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October 14, 2018

The New Paradigm in Risk Management is Direction Neutral

Almost everyone’s approach to trading/investing is forecasting price direction and calculating support and resistance for risk and reward.

This method looks at context first to judge risk and reward, based on market dynamics.

Here is what I mean by “direction neutral” and it does not matter if you trade mechanical strategies or trade a plan off visual indicators. The only difference is who (or what) is seeing the data stream.

To drive home the significance of this idea you need to contrast it to the industry benchmark. One of the pioneers of systems trading -Robert Pardo – in his original text said the following:

“Let us consider the plus side of the discretionary trader. It is quite simple. The biggest plus is that, to date, I do not believe that a systematic strategy has yet been created that equals, let alone exceeds, the performance of the greatest discretionary traders.”

I accept this as true that a robust trading system or plan will not make anyone rich, and that may be one of the reasons why you trade visually with discretion and not with systematic signals.

In other words, a trading plan or a system – at least the way Bob developed them – are statistically robust and in practice generic. They are designed to deal with all the major conditions in the markets going back over the longest period as possible. They are meant to provide the trader with an average winning trade each time he takes a position on a regular basis over the long term.

This goal of a trading plan or method is the heart and soul of the system trading school of thought that the industry is happy with and many traders do well at. Furthermore, it is likely your goal to make an average amount of money each day or week as supplemental income.

But as Bob says himself in so many words about system trading, it can be good, but not “GREAT.”   He goes on to point out the following:

“Proof of this concept is available by the mere consideration of a short list of some of the household names of the greatest discretionary traders. This short list of the greatest would include legendary billionaires such as George Soros, Paul Tudor Jones, Bruce Kovner, and T. Boone Pickens.”

You can’t argue with that, right?

One of the legends I study is Stanley Druckenmiller, and it is his notion of risk management that I set out to understand and replicate. As it turns out he did not have a corner on the idea, it goes back 100 years and in my lifetime cuts across all of the legends I am familiar with, that “the best risk management is not to take a risk at all.”

Traders like Jesse Livermore spoke about his first principle that big money is made by the sitting and the waiting, not the trading. Waiting until all the factors are in favor of his trading strategy before making the trade.

The modern-day hedge funds control risk by not taking a risk, but once everything is 100% correct based on their comprehensive system or trade plan checklist, they enter the markets and, in their words, “go for the jugular.” In other words, they leverage up and maximize profits.

It is easy to understand, once you cut through what the retail industry and the media publish every day, overlooking the above idea, ignoring or considering it trash. Our even seeing it regarding transactions or Vegas type of gambling, which is the opposite of taking no risk!

Everything the legends do is just the opposite of what the industry promotes, their idea of a trade plan. They only pay lip service to the great ones, when you think it through.  But once you take to heart what they say and what it means to implement you know it can’t be transactional or “you have to be in it to win it.”

The key rule of risk management is to avoid risk, do not take on a position until everything in your model is in your favor. A key rule of opportunity management is once you are in a position, you go for the gusto; you leverage up to maximize your profits.

To execute these two key rules, you need a strategy to get you in and out of the market profitably, the basic trade plan if you will. We have all seen strategies that work. There are many, hundreds of them that are sound.

Key number two is a governing model to tell you when to trade the strategy and when not to trade it.

Like I said above, “no one else talks about this method because no one else has my tools.” But I will rephrase because I assume others in the bastions of Wall Street and behind the boardroom walls on La Salle, that traders running hedge funds have a similar model.

Here is a Long Volatility Example

Regardless of how it is measured volatility reflects the difference between the market as we imagine it to be and the market that exists. It is that tension our model -TEM- seeks to measure its extremes and its outcomes.

If above average performance is achieved moving between short and long volatility exposure, we will only attain that edge if we relentlessly search for nothing but the truth. Otherwise, the truth will find us through volatility.
Here is an example of waiting for the 100% set up. The overarching matrix of engagement is our Technical Event Model (TEM).

One reason why a few will ignore this idea is they doubt they will ever find a method that gives them 100% certainly before they get into the market.  This doubt is imbued into all interested parties no matter what side of the desk they are sitting. It is in every sales and marketing piece that hits the airways. The 100% certainly makes the point but in the real world mark it down to 99% or whatever level gives you supreme confidence.

These numbers to the left will make sense relative to the above approach using TEM. The annual results are from a short only breakout scalping system that implements the Turtle money management method. It is easy to see that the strategy had two good years 2008 and 2018, both high volatility years and both preceded by signals provided by TEM that the year

would be a high volatility one.

However, if you assume you have to “be in it to win it” trading the system blindly, it’s a long time between drinks and a little bit of a bumpy road. In the 14-year history, there is a $53,000 drawdown. So, if one uses negative thinking and assumes poor timing, then the drawdown is a certainly. Given the drawdown, a capital manager would need $1,000,000 in funds to have the risk limited to 5% +/-.

Again, taking every trade, you would expect to pick up at least one year in ten of $200,000 or a 20% return on the account. Now, what if you have a Macro Filter like TEM that tells you when to engage this long volatility strategy?

Going into 2018, TMT’s January 18 MarketMap™  suggested the use of this exact system.  Here is how the year to date would have performed after $32.00 a trade cost to achieve the $243,528.00.  The strategy has the filter embedded in the code and you can see it keeps the systems from trading from June through August. 

The first thing a risk manager will see is the loss in May, on a million-dollar account, is a palpable 1.6%.

However, the successful fund manager needs more than one opportunity a decade, isolating one or two a year would be adequate.

ContraryThinker’s job is to provide opportunities for its professional’s advisors and managers. For all the liquid markets on either side of the trade.

ContraryThinker is always looking for the truth, nothing but the truth.
Contrary Thinking Starts Here

 

Great and Many Thanks,

Jack F. Cahn, CMT
A Thinking Man’s Trader Since 1989,
Copyright 1989-2018
Contrary Thinker 1775 E Palm Canyon Drive, Suite 110- box 176 Palm Springs, CA 92264 USA. 800-618-3820 or 25/1 Poinsettia Court Mooloolaba, QLD Australia 4557 614-2811-9889

— Contrary Thinker does not assume the risk of its clients trading futures and offers no warranties expressed or implied. The opinions expressed here are my own and grounded in sources I believe to be reliable but not guaranteed.
— Pricing is subject to change without notice. My indicators and strategies can be withdrawn for private use without notice, at any time.
— Contrary Thinker does not refund policy all sales are the finale.
–Trading futures and options involve the risk of loss. Please consider carefully whether futures or options are appropriate to your financial situation. Only risk capital should be used when trading futures or options.

NO WARRANTY / NO REFUND. Contrary Thinker MAKES NO WARRANTIES, EXPRESS OR IMPLIED, On ITS PRODUCTS AND At this moment EXPRESSLY DISCLAIMS ANY AND ALL IMPLIED WARRANTIES OF FITNESS FOR A PARTICULAR PURPOSE. IN NO EVENT SHALL CBI BE LIABLE FOR ANY DIRECT, INDIRECT, SPECIAL, OR CONSEQUENTIAL DAMAGES IN CONNECTION WITH OR ARISING OUT OF THE PERFORMANCE OR USE OF ANY PORTION OF ITS PRODUCTS.

September 15, 2018

The Bubble Indicator

 

1. Prices are high relative to traditional measures

2. Prices are discounting future rapid price appreciation from these high levels

3. There is the broad bullish sentiment

4. Purchases are being financed with high leverage

5. Buyers have made exceptionally extended forward purchases, such as of inventories, to speculate or to protect against price appreciation

6. New buyers have entered the market

7. Simulative monetary policy threatens to inflate the bubble even more.

We have pointed out number six above based on our modeling.

Our measures of volatility show that from October 2017 into the January peak the buying was based on fear of missing out FOMO. The Technical Event Model was in a sustained period of panic buying. Something that is normally an event not an ongoing condition. These late cycle buyers will flip out at the first sign of pressure on their account balance.

In fact, the February decline stopped right at their break-even level of these FOMO players; and from a long-term point of view our targets for the bear takes prices back the surprises Trump win in late 2016.

The chart here has they period of panic highlighted.

Available to CMTs, Capital Managers, and Professional Investment Advisors

Quarterly subscription $449.00 OR Annual Subscription with collaboration $1,599.00

Great and Many Thanks,

Jack F. Cahn, CMT
A Thinking Man’s Trader Since 1989,
Copyright 1989-2018
www.ContraryThinker.com

— ContraryThinker does not assume the risk of its clients trading futures and offers no warranties expressed or implied. The opinions expressed here are my own and grounded in sources I believe to be reliable but not guaranteed.

–Trading futures and options involve the risk of loss. Please consider carefully whether futures or options are appropriate to your financial situation. Only risk capital should be used when trading futures or options.

NO WARRANTY / NO REFUND.ContraryThinker MAKES NO WARRANTIES, EXPRESS OR IMPLIED, On ITS PRODUCTS AND At this moment EXPRESSLY DISCLAIMS ANY AND ALL IMPLIED WARRANTIES OF FITNESS FOR A PARTICULAR PURPOSE. IN NO EVENT SHALL CBI BE LIABLE FOR ANY DIRECT, INDIRECT, SPECIAL, OR CONSEQUENTIAL DAMAGES IN CONNECTION WITH OR ARISING OUT OF THE PERFORMANCE OR USE OF ANY PORTION OF ITS PRODUCTS.

November 28, 2017

Breaking Through the Institutionalized

Drum roll, please! I will reveal to you the best keeps secret of trading success. No matter how often it is published and waved in the face of capital managers, it will never be endorsed or widely accepted or promoted.

Because this secret runs against everything that is engrained in the industry and by the industry. In fact, the brokerage side of the community creates the basis and prime mover for everything via sales/marketing. This impacts everything from the forecast, trading methods, or ideas they encourage.

So by me giving away this secret, it will never ever be threatened. Oh, sure the big guys use it – the buy side, the capital managers, many who loath brokers. The legends and market wizards will tell you how they did it, but again they don’t care as I don’t care. Because it will never get traction among the majority, that majority includes both some in the public and some professional managers. They are all people who just so happen to be dumb money.

So, while so many traders are chasing free tips in that massive flea market called Tweeter, my crew the TMTrader’s are learning how to trade like the legends, and they are making money.

What is fascinating to me is how promoters in the industry find the 80-20 rule, they point to it as a real “thing,” but they don’t have a clue how it works.

Yea sure they can define it, here it is,

“The 80-20 rule states that 80% of outcomes (trading profits) can be attributed to 20% of all causes (strategy signals). Therefore, if the overall account profit comes from 20% of the trade entries by focusing on the critical 20% allows for more efficient quality control, in other words, leverage up to max profits.

But, what the public hears from the industry is the following advice:

“…that because the overwhelming majority of trading profits comes from just a small percentage of trades, it’s critical that traders not be discouraged by losers and that they take steps to limit losses and let winners run.”

Do you see the problem with this?

It’s merely the old platitude, “Cut your losses short and let your profits run.” What broker’s dribble! Plus, why not avoid the risk?

What you hear is to eliminate your trading losses you must cut them short or blame them on emotional or impulsive trading. Therefore, you have to use tight money stops or master your emotions.

With experience comes wisdom but only after fighting through the brainwashing the industry engrains us with. That the solution they have for it all is, “you got to be in it to win it.” No matter how they cut it up it is all about two things for the industry:

  1. Generating transactions
  2. Protecting the firm from unsecured debits.

The idea of batting for an average is one of these mentalities custom made for the broker. The goal they have created for you is the so-called investment grade policy. In other words, a plan that is regarded as carrying a minimal risk to investors (i.e., the firm). It is a product based on trading for an average, and doing that every day—if not more often. Traders understand the compounding effect of the multiplier factor. If you can day trade on average $100 a day every business day, you’ve padded your income by $2,200 a month.

What works out nicely for the brokers is this strategy fits right into statistical models of validation, which they point to as their vindication.

The greed evolves into high-frequency trader (HFT) with the idea that if you have a system producing a positive mathematic expectation of net $15.00 a trade, and if you can do that 100 times a day, you will make $30,000 a month! I will let you be the judge in that regard. I think there is a better way.

I can tell you with 100% certainty that no one is talking to you about the solution. No one is showing you how to avoid any portion of the 80% that are at best average winners. At least not until NOW!

So, I will skip ahead right here and give you a partial solution, but the gist of it is below. The partial solution is multiple systems of different styles traded as a portfolio.

We have one method that trades breakouts one that trades failed breakouts another that executes reversion to the mean plus trend follower. In the universe of systems there a few more types than the above but you get the idea.

What I do and how I train is first change in attitude, the point of view, not any change in the investment grade policy or the financial goals. Rather I teach how we get there, with less risk and how to maximize returns. Plus, it is custom fit to the style and needs of the investor/trader.

Some readers will understand the above as a dream smasher while for a handful strategy developers and traders it will be a millionaire maker.

Ok so here it is, the trading strategy is the easy part, the hard part is knowing when to trade it and when to set it aside. This is where a Thinking Man’s Trader diverges from the broker dominated industry.

Since if we have seven different kinds of market conditions, we have seven different types of trading strategies; and we have engagement based on “STRATEGY TIMING.”

Here is an example called the Hedge Fund approach one all-embracing system is used to engage one style of trading, let’s call it fast aggressive breakout type.

The strategy is Macro filtered to the extent that it only trades for three to four months of the year with a very high success rate. The account is structured to use a 10% percentage of the capital to achieve a financial risk/reward goal of 3% risk for a 25% reward in the 12 month period. You understand the 80/20 better now? Take away the small 10% of capital structure to fit it to your money goals.

Our group developed priced based model for this; it provides signals when to trade the particular strategy. There are many variations here, each fitting to the objectives and understanding of the trader.

Yes, goals can range from the modest to the grandiose making five plus times your risk capital.

So, you invested your time reading this brief and here is your take away and take it seriously. The secret to successful trading is precisely how the famous names do it; I mean Richard Dennis and his Turtle Traders.

To control risk, don’t trade, do not trade unless everything is in your favor to take a position. That is everything in their favor according to the trade plan/strategy. Once into the winning position or winning streak, go for the kill, leverage up systematically.

Great and Many Thanks

Jack F Cahn. CMT

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