November 11, 2011

Dan Shy

dan.shy@gmail.com

IN THIS ISSUE:
Welcome!

Portfolio Management: The Three Sisters

Special Reference Issue: Portfolio Management

Model Portfolio

Newsletter Structure

Welcome to a special issue of Aileron Market Balance.

A newsletter that will approach the markets with reason and rationality. And as the aileron of an airplane provides stability and balance, this newsletter too aims to reflect a balanced approach to the capital markets. At the same time this newsletter will provide a 'look over my shoulder' as to my thoughts regarding the economy, as well as specific dividend investing and trading ideas for the upcoming week. However this particular issue of this newsletter will not include specific investing or trading ideas. Because this issue of Aileron Market Balance will serve as one of the introductory issues for all new subscribers to the newsletter from this point forward. If I am going to allow ones to 'look over my shoulder' to view my investment and trading ideas though this newsletter in a responsible manner, I first need to discuss the absolute basics ...

Portfolio Management
This newsletter will be run using a portfolio management system I call: The Three Sisters. So let's begin to talk about how I construct any portfolio, and the history and reasoning behind it's construction. An explanation of that portfolio management system is thus called for

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The 'Three Sisters' Portfolio Management System

"The general who advances without coveting fame and retreats without fearing disgrace, whose only thought is to protect his country and do good service for his sovereign, is the jewel of the kingdom" - Sun Tzu, The Art of War"

Of course, there can be periods of drawdown. Drawdown is a losing trade or period of losing trades; and it is a fact and reality of life in trading. All too often, market educators fail to mention the inevitability of drawdown. Which is why you'll generally only hear the honest, and real traders will talk about their mistakes and bad trades. So of the three sisters, this is the sister that is by far, the most demanding. One mistake? And this 'sister' will take you to the cleaners. Since developing this strategy, I have had years where I enjoyed 356% returns (definitely my best to date). I have had years where I enjoyed 30% returns. One year however it was 2003. Well, I have talked publicly about 2003 when I had my daily blog. I ended the year down, -3.57% for the year. All of that good work I had built up over the course of months? Gone, because of one mistake. I learned my lesson. I have never repeated that mistake. But at the same time, I was looking at a lot of hard trading work down the drain. You can't eat off of -3.57% This taught me to develop other avenues of income. Enter, the second sister. Investing

I have related on many occasions, that in 2003 I began to develop my own personal "three sisters" portfolio management system. What is the "three sisters"? The three sisters is a portfolio strategy that can provide fantastic returns through trading, cash flow through investing, and a firm foundation to the other two accounts through savings. Thus, it allows for the accumulation of assets on three diversified fronts. I keep these sisters as separate accounts. When one of the sisters or accounts is having a hard time, then one of the other 'sisters' who is having a better time 'helps out' the other sister. There is the added bonus, that each sister or account, tends to give the other accounts boosts during good times. So let's move on, and discuss the first 'sister'.

The Investing Sister

"The Most Powerful Force in the Universe is compound interest." - Albert Einstein, attributed I have talked for years, ad naseum that investing is not trading, and trading is not investing. So again, I will spare you that speech. I am aware that there are those who do not like the concept of investing. I'm not here to debate the pro's and con's of investing versus trading. That's an argument as old as fundamental analysis verses technical analysis. However, since we have already referenced the fundamental analysis vs. technical analysis argument, allow me to use that point to illustrate a very important point when it comes to investing. Many accomplished traders use both fundamental and technical analysis. So too, rather than argue against a

The Trading Sister

"A ship is safe in harbor, but that's not what ships are for." - William Shedd Of course, the "sexiest" of the three sisters? Is that of trading. Trading promises the possibility for fantastic returns, along with associated risk. Trading, is what any market junkie loves about the market. Pouring over charts, and planning plays. Entering trades and hoping for big profits.

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method of involvement with the capital markets? I do both. I trade, and I invest. Investing is simply another method I use to generate cash flow, and accumulate assets at low prices. And let's face it, the only thing that matters in the end, is performance. However, since investing is much different than trading, it is important to note that I keep my investing accounts, separate from my trading accounts. Investing is the second "sister" as it were, in the three sisters methodology. As an investor, I have also talked about the fact that I am a dividend investor. The root philosophy and the kernel behind my approach, was the Dogs of the Dow methodology using mid cap and large cap stocks. Again, I have talked at length about the strengths and weakness of this approach, and you can find those posted discussions for free. So I will not spend time here explaining or arguing for that approach. But since I am a dividend investor? This allows for the freedom of receiving cash from dividends. Yields as high as 5% annual. Try getting that yield from a savings account, or even a Certificate of Deposit (CD) at the moment. Reinvesting the dividends if I so choose, thereby compounding the return on a single purchase of the stock itself. Over time, this can really, really add up. You in essence, receive more shares of the stock, for free Reinvesting the dividends is done through brokers that engage in the DRIP or Dividend ReInvestment Plan. And when an investor engages in DRIP or the reinvestment of their dividends, they begin to unlock the power of compounding. At any time, DRIP can be turned off, and an investor can begin to receive straight cash dividends off of the assets that he has previously compounded. And let me tell you, it's a very satisfying feeling, sitting in a beautiful restaurant in the heart of Quertaro Mexico, enjoying fine food and wine with friends. Knowing that you haven't look at the markets in two or three days? You haven't sat in your computer chair glued to the monitor having to manage short term trades? But you're still receiving cash dividends on stocks that have compounded their position size for you. Yeah. That's a very good feeling.

The Savings Sister

"I save money when I'm working so that I never have to take a role simply to pay the bills. - Gary Sinise, Actor This is the 'sister' that everyone wants to be friends with ... but no one wants to date. Especially in the current environment. With the Fed prime fund rate essentially at zero, interest rates at financial institutions around the country have plummeted. When I began with this portfolio strategy, one could open up a money market account, and enjoy 4.1% interest on their money. I would at times take a percentage of my annual return, and feed it to my investing account. Now, it's hard to find a long term Certificate of Deposit (CD) that offers 2.0%. But I think that really highlights the strength of the three sisters. Because really, you don't have to be earning a fantastic rate, for this sister, the Savings sister, to perform her job. With cash, comes utility. Because these 'sisters' or accounts, help one another out. And this 'sister' is by far, the most helpful in her purpose, or reason for 'her' existence. The savings account is split into three purposes, and used for three separate reasons, and by different percentages at different stages in the accounts growth. Drawdown Kill Switch Fund Base Savings (Which can be comprised of different aspects, which I will specify in the section on the Model Portfolio) Emergency Savings

If you are not familiar with my outline of money management principles, again, you can review that information for free. It will explain what I mean by both a Drawdown Kill Switch (Some call this the 'ruin level' of an account, that is a percentage of the

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account capital that the trader does not want to risk any more capital, and stops trading), and why I have a fund dedicated to supplementing an account, once the drawdown kill switch is tripped. To summarize briefly, if the trading account or investing account were ever to reach this kill switch level in terms of drawdown? Then a percentage of the savings account could be used to supplement the drawdown that the other account experienced. Honestly though, that is only used in the beginning. I have not used my own personal drawdown kill-switch fund in years. But it's still there, if need be. In addition, everyone should have a base savings. In better times, the entire savings account would be earning interest, and I will soon talk about how the accounts 'feed' one another. Hopefully, a way can be found out of the current liquidity trap that has occurred in recent years, and we can once again return to days of actually earning interest on our savings. What a radical thought eh? It should also be noted that I do keep physical metals, actual bullion as part of my base savings. But bullion cannot put food on the table. Regardless, a percentage of the savings accounts are also used for emergency savings. I don't care what someone's level of wealth is, everyone needs to maintain an emergency savings fund. If you have $5,000,000.00, and you develop a critical, debilitating illness? Despite having good health insurance, you had best hope that you have access to liquid funds. There are any number of emergencies that can arise in our lives. I know, I've watched it happen. I've watched patients on cancer regiments have their retirement savings eaten up, despite having health insurance. And yes, I keep this function as a part of my three sisters methodology, although at first it may not seem related to trading or investing. Because when I generate money in the markets, having these accounts as part of my portfolio strategy reminds me that no matter what sort of success I'm enjoying? Life is a precious, fragile thing, and I should do my best to prepare for unforeseen events.

Weighting, Performance and Metrics

"Performance is your reality. Forget everything else." - Harold S. Geneen As I mentioned earlier, performance will differ, from year to year. I have had 356% return years. I've had years where I returned 30%. In my personal accounts for the current year of 2009, I'm up about 32% on the investing front, 40% on the trading accounts, and up 1.49% on the interest bearing accounts at the time of this writing. And yeah then there was 2003. -3.57% yield. So yes ... performance differs from year to year. As those who have taken to heart the outline of the principles of money management know, I keep strict track of my recent performance statistics. In fact, I believe this is one of the most glossed over aspects of money management. So twice a year, I review the performance of the 'three sisters' accounts. I dedicate two days of the year, for this purpose. On July 1st and on December 24th of each year. On July 1st, I look for the accounts with the largest percentage returns, or profits. I start with a 3% baseline of the profits of the most profitable account, and feed it to the Dividend Investment account. If the most profitable account is the Dividend Investment account? Then I feed 1% of it's profits, to the savings account. Why? Because summer (usually) is a weak time period for stock prices. It's a way to assist my Dividend Investment account for what could be (though not this year) weaker prices. It is also a way to assist the dividend investment account, so that the account is in a position to better dollar cost average dividend prices by the end of the year, which is when the equities markets (usually) rally. It is also on July 1st that I find the stocks that have had the strongest gains in the portfolio, and turn the DRIP plan for that stock off for the summer and receive straight cash instead. On December 24th, I again review what is my most profitable account. I start with a 3% baseline of the profits of the most profitable account, and feed it

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towards the Savings accounts. I take a 2.5% baseline of that same, profitable account, and feed it to either the 'first' or 'second' sister, but not the third 'savings' sister. I did mention that those percentages are only a baseline. I also consider where we are at economically, and what accounts I feel will need the most help. In 2007, I talked quite publicly about the fact that I began pouring money from my savings accounts into my investing accounts based purely on the fact that I knew that those accounts were about to suffer massive drawdown, as I felt the equities market would suffer a severe downturn. So there is an aspect of weighting the different 'sisters' according to the economic environment we find ourselves in. This aspect can become very discretionary. And there you have it. Our very own personal "three sisters" portfolio management system someone's investing sister account is a more comfortable $25,000.00. Perhaps they decided on another stock. This summations main purpose is to show the value of proper portfolio management, money management principles, as have been applied from previous actionable strategies from the markets. But do not fool yourself into thinking that it's the amount of money that you have, that will make you a success. I've seen very intelligent people; doctors and lawyers, believe that because they threw $150,000 towards a particular stock that it would rise. See, a lot of people will instantly think: 2 shares of a stock. You're nuts. You're insane. That does nothing. You blew it all on the commissions No. It's not. I will adamantly argue that point. It's a beginning. And it's following money management principles, which I've come to believe are the absolute holy grail of investing and trading. And we have to start somewhere. I do not despise the day of small beginnings. In fact, I actually prefer a strong handicap, to clearly demonstrate the power of these principles, in situations that others might call impossible. As I mentioned, I'm going to very specifically show you how I will grow those 2 shares, into 300 shares. I started the Challenge Project with only $500.00. There is no more difficult handicap than that. Because I never want to hear: Well Dan, you only did that because you had a lot of money to start out. Bologna. It's possible, because one kind man by the name of Larry Williams taught me how to properly manage whatever funds I do have access to. You may see some similarities between this hypothetical Model Portfolio, and the Challenge Project that I run on my blog. The reason for this is very simple. The portfolio strategy that I use ... is the portfolio strategy that I use. I wrote both on the blog and here. But one of the difference with this newsletter, is that I will let you know exactly what I'm personally looking at for the next week, as well as the tactics and tools that I use to implement those strategies. We will begin the Model with $4,000 in the Model Investing Account, $9,000 in the Model Trading

Model Portfolio
For who has despised the day of small things? The Bible, Zechariah 4:10 The Model Portfolio will be a feature of this newsletter and it will track these tactics in action, week by week. As I have a penchant for helping those without a lot of funds? We'll begin the Model Portfolio with only $15,000 to implement this strategy. Please keep in mind, that I am not a trading or investing adviser. What I offer here in this newsletter is simply a look over my shoulder, as to how I am approaching each week, and with what mindset. Even actions based off of this newsletter, the results would differ. Why? Perhaps someone decided to put off purchasing a stock that I went ahead and purchased for the dividend investing portfolio. Perhaps someone bought the same stock after their own due diligence, but actually bought it for a better price. Perhaps the size of

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Account, and $2,000.00 in the Model Savings Account. It will not be easy to trade and invest with the accounts of only $15,000.00. Call it a handicap. Because I hope to demonstrate that it's not about how much money you have. It's about how you manage it. live as market conditions continue to evolve. In addition, I bill this newsletter as a Weekly newsletter, as I will release a major issue each week on Sunday evening or early Monday morning, beginning on November 13, 2011. But I am a person who will always work to provide paying customers with a good value. So if my market thoughts change on any given weekday, I will publish many supplementary short issues of the newsletter, discussing how my thoughts continue to evolve and how this impacts specific trades and investments that I have already written about.

Newsletter Structure
Each week, as I discuss trades, I will track the success through a Model Portfolio that will benchmark the results and worth of this newsletter. It is important to note and understand how I trade and invest; and thus it is vital that you understand that each Sunday I have a list of possible trades and market actions. I set up a list of parameters that I look to see the market fulfill before I pull the trigger on such investments. If the market fulfills those parameters, then I will read the tape on the market, and possibly pull the trigger. If the market does not live up to the parameters that I specify on Sunday night, then I most likely will not pull the trigger. I am also going to attempt to set up some sort of 'live feed' on the website that I plan on building, so ones will be able to see when and if I have entered a trade

Until next time, stay safe trade well, and remember that loving other people doesn't cost a dime.
Note: The above statements should not be construed as an investment or trading recommendation. Aileron Market Balance is a newsletter that allows subscribers to look 'over my shoulder' as it were, for my own personal specific trading and investing ideas and thoughts for the next week. But they are only thoughts as of the moment of publication, and are subject to

change. Any trades or investments that I discuss within this newsletter are simply my own thoughts regarding my own investing and trading outlook. Remember that entering any market is an individual decision. There is no guarantee that I will enter, or have entered any of the trading or investing ideas that I discuss in this newsletter; as larger or smaller accounts may require a different strategy as the ones presented here. This newsletter simply contains my trading and investing thoughts for the next week. I, the author do not grant this work for wide distribution beyond any single individual subscriber as this publication is protected by U.S. And International Copyright laws. All rights reserved. No license is granted to the user except for the user's personal use. No part of this publication or its contents may be copied, downloaded, stored in a retrieval system, further transmitted or otherwise reproduced, stored, disseminated, transferred, or used, in any form or by any means except as permitted under the original subscription agreement or with prior written permission. I personally only enter any market after watching and reading the tape and I trade using money management principles. The losses in trading can be very real, and depending on the investment vehicle and market, can exceed your initial investment. I am not a licensed trading or investment adviser, or financial planner. But I do have 15 years of experience in trading and investing in these markets. The Model Portfolio accounts are hypothetical accounts, with all of the inherent problems therein, which are used within this newsletter in an attempt to track and benchmark the results of this newsletter, and is run for the education of other traders who should make their own decisions based off their own research, due diligence, and tolerance for risk. Any pictures used within this newsletter are believed to be public domain. Any charts that are displayed using the ThinkorSwim platform, and other pictures were obtained through Wikipedia's public domain policy.