Time Frames and Exposures

 | Apr 22, 2013 | 12:00 PM EDT  | Comments
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This commentary originally appeared at 8:46 a.m. EDT on April 22 on Real Money Pro -- for access to all of legendary hedge fund manager Doug Kass's strategies and commentaries, click here.

"We are not permitted to choose the frame of our destiny. But what we put into it is ours."

-- Dag Hammarskjöld

Late last week, I mentioned that we are likely to face a lot of volatility in 2013:

Volatility and disorder are likely a more constant state in a global economy that is experiencing a new normal that remains on tenterhooks, still experiencing the deleveraging and tail issues stemming from the last down cycle and, as a result, only experiencing a fragile trajectory of growth.

To me, it's not good volatility; it's the outgrowth of uncertainty regarding economic growth and an unhealthy dependency on the policy of our monetary (Fed) and fiscal (our leaders in Washington, D.C.) authorities.

Regardless of whether volatility is heightened or reduced (or good or bad), among the three most important elements of one's trading and investing should be your time frame, appropriate exposures and risk tolerance/profile.

We all have different quotients of the above factors.

I will deal with two of the three factors this morning: time frames and exposures.

To begin with, I view the market as a continuum in which one's time frame is an essential part of trading and investing.

As a matter of principle, I rarely have a gross exposure (adding my long and short gross exposures together) that exceeds 100%. On average, when I am bullish, I am typically as much as 65% net long (deducting my shorts from my longs as a percentage of the portfolio), and when I am bearish I am typically as much as 45% net short (deducting my longs from my shorts).

In hedge fund circles, these exposure ratios place me in a conservative minority.

Depending on where we are in the market continuum determines the percentage of my portfolio that is committed to longer-term investments (both long and short) vs. shorter-term trading rentals (again, both long and short).

Under a normally trending (and upwardly sloping) market (and dependent upon my degree of confidence), I would have as much as 67% (when fully invested) of my portfolio in investment holdings (with a majority of longs), and I would have as much as 33% of my portfolio in trading rentals (again, a majority of longs).

But let's add two more market scenarios and characters -- namely, a range-bound market and a downwardly sloped market -- to the normally trending and upwardly sloping market getting us to three market scenarios.

Again, I change my exposures (investing vs. trading) dependent on the outlook:

  1. Range-bound market. If I conclude that we are likely to be in a range-bound market, I would be more inclined to trade stocks, increasing the percentage of my portfolio committed to trading and reducing my exposure to longer-term commitments. In this case, I might be only be as much as 40% committed to investments and perhaps as much as 60% in opportunistic rentals, with a mix of both longs and shorts.
  2. Upwardly sloped market (normally trending). If I conclude that we are in an upwardly sloping market, I would be more inclined to be a long-term investor in stocks. In this case, my portfolio might be as much as 60% to 70% (dominated by longs) in investment positions and 30% to 40% in trading-oriented positions (again, dominated by longs).
  3. Downwardly sloped market. If I conclude that we are in a downwardly sloping market, I would be more inclined to be as much as 60% to 70% in investment positions and 30% to 40% trading-oriented positions. In theory, my portfolio, reflecting a downwardly sloped market, would be dominated by shorts, but, in reality, it's not practical, as the asymmetric risk/reward of short sales would reduce the overall commitment to shorts even in a correcting market phase. While I would likely be net short in both investment and trading positions, my degree of confidence in the market outlook would dictate that net exposure.

Let's now dig deeper into time frames.

To simplify, here are my definitions of time frames (note: yours may be different):

  • A short-term trading position (rental) can be as little as a few hours or as much as several weeks.
  • An intermediate-term trading or investing position is typically a month to 12 months in duration.
  • A long-term investment position is typically greater than 12 months in duration.

It is important to recognize that sometimes very short-term positioning seems to contradict a market thesis -- I see this clearly in subscribers who ask perplexing questions in the comments section -- but adopting a near-term positioning that is at odds with an intermediate-term view may not be that illogical.

Let me explain.

I may do this in response to a number of different stimuli. Maybe the market has temporarily overshot to the downside and has become oversold. Perhaps the reason for the market's slide is not justified or an external shock (e.g., Cyprus bailout, a terrorist attack, geopolitical risks/events, a failed or surprising election outcome in Italy, etc.) contributed to the drop, and I expect the conditions to be remedied/addressed.

Or it might simply be my lame attempt to game or react to Mr. Market's volatility.

As an example, I started out last Monday by outlining an intermediate-term bearish thesis. I was short SPDR S&P 500 ETF Trust (SPY) but covered my short hedge a few days later at about $154.90 -- after the market's ugly performance earlier in the week.

As I see it, my job is to be transparent in analysis (of markets, sectors and individual stocks) and also to be transparent in my entry/exit points. Along the way, I try to provide other lessons -- for instance, in risk control, as your investment/trading batting average does not necessarily link to superior returns.

But what must be recognized is your risk profile and time frames are likely different than mine (or anyone else's), so when I chronicle my investments and trading rentals, it is important to have the proper perspective discussed in today's opening missive so that you can better understand my tactics and strategy (which may or may not be appropriate to you).

Always consider your own time frames and risk profile/tolerance in determining the suitability of exposure and how you weigh your involvement in trading vs. investing.

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