What’s this all about?
This is about sharing value added tools for decision making, more specifically wealth management and capital preservation. You know, there’s a lot of noise out there. No wonder we fail when we try to make efficient trading and market decisions in the mid of all this hustle and bustle. So, what’s the solution? Simply stated, build tools that provide a denoised signal and that simultaneously help us to keep our emotions under control.
In this blog we will periodically (weekly) release 2 of these “awesome” tools. Both will be helpful devices for analyzing the risk/reward of being long/short the SP500 (cash). The reasoning we come up with is easily applicable to the futures contract or the ETF index, but to tell you the truth we expect you to do it all by yourselves. So lets get started.
Tool 1: ExtremeStops
It is very well known that stopping losses is probably one of the most important problems to solve if you want to be successful in keeping your capital. They won’t turn a bad decision into a good one but at least they will help us preserve our capital so we can shoot again and remain playing the game. If they are so important, How come they are so overlooked? Why is the market space brimming with unsophisticated analyses that never go beyond a trailing stop or a bollinger band? Yes, everybody works with this crumby tools without even questioning whether or not they suit our purposes. The fact is that these stops don't answer correctly the question we make in the first place, and therefore are inadequate for what we want.
Lets state what we want first. We need a market level that in case we are wrongly positioned stops our losses helping us to avoid the almost sure losses that are coming next. If there aren't more losses in the pipeline why stopping ourselves out? So the right stop loss is the one that is triggered for a good reason, more losses are coming. Neither trailing stops nor bollinger bands contain any logic that efficiently deals with this problem. They do of course stop our trading but not necessarily help EFFICIENTLY increase our chances of success.
ExtremeStops deal with this problem by generating 2 stops (most of the time asymmetric) per bar (week) trying to avoid being triggered if whats coming for the next 1-2 bars (weeks) is not “bad enough”. So, as you see we pushed them to the extreme to be as accurate as possible, but be careful, it is a sort of optimization problem (not exactly but close) and if you push too much you will end up ruining the whole idea. Since it is a statistical procedure it is not flawless, but still increases the efficiency of our decisions dramatically. Why two stops? Because at every given bar there might be two opinions on the market (long/short) and we don’t know which one is correct beforehand. Both opinions deserve to receive some help to remain in the game, don’t you think. Now wait a minute...is this a kind of ex ante risk control procedure? Yes, exactly we work out the chances of success before we engage in the trading decision. But thence it follows that you should have little faith in ex post VaR procedures and the like. They only serve the bureaucrats purposes (back office) and don't belong to the ex ante risk control discipline as we want it. Ok, ok, maybe we were to tough in this one, all those procedures provide some insight for those combinations of assets we use to call "portfolios", but it is always ex post and with no real value for the trader or asset manager day to day job of preserving capital. We will talk about that at another time.
One last comment on stops. Remember that stop losses require a careful assesment for reentry. You should have your reentry criteria always ready to shoot. In case you don’t have any, start thinking. The next tool will provide some (only some) insight in this respect.
Tool 2: Dynamic Technical Probability Assesment (DTPA)
DTPA assesses the chances we have in the next few bars (weeks) of the market (SP500) going above or below the latest average trend. The source of information is very different from the one we use with ExtremeStops, so we are covering a different need here that is also independent in nature (complementary). DTPA takes market metrics and returns probabilities. By its own, this tool is capable of describing what sort of waters are we entering into for the next few bars. Since DTPA output is so simple it does not deserve more explanations but an example that will be available in our first release (after Easter holidays of course).
It is inescapable that the combination of ExtremeStops with DTPA deserves at least a piece of your time if what you want is preserve your capital. Although we know it is not really necessary we have to write the next few lines anyway, just a mere formality.
Disclaimer: We hold no responsibility for any of your trades, you are liable for what you do with your money under management and you are supposed to take care of it by yourself. We make no claim or whatsoever that these tools are infallible, so there will always be a chance that provide a wrong signal or probability that does not match with the real market experience. The service is provided as is with the only aim of helping the decision maker when he comes to grips with the turbulent markets we are living these days. We are also not making no offer or solicitation to buy or sell securities, securities derivative or futures products of any kind, or any type of trading or investment advice, recommendation or strategy. We do not commit to any regular update of our figures, charts and information, and therefore we are not liable if we don’t want or can’t release the information in its due time. Also keep in mind that exiting successfully from a position depends on market conditions in which liquidity and breadth play a relevant role. The absence of liquidity might ruin part if not all of your exit strategy at certain times of extreme stress. If you don’t accept these conditions please don’t read this blog anymore.
