Sunday, July 26, 2009

I've thought a lot the past few days about what to post this weekend and about reviewing the current SDS and BGZ trades, etc. There are lots of things worthy of mention, but they are not that well organized in my head for a post, and I don't know that charts, etc are really important in taking away whatever needs to be taken from these trades from my end or from your (blog followers) end. So here are some thoughts that may not be in any particular order....

-money management is the most important aspect of long term success. if following the basic guidelines I've given, a drawdown like this can certainly be regained over the course of several trades.

-depending on how you measure momentum or short-term trend persistency, the last 2 weeks have experienced sustained upside momentum only comparable to about 5 other 2 week periods in 100 years or more of the S&P 500. So we may have just experienced something that, in context, only happens every decade or so.

-in looking back at the both the BGZ and SDS trade, I can find no major flaw in the SDS trade compared with my normal filtering process, it is just a matter of an extraordinary market environment/event; for the BGZ trade, I am satisfied with the entry, but let a "belief" about the larger market environment, interfere with the trade management/stop placement

-there are both dramatic fundamental credit contraction forces as well as historically un- precedented credit market intervention contrary to those forces, and over the last year the market has experienced historically unprecedented moves both down and up. I fully expect that we will continue to see these types of moves periodically for some time.

After being on the "right" side of the market for basically the entirety of this blog's history, I found myself somewhat blindsided (I should say "I was blind to the market" rather than shifting blame to the market from myself) by this past week's market move. Without going back over all the analysis in recent months, my conclusions are basically that I wouldn't change much (if any) of my short-term analysis of patterns, etc, since the March lows; HOWEVER, I think the move this past week means that some aspect of my "big picture" view was off as far as integrating this move into the larger market picture. From the size and speed of this move up, coupled with historical studies looking at the few, but similar, instances of such persistent momentum, the outlook appears to be modestly bullish for the next few weeks at least. I will not get into any details of possibilities in this post though.

For blog trading I use both a systematic and a discretionary approach. The systematic part is defining trend and entering and exiting with objective indictors. The discretionary component is in pattern identification, etc, for identifying high probabilities of trend reversal. Additionally, any type of stop placement or movement prior to an objective exit signal, is discretionary. For anyone who has followed the blog for a while or looked through the "Best Posts" area, will understand that rather than using stops for most trades, I have given guidlines on risk control by position sizing. Again the reason is that for a mean reverting style of trading, use of stops will almost certainly decrease long-term performance. So, on a core level, I guess my goal with the blog style is more aimed at absolute return than avoiding any drawdown.

From looking back at the BGZ trade, 2 weeks ago I had noted on the blog that the short-term was tilted significantly to a bullish edge, but that I felt it was not "safe" to place a breakeven (or better) stop without high risk of getting stopped out of an otherwise good trade. This trade is probably the only trade since starting the blog that I really feel I should have done differently. While I am using an objective model for the trade exit potentially, at that point (due to the effects of trendless volatility on these funds), a stop should have been placed or just made an outright exit, and looked to re-enter. However, the main reason for the trade was that the June highs could have been a significant multi-month high from my perspective, and it wasn't until late last week, when that proved to be untrue.

At this point, there are several indications that the market "should" experience at least a period of consolidation over the next week or so. Maybe there will finally be an exit signal for the current SDS trade, possibly at better prices than current ones. The short-term model is still showing a glaring bearish divergence, and while this breakout has me convinced of its legitimacy, we certainly could see at least a sharp pullback for a couple days.

For the truly long term investment picture (buy and hold) I believe the current move to new highs actually is very negative in that "the bear market" may be less far along in its pattern, and probably price destruction as well, than my prior working assumption. While neither I nor anyone else has a crystal ball foreseeing precise market action, to the extent that generalizations can be made from a study of market history and human psychology, I could not suggest to a friend or loved one to move investments more heavily toward equities at this time. It takes a combination of knowledge and confidence to act contrary to prevailing beliefs in this regard, but in my estimation, there will be greater reward in the future.

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