Tactical trading and long-term strategic asset allocation are two investment strategies that seem worlds apart. Can a strategic investor really switch to tactical trading for short-term opportunities?
Received wisdom is that strategic asset allocators should have a long-term investment strategy. A sensible approach to risk, strategic asset allocation and a willingness to ride out the highs and the lows, should lead to a profitable portfolio.
Yet, we live in a time when market volatility is being driven by unpredictable events. In the UK, Brexit saw sterling experience large price movements. While this year coronavirus has produced extreme turbulence, with the FTSE 100 seeing its biggest drop in four years on Monday. Both events lend themselves to short-term tactical trading.
But can one investment strategy pair tactical trading with strategic asset allocation?
Tactical allocation is fine-tuned based on market conditions. That means being able to quickly change a portfolio based on near-term price movements.
For example, if the energy sector is experiencing a slump, a trader might reduce their exposure and switch to a sector on an upswing. Cash can also be a significant part of the portfolio as just being out of the market is perfectly acceptable if there's not the right opportunity available. With cash on hand, the trader can quickly back stocks rather than go through the rigmarole of exiting a position.
This style of trading is inherently riskier than strategic investment. The risk is that you rush into picking up shares in a booming stock, only to find you’ve bought at the top of a rally. As billionaire investor Ray Dalio puts it:
“The biggest mistake that most people make is to judge what will be good by what has been good lately. So if a market has gone up a lot, they think that’s a good market rather than it’s more expensive. And when it goes down a lot over the last few years, they think, ‘That’s a bad market, and I don’t want any of it.’”
“The biggest mistake that most people make is to judge what will be good by what has been good lately. So if a market has gone up a lot, they think that’s a good market rather than it’s more expensive. And when it goes down a lot over the last few years, they think, ‘That’s a bad market, and I don’t want any of it” - Ray Dalio
Strategic asset allocation
Strategic asset allocation focuses on creating a diverse portfolio to achieve a specific long-term investment goal. By investing in a diversified set of assets over a long timeframe investors minimise risk if one asset class underperforms. For example, this could mean a portfolio is comprised of 50% shares and 50% bonds. Over the long-term, stocks should gain - it’s just a case of being fully invested throughout all the ups and downs.
With this style of trading, it is unlikely that a strategic investor will change their allocation based on short-term opportunities or volatility. Instead, they will have a sense of the long-term risks to their investments. Only if there's a significant change in long-term outlook will they shift allocation.
One shot, one kill
Can a trader have it both ways? Stephen Guilfoyle writing on Real Money thinks so.
Guilfoyle uses the analogy of tactical trading being a sniper weighing up an opportunity in their sights. Whereas strategic asset allocation is best described as mortar fire - where you are looking to cover a larger area.
According to Guilfoyle a strategic trader can shift their mindset to identify tactical opportunities:
"The trader takes the tactical approach... to Understand in order to Identify avenues of approach and targets of opportunity, so one may Adapt to changing environments in order to Overcome obstacles presented, and then carry on to Maintain balance."
Ultimately, Guilfoyle is arguing that the strategic trader slows down and analyses the situation before making a tactical strike. As he puts it: "This is ‘sniper rifle’ type stuff. One shot, one kill."
“The trader takes the tactical approach... to Understand in order to Identify avenues of approach and targets of opportunity, so one may Adapt to changing environments in order to Overcome obstacles presented, and then carry on to Maintain balance” - Stephen Guilfoyle
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