November 5, 2013

Barbell Strategy

your strategy is to be as hyperconservative and hyperaggressive as you can be

you need to put a portion [of your money], say 85 to 90 percent, in extremely safe instruments, like Treasury bills

The remaining 10 to 15 percent you put in extremely speculative bets, as leveraged as possible (like options)

That way you do not depend on errors of risk management; no Black Swan can hurt you at all, beyond your floor, the nest egg that you have in maximally safe investments.

This quote is from The Black Swan: Second Edition: The Impact of the Highly Improbable Fragility by Nassim Nicholas Taleb.

Talebs contention here is that you will know you are taking on risk, but you will probably incorrectly estimate HOW MUCH risk you are taking on.

For example, when you buy a stock, you know that you COULD lose money. You can logically reason out that you ARE taking on risk.

But the catch is that you probably wont correctly estimate the AMOUNT of risk you are taking on.

Say you bought a stock thinking it could only lose 10%. Or that your stop loss would save you from losses of more than 10%.

But its possible that the stock could drop to 0. Or the stock could gap down on open and jump right over your stop loss. Suddenly the 10% loss you were prepared for is now a 50% loss. Neither of these possibilities is likelybut we are bad at estimating HOW likely, so we will likely underestimate how likely.

Talebs point is that because we are bad at estimating HOW MUCH risk, the best way to take on risk is to take an ALL or NOTHING approach to risk.

No Risk

For the nothing side of taking on risk, he is recommending that you put 85 to 90 percent of your money in the safest investments you can find.

And by safe he means guaranteed return, with no chance of loss. Even if that return is miniscule.

This does not include blue chip stocks, or well-established company bonds, or any of the other safe investments that investment advisors would suggest.

I think it would include CDs (Certificates of Deposit) that were FDIC insured, and of course the Treasury bills mentioned in the quote above.

The idea here is that no matter how poorly the market does, the bulk of your money (85% or 90%) is always safe.

For my own investing, I consider this safe money to be my answer to how much money do you have?

Any money I have in other investments, I consider to be already gone.

By taking this frame of mind, I never suffer the emotional pain of losses in my investments. And I always feel secure because I know my floorthe lowest my net worth can go.

All Risk

For the all side of taking on risk, he is recommending that you put 15 to 10 percent of your money in extremely speculative bets, as leveraged as possible (like options).

I particularly like that he calls them bets. These arent investments. They are gambles.

And he mentions options.

As of today, there are 1711 stocks on Dividendiums list that have options available for tradingand thats only dividend stocks.

And each of those stocks has multiple strike prices and multiple expiration dates. If a stock has 10 strike prices trading for 5 expiration dates, thats 50 different options per stock. For just the dividend stocks, thats more than 85,000 possible option bets.

So now we have to figure out which ones to buy.

Which Options?

Ive been using this barbell strategy for a while now.

And over the past few years, I have been refining how I chose the optionswhittling it down from the ocean of 85,000 options to just a few purchases each month.

I now have a system that plays against the biases of other tradersagainst their tendency to misestimate how much risk they are taking.

The system looks for where it appears that the options traders are underestimating how much risk they are taking.

Then the system tells me to place very small bets. Less than $1 per share, and often less than $0.50 per share.

If the bets pay off, then I could make hundreds to thousands of percent returns on the trade.

I recently detailed 5 of those options trades that paid off. The returns for the trades ranged from 289% to 2664%.

Happiness Risk

What I really love most about this method of investing is that when I barbell my investment risk, I am completely avoiding any happiness risk.

I hate to lose money unexpectedly. It just puts me in a bad mood.

With this strategy, any money that I put into options is already assumed lost. Thats what I expect. I dont count the value of the options I own. I dont even look at that value.

After I buy an option, it will either expire worthless, or in 3 to 12 months it will be worth a substantial amount.

If an option expires worthless, I never know. The system doesnt tell me about those. And I assumed that money was gone anyway, so I wont miss it.

But if an option has appreciated a substantial amount, I get an email telling me to sell it immediately.

So the only emails I get from the system are buy emails and profit emails. Both are fun to getthe profit emails are substantially more fun of course.

And in the mean time, I intentionally spend zero time watching the market. I dont even know what stocks Im buying or own. But I know that I cant lose more than my floor, my safe money.

In fact, someone asked me yesterday how many different options I currently ownI didnt and still dont know. I think its some where between 25 and 75 different options.

I could of course look it up in my trading accountbut then Id be risking my happiness by seeing numbers that I dont want to know.

When I place my trades, I intentionally avert my eyes from the trading balance and any of the profit/loss numbers on the individual positions.

I only want to know about gains because that eliminates the risk to my happiness.

The System

If this system sounds good to you. If you like the idea of getting only buy emails and profit emails, and not spending any time watching the market. You can signup to use the system too.

There are only 200 spots available.

After the spots are filled the system will stop allowing new signups.

This makes sure that the options the system recommends are available for all the subscribers to buy. (Some of these are very thinly traded.)

If youre interested, want more information, or want to sign up, check out the DEMO of how the Options Trading Service works .

Summary

Our poor abilities at estimating risk make it likely that we will underestimate how much risk we are taking on, and end up losing a lot more money than we thought we could.

To avoid this mistake, we should instead carve out a portion of our money (10% to 15%) to risk on highly leveraged bets. And keep the rest (85% to 90%) as safe as possible.

One way to find those highly leveraged bets is to use Dividendiums newly available Options Trading Service .

In fact, this Barbell Investment Strategy is the whole reason I created this service.