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    New Way to Measure Risk

    August 2, 2021

August 2, 2021

New Way to Measure Risk

Playing defense is key to Alpha, in other words, risk management.

It’s simple math if your investment or portfolio experiences a drawdown of 33% for it to get back to even the investment needs an 50% advance, full stop. So why take a risk for an average or a  below-average opportunity?

Way too many professionals and self traders use the trailing P&L as an indicator for on/off risk. In reality, the market does not care about the size of your account that determines the size of your stop loss. Much of this “post hoc” logic puts the advisor/manager/trader behind the eight-ball because being stopped out does not tell you if the position was wrong, it just tells you the account was not big enough or the amount of emotional stress was too large being forced to sell. Worse yet, holding on into a low where the media – be it network or social – has a clear rationalization of why the market is in dire straights and dumping shares just in time for the bottom.

The featured charts in this issue show how risk is seen today, August 2, 2022, and my experience calling peaks since 1987 is my downside expectation has been understated. The timing is right on but the target is surpassed, which is fine as Contrary Thinker has tools to manage that and see the panic bottom.

However, today my methods have advanced since 1987 – and I am proud to say I still work with some of the same professionals. Back in the late 80’s Fibonacci retracements and EWT wave relationships were used. Today it is the volatility model I have developed – TEM- speaks loudly about the emotions or rationale behind the market.

Procuring shares for no underlying reason except the motivation of great profits is not a solid foundation. All of the US indices in the five chart windows shown here peaked on “poor buying,” as the old-timers call it. Today it’s called FOMO or irrational buying.

For that reason, it’s a fact that if bought on an emotional basis, it will be sold on the same. Hence when the shares go underwater for the “emotional buyer” and hit the trader’s pain threshold, they will dump the shares and stop listening to the perma-bull tunes promoted in the media.

On the charts, the “Red” shaded areas show where panic buying began and where it ends. CT measures risk to the price level where the panic buying started. The percent risk projected is annotated on the charts. I also highlight in blue the annual support zone for this year as the max level thus far. This max risk level is based on ratio projections from last year’s high/low action, which are visually clear zones for reversals or breaks.

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