I was asked by a good friend today whether he should exit positions that on average were down 60-80%. My answer:
Dear Don Jr.
As a general rule exit and conserve that risk capital to trade another day.
Best,
Allan
We have a trading system that trades with stops on new positions between 60-100%, the latter being no stop at all. We are not so naive to think that we can trade stock and index options without going through some drawdowns and tough periods. Today's update is not to make excuses but news-event driven markets are not often kind to systematic trading systems. The very bearish pattern recognition analysis is still in tact, the intermediate term trend still down and this rally over the past 10 days still counts best as counter-trend. Below is a chart of the S&P that illustrates my point:
So why exit now when we are so close to reversing back down, especially since the system doesn't like stops?
First, the market right now is news-driven and it will eventually get back to it's intermediated term trend, but we don't know when or from where. Second, after the market turns back down, on a path to take out the October 29th lows, the system will start triggering new Sell signals allowing us to put money to work, and third, if your position gets to the point where it is stressing you out, get out.
It is very important that when those new signals start being triggered that you are ready, willing and able to take them. Some traders will be, some not. If you lose 80%-100% on a few trades in a row, how anxious will you be to take the next trade? Remember, we recommend that no more than 10% of your speculative money be placed in any one trade. That chances of 10 trades in a row being wiped out without first hitting at least some triple digit profit targets are close to nil.
Look at the table below and you see 8 out of 22 trades, over 1/3, have already hit triple digit returns. Zillow (Z) is up 200%... in one day. And there are still 44 days for the nine December trades to reach +100% or higher. Again, the chances of 10 out 10 trades in a row to get wiped out are close to nil.
The stock market has a way to fooling most of the participants most of the time. It is in the midst of doing so right now. The intermediate term says still down. If that ever changes the system will start generating Long signals. It's called trend following.