|  David DeRosa is the president of DeRosa Research and Trading, Inc. He is also an Adjunct Professor of Finance and Fellow of the International Finance Center at the Yale School of Management. He writes a thrice-weekly column for Bloomberg News on international finance and world politics. Books In Defense of Free Capital Markets , Bloomberg Press 2001 Options on Foreign Exchange , John Wiley, 2000, 2nd ed. Currency Derivatives , John Wiley 1998 (editor) Managing Foreign Exchange Risk , Irwin 1996 General principles and the dangers of financial engineering -
Don't confuse trading with investing. I think of investing as a long- term process of wealth accumulation. If you want to speculate that is fine, but you should have a predefined portion of your total portfolio reserved for that activity. Use stop-loss orders and buy options to hold potential trading losses to non-catastrophic levels. -
Avoid investment 'products' . . . Financial engineering is more the friend of the broker than it is of the investor. Often these products are laden with fees. They are hard to understand, too, in a risk context. Get as close as possible to the primary securities as possible. -
. . . except build your core portfolio with index funds. I am a huge fan of common stocks held in diversified portfolios for the long haul. One exception to my remark about investment products is index funds. They are tax efficient and cost efficient. -
Don't be fooled by high yields or high coupons . Investors frequently expose themselves to great risk by seeking superior cash returns in emerging markets debt and distressed sectors. Often the risk-return trade off for these sectors is pitifully inadequate. -
Sovereign risk can be just as lethal as private sector risk. Many investors learnt the hard way in the decade of the 90s that sovereign risk can be significant when they saw their Mexican bonds, Brady bonds, and Russian bonds suffer steep and sudden loses. -
Never trust mechanical risk models. As I was quoted in Roger Lowenstein's book on Long-Term Capital Management, 'statistical risk models are lighthouses for the soon to be shipwrecked'. In the same way, don't be overly concerned about track records and Sharp ratios when considering investing with a professional investment advisor. -
Never make an investment that is predicated on a fixed exchange rate regime 's survival. Fixed exchange rate regimes are prone to explosive convulsions, as we saw in Thailand, Indonesia, Mexico, Europe (the famous Exchange Rate Mechanism crises ), Brazil, and Russia. -
Never try to 'catch a falling knife '. Markets may at times overreact but there is no way to know what is real and what is exaggeration. -
Avoid naked options. Never write naked puts or calls unless you are a professional option trader . -
Be very cautious about the use of leverage. In a market panic, margin calls will force you to liquidate at prices and times not of your choosing. www.derosa-research.com |
