Investment Philosophy Part 1 – A Word on Losses

I want to take the time to discuss my investment philosophy in a bit more detail as I believe it will provide you, a potential partner, more clarity into the mindset of your potential money manager. I will break these investment philosophy pieces up into three different parts, with this first part being about losses.

You might be wondering why I am starting with losses, given the main goal of firms is to maximize profit. That is not the main goal of Rockvue Capital. The main goal is to minimize losses and restrict drawdowns as much as possible. By doing this, I am able to let the profits take care of themselves, while preserving my capital, and your capital. Let’s breakdown how I do this in Rockvue Capital. (The investment philosophy discussed herein these three parts have solely to do with the Voyager Fund. The SteadFast fund is algorithmic and independent of discretionary action from myself).

Using Stop – Losses To Mitigate Risk

The most important factor in mitigating risk and drawdowns in the Fund is through the power of stop – losses. Stop – losses for those that aren’t familiar, are used in trading to set a predetermined price at which one exits a trade. Using an example, let’s say I want to buy stock XYZ on a breakout at $5 on a symmetrical triangle pattern. Now, on this trade, I will place my stop – loss order on a price at which my bet would be wrong. In other words, I would place my stop – loss at a technical point that would signal me to get out. If this still doesn’t make sense, feel free to email me with any personal questions.

Here is the most important part about using stop – losses: I have yet to sustain an individual loss of greater than 1% per trade. This is very important to me, and it should have the utmost meaning to you as a potential partner. Through the power of stop – losses and moving those stop – losses up as soon as I can, I am able to lock in profits as soon as possible, and try to get to breakeven as soon as I can. This is what I am referring to when I talk about minimizing as much risk as possible. Now that you understand a little bit more about how I manage risk technically from stop – loss orders, I would like to take the remaining time of this memo to discuss my views on losing in the markets.

How I (And You) Should Handle Losses

My view on losses may come as surprising to those who haven’t read my work before, or frankly who are reading this memo and haven’t read previous memos. I will make a lot of losses. Statistically my losses will outnumber my wins, the scale of which I do not know specifically. So far, the ratio is close to 45% winning percentage. I am not worried about this. In fact, I would be completely comfortable with a 1% win rate if at the end of the year I am net profitable. I don’t believe this will ever happen, but the point I am making is that I am a firm believer in Pareto’s Principle.

Pareto’s Principle states that 80% of outcomes come from 20% of the inputs. If I can focus on the 20% profitable trades, I can sustain 80% of my success from 20% of those trades. The reason that I am comfortable with this principle is that the losses I sustain are very small compared to the size of the gains I receive on my profitable trades. I hope that you understand this principle as a potential partner in the Fund. If the idea of suffering lots of small losses is something that you are not comfortable with, I completely understand, but I would love to discuss it with you personally before making a decision to either invest or pull capital.

Positive Asymmetry in The Fund

As a caveat for my talk on losses, I want to end the memo with a word on positive asymmetry. The Fund will at all times have a positive asymmetric skew to the profile of its returns. This goes back to the Pareto Principle I discussed earlier. If you look at a Normal Distribution, you will see a symmetrical bell shaped curve along the various probability distributions. This is what the return distribution will probably look like at Rockvue Capital: 

Image result for asymmetric investment return

As you can see, the amount of small losses (as the x axis shifts towards the left) will outnumber my wins, which is what we should expect going forward. however,  the power in asymmetry is that the smaller number of profitable trades will cover for the losses and (hopefully) return a net profit after commissions and expenses.

A Final Word

This first memo got a bit mathematical and technical, so I apologize if some of this material went over some heads, that was not the intention. When dealing with losses, it is important to get granular to understand the reasoning behind my philosophy on losses and the purpose of my stance to the firm.

Once again, all of what I do directly impacts your potential capital investment. For this reason, I want to be as transparent as possible with my philosophy. Stay tuned for Part 2 of the Philosophy Memos where I discuss the criteria on which I invest in equity positions.


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