 220 yards from where the group's estimate said it would be.

 

Ok - why tell this story.  Because collective wisdom is what the stock market operates on.  It is why it is generally an efficient market.  The various participants individually all have guesses about the fair value of a stock.  These guesses are made up of lots of random guesses + a tiny bit of signal information in each guess.  As these guesses are aggregated, the random parts cancel each other out and what remains is mostly pure signal.

 

I long ago gave up on using the Kelly Criterion.  That is because according to the Kelly Criterion the size of the bet is determined by the formula:  Edge/Odds = size of bet.  But here's the thing - according to the formula if your Edge = zero, then the size of bet is "Don't Bet!". 

 

If most of us are truly honest with ourselves, do we really have an edge in picking an individual stock vs the market.  Do we think our guess as to where the "missing sub" is located is going to be more accurate and correct than the collective wisdom of a diverse group of actors with money on the line?  Are we really just punters when we think we are experts?

 

The good news is that unlike most gambling games (which are negative sum), the stock market is a positive sum game.  All we need is to go with the market via diversification in a group of 10-15 high quality businesses and we will do fine.  So my recommendation is to put away the Kelly position sizing stuff because if you think you have an edge then you are making big bets that you alone can locate a "missing sub" better than the market can.

 

wabuffo

 

p.s. the USS Scorpion story is also featured in James Surowiecki's "Wisdom of Crowds" book.

 

the problem is  for the wisdom of the crowed to operate in stock market you need diversity and independence which usually breakdown at market extreems.

[Jurgis]

I long ago gave up on using the Kelly Criterion.  That is because according to the Kelly Criterion the size of the bet is determined by the formula:  Edge/Odds = size of bet.  But here's the thing - according to the formula if your Edge = zero, then the size of bet is "Don't Bet!". 

 

If most of us are truly honest with ourselves, do we really have an edge in picking an individual stock vs the market.  Do we think our guess as to where the "missing sub" is located is going to be more accurate and correct than the collective wisdom of a diverse group of actors with money on the line?  Are we really just punters when we think we are experts?

 

The good news is that unlike most gambling games (which are negative sum), the stock market is a positive sum game.  All we need is to go with the market via diversification in a group of 10-15 high quality businesses and we will do fine.  So my recommendation is to put away the Kelly position sizing stuff because if you think you have an edge then you are making big bets that you alone can locate a "missing sub" better than the market can.

 

wabuffo

 

p.s. the USS Scorpion story is also featured in James Surowiecki's "Wisdom of Crowds" book.

 

Serious question, if you feel you have no 'edge' (which is a quantitative concept i.e., better odds than average), why are you picking stocks at all? There would be no point.

 

Because people are overoptimistic about their abilities and therefore they think they have an edge when they really don't.

 

.......

 

On the other hand, as someone has already mentioned, Kelly's does not really capture the time dimension. A good/great business may be "efficiently valued" for today, but still provide a good/great return if held long time. Market often undervalues (not "always" like Gorilla Game claimed, but "often") undervalues long term compounders.

[valueinvestor]

I think people have an edge when it’s small sums. It’s hard to have an edge with large sums.

 

Secondly - average holding period iirc is 1.5 years. So market is pricing stocks to that period for all intensive purposes. Hence, if one has a holding period that’s longer, that’s another way to have an edge.

 

Thirdly, some edge such as NAV calculations unless there’s a catalyst can be modelled in a computer that can execute trades faster. So when people pretend  that’s an edge is ludicrous imho.

 

However things off the financial statements such as brands, strategy, hidden assets, and etc can provide an edge over computers.

[Simba]

I generally looked at how other fund managers did it and just copied them. Go find some highly rated mutual fund managers for a good idea. You’ll often notice they are diversified and never go all in gangbusters on a play (cough: ARK). You’ll also see generally a lack of turnover.

 

You can find investment letters and videos and see how other fund managers invest. I haven’t seen any books, if you see some do share what you find.

 

Kelly Criterion simply reinforces not to go 100% in any position as your risk of ruin is high. It teaches you an optimal ratio (which most find is too high).

 

Also Some people here have given good advice on how they see positioning sizing. 

 

To add to the discussion, you can maintain an excel spreadsheet with your portfolio weights, and update accordingly. Helps when you actually visually see what weights are where

[valueinvestor]

Also I subscribe to Bruce Berkowitz (bad performance, but wisdom may not be bad), what happens when a stock goes 90% down? Are you prepared to purchase more? Amazon had 90% drawdowns twice, iirc. Especially with microcap positions, if it goes down 90%, then it means I get to own a meaningful portion of the company.

 

Just because there's a ticker, it does not mean the shares are worthless.

[Rod]

We should also consider that position sizing isn’t just about how much you put in at the start but how you adjust the position size over time. Many people like to trim winners because they feel it’s too risky to allow their portfolio to become more concentrated. I think this is the wrong way to look at it. I’d be interested to know what others think.

[writser]

Also I subscribe to Bruce Berkowitz (bad performance, but wisdom may not be bad), what happens when a stock goes 90% down? Are you prepared to purchase more? Amazon had 90% drawdowns twice, iirc. Especially with microcap positions, if it goes down 90%, then it means I get to own a meaningful portion of the company.

 

Just because there's a ticker, it does not mean the shares are worthless.

 

Slightly off-topic, but people were shitting all over Bruce a few years ago, but he has actually been doing very well lately - of course that doesn't make the news.

 

https://www.morningstar.com/funds/xnas/fairx/performance

 

Up 47% in 2020,  top 2 percentile performance for the past 1,3, and 5 years. I like his approach. Really seems to be doing his own thing.

[coc]

Also I subscribe to Bruce Berkowitz (bad performance, but wisdom may not be bad), what happens when a stock goes 90% down? Are you prepared to purchase more? Amazon had 90% drawdowns twice, iirc. Especially with microcap positions, if it goes down 90%, then it means I get to own a meaningful portion of the company.

 

Just because there's a ticker, it does not mean the shares are worthless.

 

Slightly off-topic, but people were shitting all over Bruce a few years ago, but he has actually been doing very well lately - of course that doesn't make the news.

 

https://www.morningstar.com/funds/xnas/fairx/performance

 

Up 47% in 2020,  top 2 percentile performance for the past 1,3, and 5 years. I like his approach. Really seems to be doing his own thing.

 

His performance over the last few years is no better than ever, he simply had a huge leftover position in JOE after his investor exodus which has gone parabolic within the last six months. I wouldn’t go revising your opinion based on this.

[thepupil]

i agree. without having ever spoken to the guy, my interpretation of events is that Bruce more or less gave up on managing a public mutual fund portfolio and got a consolation prize for a great run of a big (but heretofore neglected and unsaleable) slice of the redneck riviera. then CryptJOE went nuts and he's redeemed himself on recent performance metrics. I've been long JOE options and have made out nicely, but I don't really see any evidence of Bruce being a capable stockpicker or that he's doing anything at all.

 

you can buy JOE or Fannie Freddie directly.

 

https://www.fairholmefunds.com/reportsmgt

 

2019 Year End

41% JOE

38% Cash

20% Fannie Freddie

 

2020

65% JOE

20% Cash

10% Fannie Freddie

[bizaro86]

Wasn't there some rule change awhile back that required him to be diversified? How come he is allowed to have that much JOE?

[thepupil]

Yea there was some discussion of this in a thread, I was thinking at one point that FAIRX would have to distribute JOE shares or sell, but that hasn’t happened and I ever dug in to find out the details.

[rkbabang]

I long ago gave up on using the Kelly Criterion.  That is because according to the Kelly Criterion the size of the bet is determined by the formula:  Edge/Odds = size of bet.  But here's the thing - according to the formula if your Edge = zero, then the size of bet is "Don't Bet!". 

 

If most of us are truly honest with ourselves, do we really have an edge in picking an individual stock vs the market.  Do we think our guess as to where the "missing sub" is located is going to be more accurate and correct than the collective wisdom of a diverse group of actors with money on the line?  Are we really just punters when we think we are experts?

 

The good news is that unlike most gambling games (which are negative sum), the stock market is a positive sum game.  All we need is to go with the market via diversification in a group of 10-15 high quality businesses and we will do fine.  So my recommendation is to put away the Kelly position sizing stuff because if you think you have an edge then you are making big bets that you alone can locate a "missing sub" better than the market can.

 

wabuffo

 

p.s. the USS Scorpion story is also featured in James Surowiecki's "Wisdom of Crowds" book.

 

Serious question, if you feel you have no 'edge' (which is a quantitative concept i.e., better odds than average), why are you picking stocks at all? There would be no point.

 

Because people are overoptimistic about their abilities and therefore they think they have an edge when they really don't.

 

Exactly.  And consider this, are there really only 3 or 4 market beating stocks in the world?  I think there are a lot of them.  If you really have an edge then you should have no problem finding 30 market beating stocks to hedge against the possibility that your edge isn't as sharp as you think it is.

 

 

[jm25]

Will you share what those two stocks are?

 

Agree with everyone above, but just to add I would rather own one stock that I paid a great price relative to future cash flow/margin profile, then 100 overpriced/overvalued stocks.

 

I essentially own a two stock portfolio that's 90% of my net worth. While the third is about 5% and the rest is a basket of workouts about 5%.

 

There are great opportunities in the market. I found an under-the-radar stock that has a couple of businesses and a liquid stake in a grower that's also under the radar, where it has long runway. Priced under cash per share, not even book, but because it's a small company under $100M, and circumstances the screeners are not updated yet.

 

I think position sizing has to relative to price paid, ability to generate more capital for dollar-cost averaging, and stage of your life.

 

My portfolio hasn't had a drawdown yet, but when running portfolios for others, I've experienced 50%+ drawdowns in a holding, but overtime it worked out, especially if you bought at the dips. While the other two holdings haven't gone down.

 

EDIT: Philosophy can change on a dime. Not a portfolio manager/financial advisor, when running portfolio, I meant my family.

[spartansaver]

Will you share what those two stocks are?

 

Agree with everyone above, but just to add I would rather own one stock that I paid a great price relative to future cash flow/margin profile, then 100 overpriced/overvalued stocks.

 

I essentially own a two stock portfolio that's 90% of my net worth. While the third is about 5% and the rest is a basket of workouts about 5%.

 

There are great opportunities in the market. I found an under-the-radar stock that has a couple of businesses and a liquid stake in a grower that's also under the radar, where it has long runway. Priced under cash per share, not even book, but because it's a small company under $100M, and circumstances the screeners are not updated yet.

 

I think position sizing has to relative to price paid, ability to generate more capital for dollar-cost averaging, and stage of your life.

 

My portfolio hasn't had a drawdown yet, but when running portfolios for others, I've experienced 50%+ drawdowns in a holding, but overtime it worked out, especially if you bought at the dips. While the other two holdings haven't gone down.

 

EDIT: Philosophy can change on a dime. Not a portfolio manager/financial advisor, when running portfolio, I meant my family.

 

Sea and Crescita?

[Patmo]

Very cool discussion and interesting viewpoints. I have become more and more concentrated for practical purposes - I don't have the time/energy/will to keep tabs on enough companies to a degree I am comfortable putting money in so I just dump more money in the stuff I already know. It might increase risk of ruin, I dunno, we'll see.

 

I have spent some time/energy in the past on various companies (not a crazy amount but just enough) so I have a decent broad view on their value and can catch up to the news quickly if something drops in price substantially. I made most of my money going in and out of the same few companies that have somewhat volatile share prices, like TECK. When I venture out of this group of companies I am familiar with, I get burned more often than not.

 

One day I'll just say "screw this" and go 100% google and forget everything until I retire.

[valueinvestor]

Will you share what those two stocks are?

 

At the moment - no. It took months of research and still building a position. May not release ever because I want prices to stay low.

 

Will you share what those two stocks are?

 

Agree with everyone above, but just to add I would rather own one stock that I paid a great price relative to future cash flow/margin profile, then 100 overpriced/overvalued stocks.

 

I essentially own a two stock portfolio that's 90% of my net worth. While the third is about 5% and the rest is a basket of workouts about 5%.

 

There are great opportunities in the market. I found an under-the-radar stock that has a couple of businesses and a liquid stake in a grower that's also under the radar, where it has long runway. Priced under cash per share, not even book, but because it's a small company under $100M, and circumstances the screeners are not updated yet.

 

I think position sizing has to relative to price paid, ability to generate more capital for dollar-cost averaging, and stage of your life.

 

My portfolio hasn't had a drawdown yet, but when running portfolios for others, I've experienced 50%+ drawdowns in a holding, but overtime it worked out, especially if you bought at the dips. While the other two holdings haven't gone down.

 

EDIT: Philosophy can change on a dime. Not a portfolio manager/financial advisor, when running portfolio, I meant my family.

 

Sea and Crescita?

 

It's Crescita - or is it?  ;D

[valueinvestor]

Exactly.  And consider this, are there really only 3 or 4 market beating stocks in the world?  I think there are a lot of them.  If you really have an edge then you should have no problem finding 30 market beating stocks to hedge against the possibility that your edge isn't as sharp as you think it is.

 

Considering edge for me comes from in-depth research - it's quite hard to research in depth 30 market-beating stocks, hence why I usually reserve to 3-5 max, where 2-3 are over 90% of my capital allocation. Secondly, unless investing is a full-time job and you have analysts, I don't even know a lot of market beating funds that have 30 stocks in their portfolio that beat the market over time. Berkshire has 50 equities I think at most.

[Simba]

We should also consider that position sizing isn’t just about how much you put in at the start but how you adjust the position size over time. Many people like to trim winners because they feel it’s too risky to allow their portfolio to become more concentrated. I think this is the wrong way to look at it. I’d be interested to know what others think.

 

On trimming winners. I’ve struggled with it. I’ve left a lot of money selling early. I’m going to try letting winners ride this year

[valueinvestor]

I find it funny when people say they’ve trimmed their winners because I read it as they’re reinvesting in their losers. I think the better approach is to have more capital coming in and invest when it’s dips. Sometimes if I felt my initial purchase was high, I would just have an appropriate cash position. 

 

One might say it’s better to invest in second best idea, but I say if it’s not  first - it’s last.

 

Can one have failures? Yes. I’ve invested in ~30% of my portfolio in Valeant @ $220, iirc. Reinvested at subsequent dips and still made it out okay. However, it allowed me to learn and still beat the market by a large margin. Valeant wasn’t my only colossal failure either.

 

If you’re going to diversify more than 3-5 stocks, I would rather index. The time spent to keep on top of these companies plus their competition, as well as any new news that can have a major effect on the price is difficult. I have a hard time managing 3. 

 

Can anyone on this board tell me that 99% of their performance come from more than three stocks? Genuinely want to know - typically I find my best idea account for 90% of my performance, also 90% of my loss.

[coc]

If you’re going to diversify more than 3-5 stocks, I would rather index. The time spent to keep on top of these companies plus their competition, as well as any new news that can have a major effect on the price is difficult. I have a hard time managing 3. 

 

Can anyone on this board tell me that 99% of their performance come from more than three stocks? Genuinely want to know - typically I find my best idea account for 90% of my performance, also 90% of my loss.

 

Yeah, I'm with you. I always say a half-dozen max, for me. I mean, Berkshire has $125B in a single stock. According to financial theory that's insane.

 

Personally, I just cannot get my head around the idea that 30 stocks is "less risky" than 6, if the 6 are reasonably different from one another and are the right sort of businesses. The "risk management" of having a bunch of 2-3% positions is offset by the fact that your winners are not propelling your portfolio forward enough. Unless you have 30 equity stub options or VC plays.

 

Someone mentioned Mark Sellers in here - what he did was nuts. I don't think that's a good example to follow. He missed the concept of fragility. E&P companies are concave to the commodity price. A move from $6 gas to $3.50 gas = bankruptcy unless your costs are totally rock-bottom.

 

At the end of the day, everyone's comfort level is going to vary...lots of ways into heaven.

[SharperDingaan]

"Can anyone on this board tell me that 99% of their performance come from more than three stocks? Genuinely want to know - typically I find my best idea account for 90% of my performance, also 90% of my loss"

 

Performance can also come from strategic overlays. 

Example: FFH. Cash parking spot for us, since mid December through to about the end of next week. Four trades, an entry, a short-term BB driven swing trade, and an exit. Yet our 'all in' return will be around 25-30% - on simply cash management.

 

We prefer concentrated portfolio's, but strategic overlays are part of the return - occasionally, most of it.

Sometimes it goes your way, sometimes not so much.

 

SD