Knowing When Not to Trade!
The second most important trading rule is knowing when not to trade!
You’ve got to know when to hold ’em
Know when to fold ’em
Know when to walk away
And know when to run
You never count your money
When you’re sittin’ at the table
There’ll be time enough for countin’
When the dealin’s done
The Gambler, popularized by Kenny Rogers, 1978
The Stock Exchange is all about trading. Each week we do the following:
- discuss an important issue for traders;
- highlight several technical trading methods, including current ideas;
- feature advice from top traders and writers; and
- provide a few (minority) reactions from fundamental analysts.
We also have some fun. We welcome comments, links, and ideas to help us improve this resource for traders. If you have some ideas, please join in!
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Retirement Day Trader:
How to Sell Weekly Options for Steady Income
Review: Bear Momentum?
Our previous Stock Exchange asked the question: Are you trading bear momentum? We looked at the stages of a market cycle, drawing upon the work of Dr. Brett Steenbarger. From there we looked at some techniques for trading the “bear momentum” part of the cycle.
This Week: Know When to Walk Away
The second most important trading rule is knowing when not to trade! [The most important is excessive position size, which can destroy any system.] Volatile markets create a trap for traders. A look at a chart will show there was money to be made. This apparent potential is very tempting to anyone on the sidelines, as our team of models has been in recent weeks.
After many months of quiet, volatility(NYSEARCA:VXXB) returned in October, 2018. Volatility provides the potential for big trading gains. How can traders realize that potential? Systematic trading requires three different elements:
- Timely exit
The trader’s time frame must allow all three — recognize a setup in time to harvest significant gains without overstaying your welcome. Dr. Brett Steenbarger refers to this as the market’s true clock.
Imagine playing basketball when the shot clock randomly changes from 24 seconds to 48 seconds, then to 12 seconds, and then back to 24. A team that had one way of running plays–and one time calibration–would inevitably play suboptimally. The market’s shot clock changes over time, but so often we don’t.
For a closer look at what is required, let’s turn to legendary trader Richard Dennis.
Richard Dennis and the Turtles
The Turtle story began with a bet between two commodity (NYSEARCA:DBC) traders on whether successful trading could be taught or was the result of some innate gift. If you are a trader, this probably reminds you of a movie, Trading Places. The Dennis bet with William Eckhardt was a real-life version of this story. The full story is well worth reading.
Here is a true/false quiz for prospective turtles:
The big money in trading is made when one can get long at lows after a big downtrend.
It is not helpful to watch every quote in the markets one trades.
Others’ opinions of the market are good to follow.
If one has $10,000 to risk, one ought to risk $2,500 on every trade.
On initiation one should know precisely where to liquidate if a loss occurs.
And here are the key rules for the team via Michael Covel:
Look at prices rather than relying on information from television or newspaper commentators to make your trading decisions.
Have some flexibility in setting the parameters for your buy and sell signals. Test different parameters for different markets to find out what works best from your personal perspective.
Plan your exit as you plan your entry. Know when you will take profits and when you will cut losses. (To learn more, read The Importance Of A Profit/Loss Plan.)
Use the average true range to calculate volatility and use this to vary your position size. Take larger positions in less volatile markets and lessen your exposure to the most volatile markets. (For more insight, see Measure Volatility With Average True Range.)
Don’t ever risk more than 2% of your account on a single trade.
If you want to make big returns, you need to get comfortable with large drawdowns.
The Turtles reportedly made $175 million in five years — in 1983 when that was big money! One key to their performance was that they waited for the right time for their method.
Given the market’s recent gyrations, it is wise to be cautious. Those big potential gains can also be big losses, if your own “clock” does not match the market’s. Our momentum based models have exited their trades recently, waiting for more conducive conditions. This is not a call on the direction of the market, but rather a risk control measure. We get aggressive with our positions when conditions are right, but exhibit prudence when they’re not.
Many traders have been caught leaning the wrong way in this event-driven market. Today’s Powell press conference is a good example.
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: Our regular editor, Blue Harbinger, a source for independent investment ideas is traveling to a conference.
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. He reports that we should still exhibit some patience. Meanwhile, we have our regular ratings updates from Felix and Oscar.
Felix: This week I ran the stocks of the Russell 1000 through my technical trading model, and I have ranked the top 20 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. If you wish to jump-the-gun for resuming trading, these are some names to consider.
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.
Readers are welcome to suggest individual stocks and/or ETFs to be added to our model lists. We keep a running list of all securities our readers recommend, and we share the results within this weekly “Stock Exchange” series when feasible. Send your ideas to “etf at newarc dot com.” Also, we will share additional information about the models, including test data, with those interested in investing. Suggestions and comments about this weekly “Stock Exchange” report are welcome. Your can also access background information on the “Stock Exchange” here.