Avoid Excessive Position Sizes Is an Important Rule of Trading
The most important rule of trading is to avoid excessive position sizes!
And while our momentum based trading models had been sitting on the sidelines in recent weeks, this week they’ve started to dip their toes back into some trades. As market capitulation has tamed, volatility (as measured by the VIX(NYSEARCA:VXXB) has fallen, and the bulls have been regaining some momentum, as shown in the following chart.
But before you go diving headfirst into any big trades, it can be worthwhile to consider some counterpoints and views. For example, according to twitter zen master, Michael Batnick:
“Any time that you have such a strong bounce and you’re still below the 200-day moving average, by definition, you’re in a lousy market environment… The previous five times this happened it was near lows but not necessarily at lows.”
However, Batnick goes on to explain that:
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“Four out of five times this was a dead-cat bounce but that doesn’t mean that there’s an 80 percent chance that this falls apart because we’re dealing with a tiny, tiny sample size. So take that definitely with a giant grain of salt.”
And while market direction and volatility can help us determine the strength of momentum (whether it be bull or bear momentum) there are other ways to identify big market trends too. For example, this article from Visual Capitalist helps identify some potentially big trends in the cannabis industry, which is forecast to grow dramatically in the years ahead, as shown in the following chart.
Cannabis Trends and Innovation:
We highlight market trends in the cannabis industry because one of our models purchased a stock in this industry just yesterday (we’ll have the trade details later in this report). And for your consideration, the five innovations highlighted by the very interesting Visual Capitalist article include:
1. Agricultural Technology:
2. Medical Cannabis:
3. Consumer Products:
4. Payments Processing:
5. Data Analytics:
We are sharing the performance of our proprietary trading models, as our readers have requested, as shown in the following table:
We find that blending a trend-following / momentum model (Athena) with a mean reversion / dip-buying model (Holmes) provides two strategies, effective in their own right, that are not correlated with each other or with the overall market. By combining the two, we can get more diversity, lower risk, and a smoother string of returns.
Since many clients combine the trading models with our long-term fundamental methods, they have additional diversity of methods without the need for short-term timing.
For more information about our trading models (and their specific trading processes), click through at the bottom of this post for more information. Also, readers are invited to write to main at newarc dot com for our free, brief description of how we created the Stock Exchange models.
Expert Picks From The Models:
Note: This week’s Stock Exchange report is being moderated by Blue Harbinger, a source for independent investment ideas.
Vince, the father of the models, has carefully researched and defined rules for stopping trading during unfriendly times and returning when opportunities are more attractive. This week, our momentum models are dipping their toes back into some trading positions, per our disciplined process which stresses balance between prudence and aggressiveness.
Athena: This week I purchased shares of Canopy Growth (CGC). This company engages in the production and sale of medical cannabis.
Blue Harbinger: Well first of all, I am happy to hear you’re actually entering some trades again after sitting on the sidelines for a few weeks while the market capitulated and searched for direction. Secondly, if I traded only based on technical analysis (which I personally do not–long-term fundamentals first for me), this trade looks good. The market appears to be heading higher, Canopy Growth has broken its 200-day moving average, and I personally like to buy attractive stocks on a down day (Canopy was down more than 4% yesterday–the day you bought).
Athena: That’s all interesting information, however I do trade on technicals first, and I typically hold for a matter of weeks, not years.
BH: So you don’t care that Canopy is in the middle of an industry with massive growth projections? The company offers products including oils and concentrates, soft gel capsules, and hemp. It focuses on the treatment of chronic pain, seizures, muscle spasms, nausea, and loss of appetite.
According to this recent excellent article by Darren McCammon:
Cannabis is a burgeoning new sector which will develop popular branded products and a disruptor to many existing worldwide brands… Canopy is at the forefront of this disruption as well as a leader in the development of superior, patented, branded products.
Athena: Thanks again for your “pep talk” Blue Harbinger, but I am an emotionless technical trading model.
BH: Suit yourself, Athena. Anyway, how about you Holmes–any trades this week?
Holmes: Yes. As the resident “dip buying” model, I’ve not been sitting on the sidelines in recent weeks like our momentum models. It’s been business as usual for me, and this week I sold my Coca-Cola European Partners (CCEP) shares on Monday.
BH: You know Coca-Cola could eventually get into cannabis related energy drinks. That would be a massive force considering Coca-Cola’s worldwide distribution network for its products.
Holmes: Maybe someday, but I recall the CEO recently explaining there were no plans to get into cannabis at this time. Besides, that is a long-term theme, and my typical holding period is only about 6-weeks; I am a technical trading model, not a long-term investor.
BH: Well I recall you purchasing those shares in late December (see: Are You Trading These Crazy Markets), so it appears you turned a very healthy profit on that trade. I am glad you’re making money in these markets. Here is a look at the Fast Graph if you ever want to consider more long-term fundamentals.
Holmes: Gee thanks, BH.
Felix: While you two continue to talk over each other about technical versus fundamental analysis, I’ll share a trade. This week I purchased Flex (FLEX). I am a technical model and momentum trader, and I typically hold for around 66-weeks.
BH: Finally, someone that holds for longer than a year. This company provides innovative design, engineering, manufacturing, real-time supply chain insight and logistics services to companies of all sizes in various industries and end-markets. Do you like Flex’s price-to-earnings ratio, Felix?
Felix: You’re not getting this, BH. I am a technical model, not a fundamental analyst.
BH: Well if you’re a model then you should be able to process a lot more data, and share a lot more ideas. What have you got for us, Felix?
Felix: This week I ran the stocks of the Dow Jones Industrials(NYSEARCA:DIA) through my technical trading model, and I have ranked the top 19 for you in the following list. As a reminder I am a momentum trader, but I hold for a longer time period than the other models–typically around 66 weeks.
BH: I see Boeing (BA) at the top of your list. That stock has been on fire in recent years, and apparently that new 797 is a big deal. Thanks for sharing.
Oscar: I have some ETF rankings for you. As our resident sector/ETF rotation model, this week I ran our “High Liquidity ETFs with price-volume multiple over 100 million per day” universe through my model, and the top 20 are ranked in the following list.
With the market trending higher this year, some bulls are starting to feel more confident. But rather that getting crazy and betting the farm that this market is going higher (you’d have to be on a cannabis farm to do that), we’re being prudent by only dipping our toes back into some momentum trades. Avoiding excess position sizing is rule number one of trading.