Valeant Pharma – Risk Management Follow Up
For this week’s SIA Equity Leaders Weekly, we are going to update the report we wrote about on Oct. 1, 2015 on Valeant Pharmaceuticals Intl. This is an exercise in real-time risk management at work and serves as further education in our Relative Strength Methodology.
Valeant Pharmaceuticals Intl (Matrix Position Chart)
Risk Management is one of the most important and least understood aspects of investing! A whole generation of investors were taught to simply diversify their portfolio across different asset classes, sectors, regions and styles and to hold for the long term. They were told to expect a major drop in the markets every couple of years but if they didn't let their emotions control their investment decisions, they would achieve their long term objectives. Well, after 15 years of a volatile sideways market, many investors are re-examining their investment process and looking for a more solid foundation for investing that incorporates a more comprehensive understanding of risk management.
The biggest challenge facing most investors is how they incorporate a risk management strategy into their investment process. For most investors defining risk is a very subjective exercise, whether you are looking at fundamental or technical indicators. For many it requires them to predict or forecast overvalued and undervalued scenarios. The problem with this approach is one never knows if they were right until after the fact! At SIA, we define risk by analyzing the price movement of an investment "relative" to the price movements of other investments. This gives us an objective approach to understanding risk that also aligns itself with how the markets actually operate. Markets operate based upon "money flows" from one area of the market to another. It is these "money flows" that are constantly changing the risk profile of every investment, sector, market and asset class. Aligning ourselves with the changing risk dynamics of any investment is how we identify periods of increasing or decreasing risk. A powerful tool we use to accomplish this is the SIA Matrix Position Chart. Here we have included the chart on Valeant. As the blue line moves through the 3 colour coded zones, it gives us a real time picture of the longer term risk profile of Valeant relative to its peer group and provides us with an objective and bias free perspective of how the market is trading Valeant at this time. This tool prevents us from having to subjectively predict or forecast overvalued or undervalued scenarios for Valeant but rather enables us to effectively align ourselves with the collective opinion of all market participants at any given time.
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Valeant Pharmaceuticals Intl (Point & Figure Chart)
VRX.TO hit our secondary sell signals on Sept. 25, 2015 @$265.01. It wasn't at the exact top and we will not get back in at the exact bottom. The belief that successful investing requires buying low and selling high has done tremendous damage to countless investors as they try to unsuccessfully "outsmart" the market. The reason is that buying low and selling high requires subjective analysis and forecasting. One is trying to "trade" against the crowd. Again, the problem is that you don't know if you are right until after the fact. Take a look at this recent downtrend in VRX.TO. How many investors got fooled by the ~12% bounce in Valeant as it moved from approx. $212 to $240? Having declined ~38% to $212, many investors thought the carnage was over and it was a lower risk entry point back into VRX.TO. Many will argue that the negative news story about its accounting practices led to a further unexpected decline in this stock and at some point this will get resolved and reward those who kept buying on the way down? Perhaps ... but even if this occurs, the point we are making here is that just because a stock is falling doesn't make it a good buy! The reason it is falling so hard is because supply is significantly exceeding demand.
At SIA our business is risk management ... it is capital preservation first and foremost! Preserving capital is all about managing risk. Buying a falling stock is not risk management in our opinion, it is speculation! The fact that an investor might be right from time to time doesn't justify this approach as it only takes a few mistakes to dramatically impact your portfolio results. This mindset of buying falling stocks because they will eventually go back up is based upon the mistaken belief that successful investing is achieved by buying low and selling high. This will be a hard mindset to break for many. Our perspective is that successful investing can be achieved by capturing the fat part of the uptrend and avoiding the fat part of the downtrend. Is it perfect? Of course not! Does it have to be? Of course not! If it simply increases the probability of finding strength and avoiding weakness, it tilts the odds in your favour! Successful investing is not about having more winning trades than losing trades but rather knowing how to manage the "magnitude" of your winning trades relative to your losing trades. To do this successfully over the long term requires a more comprehensive understanding of risk management and a very different mindset for investing!
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For further discussion on how to incorporate SIA's risk management methodology into your investment process, you can contact our customer support at 1-877-668-1332 or siateam@siacharts.com.
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