Forum Archive Index - March 2004

["tennyson@caverock.net.nz" <tennyson@caverock.net.nz>]

Hi Gavin,

> 
>>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.
>

OK but since this is an investment forum, it pays not to be loose with 
important terms like 'risk' I think.

> 
>>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.
> 

Support and resistance in the charting are terms relating to share 
buyer behaviour that have nothing to do with the fundamentals of the 
business.   Therefore these are not investment terms.  A  business that 

1/ retains earnings and 
2/ continues to make a profit 

must have an increasing business worth (immediately) and share price 
(eventually).     Of course in the short term the share price might go up 
and down, but in the long term it must go up and up.    A good 
investment it will always satisfy the two conditions I outlined.    As long 
as the the investment remains 'good' the direction that the share price 
will go is certain if you wait long enough.   Because of that certainty 
there is no 'risk' in the way you define it.

>
>>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.
>

I think that is an extension of what I was trying to explain above, but 
with the argument extended to more shares.   If you have enough 
shares, and let's say you buy the index, so you have everything, then 
the chances of going broke are near zero, and the chance your 
'portfolio' will rise with the index is a certainty.

> 
>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.
> 

There you go again 'generalising' the discussion, but in financial terms 
there is rarely such a such thing as a no win risk.   If you think a 
company is going to go bankrupt you can short sell its shares and still 
make a profit from your speculation, for example.

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

I don't think there is any room to tie the definition of the word 
'speculator' in with the word 'risk'.   A 'basic investor' can do an 
extensive but poor analysis and still expose themselves to significant 
risk.    An investor need not necessarily carry less risk than a 
speculator.  Speculators trade 'the market'.   Investors trade 'the 
business'.   Risk is a hazard for both.

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

Yes, but so what?   What does that have to do with the distinction 
between a speculation and an investment?

>
> 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).
>

I can't argue with your statement that

" investment is speculative because you are making a decision
 now on an outcome that is not certain."

when you include 'speculative' in its common English meaning. 

I can point out. though. that unless you believe that certain 
investments are pre-ordained, it is not a useful statement to make.    
The bank term deposit is risky, despite what you claim, and I am not 
talking about bank failure here.  

Let's say you put $10,000 in the bank for two years at 6% interest.
I put $10,000 in the bank for 5.5% over one year.   Then after interest 
rates have risen I reinvest the money at 7% for the second year.     
That means that after two years I will have more money in the bank 
than you.      Despite you opting for a two year 'fixed term', you are 
actually taking a risk on the direction that interest rates will move.

So what does this mean?
Uncertainties are there *all* forms of investing and *all* forms of 
speculation.     You cannot make a distinction between an investment 
and a speculation on the basis that one is more 'risky' (your definition, 
uncertain) than another.
 
> 
>Volatility is a partial measure of risk of an investment, but it only
>represents risk that the market can put a figure on. 
>

I buy share 'A' that rises 20% in value.    I buy share 'B' that falls 20% 
in value.    Given the benefit of hindsight, which company do you 
consider was riskiest?

>
>Not all risk can be valued by the market.
>

OK, Give an example of risk that cannot 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). 
>

You give me ten hundred dollar bills at the start of the year.  I use the 
money and at the end of the year draw out eleven hundred dollar bills 
from my bank and give them back to you, so paying you ten percent 
interest for the loan of your money.  

Now here is your question, and I want you to think -carefully- about it.    
Which *one* of those bills I hand back to you represents your interest?

>
>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.
>

Provided the population is growing and the average income is not 
falling you will be able it cash in your house for more than you paid for 
it.     This is a certainty, but that doesn't stop some houses 
appreciating faster than others.    If you wait long enough, you will get 
your money back.

> 
>>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 the company is  retaining earnings and making profits over a ten 
year period then you *do* know that the pie is growing.   You cannot 
guarantee what price Mr Market will be offering you in precisely ten 
years time of course, when he comes to your pie cart.     But if the price 
he offers does not reflect the underlying value of the business you 
have baked, then you don't have to sell to him.  You can simply wait 
until he offers you a sensible price which might be in eleven, nine or 
even five years time.

>
> 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.
>

You have totally missed my point.  If you are *invested* in a business 
then you don't care *what direction* Mr Market moves.    You can take 
advantage of Mr Market if he offers to buy your shares at a ridiculously 
high price of course.    You can buy shares off Mr Market if he wants to 
quit them at an absurdly low price.   But as soon as you start worrying 
about what Mr Market is doing, you shed your investor coat and 
become a speculator.  Be warned.  It does not pay to speculate in any 
short time frame against Mr Market, as Mr Market is usually right!

However, If you focus on a business plan, sales and profitability then 
you *can* be sure your business pie will grow.  You have to forget 
about what direction Mr Market is going if you want to be an investor. 

> 
>>>Put simply...
>>>Speculation + Risk Management = Investing
>
>> I don't know where that definition came from, but I would
>> suggest it is totally wrong.  
>
>We had different meanings of speculation. I classify
>traders and speculators that incorporate risk management
>as investors.
>

So someone who puts their money on term deposit at the bank is a 
speculator, unless they do a full financial analysis on the banks 
position?  I don't think so.    I suggest to you that risk management 
cannot be used as a tool to separate investors from speculators.

>
>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. 
>

Please explain how setting a 'stop loss' at $3.95 while the share you 
hold trades on the market at $4 will have any influence on whether the  
the share actually falls to $3.95 or not.

>
>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.
>

Not at all.  Gambling on the direction a share price might go short term 
is pure speculation.  There is not an ounce of investing in it.

Graham and Dodd in the book 'Securities Analysis' wrote about the 
terms investing and speculation in the 1930s and the finance definition 
of the terms has not changed since. 

> 
> Risk management is important, and a completely related concept.
>  My dictionaries 
>

What finance dictionary are you using again?

>
>definition of speculate contains the word risk, and the
> definition of investment contains future benefit. 
>

But your dictionary doesn't say that investment *contains no risk* and 
that speculation *cannot get you a future benefit*, does it?

>
>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.
> 

Yes and poor investors and poor speculators are often 'poor' because 
they do not understand risk.  So how does the term risk allow us to 
distinguish between investors and speculators again?   (That is meant 
to be a rhetorical question by the way)

>
> 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.
> 

Risk management is a tool used by both good investors and good 
speculators.   You cannot use the tool of risk management to 
distinguish investors from speculators.

SNOOPY


--
Message sent by Snoopy 
on Pegasus Mail version 4.02
----------------------------------
"Dogs have big tongues, so you can bet they don't 
bite them by accident"


----------------------------------------------------------------------------
To remove yourself from this list, please use the form at
http://www.sharechat.co.nz/chat/forum/