Changing Calendar Doesn't Change Investing Style

Life and markets are uncertain. And more than any other holiday, New Year's is the acknowledgement of that uncertainty. The reality is that some of us ringing in 2008 might not be around to ring in 2009. But we're here now, so we celebrate having marked the achievement. The holiday is a shared acceptance — a pep rally of sorts — of the fragile and ephemeral nature of life. Ask the folks at Sowood, Amaranth or Pirate Capital about how quickly the world can change. As the saying goes, Man plans and God laughs.

To comfort ourselves we make resolutions to improve our lives, usually by bettering our health or relationships.

Traders, at least the good ones, understand the calendar really doesn't matter when it comes to making smart decisions. Nothing fundamentally changes between Dec. 31 and Jan. 2. To that end, there's no good reason to turn over your entire portfolio simply because it's 2008. Many of last year's big ideas could easily continue in the New Year as well.

As investors, we are constantly re-evaluating the state of the markets. So instead of predicting 12 months out, I focus on looking at the 12 minutes just past. The long haul begins on Jan. 1 — and every other hour of every other day.

Case in point is the subprime credit crunch. While it now dominates business news, the real story started way back in June with widespread and persistent weakness in banking and financial stocks. The write-downs and other fundamental news only came after the big move had already been made.

Of course, in order to capitalize on it — by shorting homebuilders or banks, for example — you had to put your money on the line. What seems like a sure thing now felt like a real gamble. When Hovnanian Enterprises (HOV) fell from $30 to $15, many people were buying the stock under the premise that "it can't fall any further." Four months later it trades around $7.

Same goes for some of the seemingly conservative income ideas that enjoyed popularity as interest rates fell. RMK Advantage Income Fund (RMA), for example, which is described on its sponsor's web page as consisting of "a diversified portfolio of primarily high-yield debt securities from multiple asset categories," fell from $16 to a little over $4 over the past year.

All things being equal, the longer I run on the treadmill, the more weight I'll lose. But when it comes to our investments, the hours of effort we put in are not always analogous to the end result. Whether or not we spend five hours or five minutes analyzing Bank of America (BAC) won't make any difference on how the stock performs. The purpose of research should be to give you confidence if your positions. If five hours pouring over the books of Washington Mutual (WM) isn't enough to convince you to buy the stock, then maybe there's a better name you might consider.

We can't control the markets, only our exposure to them. And I think a smart trading resolution for 2008 is to get back to the basics and be even more diligent about risk, both the type and size you choose to take.

The investors most hurt this year were those who made leveraged bets on stable relationships that quickly became unstable. Like the options-writing approach I've written about in the past, they tend to make small amounts of money regularly until a market dislocation occurs and liquidity dries up. What kills them isn't their investments but their scope. It's just too easy to lose the farm when you bet the farm.

There were certainly some standouts, such as Apple (AAPL) and Archer-Daniels-Midland (ADM), but 2007 was a year in which broadly diversified portfolios including stocks, bonds, commodities and foreign exchange, generally did just fine.

And although we often benchmark our own portfolios against the Dow or S&P 500, it's worth noting those are unmanaged indexes with 100% exposure to stocks. If you were able to post a healthy chunk of the Dow's gain without having your entire portfolio in equities, that's a solid performance. In the past few months, the market's leadership has gotten even narrower, meaning that choosing the right risks becomes even more important.

You can always find a way to manufacture risk in the market. But the successful traders in 2008 will be those who take the right risks in the right way. For me, that means concentrating on strong, under-the-radar ideas in a prudent way. Livestock, for example, which I wrote about a few weeks back, just might have its day in the sun in 2008. The trick is to ensure that even when I'm wrong one bad trade doesn't wreck my entire year.

We ring in a much different market in 2008 than we did 50 or even 10 years ago. For today's investors, execution is measured in milliseconds and securities move 24 hours a day.

But the basic core of disciplined trading — cutting losers, letting your winners run and taking reasonable risk in high-probability trades — hasn't changed since the days of Bernard Baruch and Charles E. Merrill. So while I don't know how the stock market will perform in 2008, I am confident that it's those ageless maxims that will help traders of all sizes navigate a successful course. Here's to a successful journey.

Jonathan Hoenig is managing member at Capitalistpig Hedge Fund LLC.