Risks of the MultiStage System

One of the questions I receive frequently is about the risks of my MultiStage Trading System. People want to know what the risks are and how I mitigate them. To some degree there is no good answer. At least not the answer people really want... like, "there is no risk"... or, "it's very low". The fact is, anytime you are investing in the stock market there is risk. Stocks go up and they go down. They react to market fundamentals, economic factors, and news. All of the risks inherent in stock trading apply here, but I can be a little more specific to risks of the system:

• Anomalies: Statistical anomalies occur in the market and can create substantial drawdown (9/11, Lehman, etc.). Currently these are few enough that I am willing to endure the risks, but they exist and should not be ignored. In order to understand these well I’ve done an exhaustive study of the 11 year history of drawdowns of this system. You might want to read that post and you’ll get a feel for what the historical “worst case” has been.
• Neutralization: In my opinion, this is the biggest risk. Not because it has a high probability of happening, but because if it does the gig is over. Market conditions could change in a way that renders the current system ineffective. In all likelyhood this won't happen over night. Instead we would see a gradual diminishing return. In order to understand if this is happening I monitor several metrics and market conditions to be sure that my approach remains effective.
• Human error: While I make every effort to follow the trading parameters precisely, occasionally mistakes are made. Mistakes are tracked and measured to determine their impact, and how to avoid them in the future. Additionally, trading automation is employed for several steps of the trading process. This migration will continue as technology and resources allow, reducing the probability of errors. Finally, each month I compare my actual trades to the trades of the model. Rarely are there variances, but it shows me exactly where I didn't follow the model precisely.

Aside from these, and as stated above, all of the risks normally associated with stock trading exist. One of the fundamental ways of managing this risk is to pay close attention to position sizing and only take trades that have exceptionally high probability of success, another inherent property of the MultiStage Trading System.

Good Trading...