Forum Archive Index - March 2004

["Gavin Treadgold" <gav@rediguana.co.nz>]

Hi Snoopy.

> I get the impression you might be mixing disciplines with your
> definitions.

Yes we both have different understandings - I wouldn't say we are mixing,
you are just approaching with a specific application - finance/investing,
whereas I am taking a holistic approach to risk.

> The potential for upside is not risk.

Yes it is. Until the uptick occurs, it is not yet certain, it still may or
may not happen. Hence there is a risk associated - that is that the uptick
will not occur. This is not the same as it going down either - think of a
stock stuck between support and resistance.

> There is an academic view out there that risk is correlated
> with return, and the upside is in some way irrevocably tied
> to the downside.  In my observation this is rarely true.

Yes, wasn't it Markowitz (sp) the father of portfolio theory that originated
this idea? By combining multiple investments, you can potentially mitigate
much of the downside, without decreasing the upside potential.

> 'Pure risk' (as in being hit by a car) is an insurance term
> which, as I see it, has no relevance to discussion on investment.

No, it is not limited to insurance - because these days you can't insure
against all 'pure risks'. When talking generally about risk, it defines any
risk where there is no positive potential - i.e. where there is no point
speculating.

> No I never said that.    Good speculators are very good risk
> managers.

Yes, I should clarify as I was speaking generally - thank you for calling me
on that. When I was using speculator - I was meaning anyone who participates
in speculative risk - be it a gambler, trader or whatever. But a basic
speculator either doesn't (through choice) or isn't able to manage the risk
associated with what they are speculating (such as certain gambling games
that are random). Professionals should, as you mentioned, manage their risk.
I didn't mean to lump them with the generic term speculator.

> No, investment is not speculative in the sense that return is tied to
> share price movement.    If an investor bought a share in a company
> on the sharemarket which he then decided (with others) to
> take private, he would not be concerned if the company was
> never publicly traded again.  A speculator OTOH would have no
> interest at all in following the fortunes of a private company.

But certain risks would still follow the company if you took it private...
perhaps it may be harder to access capital in the future?

I still stand by my statement that investment is still speculative (in the
most general sense of the word), because you are making a decision now on an
outcome that is not certain. Fixed term interest is so close to a certainty,
that you could probably assume it is certain, hence there is negligible risk
associated with it (always bank failure though etc).

> They are interested in *ultimate*  return, or what
> happens when they sell the house or the term deposit matures.  Quite
> rightly so in my view.    It is pointless worrying about the
> day to day
> flucuations of the worth of your term deposit or house, when all that
> really matters is what happens when you cash up.

Quite agree with the approach - typical of the long term buy-and-hold
investor.

Volatility is a partial measure of risk of an investment, but it only
represents risk that the market can put a figure on. Not all risk can be
valued by the market.

In very few cases are you guaranteed cashing up at a higher price (fixed
term interest is probably the only near certainty here, and it is only
certain because the interest rate flucuates - so the risk remains the same
but the return varies). Whilst the probability is good that you will be able
to cash in your house for more than what you paid for it, it is not a
certainty in every case.

> If the pie is growing you are investing. It really is that simple.

Sorry, it ain't that simple, because you don't know if the pie is going to
grow or shrink in ten years time. If it isn't a certainty, then it is not
simple. Only if you are certain that the pie is growing will it be as simple
as you suggest. Monkies can make money (and did) during bull markets, it
ain't as easy during bear markets when the pie is shrinking.

> >Put simply...
> >Speculation + Risk Management = Investing
> I don't know where that definition came from, but I would
> suggest it is totally wrong. The idea that speculation does
> not involve risk management is demeaning and facile to
> professional speculators.

See my previous clarifications and you should see where I came up with this
statement. We had different meanings of speculation. I classify traders and
speculators that incorporate risk management as investors. Basic speculation
is still gambling because you have not affected the outcome in any way. As
soon as you incorporate risk management, you are effecting some control over
the outcome - mostly reducing the downside. When you do this you become an
investor, someone looking to make a return on some something that is not
certain or guaranteed, and you have improved the odds because of your
actions.

> In the Graham and Dodd definition of 'speculation' and 'investment',
> risk managemt isn't even mentioned.   'Risk management' is an
> important but completely unrelated concept.

Risk management is important, and a completely related concept. My
dictionaries definition of speculate contains the word risk, and the
definition of investment contains future benefit. The future is not certain,
hence there is an element of probability, and where there is probability,
you need risk management to deal with probability.

Risk management is closer to the heart of investing (including trading, long
term buy-and-hold, professional speculators etc) than almost any other
discipline.

Look at most of the techniques that get discussed here - either TA or FA and
nearly all are risk management techniques in some guise. Without them you
would be purely speculating (or gambling to hark back to the title of the
thread) - and not managing your risk.

Cheers Gav







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