Thinking like the Great Ones
December 29, 2020
December 29, 2020
To be Great, you need to think as the great ones think.
Pardo points out that the “Proof of this concept is available by the mere consideration of a shortlist of some of the household names of the greatest discretionary traders. This shortlist of the greatest would include legendary billionaires such as George Soros, Paul Tudor Jones, Bruce Kovner, and T. Boone Pickens.”
One of the legends I admire and studied 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. The right concept of risk management goes back hundreds of years to Livermore – “… it’s the waiting, not the trading.”
Livermore uses the Dennis Rule, and it cuts across all the legends from the beginning of trading history, the Market Wizard series, into today’s Hedge Fund greats.
The best risk management is not to take a risk at all.
The modern-day hedge funds control risk by not taking a risk. Still, once everything is 100% correct based on their comprehensive system or investment checklist, they enter the position and, in the words of Druckenmiller, “go for the jugular, they leverage up throughout the trend to maximize profits. Turtle Traders use this method with their trend following systems, marking their account value to the market at the end of the day. It is what Soros calls his “one-way trade.”
This idea is easy to understand once you cut through what the retail industry and the media publish every day, pulling on your fear and greed. They overlook the above idea of waiting, ignoring, or they consider it trash. The financial press and part of my industry even see investing or trading only from an “act now,” “happening now,” breaking news environment, making it transactional and Vegas type of gambling, which is the opposite of taking no risk, aka risk management!
Everything the legends do is just the opposite of what many in the industry promote. They only pay lip service to the great ones and use their wisdom to take Social Media polls. But once you take to heart what the legends say and what it means to implement their knowledge, you have advanced your capabilities beyond the majority.
By now, you have realized you need a method that tells you when there is low risk with a high reward condition. The reward side of the idea – opportunity management – is once you are in a position, you go for the gusto; you leverage up systematically to maximize your profits. The Soros “one-way trade.” In this way, you can trade 10% of the time, with 10% of your capital. As such, your reachable objective is a return profit on your account that beats the average return of the long-term S&P. Or you can go “all in” with a more significant asset allocation to make a fortune.
To execute these two critical rules, you need a strategy to get you in and out of the market profitably, the primary trade plan if you will. These are the robust trading strategies or formulas based on the Pardo tradition. Many hundreds of them are sound with better than average profits. But what is critical is they all have periods of profit run-ups and drawdowns, which is what you want to control via a system’s model.
The model I developed is called the Technical Event Model (TEM). Technical because it is 100% price based. It tells you when to trade the strategy and when not to trade it. It will tell you if it is a good time or a wrong time or an excellent time for any traditional, well tested, and robust strategy. For the professional advisor and capital manager, I call it the New Paradigm, a new way of thinking that turns a strategy into a comprehensive investment or trading SYSTEM.
Because of the popularity and shared knowledge, the industry has, I will use the robust day trading volatility breakout strategy for one example. But the model is universally applicable.
Breakout systems are designed to capture the next immediate move after the market moves past a certain point. The trader is not concerned with any long-term forecast or analysis, only the immediate price action after the trigger is hit.
Volatility breakout systems are based on the premise that if the market moves a certain percentage from a previous price level, the odds favor some continuation of the move in the same direction. This continuation might only last one day, several days, or go just a little bit beyond the original entry price if the net profit is worth the risk.
With a breakout system, the trade is always taken in the direction that the market is moving at the time. It is usually entered via a buy or sell stop. The bit of continuation that we are playing for is based on the principle that momentum tends to precede price.
There is also another principle of price behavior that is at work to create trading opportunities. The market tends to alternate between a period of equilibrium (balance between the supply and demand forces) and a state of disequilibrium. This imbalance between supply and demand causes “range expansion” (the market seeking a new level), which causes us to enter a trade.
There are several ways to create short-term volatility breakout systems. I have found that different types of systems based on range expansion test out quite similarly. Therefore, whichever method you choose should be a matter of your personal preference.
A full range of sound breakout systems from the “Turtles” method with the 4-week high/low channel breakout to the following one-day breakout strategy.
The strategy takes the high low range of the previous day, multiplies that by 55%, and adds the result to the next day’s open for the entry buy trigger and subtract it from the open for the short entry stop price day. If filled, the opposite level is your day stop, and the exit is on the open next.
Without money management stops – both stops losses and profit stops – here are the basic code results on the mini-Nasdaq 100 futures. The table above shows the monthly performance of the strategy.
The two-year period made $289,060, where it adds a contract after a winner and reduces back deals to one lot after a loser.
But look at the historical risk, with several months of losses over 30k. Plus, look at all the months that had typical or average months. The average month is an $11,000 profit. But how can you trade over the long term for an average month when your potential risk is over $30,000? You need to base your trades on the “Dennis rule.”
To focus and trade only the above-average opportunities, part of the TEM model uses the implied volatility data from the CBOE. VX is the ticker symbol for the CBOE VIX Index Future. VX is a measure of expected price fluctuations in the S&P 500 Index options over the next 30 days. The predictive nature of the VIX Index makes it a measure of implied volatility. The index is derived from an option’s price model and shows what the market suggests about the stock’s volatility in the future. It is not one that is based on historical data.
In the above chart, I have high-lighted when volatility – VX- is oversold when you apply one of your favorite overbought/oversold oscillators on it. For TEM, I use the %BB, which is my Bollinger Band Oscillator.
The oversold reading says that the market’s concern about a significant change in the market’s price is extremely low; hence it is oversold and ready to cycle back to the other extreme.
Based on a calendar month, not a week but a typical accounting month, when VX is at an extreme, you engage the above system for the month and continue to trade the next month; if VX has not hit a radical in the other direction, an extreme overbought.
Instead of being at risk for 24 months, you are only in the market for half of that time. You have doubled your average monthly return to over 20k; and lowered your historical risk to $3,900, only 10% of the risk potential trading suboptimal trades.
This is the new way of thinking and the new approach to systems trading, the new paradigm, and the results are in the following table.
With the Dennis rule’s adoption and having a tool, a model that tells you the coming period, be it a week or a month or more, an extended calendar period will be the best to engage your trading plan. Your trading strategy will be optimal. Traders can now manage their money without their profits and losses managing them. You are currently in control with a price-based model that makes your plan a comprehensive system.
Contrary Thinker is a diversified financial services firm.
Publishing: Volatility Reports an advisory blog and market’s newsletter based on this new model. MarketMap Scenario Planner Contrary provides advanced tools for trend bias and change of trend timing based on mundane market cycles, seasonal event-based cycles, tidal cycles, astronomic and astrological event-based cycles
The visual indicators and signal generating systems are available as plugins for TradeStation – the same tools used in our publications- rent or purchase. They will be available for rent again in 2021 at TradeStation’s TraderApp Store
Swing Trading Ideas – both bull and hedge (bear) are provided both in our publications, via email and iPhone apps.
Great and Many Thanks,
Jack F. Cahn, CMT
Contrary Thinker since 1989,
Contrary Thinker 1775 E Palm Canyon Drive, Suite 110- box 176 Palm Springs, CA
92264 USA. 760-459-4681 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.
–Trading futures and options involve the risk of loss. Please consider carefully whether futures or options are appropriate for your financial situation. Use only risk capital when trading futures or options