By: Alon Horesh
– 3-minute read
– Note: This is part-one of our two-part series on the importance of having an investment strategy.
Photo credit: liveoakinvestors.com
You wouldn’t go skydiving without a parachute. And you wouldn’t go rafting without a life vest. So, why would anyone trade financial instruments without an investment strategy?
It seems counterintuitive, but it happens.
Often times, rookie investors believe they can ‘feel’ their way through the markets. They watch a few hours of CNBC and think, I’m Ready!
Don’t be that guy. Because when you enter the arena unprepared, you stand to lose a lot more than just your pride.
What Is An Investment Strategy?
At its core, an investment strategy is your blueprint to outperform the market. Some focus on portfolio growth and capital appreciation, while others prioritize income and capital preservation. On one end of the spectrum, some portfolio managers employ a pairs trading strategy. You take two highly correlated assets – ones that statistically trend in the same or opposite direction – and wait for their correlations to break. When this happens, an astute trader shorts the overvalued asset and uses the proceeds to buy the undervalued asset. When the correlations revert back to their historical norms – the undervalued asset increases in price, while the overvalued asset decreases in price. The end result? Positive returns from both trades, without using any capital of your own.
On the opposite end of the spectrum, you have low risk, high return trading systems. Here, you can employ a covered call investment strategy. It’s an extremely safe investment. When markets are non-trending or stuck in a consistent range, you can generate income by owning an asset – it can be an individual stock or ETF – and selling call options on the very same asset. Because the counterparty pays a premium to buy the calls from you, you receive upfront cash from the sale. The proceeds are similar to a dividend. If the options expire worthless, the extra income is yours.
Whatever your risk tolerance, there are several winning investment strategies that can deliver alpha. And with reliable investment recommendations, you have them at your fingertips.
Why Is An Investment Strategy So Important?
Jack Schwager once said, “You Just stay focused on what you have to do.”
When it comes to developing profitable investment strategies, he couldn’t be more right.
If you take the time to develop a proven methodology, it quickly becomes a winning investment strategy. And as markets become increasingly interconnected, accessing expert investment recommendations are more important than ever.
When you follow a professional trader, his goal will be to achieve the highest expected return per unit of risk. To do so, you need to maximize your Sharpe Ratio. By rigorously back-testing a strategy – using historical trading data – you gain statistical insight into how the strategy performs and the risks involved. To perfect the investment strategy, you analyze the data and make small adjustments to your approach. What you’re left with is a strategy that’s Mean-Variance Optimal (MVO).
Remember, markets are complicated and behavior in one ripples across others. But, when you have professional trading advice, you’re always prepared to strike. If sentiment becomes overly bullish or bearish – causing assets prices to deviate from fair value – you’ll know exactly when to pull the trigger and how to take advantage of the overreaction.
Up next, stay tuned for part-two of our series.
And, as always.