Mar

7

Chris Cooper wrote: "I am trying to determine what lessons I should learn about my trading during the past week of large moves in the markets."

If the objective is consistent profits (positive returns), how can this be accomplished under all market conditions?

Persisting stable drift, such as the 8-month period that ended last week, requires long exposure/leverage. But as recently demonstrated, this approach has risk that cannot be controlled while maintaining exposure.

Even more ironic is the plight of those who concluded that the 00-03 bear market was "a big one," which would continue as a rational correction of the prior irrationalities. Or the OMWPS (older white males with pony-tails) still holding PALM and EMC from their days as millionares circa 19 and 99.

"Dang!"

Maybe the problem should be reframed: Consistent profits are illogical, because no one can anticipate 2/27's, 911s, nor 3/00s. (OK there were many who got one right; some got two, and even a few all 3. Just as magical as 9 heads in a row.)

The only state of risklessness is death. We reach for risk as we follow the path of the delusional Quixote in the moribund hunt for immortality.

Bill Rafter adds:

Depending on how one defines "consistent profits," they may be achievable to the extent that they are more frequent than random would dictate. We would suggest that the focus should be more on reducing the number or severity of periods of negative returns.

Our experience is as follows:

If your investment universe is large-cap stocks, you are going to be vulnerable to overall market declines. Your only escape is to find a tool/indicator that enables you to change your universe during those periods. Some sector rotation will work to the extent that you will be able to claim positive relative returns, but we don't call that "winning," although Wall Street generally does.

If your universe includes mid-cap, small-cap stocks, and foreign equities, you are going to be less vulnerable to overall declines, particularly if such declines occur over an extended period (e.g. 2000-03). But in a "whoosh" such as the market experienced last week, it is more likely that all will fall somewhat together until the panic subsides. If you can predict the whoosh, then good for you. But if you cannot, and your universe is equities, you must find some of those that will behave somewhat independent of the averages.

Brian J. Haag writes:

I've said this in response to various topics, but I will continue to beat the table on it:

The biggest reason so many people perceive increased correlations is because they look at everything in dollars. That's fine; but then they shouldn't be surprised when correlated moves happen. Any time you buy something for dollars, you are essentially selling dollars (or loaning them out, if you want to get all "swappy" about it). So if, after you have made your trade, people decide they like dollars more than your asset, you will lose. And sometimes they decide they want dollars more than just about anything else –and then almost everything goes down together.

It is extremely instructive when looking at a trade (even if you are relatively high-frequency) to price the asset in question in terms of other assets. For example, how much did US equities drop in terms of Euros? Or in terms of gold? It's not orthodox to think of long stocks/short gold as a hedged trade, but sometimes it is. The key is to have the trade on in the right amount and at the right time (of course, that's the key to every trade). But in any case the trade will have add a different kind of diversification, which is probably what you're really after. Call it a "correlation call."


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