Kass: Adapting to Mr. Market

This blog post originally appeared on RealMoney Silver on June 22 at 7:55 a.m. EDT.

"Everyone thinks of changing the world, but no one thinks of changing himself."

-- Leo Tolstoy

The disproportionate influence of high-frequency trading strategies has resulted in an increasingly volatile, trendless and often random market over the past several months -- difficult for most investors (especially a buy-and-hold kind) to navigate.

Grandma Koufax used to say, "Dougie, take and adapt to what Mr. Market offers you."

I always listened to Grandma when she was alive, and I remember her investment tenets (and life lessons) since she has passed 15 years ago.

Here are eight ways that I have responded and adapted to the market's changing character:

1. While my portfolio management is almost entirely based on fundamental analysis, I have increased my "normal" cash positions in order to trade around my investment positions.
2. I am now a more active trader, trying to take advantage of broad and swift intraday moves.
3. When programs clobber markets, I have the cash reserves to add to positions I am convicted in analytically.
4. When programs ramp up markets, I automatically pare back positions, regardless of my fundamental conviction.
5. I am less concentrated and more diversified. No individual long equity position accounts for more than 3% of my Partnership's assets, and no individual short equity position accounts for more than 2% of my Partnership's assets.
6. I am also diversified across industry lines. No industry accounts for more than 12% of my Partnership's assets.
7. I maintain solid risk control. If investment positions (long or short) drop by 7% or 8% from my cost basis, I automatically reduce the position's size (even if that reduction is modest), and I revisit my analysis, making sure that I still know more than Mr. Market does.
8. My Partnership is never leveraged.

In summary, in these volatile times, be opportunistic (trade more frequently), stay unlevered, be diversified and err on the side of conservatism.

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Doug Kass writes daily for RealMoney Silver, a premium bundle service from TheStreet.com. For a free trial to RealMoney Silver and exclusive access to Mr. Kass's daily trading diary, please click here.

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