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Trading in today’s Volatile times.

By October 15, 2008February 29th, 2024Active Investor Education, Uncategorized

Whilst the world equity markets continue to display high levels of volatility and irrational behaviour in line with the turmoil being experienced in financial markets, now is a great time to reflect on how these conditions have impacted your own trading and exposure to the markets and how to learn from any mistakes so that they are not repeated in the future.

It is an often quoted line (and one that I am constantly reminding people) that you cannot engage in any trading or investing activity without a predefined plan that will include an investing strategy (or strategies) that is proven to be profitable over the long term. Your strategy can also be referred to as your trading ‘edge’. More will be written about what an ‘edge’ in future postings.

Those of you with a detailed trading plan will, hopefully, have stuck to the rules detailed in that plan and taken the steps detailed in that plan to exit trades as and when the rules told you to do so thereby reducing exposure to a falling market. Your strategy may also include portfolio hedging rules under certain market conditions.

For those of you following the SPA methodology, this simply involves taking the exit signals, as and when they occur and reducing exposure to the bear market. The exit signals are executed without any subjectivity or rationalising of the decision – the positions are simply exited according to the rules within the SPA system.

Those traders who have not acted on exit signals, or became subjective in the decision-making process, may now find both the share portfolio’s and the cash amount available to take future signals significantly more reduced than what they should have been! Portfolios can recover from 10% loss trades or even 30% loss trades but large loss trades in the regions of 70% to 95% wipe out portfolios, especially if traded on leverage. There have been plenty of large negative moves such as these in this market even in stocks that were considered fundamentally sound when this bear market started. Proven exit signals using technical analysis is the ONLY way to eliminate large loss trades.

There are many, many lessons that we can all learn from this latest phase in the ongoing saga of the equity markets. From a period of extreme euphoria only 12 months ago, the markets are now in a period of extreme pessimism and capitulation. This too will change, as it always does. With a detailed plan and methodology for engaging the markets, we will be able to confidently go about our business and re-engage the market as the world moves on and trading and investing opportunities continue to present and re-present themselves.

I look forward to your comments and input into my blog and hope that it can become a forum for us all to share our ideas, knowledge, and experiences.


  • Colin Opwald says:

    With the advent of new paramaters that have created situations never before experienced, do all the “old” methodolgies of trading still apply ? We know that the price of the share has little to do with the value and that the herd mentality of those that invest in the market currently is swinging wildly, does that create an opportunity for long term whilst the short term perhaps is less palatable. Is it time for a different strategy ?? eg. A proportion (0-50%)of ones portfolio now specifically long term and the short and medium term to restart when there is less volatility.
    Thanks for the opportunity and I look forward to the thoughts of others.

  • Frank Sweeney says:

    Gary,I am a SPA3 MPS user since 15/11/07
    As of 15/10/08 (before today’s plunge)my Total Capital has been reduced by 32.5%(while the All Ords has gone down 35.2%) It seems to me that the SPA3 market risk management is inadequate.
    To keep me in the market all through this severe downtrend in times of such high risk seems to be a failure.I stuck with it after your ATAA address in Perth several months ago reassured me.I’m beginning to doubt the system
    ( since I now need a 50% return to get back to even).Your comments would be appreciated.
    Cheers, Frank

  • Les Grant says:

    Congratulations Garry,
    As a proapective buyer I am ecouraged by the level of professionalism that you and your company is displaying. I look forward to good things in the future (if there is a future in the markets!!!) in which you can help us find the way.

  • Laurie Vicary says:

    I will be interested to see your response to Frank Sweeney as his experience seems to be at odds with what you claim for mechanical trading. I guess the market volatility and the way that some stocks have gapped down significantly, makes it hard for the system.
    My interest arises from the fact that I am a prospective purchaser of the SPA3 system.

  • Rose says:

    I am delighted to be invited to participate in the blog asn I have followed lots of columns you have written over a long period.

  • Annabella says:

    I guess I am as confused (or more so) than the rest of the investors/traders out there as to what works best this current market. I’m what you might call a lazy investor – I’m not interested in very technical stuff and find it hard to follow stats etc. I am however very good at following & executing a trading plan which is one of the reasons I started using SPA to trade. I started my SPA portfolio on 1st of Sept 08 & I have confidence in it and love the integrated portfolio management aspect to it. I wish I could say that I was in profit with it but alas I am aprrox 10% down in one portfolio & about 15% in the other. My long term portfolio held with no stop losses & no system to alert me to get out of the trade is massively in the red – luckily with no leverage! One of my other portfoilio’s managed by a financial adviser has had two margin calls in the last 2 months and has lost an awful amount of value. So this leaves me wondering how the best way to split money allocated to share market investing/trading, how to protect long term investments etc, etc. I will keep trading with SPA and will try to trade my way out of the losses in the long term portfolio. I guess this market has me wondering if there still is a place for long term investing and if so how to protect the portfolio or whether all monies should be put to work with the SPA methology?

  • JohnT says:

    Hi Gary nice to have another chat forum for all to be involved imparting your knowledge and experience on those of us that are less initiated – look forward to your opinion & views of the variables confronting forward trading

  • Larry says:

    I have been using the SPA trading system since 1 June 2008, and have calculated that I am considerably better off than the overall index. Because of the current state of the market I have decided to take only sell signals of stocks that I hold and limit any buy actions to stocks that are from sectors regarded as low risk. I am sure that this market has a lot more downside to go and that at the end of it there will be many bargains buys coming up through the SPA system.

  • hugh says:

    I am a potential buyer of your system but like some comments above wonder whether the methodology has been made obsolete by the events of the last few months.After all,most hedge funds would claim some proprietorial ‘edge’ or approach to their investments and they are suffering in this environment and needless to say some of those are ‘mechanical’.Indeed,my understanding of investment banks is that they use a Value At Risk model based on historical data and forecast market moves/prices accordingly and they have proved to be totally inadequate.Surely,in irrational markets the markets are more likely to override any ‘mechanical’ system which cannot allow for emotions like fear or panic ?

  • maxpemberton says:

    i havent been trading long pulled my money out before it got to bad i was trading with aureus but now have taken on spa three am trying to get back in at the moment i can understand people not being happy about losses but its the nature of the beast when it comes good i am hoping it will be very good till then ill keep plugging on 1 thing to remember greed caused this

  • Gary Stone says:

    Reply to Comment by Charles:

    Charles, For those that are out of the market, for whatever reason, or have not yet started a portfolio, it would be far better to sit this volatility out. Active investing is a challenge under ‘normal’ market conditions for those embarking on the active investment journey. This is abnormal price action at the moment. Having said that, such price action does occur in the markets and it is ‘normal’ for this to occur but usually many years apart from the previous occurrence.

    I suggest that this is not a market to ‘start out’ in. It would be better to wait for the next SPA3 Low Market Risk signal and then get going. In the meanwhile, you can continue to learn the processes and get your trading account etc ready to go.

  • Des says:

    I have been trading SPA3 for quite a while, and made some profits early.
    However, as I was unable to get initial training and believed I may not have been using the package to best advantage, I chose in December to transfer to the CBS trading system using SPA3.
    This, I believed, in essence was placing the abilitiy wthin fully trained personnel to make best use of the package.
    However, losses only were made during the initial phases.
    When the market downturn occurred, these became even more significant, with the package appearing to buy after other investors bought in, and sellinmg after panic investors sold.
    Most purchases during this time have made a loss, and those making gains have quite often been sold after losing the major portionof that gain.
    I have not fully lost confidence in the principles of this package, but question it’s ability to make proper decisions in this market with the predefned settings applied as suggested by Sharefinder.

  • Fiona says:

    I am a SPA3 customer, but have been taking so long to study the reference books and write my trading plan, that I sat out of the market over the last 3 or 4 months. Thank you Gary for your advice to Charles, as I will take it on board as well, and wait for the next Low Market Risk signal before beginning a new portfolio. I have just started a paper SPA3 portfolio this week, and of course have been unable to buy anything.

    For the record, my long term portfolio has suffered some enormous losses. Some stocks lost 80% of their value. I did not previously believe such losses were possible across so many shares at once, and was prepared to live with maybe a 30% drawdown for a while. But 80% was unimaginable! I also had warrants with no exit strategy and lost 100% of my capital there.

    The thing that saved me was that by Jan 2008 I went to 80% cash due to takeovers and didn’t reinvest that money. I am confident that good stocks will come back. I am looking forward to applying better money and risk management skills, and am most interested in your Hedge research.

  • fiona says:

    Re Des’ comment: “with the package appearing to buy after other investors bought in, and sellinmg after panic investors sold. ” I have noticed this. It is contributing to my sense of wariness in starting my portfolio.

  • Gary Stone says:

    Reply to Comment by Colin:

    Colin, Good question. Discretionary traders and acedemics use this to ‘knock’ mechanical systems. Their general claim is that the market ‘works out’ a mechanical system and becomes efficient to it thereby negating the ‘edge’ of the system. What they leave out is that this may be possible if the mechanical system becomes a large portion, around half or more, of the liquidity of a given market. Obviously SPA3 is nowhere near that. Such a statement is more applicable to mechanical systems used on some of the commodity futures systems traded by money managers in the USA with large sums of money under management than a sharemarket-wide system such as SPA3.

    People need to think of the market as a place that a near-limitless number of variables come together with, amongst many other things, each and every participant being a market variable. To believe that the market has become efficient to a single stock trading mechanical system that relatively has very low liquidity compared to the overall daily turnover of the market is an extermely low probability scenario.

    In conclusion, the market is a place where consistency is rewarded and inconsistency is severly punished. The market wants you to chop and change strategies. Those that remain consistent but make minor alterations to their existing processes, according to the lessons learned from this market, will do well when the market turns again.

  • Kurtis says:

    I am of the belief that no mechanical system will work in a market demonstrating the volatility seen. This is history making volatility so if you are not already in the market, I would not be entering now. Mechanical systems are great to remove emotion in trading, however, this market at present is all about emotion. Resulting in sustained abnormal price action. I have little doubt that when these times settle, systems such as SPA will once again assist in market timing.

  • Mark says:

    I agree with much of the sentiment expressed here. Mechanical trading does remove the emotion. However the unprecedented market volatility will hit stops irrespective of fundamentals. I use the market sentiment to determine in which segments I would even consider a trade…for example health care. Anything this is not WCB in the sector I steer clear.

    That said, I am in cash and just not prepared to risk in this irrational market. Who can predict the 500+ points in the US market that trash stocks?

    I like SPA3, I think it is easy to use once you spend understanding it.

  • Marisa says:

    I am still in the process of looking at various systems and educational workshops, SPA3. M

    With current market conditions my plan was to look at your figures over the next 12 months as I don’t believe I need to be in a rush.


  • Eric Gibbons says:

    Gary, I too am a CBS- SPA3 client.
    I understand that in a mechanical system you must take all relevant signals; that you cannot pick and choose.
    However, I am surprised that SPA3 seems to be giving signals to buy on the long side when the market is seemingly in a strong downward trend.
    Any enlightenment you can give re this perceived anomaly would be appreciated.

  • Gary Stone says:

    Reply to Comment by Frank Sweeney:

    Frank, After today’s plunge your SPA3 MPS portfolio will be down about 0.25% on the day compared to the ALL-ORDS being down 6.7% on the day. This happens because of greatly reduced exposure to the market. That will put your portfolio 7% ahead of the ALL-ORDS which is down 39.5% over the 11 months. This is below par for SPA3 portfolios using Risk Profile 2 which should be down around 24% to 28%, depending on size of portfolio, compared to the ALL-ORDS being down 41.5% from it’s peak on 1/11/07. One of the main reasons is cost of brokerage relative to average trade size. For example, larger SPA3 MPS portfolios ($250K – $500K) over the same period are between 24% and 28% drawdown which is similar to the publicly traded SPA3 Portfolio. The avg cost of brokerage per tranasaction (x2 per trade) for a $125K portfolio has been 0.6% during this bear market (half position sizes) whereas it has been 0.24% per transaction for a $500K portfolio.

    Also, SPA3 can be traded with Risk Profile 1 or a hybrid of Risk Profile 1 and 2. Risk Profile 1 would have had a SPA3 portfolio in 100% cash all the time, bar 8 weeks, since 17/11/2007. A hybrid of Risk Profile 1 and 2 where trades are only executed in Low Risk Sectors would have had SPA3 portfolios in cash more than Risk Profile 2 and would hence have had far less drawdown. There were customer SPA3 portfolios in the green during the 2007/2008 FY (+2% to +6.5% compared to the ALL-ORDS down -15.5%) using these more conservative SPA3 Risk Management alternatives. However, during the bull market they would not have made as much profit during the rising market from Mar 2003 – June 2007. The Trading Plan for SPA3 MPS uses Risk Profile 2 which is the same as the SPA3 Public Portfolio which has reached a maximum drawdown of 29%. Will continue with a new SPA3 Risk Management process that will be announced to our customers tonight in a separate post.

  • Gary Stone says:

    Reply to Comment by Frank Sweeney (cont.):

    Frank, All active investors must review their Trading Plans DURING this market downturn and make adjustments according to the lessons learnt otherwise the reduction of capital would have been without gain. One of the adjustments that we will make to SPA3 is the introduction of SPA3 hEdge which will hedge a SPA3 portfolio during SPA3 High Risk markets according to a simple set of mechanical rules and by using the SPI, shorting an ASX200 CFD or even buying Puts on the XJO. I suggest that the simplest method will be shorting an ASX200 CFD with a CFD provider.

    Over the life of the publicly traded SPA3 Portfolio, as at the 15/10/2008 close, the SPA3 Portfolio is $150K better off and has actually risen above the highest point that the SPA3 Portfolio reached without hedging due to the EXTREME downward markets that have occurred in the last 2 weeks meaning that it now has zero drawdown. If markets rise quickly the hedge will fall in value which will generate some drawdown but will be far less in drawdown relative to a non-hEdged SPA3 portfolio. I also tested a $125K SPA3 MPS portfolio since the top of the market on 1/11/2007 to current and instead of being around 30% – 33% drawdown the portfolio is around 5% – 8% drawdown.

    I would have loved to have this Risk Management process in place before the market downturn but it was not to be. However, we have learnt from this period of downturn and introduced a new Risk Management rule that is simple in nature and in execution but with large effect. It is bound to provide peace of mind for all SPA3 active investors while trading the next bull market knowing that capital can be protected against a similar downturn to this one which will occur again at some stage, we just don’t know when.

  • Piyush Shah says:

    After your reply to Frank, I think it is not a right time to enter market, However it seems right time to get more and more knowledge and be ready. Again on second thought Where is limit ? You study one corse or method and again it is never full proof and you have to learn further. It is a never ending journey. Really speaking I am baffeled and more and more confused.

  • Jim Holcombe says:

    Thanks for this new innovation.

    I have been a SPA user since 2000 or there abouts, so have developed my trading plan to the extent that I am focused on mechanical rather than emotional trading. My super fund equity suffered a 4% drop in the first week of this financial year and has traded down to a maximum drawdown of 10% so far. Currently down 8%. How far has the All Ords dropped since 1st Jul? – What has produced this performance? ‘The Edge’ as Gary calls it and my trading plan.

    When the market risk went high on 27 Jun, 19 Sep, and 10 Oct, I reduced exposure to the market such that, although individual trades may have suffered significant losses, the nett loss to the porfolio is not major.

    If you are starting out, you need to understand that approximately 60% of trades will be loss trades which on average are typically less than 10% and the other 40% trades will vary from +0.01% to huge profits providing ‘The Edge’. So initially if you have 10 trades, 6 will be closed early with a drawdown on the initial portfolio.

    I agree with Gary, the current market, with market daily swings + or – 5 or 6% is not one to start investing in (and SPA is confirming this as there have been very few ‘Buy’ signals in the last couple of weeks).

  • Gary Stone says:

    Reply to Comment by Hugh:

    Hugh, Please see my reply to Colin above where I talk about the market ‘working out’ a system and becoming ‘efficient’ to it. Systems go into drawdown as do portfolios. ‘Long’ systems go into drawdown in falling markets and ‘short’ systems go into drawdown in rising markets. This is just the way it is. The key is that the drawdown that portfolios experience CANNOT be so large that the portfolio cannot recover.

    Over the last 6 months both myself and others in our business have taken calls from non customers (enquiring about SPA3) that have experienced drawdowns well in excess of the market, some down by > 60%, even 70% & 80%. And that was well before last week when the market fell another 20%. I just hope that they reduced exposure. SPA3 simply does not get to such a point.

    Because a system goes into drawdown it doesn’t mean that it is obsolete. You can keep an eye on our public SPA3 Portfolio. It will come out of drawdown and make a new equity high at some stage in the future. Every participant in the market needs to have a process that has an edge that they trust and surrender to. The market will test each and every one of us. We are all being tested right now. The question is: Who will pass the test and who will fail?

  • Gary Stone says:

    Reply to Comment by Des:

    Des, By definition, SPA3 entry signals will occur after a medium-term trend has started. It doesn’t start the trend. The trend is started by early adopters who change the trend to up from down or sideways. Once the trend starts, SPA3 jumps on the back of it. Likewise for exit signals. SPA3 doesn’t start the down trend. Price action must have already started falling in the medium-term for SPA3 to generate an exit signal.

    To SPA3 an entry signal that occurs in a falling market looks the same as an entry signal that occurs in a rising market. The same criteria need to be met. In a falling market for most stocks the trend doesn’t “pull through” but when the overall market turns those trends will “pull through”. Nobody can tell how long the falling market will continue and when it will turn so we continue to probe the market, even when it is falling, however, with much smaller position sizes and hence far less overall portfolio exposure. With the recently announced SPA3 hEdge Risk Management process, drawdown will be far less if we go through a market like we have are currently enduring.

    I also trade SPA3 and I am also in drawdown since December. Given the market I expect to be.

  • Justin says:

    Garry well done I think this is a great initiative by Sharefinder.

    I have not yet invested in SPA3 nor taken the step to buy into the market, my hesitation/caution in this case has paid off but I am still keen to get into the market at some stage. Initiatives like this one taken by you give me more confidence that SPA3 is the tool that I need as you are listening to your customers! These are obviously unprecedented times in the market and I would doubt that any system or process could have pre-empted the current market volatility!

  • Helen says:

    we have found that trading with spa or intelledgence in a bear market is too hard and always looses, so now our trading plan is to get out of the market completely and stay in cash when there is a bear market. It is also a nice rest.

  • Vlad says:

    Great to see this blog emerging. This is a place where the true state of things can be seen better than in promotional materials or seminars. I have already seen several negative impressions from SPA3 users here and still to see a user who is happy with his/her results, not just with his/her expectations.

  • Gary Stone says:

    Reply to Comment by Kurtis:

    “I am of the belief that no mechanical system will work in a market demonstrating the volatility seen.”

    Kurtis, One of the biggest problems that the majority of traders have is their definition of ‘working’ or ‘not working’. When a mechanical system, self developed or otherwise, goes into drawdown they see it as ‘not working’. They then proceed on a never ending journey of chopping and changing their ‘system’, processes and trading instruments and searching for ‘better’ indicators. This will be an eternal search because their definition of what works and what doesn’t is flawed in the first place . As I said in an earlier response, ‘long’ systems go into drawdown in falling markets and ‘short’ systems go into drawdown in rising markets.

    SPA3 has achieved 17.5% CAGR over the last 7.7 years including this drawdown when the ALL-ORDS has acheived just 3.5% CAGR over the same period. SPA3 is working just like it has been researched and has been traded over the last 10 years. It is expected to go into drawdown when the market falls by 40%. It is expected to have more losing trades than winning trades even in a rising market let alone a falling market. The Risk Management rules will ensure that exposure is greatly reduced in a falling market. We have been stating this quite publicly and transparantly for over 10 years. The key is that it doesn’t go into drawdown beyond a point of no return like so many others in this market, most of whom do NOT have systems, process or the right mindset for active investment in the market.

    The majority of active investors still have to solve the problem of what they will trust when the market turns. Their gut feel or a set of processes that has massively outperformed the market and alternative investment avenues like managed funds in both up and down markets? You see, active investing should be a relative game not an absolute game. And it is a relative when you have an edge that outperforms the market. It becomes an absolute game when you get beyond the point of no return.

  • Ivan says:

    Hi Gary,

    just out of interest, further to the hedge discussion from last night, what does the CAGR rise to if the “hedge facility” was deployed over the last 7.7 years

  • Barry says:

    We started trading SPA3 when the market turned low risk last May.
    We are currently in drawdown 25% having followed all signals as per Profile 2 until the 24th Sept. when we slightly modified our trading plan.
    I understand from the eUGM that the SPA3 Portfolio 1 would currently be around $500K if the hedge had been used. To get a comparison before this major bear market, what would the figure be as 15/11/07 using the hedge.

  • Gary Stone says:

    Reply to Comment by Ivan:

    Ivan, The CAGR over 7.7 years using the SPA3 hEdge rises to 23.3% compared 17.9% without using the SPA3 hEdge during the entire 7.7 years. The difference is $150,000 in absolute portfolio value.

  • Ivan Fisher says:

    Thanks Gary, but I forgot to ask if you have some figures for the SPA3CFD with and without the hedge for the same period ? Also, I’ll be interested in your reply to Barry who wanted to know hedge performance up to 15/11/07. regards Ivan

  • Gary Stone says:

    Reply to Comment by Barry:

    Barry, With the SPA3 hEdge applied throughout the life of the portfolio up to 15/11/2007, the portfolio value on 15/11/2007 was $482,220 meaning that the portfolio would not have experienced any drawdown up to 15/10/2008.

    However, there is still an open hEdge right now sitting in large profit that has caused this due to the sharp falls that have occurred on the ASX200 index since 1 Oct. The open hEdge trade will give some of the hEdge profit back when the market rises and generates a hEdge exit signal which will, in turn, reduce the portfolio value. The open SPA3 trades will rise in value but not by enough to negate the ETD (End of Trade Drawdown) of the hEdge trade. We will have to wait to see what the portfolio value is when the hEdge trade is closed out.

  • Ivan says:

    Hi Gary, thinking about this hedge, it opens up quite a few possibilities which no doubt you’ve already thought of and/or back tested. A couple of that spring into my mind is that one could maybe increase the leverage of the portfolio with “relative safety” and the other would be to move risk profiles, say from 2 to 5. I’m sure this is all able to be back tested so it would be interesting to see a table of different outcomes using variables such as leverage, risk profile, maybe even % hedge. Outputs such as CAGR, drawdown, net profit etc. (kinda like chapter 7 in the SPA3CFD manual) I’m sure you would love to “number crunch over lunch” that lot !


  • kyle says:

    Gary, thanks for this blog, when you say

    Nobody can tell how long the falling market will continue and when it will turn so we continue to probe the market, even when it is falling, however, with much smaller position sizes and hence far less overall portfolio exposure. With the recently announced SPA3 hEdge Risk Management process, drawdown will be far less if we go through a market like we have are currently enduring.

    Is there not a risk that the probing of the marking that results in drawdown will, in the case of a prolonged downturn, eventually run capital down to a point where one cannot continue? Hedging will reduce this effect but a long enough bear market would achieve the same result.

    Such a result might define “not working” as discussed above.


  • Gary Stone says:

    Reply to Comment by Ivan:

    “…one could maybe increase the leverage of the portfolio with “relative safety” and the other would be to move risk profiles, say from 2 to 5. I’m sure this is all able to be back tested …”

    In the long run SPA3 Risk Profile 5 will provide the biggest profits but along with that will come the deepest drawdowns. It comes down to strength of trading mindset as to whether the drawdowns can be handled over the long run.

    Theoretically the ideal investing situation is to find a small edge that is a “dead cert” and then leverage it to the hilt. However, there is always the outlier event to keep in mind. The outlier event is one that is unforseen, uncomprehendable in advance and even unbelievable WITH the benefit of hindsight. LTCM comes to mind where the inventors of Options (ETOs) defined a tiny but “dead cert” edge and leveraged the hell out of it. An outlier event occurred in Russia that caused a wipeout (drawdown beyond recovery) of their portfolio. This is what happens with leverage – at some stage an outlier event wipes out a portfolio. I have heard so many ugly real life stories of this happening in the last 18 months ranging from put writing strategies to straight-out leveraged portfolio strategies where people have lost ALL their investment capital plus more, like their house! The current markets that we are living through should also be put in the category of ‘outlier’ event. The ugly part of leverage is exposed when outlier events occur just as Lehman Bros and many others have discovered in recent months.

    So I would not recommend that too much risk is taken with any investment strategy. The important phrase in your positing is “relative safety”. Safety and risk are relative to each one of us – this is what makes the markets what they are and it is also what each one of us has to discover for ourselves. And it is an everchanging thing as we learn more and gain more experience but beware the next level, it may just be a level too far. SPA3 outperforms the market in up and down markets and over the long term by many compounded percentage points p.a. This should be sufficient.

    There are many concepts and combinations that we have back tested and would like to back test. We will never get them all done. % hedge is a good one and one that I will be writing up in the SPA3 hEdge documentation.

    Another point on back testing. It is impossible to back test the entire universe that surrounds a concept and even if it could be done there will be variables that will occur in the future that do not even exist now that will be outside of your defined set of varibales to research. This means that risk cannot be researched away or defined away. It will always be there. So we can either run for the hills in fear or we can embrace risk because the upside of risk is reward and reward flows from overcoming fear and fear is conquered through faith and trust. So the question will always be: “In what do we place our trust wrt trading and investing?”

    Also, I ommitted to answer your earlier question about SPA3 hEdge with SPA3CFD. There won’t be much difference between heding a SPA3 portfolio and a SPA3CFD portfolio because we only hedge when Market Risk is High and the SPA3CFD processes are exactly the same as the SPA3 processes during SPA3 High Market Risk periods.

    Regards, Gary.

  • Gary Stone says:

    Reply to Comment by Kyle:

    “Is there not a risk that the probing of the marking that results in drawdown will, in the case of a prolonged downturn, eventually run capital down to a point where one cannot continue? Hedging will reduce this effect but a long enough bear market would achieve the same result. Such a result might define “not working” as discussed above.”

    Kyle, This is right at the heart of the entire matter of trading. In essence, this is the fear that everyone has and it is the greatest single thing that every investor, active or passive, has to overcome. The question is, how can it be overcome?

    As a starter, study Mark Douglas’s book “Trading in the Zone”. Also, Try and get a set of his “Path to Consistency” tapes and listen to them over and over again. They were out of production but I believe after chatting to Mark by phone last week that they will be available again soon. Visit: Mark Douglas’s website

    Part of the process of overcoming this fear (let’s call it a “universal fear” because there are fears which Mark calls primal fears that need to be overcome on each individual trade) is deploying an edge in the given market(s) that you trade. You can either develop you own edge or you can obtain one. Either way, you ultimately need to trust the edge that you trade.

    There are two kinds of edges, mechanical edges and discretionary edges. BTW, by definition, an edge will make money over a large sample of trades otherwise it is not an edge. I will leave the details of this comparison for another Blog posting in the future.

    The SPA3 edge has proven through live trading for over 10 years, and even in this outlier event that we are experiencing right now, that SPA3 drawdown is less than the market drawdown. The SPA3 Risk Management rules ensure this. If the market continues to fall, say to -60%, then the ongoing probing will continue but there are fewer and fewer signalled trades to the point of possibly even none and the ones that are signaled are opened with half position sizes all ensuring that portfolio exposure to the market is greatly reduced which, in turn, means that a SPA3 portfolio hardly falls while the market continues to fall. SPA3 hasn’t got to 0% invested before (unless by choice through using SPA3 Risk Profile 1) but has been as low as 12% invested (i.e. 88% cash).

    SPA3 does not deploy leverage at all but even SPA3CFD (which does deploy leverage) doesn’t use leverage during a SPA3 High Risk Market. IMHO leverage is one of the main causes of people acheiving portfolio wipeout. Combine leverage with no well defined exit strategy and you have a recipe for disaster.

    So in a -60% market on the index our research shows that SPA3 portfolios, on average, (depending on size of capital and SPA3 Risk Management rules used), would expect to endure a -30% to -45% drawdown. This is without using SPA3 hEdge. Having said this, it is possible to nearly eliminate drawdown in such markets by using a more conservative SPA3 Risk profile but such a profile will make less profit during a rising market. This is is without using SPA3 hEdge which would help even more.

    While we are doomsdaying let’s look at the worst possible scenario. In the event that a 1929-type outlier event occurs, which was -86% on the Dow, we would still expect to have drawdown of far less than the market (-43% to -57% for SPA3 Risk Profile 2 portfolios) but it wouldn’t really matter anyway because 1929 was nearly a total reset of all asset values for just about everybody. We might all be standing outside Baker’s Delight nationalised bakery for our daily handout!

    Which is why I said in an earlier posting that it is all relative. For an equities edge to be considered working, it must go down by less than the index of a falling market and rise by more than the index of a rising market. And not wipeout. There is a very low probablity of wipeout for an unleveraged equities edge that uses technical exit signals. Technical exit signals that are mechanical and that are followed ELIMINATE large loss trades such as Babcock & Brown, MFS, Allco, Centro, ABC Learning and many others.

    In my view a portfolio wipeout is drawdown beyond 70% – 75% where a portfolio needs to rise by 233% – 300% to reach the value it was at before the 70% drawdown occurred. This can still be achieved with favourable marlet conditions (the Dow rose by 356% in the 4.5 years after the 1929 – 1932 crash.) For medium-term trading the portfolio should also remain above a minimum of $50,000 to remain above a meltdown point caused by minimum brokerage levels.

    The point is that a SPA3 portfolio of $125K or greater should not get anywhere near wipeout and the market conditions required to get anywhere near wipeout will be so severe that it won’t really matter because all asset values will be so depressed and cash will be so inflated (to give you an idea imagine the financial system around the whole world being like Zimbabwe’s at the moment) that we’ll all be in roughly the same boat.

    I know that this is pretty ugly stuff to be discussing but we do need to know the boundaries of any environment in which we operate. We better leave it there.
    Regards Gary.

  • Otto C. says:

    At a time in the past I was a SPA subscriber and having looked at many approaches to share trading I have found your mechanical system the best and the most consistently reliable. I have also traded futures in currencies and commodities for an eight year period in the past using a trend-following mechanical system, giving me modest but positive returns. For share investing (holding for a year or more) I have used company and share value fundamentals to make selections, resulting in a compound return before tax of 27% over a ten year period. However, progressively from November 2006 to July 2007 I sold ALL my shares, because I could see that the American economy and stockmarket was in “mania” territory. I based this view on observations of debt levels (even higher than pre-1929 as % of GDP), over-inflated asset valuations (similar to Japan in the late 1980’s), price to book ratios of stocks well above normal and other signs of economic deterioration. I wasn’t alone in taking this view, several writers also warned of a pending major dislocation in the economy (see: Robert Prechter, Harry Dent, Bill Bonner and Addison Wiggin in the USA and Steve Keen in Australia – although I only heard of Keen in the last few weeks). Thus whilst I think your system is excellent during long-term boom times (such as we have seen for most of the time since the second world war) it does expose followers to inevitable losses during a meltdown as seen at the present time. Granted, your risk adjustment reduces this loss and the result will still be better than the market average. Given the strong and likely severe bear market, will you consider amending your risk calculations based on an analysis of market and economic fundamentals, so that at really bad times there is zero investment in stocks? For what it’s worth, in my opinion the causes that led me to my concern about the US economy have not improved (and Europe also has deep problems), so I believe that stockmarkets around the world still have long, long way to go down.

  • Gary Stone says:

    Reply to Comment by Otto:

    “Given the strong and likely severe bear market, will you consider amending your risk calculations based on an analysis of market and economic fundamentals, so that at really bad times there is zero investment in stocks?”

    What you are talking about is a shut off valve for SPA3. This is used by trading systems in futures markets and trading of other leveraged intruments. We have considered this (in fact I spent many man months of R&D working on a SPA3 index to implement such as tactic) but have decided to implement a different solution to achieve the same outcome, SPA3 hEdge, which hedges a SPA3 portfolio during SPA3 High Risk market periods. We will be releasing the documentation and rules in the next few of weeks (as soon as possible).

    The big problem with a portfolio shut off valve is how do you tell in advance when we are facing a “really bad time” and a not-so-bad-time and a temporary market beather and get it right most of the time. You used fundamental economic data in this instance and got it right. Research and human performance shows that it can’t be done on a consistent basis. Will your criteria be repeatable the next time we have a severe market downturn?

    Another problem with using a portfolio shut off valve is not knowing when to start up the portfolio again. There are ways of doing this that futures markets money managers use but they are pretty complex for private investors to implement.

    This is why we advocate a mechanical methodology – everything that a mechanical trader does is repeatable in the future. With SPA3 hEdge in place the fear of a “really bad time” can be subdued (hopefully eliminated for most) and the associated losses can be mitigated for the SPA3 ‘long’ strategy.

    I accept your opinion about the future direction of the market. I try not to have an opinion about future direction as it affects one’s execution paradigm. However, Warren Buffet is reputed to have recently made his biggest buying commitments ever (on his personal account, not Berkshire Hathaway’s). My point is that there will be many opinions out there. At times like these opinions are magnified. This is all part of the melting pot that makes a market. The task for each investor, private or professional, is to achieve objectivity and consistency.

  • Otto C. says:


    As usual your comments are always interesting and give readers the opportunity to challenge their own thinking about trading methodology and (more importantly) psychology. I thank you for your reply to an earlier comment I made and for your article about Warren Buffet. Today I would like to add the following thoughts.

    I saw an interview with Buffet on TV where he mentioned the points made in your article, but he also said that up till now he had all his money (in his personal account) in bonds, not in stocks, but he was now willing to again enter the market. The interesting point here is that Buffett actually did ‘time the market’ because he had not been invested in stocks. Clearly he took a view that the economy was overheated and stocks in overbought territory. In 2003 he had also referred to financial instruments in America as ‘financial weapons of mass destruction’.

    For short-term trading I believe that a mechanical system, such as SPA, is the only way to go, because it is the only method that allows testing of performance going back in time and thus give the confidence that enables one to have the courage to keep on trading consistently. Even in major bear markets there are upward corrections (as we are seeing in the last few days) and this volatility can result in profits. However, during bear markets there is a bias towards losses in share trading as one is long in shares, as distinct from futures trading where one can be either long or short.

    Investing in shares for the long term is an entirely different matter because the potential losses can be devastating if a position is held through a severe market meltdown as was experienced in the 1930’s and seemingly at the present time. The conventional wisdom of financial advisors is that one must be in the market for the long term, but most are silent on what long-term means; is it 3, 5, 10 or 20 years? The Dow took 25 years to reach the high at which it was just before the crash of 1929 to 1932; after having fallen by as much as 89% from its high point!

    Falls in the market of this magnitude are not that unusual. The Nikkei in Japan fell by 80% from a high of 38,806 in 1989 to 7,607 in 2003 (it went up since then but is nearly back down to this level now). The NASDAQ dropped by nearly 80% between 2000 and 2002 and the German DAX fell by 73% during the period 2000 to 2003. Falls of over 40% are quite common; I have counted 11 in the USA over the last 100 years.

    The big crash and depression of 1873 lasted 5 years and was reportedly more severe than the 1930’s crash, with many bankruptcies including bank failures, high unemployment and closure of the New York Stock Exchange for 10 days. It arose after a period of high debt with easy credit of the sub-prime variety and inflated land and property prices in the US and Europe. Although I do not have the stock prices of that era one can assume that the stock market falls were severe.

    I think one of the problems is that the people alive during the big depression in the US, and consequently also most Western countries, are not around any more, at least not in decision making roles and the memory of those days is lost; even Warren Buffet was just a baby during the big depression of the thirties. I have read about high profile people of that era who lost their fortunes and never again returned to the stock market. I think reading about it and experiencing it are entirely different things.

    There are other times than the very big market meltdowns where people can suffer very poor returns. The 25 years wait from 1929 to 1954 to get to the same price level as earlier goes beyond the period most people are prepared to wait. But even waiting for 10 years can be painful and US stock prices were lower than 10 years earlier on 16% of all days over the last hundred years; at least in the bank the money can earn interest. Granted, these statistics assume buying stocks at a peak and selling at a low which fortunately we can avoid most of the time.

    Yes, timing the market is not easy and usually not necessary, but there are times when the excesses of nations send out strong signals that problems are ahead, where certain aspects of an economy are in ‘mania’ territory. Everyone has heard of the tulip scandal, the South Sea Company bubble and the 1930’s depression, but we also had (and still have) a huge debt bubble in the USA and also in Europe that must find a resolution before things can get back to normal.

    Conventional economists do not acknowledge this, but writings by the economist and Noble Prize winner Irving Fisher in the 1930’s (after he re-examined his earlier and wrong conclusions) and today the work by Professor Steve Keen in Australia show the traditional theories are based on wrong premises. If we look at the work of these people we can see that major dislocations in the economy that eventually lead to depressions and collapses in the stock markets are predictable.

    Warren Buffet has acknowledged the excesses of the market and stayed out of stocks until now. I have the greatest respect for his investing skills, but it is worth noting that he made his fortune during the long-term boom period since the Second World War.

    In your response to my earlier blog you asked whether fundamental criteria can be repeatable the next time we have a severe market downturn. I believe it can, Robert Prechter in the US and Steve Keen in Australia are living proof of this, they predicted the present scenario six and seven years ago. This said, there is a problem of precision in forecasting, the economy has chugged along with share prices rising for many years whilst the seeds of a collapse were already present. The only way to handle that is to take note of the danger ahead and then watch for more immediate indications of a turn in the market, although this part of the decision does require an element of human judgment.(Although I have not done so, maybe a form of trailing stop could introduce an degree of objectivity?)

    Incidentally I had developed an algorithm using stock prices and performance data over the last 90 years which gave mechanical signals of major falls shortly before the market turns in 1929, 1987 and 2008, but also in 1936 when the market in Australia went more or less sideways for a long time. However, I do not give much credence to this approach as only four signals is not statistically reliable; I prefer instead to rely on fundamentals for the truly big changes in the market.

    Gary, maybe you are right and there is no better way than to follow your mechanical system with the inbuilt risk adjustments for acceptable returns over the long term, however at this time I prefer to follow what I perceive to be strong indications that the economy must first adjust before the stock market gets back to a sustainable uptrend.

    Otto C.

  • Alex says:


    Your discussion of the current market conditions,is very insightful.I am a novice trader of only 3 years, but I also read extensively, from many sources and I also concur with your assessment of the market.My husband has been in real estate sales for the last 12 years and the mania there has been incredible is and overdue for correction.

    Nevertheless, a profitable trading strategy “should” theoretically be able to be traded in almost any market conditions, although the increased volatility is a challenge.I am not an SPA client, and I have also experienced drawdown in my portfolio, but not of my equity, only from my profits, so I believe this is a good result, in this market.

  • Gary Stone says:

    Reply to Comment by Otto:

    Thanks for your posting, it is an excellent contribution based on much research that all readers, including myself, can learn from.

    “The interesting point here is that Buffett actually did ‘time the market’ because he had not been invested in stocks.”

    I agree with this and he does quite a few things differently to what most believe he does. The “weapons of mass detsruction” was in reference to Exchange Traded Options. He has always bagged options but uses the exact same concept himself through OTC options which he negotiates directly with companies.

    “…maybe you are right and there is no better way than to follow your mechanical system with the inbuilt risk adjustments for acceptable returns over the long term.”

    There are many ‘right’ ways to go about it and it doesn’t really matter which ‘right’ way is used provided it meets the investors personal requirements of skill level, time available, investing horizon and capital. I know that all the ‘right’ ways will display similar characteristics. Regardless of which markets / instruments are invested in they will have a method of determining when to maximise exposure to rising prices and minimise exposure to falling prices. There are various techniques that can be used to do this but they will all be made up of a combination of timing, position sizing and risk management. Even Warren Buffet does this.

    Having said this, there are many more ‘wrong’ ways of doing it than ‘right’ ways. The wrong ways will omit all or portions of timing, money management and risk management.


  • Charles Fleming says:

    Congratulations on the initiative Gary and I’m confident that as a new subscriber there will be benefits for all. I have yet to open my SPA portfolio and wonder whether it would be better to wait for reduced volatility in market before doing so. Still have “old” portfolio to pick up eventual kick off.

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