High Risk Trading

by Wes Bridel on May 11, 2011

in Stewardship

Out of all the portfolios we have been talking about (and will continue to), the one that is probably that most should avoid (but many don’t) is high risk trading.  Today, we’ll talk about…The Paper Gusher Portfolio

Cactus was a West Texas oilman.  Not only that, but he was a second generation oilman.  He had learned early and often that you have to take risks to hit the big score.  And you have to move fast and go where the action is.  That’s how he made his money in the oil patch and that’s the philosophy he’s going to carry into managing his brokerage account where he does high risk trading.

Now don’t go thinking you know everything about Cactus just because he’s a wildcatter.  He’s been around long enough to know that you don’t bet everything you’ve got on one hole.  Big risks are where big rewards lie, but if you put all your money in one dry hole, you’re starting over.  He’s too old to start over and too savvy to do so even if he was still a youngster.

Cactus keeps about 50% of his liquid net worth in whole life cash value at his favorite mutual company so that they can earn him the highest possible tax free return on his safe dollars.  This money provides enormous security for him so that he’s free to take the big risks in his high risk trading account.  He also keeps 30% of his liquid net worth in physical gold and silver knowing that although they will bounce up and down, they will always be worth more fiat currency than what he originally put in them down the road.  Finally, Cactus has a substantial monthly cash flow from the rigs which bring up oil and gas every month rain or shine.

Knowing this, he takes 20% of his liquid net worth and sets about high risk trading.  Because it’s a trading account, Cactus doesn’t have the same set allocations that our previous investors had.  Instead, he takes a position when he thinks the time is right, and he looks to unload it when the trade has run its course.  This might be because it went against him and he had to cut his losses at his predetermined 10%, or it might be because he feels the trade doesn’t have enough potential left in it and it’s time to get out while the getting is good.  But Cactus does know very well that a market can run longer than any reasonable person would think it can and so he’s hesitant to sell to early if he’s riding a winner.  But one thing he will often do is sell a portion of his gains when he’s made a significant profit (he uses different percentage rules depending on the type of trade).  This ensures that he’ll get out with a hefty profit, but leaves a portion of his funds in the trade to see how high he can ride the “gusher”.

Why’d you think he calls this “The Paper Gusher Portfolio?”  His oil man’s nose is always looking for the next gusher whether it be in the ground or in the stock markets!

Cactus will trade anything that looks like it can be a gusher, but he’s only willing to play the long side.  He knows that shorting things can be a tricky business and he’s had too many people underestimate him in his life.  He’s not going to go around underestimating stocks.  There’s enough money sloshing out of Washington these days that he wouldn’t be surprised if everything went up!  Cactus’ll take the long side of his speculations, Thank you very much.

Let’s look at some of the things he has traded…

A Volatility Index

A Double Long Gold Fund

An Oil Commodity Fund

A Broad Market Commodity Fund

US Gov’t Backed Mortgage REITS

A Financial Company Fund

A Gold & Silver Bullion Fund

Junior Gold Mining Producers & Explorers

The first thing to know about Cactus’ style is that he’s not afraid to do nothing.  Most beginning speculators always feel like that have to “DO” something.  This is a recipe for disaster because sometimes there’s not a great position to take.  Cactus knows that this account is available to take as much risk as he feels is a good one, but when he sees the way most speculators act, he always wonders, “Why would you put your good money at risk if you don’t feel certain you can hit a gusher?

So when he doesn’t have a great idea, he’ll either leave his money in cash, or buy short term Treasury Bills, or put his money in a gold &/or silver trust depending on how safe that looks, or sometimes he’ll put his money in a mortgage REIT to collect big dividends if he thinks it’ll be there long enough and the Federal Reserve looks like it will cooperate with interest rates.  He likes to earn what he can when his money is sitting idle, but the most important thing is to not lose it, so he always takes that into account when deciding where to park money waiting for the next trade.

One thing we forgot to mention about Cactus’s trading account is that he doesn’t only hold short term trades.  He also speculates on individual junior gold miners and explorers.  That business is near to his heart because he feels like if he had grown up somewhere other than West Texas, he might have been a prospector instead of a wildcatter.  The business is similar.  A small investment can either be a bust, or strike it rich.

So he portions small amounts of his portfolios in the companies that he feels have the most potential for explosive growth because these companies prices can explode by hundreds or thousands of percent in little to no time with the right find or a buyout by a major.  He gets information like this from people he’s met over the years and from publications like Casey Research’s International Speculator Newsletter.  Sometimes these positions are gushers right away, sometimes they take a few years to develop, and sometimes he’s wrong and has to move on.  But the gushers increase the size of his trading account more than anything else he does!

One of Cactus’ favorite trades is to trade volatility.  He waits until the market has grown incredibly peaceful, indifferent, and optimistic.  When the world believes that nothing can go wrong in the stock market.  When volatility (as measured in the VIX index) has become incredibly low.  And then he buys.  The hard thing about this sort of trade is that it can always go lower, so he always uses a smaller position so that he can scale in with larger and larger purchases if he ends up being early.  The beauty is that when the market wakes up to the reality that markets do crash from time to time, it can turn into a gusher very quickly.  Of course, if he’s too early, this trade can really hurt since it decays over time as he holds it.  Timing is one important key to being a good trader!

Another of his favorite trades is to buy into the double long gold fund.  One thing Cactus always keeps in the back of his mind is that gold prices tend to do very well seasonally at the end of the year.  So he likes to buy the double gold fund at the end of August and watch it run up at the end of the year when he takes profits.  Of course, he doesn’t do it blindly, but looks at what’s going on in the world and if governments are fomenting instability and fear and the seasonality is right, he’ll make that move every year!

He’ll do similar things with his oil futures fund, and many other commodities futures funds when he feels the time is right.  Sometimes he just uses the broad basket commodity fund to bet on inflation seeping into the sector as a whole.  These funds don’t make good long term holdings, but when he feels that the market is about to pop, he’ll jump into them, no question.

Of course there are thousands of opportunities to speculate and Cactus will move on anything that he feels he’s got an advantage on.  But the last one we’ll mention here is the financial fund.  Financials have a habit of leading the market either up or down.  When Cactus feels that the market is ready to bounce up, he’ll sometimes find a particular stock to bet on.  At other times, he’ll speculate on the basket of financials fund.

This is Part 5 in a series on Real Life Examples of Portfolio Management.  You can read the previous posts at: Pt 1, Pt 2, Pt 3, & Pt 4.  We just finished a series on the different types of investors which you might want to check out at the following links:  Pt 1, Pt 2, Pt 3, Pt 4, Pt 5, & Pt 6.

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