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Position Sizing Safeguards
The Smart Profits Report: Issue #263
Thursday, December 1, 2005
Position Sizing Safeguards: Prevent Corporate Lies From “Cooking” Your Portfolio
By Karim Rahemtulla
Chairman, Mt. Vernon Research
It’s been several years since the Enron, Worldcom and Global Crossing stories surfaced, and the market is a better, more honest place, right? Wrong!
The level of executive mismanagement and outright fraud is rampant in corporate America. Companies still lie, cheat and rip off their shareholders with bold promises of better growth, debt reduction, “plans” for a turnaround and rosy projections for future quarters.
What drives these executives to at best mislead investors, and at worst commit outright fraud, like that at Adelphia? The answer is simple. Too simple. So let’s look at how and why they do it… and the most important rule of thumb: to safeguard with position sizing.
Loading Up on One-Time Charges
The simplicity of this common deception is what makes it work every time. Executives know, for the most part, that their jobs and incentives are based on short-term performance. Earnings have to be good - or they must be projected to be good - just long enough for the bonuses to be paid, and the stock options to be vested and cashed out.
How does it work? Well, just sell a bunch of phony baloney to Wall Street and get the little guy to bail you out by buying into the hype. And when the time comes to reveal the ugly numbers, throw in a bunch of “one-time” charges and blame the weather.
These charges are never one-time events, but are recurring in some form or another, so that investors never know the true earnings or condition of the company. Then, hungry investment banks come along and finance the bogus companies to collect the fatter fees that can be extorted from companies in dire need.
After all, the real money is coming from other people, not the investment banks. And by the time the banks are found culpable, they will have made a ton of money trading the shares to the ground, and then more money from bankruptcy fees - enough to cover any slap-on-the-wrist fines they receive.
What You Can Do About It… Using Position Sizing
Make sure that if there is one rule you follow, it is to position size. Do not overload into any one investment idea. No matter how much of a “sure thing” you may think it is, know that the information that you are investing on is often tainted by the company before it is released to the public or the investment analysts. It’s a rough world out there, and investors are more often the prey and not the predator.
Position sizing allows you to risk only a small portion of your capital in every trade. This way, if one investment goes sour, the impact on your portfolio is relatively minor. Invest a little to make a lot - not the other way around.
Good Trading,
Karim
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Today’s Smart Profits Cribsheet
- For some additional guidance before your next trade, head back to Smart Profits #229, Option Position Sizing: How Much to Invest in Each Option Trade.
- If you’re not familiar with position sizing techniques, head to Smart Profits #193 right now - Position Sizing -The Most Powerful Investment Concept in the World. Every investor, no matter how experienced, can benefit from this principle. It’s the best way to control the fate of your portfolio.
Related Articles:
- Implied Volatility - The Impact of Beta on Your Option Positions
- Portfolio Position Sizing: The “10% Rule” for Safe Option Profits
- Options Straddle - Using A Straddle to Harness “Uncertainty”
