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Tackle Today: Tales of Diversification 📖

February 7, 2019

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≈ Grandma is always right. ≈

“Don’t put all your eggs in one basket.”

Grandma

Yeah, she is right, as usual. What she forgot to tell us, though, is that there are literally hundreds of approaches to accomplish that same goal. Let’s take three successful investors and analyze, from a high-level standpoint, what are their pragmatic approaches to the eggs/basket enigma.

Warren Buffett preaches concentration, however, if you grab Berkshire’s SEC filings you will come to the conclusion that there’s more diversification there than in most portfolios you will ever encounter down the road. He seems to be heavily concentrated on business that he perfectly understand, and that’s quite a diversification.

“If you know that you are vulnerable to prediction errors, and accept that most ‘risk measures’ are flawed, then your strategy is to be as hyper-conservative and hyper-aggressive as you can be instead of being mildly aggressive or conservative.”. Taleb’s Barbell Strategy is utterly simple: nothing in the middle, like a barbell. On one end, hyper-conservative assets; on the other, the hyper-aggressive ones.

With the Paradox of Higher Returns with Lower Risk, Mark Spitznagel puts dynamic hedging in the spotlight. The Tail Hedge system he developed based on his studies in the Austrian School and market interventions by Central Banks, allows his clients to be hyper-aggressive by protecting their portfolios from fat-tail events. This provides room for a much substantial allocation on high-risk assets.

Financial markets are a sterilized environment, apparently leaving no room for conventional wisdom, like those of our ancestors. It never occurred to me that following grandma’s advice would signify thinking outside the box.


Chart of the Day

Barbell Strategy

“If you know that you are vulnerable to prediction errors, and accept that most ‘risk measures’ are flawed, then your strategy is to be as hyper-conservative and hyper-aggressive as you can be instead of being mildly
aggressive or conservative.”

— Nassim Taleb —


Video of the day

Mark Spitznagel on the Paradox of Higher Returns with Lower Risk

Mark Spitznagel discusses the paradox of higher returns with lower risk.


Today’s line up

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The Breakthrough Part II

So last week we talked about how the pros put themselves in the best position to be successful by reducing risk at every possible turn and making it their sole mission to do so.  Did this make sense?  Did this concept occur to you as a newer trader?  It seems so simple but in practice, it can be harder than one can believe.

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2 Replies to “Tackle Today: Tales of Diversification 📖”

  1. Avatar EllenHodgson says:

    How do I set up Mark Spitznagel’s method? Can you do a video tutorial on how to set up his Tail Hedge method in TOS? I also read more about his method and he used an example with 97% SPY ETF and 3% S&P 500 Futures put options. He says, “just spend a fixed amount of capital each month on way-out-of-the-money four-month puts on S&P 500 Futures (with straightforward constraint to avoid the priciest options) and mechanically “delta-hedge them; the puts are kept until expiration or sold if they explode to a ridiculously high level. Pretty basic stuff, really.”

    1. Hi, Ellen.

      Did you read his book The Dao of Capital? Before we go into the details on *how* to do it, I think we must base our decisions on the theory. It’s a dense book that represents a 180º shift in our mindset—it seems to me. I strongly recommend you read it. His concept of approaching the markets via the roundabouts is very interesting.

      I didn’t get to the practical part of it yet, but I am sure he does not reveal his system in its entirety. He reveals some backtesting examples, as far as I can remember. That is his inteclectual property so I guess it would be hard to figure out how he does in every detail.

      Jesse Felder, in his 2016 article (https://thefelderreport.com/2016/08/15/worried-about-a-stock-market-crash-heres-how-you-can-tail-hedge-your-portfolio/), tried to dissect the strategy. Nice reading.

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