Friday, January 23, 2009

The Nature of Risk Part Two

Justin Mamis's book, The Nature of Risk, is now on my 'must recommend' list for new investors. I'm not longer a new investor, but I sure learned plenty from it. There is a mosaic of points that he makes about time, price and information risk that is so cogently said, that I've not considered them together in such a way. Consider these points. . .

* At the bottom, there is maximum negative, and no positive, information, but the price risk is minimal. (p 36). . . The price risk--because selling is exhausted--has been taken out of the stock, even though we have total information risk.... At the moment of maximum information risk, the price risk is mininal.
* The more information that becomes available, the greater the price risk because the stock has already risen (p. 42). . . Thus at the point of maximum positive information we also have maximum price risk.
* Time risk is alwasy present for those who are over anxious to bottom-fish.What does eventually turn out to be the bottom eighth--in hindsight--is a high-risk place to buy a stock. (p. 34)


russell1200 said...

It's a good idea, but I am not sure that what he is saying is true.

Shiller has noted that what is a more appropriate point is that at the peak, the bad news is ignored, and at the bottom the good news is ignored.

What will make it difficult is that when you start seeing the good news, you will have to start reinvesting. And then loss money for a year or so as everyone ignores the good news. That is an excruciatingly difficult psychological hurdle to get over.

Leisa said...

Mamis's points are directed at individual stocks. His points were not in the least meant to characterize market tops or bottoms. I did not make that clear in my post.

Napier also notes the ignoring of good news at bottoms--and in fact goes to some pains to refute the "buy when the news is worst" noting that the market continues plunge. Rather, the bottom is marked when the news is good and it is not met with buying. (Selden states that bottoms are listless places. Because this market is not listless, I do not believe it is a bottom yet).

Mamis notes that the absolute best time to buy as stock is when on bad news it fails to go down further. He then invokes the time risk element.....

Interesting nuance between the market not meeting bad news with going lower v. not going up on good news.

russell1200 said...

If we get to 2010 with the same kind of market we will be in a Benjamin Grahm value investing type market. Strictly following Grams' precepts has generally not been possible because their would be nothing to buy. A couple more years of this and people will begin to give up on stocks. But it takes a while.

But my comment would also apply to an individual stock. Many of todays companies are very much in danger of going broke. C at $1 may not be much of a bargain. C at $1 (at the moment it is somewhere around $3.50) can be just as risky as C at $50.

Now if you were to buy C leap-puts that are way out of the money ($15 strike in 2011 is something like 30 cents), and a number of other companies in similar straights (lets say 4 of them) you would probably only need one of them to recover and you would be ahead of the game: possibly way ahead. But you would have to be willing to live with a lot of nail biting. It's pretty much Taleb's strategy and he would tell you it is not a lot of fun.

smallawei said...