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The last few months have been extremely tough going for medium term active share investors. This has been exacerbated this past week with a rapid increase in volatility and the markets once again moving into a high risk phase. Events such as these are not un-common in the markets and as traders and active investors we must be prepared for events like these and accept that they are one of the many risks associated with engaging the markets. Anything can happen in the markets and the events of the past week serve to remind us that we have no power over the market and that seeking to predict and forecast what the market will do next is more often than not a futile exercise. As disciplined and focused traders and investors, our role is to REACT to the events that occur in the market and have a well researched trading plan that specifies what we MUST do in such circumstances. This will include the management of risk and money through appropriate exit strategies that we clearly define well in advance of such events occurring.

As traders and investors we are operating in an environment with an unlimited number of unknown participants and a limitless number of variables. At any one time any change to one or more of these variables can result in any number of unforeseen circumstances unfolding, often extremely quickly. Each price move is the result of an action by another market participant based on their belief as to what price will do in the future. This is what makes the market what it is – thousands of buy and sell parameters interacting to cause changes in price. It is these interactions that combine to present us with great opportunities to generate profits, just as they present us with the potential to generate losses. We have absolutely no way of knowing what these decisions may be or how the combined result of all these decisions will cause the market to behave. As Mark Douglas states, one of the 5 fundamental truths of the markets is that “every moment in the market is unique”.

We can really only know and understand our own decision making processes and ensure that we strictly adhere to the rules that we have put in place for us to follow. These are our entry & our exit rules and our risk & money management rules, in the timeframe in which we choose to engage the market. At any point in time we have no way of knowing if a trade we enter will be a profitable trade or a losing trade, in our chosen timeframe, because “there is a random distribution of wins and losses for given set of variables that define an edge.” (Another of Mark Douglas’s 5 fundamental truths). What we have are knowledge of the probabilities of the trading strategy we are using and the money management and risk management tools we will employ to minimise our losses by cutting out of losing trades, and to maximise the returns from our winning trades, in our chosen timeframe. This will provide us with our edge over the market over the long term and a large sample of trades.

There is always room to improve a mechanical or discretionary edge within the stated timeframe and stated edge objectives, as perfection in the markets does not exist. The research challenge is to affect modifications to an edge that improves the edge in certain market conditions but does not negatively affect it in others. The overall edge must not be diminished. This research must be conducted away from the heat of the market, i.e. don’t trade modifications that are in research on the fly or allow current market conditions to dictate trading decisions on a discretionary basis.

The ultimate challenge is to trust the edge that you are currently using, at all times, to achieve consistency and objectivity. Whist easier said than done – that’s why it is a challenge – it is the probabilities of the edge over a large sample of trades in which you need to trust as trust overcomes fear and consistency cannot be achieved whilst fear is in control. And you cannot fear and trust at the same time.


  • Shane O'Sullivan says:

    Hi Gary

    Succinct post as always, but I would just add that when you say “money management and risk management tools we will employ to minimise our losses by cutting out of losing trades”, I feel this cannot now be related to SPA’s performance in such a wide range trading market as we currently have. The reasons have been thrashed about in many other forums, but for the moment, until I see that the range has been broken one way or the other, I really cannot trust to exits other than my own.

    I do not believe the edge has been researched in such a climate and unfortunately, the exit rules for this climate are frankly inadequate. It will improve, of that I am sure, but I have not had the confidence in the system for some months to allow 40 and 50%+ drawdown from equity peak before exiting on my own.

    Cheers Gary and thanks for all your tireless work



  • Gary Stone says:

    Reply to Comment by Shane:

    “I do not believe the edge has been researched in such a climate and unfortunately, the exit rules for this climate are frankly inadequate.”

    The rules have been researched across many ‘climates’ including climates such as the one we are currently experiencing. If a long trend following edge is measured over just the market conditions that we are experiencing at the moment it will be negative. No doubt about that. And this should not be a surprise to anyone as the market is range trading and in a wide range at that. If the same system is researched over just a strong rising trend teh edge will be massively positive. Again no surprises there.

    However, Shane, given your trading experience and systems design experience you should know only too well that changing the trend following exit rules to perform better in a wide range-bound market will only make the edge far worse when the market trends again. Whenever a rule change is made to improve one area of a system it almost always diminishes the system in other areas.

    Further, such a wide ranging market occurs very infrequently so the question begs how much change should be made to cater for a small sample of trading conditions.

    The answer therefore does not lie in changing the exit rules it lies in the risk and money management rules, that is, deciding how much capital to commit to a market that does match well enough the system being traded. Before that can be done the trading conditions need to be identified in a timely manner for the risk and money management rules to play their role.

    Remember, no system matches all markets. This is a given which means drawdown is a certainty.


  • David Sayer says:

    Hi Shane,
    The current market conditions have definitely proved challenging for a great majority of medium term traders, SPA3 included. Sideways ranging markets are VERY difficult to trade and the rules that apply to other market conditions have failed to perform this time. Many experienced traders and authors have stated this succinctly. To exasperate the problem, sideways ranging markets have historically only lasted for 2 to 3 month spans; this market has been in place for nearly 9 months.

    You refer to 40-50% drawdown from the peak price. If I may clarify for others, you are talking about individual trades and the delayed exits caused by this market. They are historically much faster. We haven’t seen those drawdown figures for overall un-leverage SPA3 portfolios. As you know the exit signals have been researched and are proven for medium term trading. Whilst this has been proven through a long history of past performance we are not resting on our reputation and are rapidly researching new ways of identifying future range trading market periods so SPA3 can be further improved. SPA3 is not a perfect system and whilst it has proved to out-perform the market bench mark over a large sample, there is always room for improvement. The market has tested SPA3 and SWS. We are responding and excited by the new challenge.

    Regardless of the research outcomes, the general principles of applying money management and risk management rules still apply. Without a set of rules by which to trade, we would have no reference against which to compare our research. In turn we could thus never achieve consistency.

    Thank you for your support. We will continue to keep up the work and support of customers.

  • Gary Stone says:

    Response to Comment by Shane:

    “It will improve, of that I am sure, but I have not had the confidence in the system for some months to allow 40 and 50%+ drawdown from equity peak before exiting on my own.”

    40 and 50+ drawdown is NOT possible using SPA3 trading equities ONLY, that is, unleveraged trading. It is possible using SPA3CFD, that is using CFDs to leverage a portfolio, depending on how much leverage is being traded with.

    In such a wide range-trading market between Oct 2009 and May 2010, when the maximum swings have been around 10% in the All-ORDS, SPA3 unleveraged portfolios can reach 20% drawdown although this is at the upper limits.

    On the other side of the equation, you are right, “it will improve”. By that I mean both the market will trend up again at some stage and that we will improve SPA3 by introducing rules to allow users to step aside in range-trading markets.

    Also, in trending markets, SPA3CFD, using CFDs to leverage a portfolio, has the portnetial to grow a portfolio by 300%+ when the index rises 20%.

    Just need to put both the ups & downs and positives and negatives into perspective.


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