In the midst of the recent market volatility and account drawdown, I’ve received a few questions about my trading strategy. I’m happy to answer these questions any time, and of course they seem to be far more frequent during equity pullback (drawdown).
Believe it or not, these questions are extremely easy to answer. As a quantitative trader I follow a strict set of rules that I have tested and measured. I believe this set of rules has a significant edge. I’ve written a lot about drawdowns and losses on this blog, so in no way do I believe they are avoidable. They are just tolerable and a part of the system.
Why did you sell XXX?
One common question is why I sold a particular stock at a particular time. My tested trading rules predetermine the exit point for every trade before it is entered. Some exits are profitable, and some not, but all follow specific rules. I don’t reveal my exit rules, as they are a part of my proprietary trading system. Specifically, I was asked about why REDF was sold last week. That particular trade was exited because it had reached a preset profit target.
Why did you suddenly become full invested?
After many weeks of minimal market exposure, and quite a lot of time fully in cash, it might seem odd that I was fully invested. Backtests indicate that average exposure to the market over the past 12 years is about 25%. This average, however, is made up of many times in all cash, lots of small positions and a few occasions when I was “all-in”.
To be a little more precise, in backtesting over the past 12 years there have been about 85 occasions where I was fully invested, or nearly so. On average that’s about seven times per year. Generally these fully invested “moments” last only a day or two, with the longest lasting about 10 days.
Why did you invest so heavy in silver stocks and ETFs?
Another question that was asked was why I had so many positions in silver during this last onslaught of trades. This is similar to questions I have answered in the past about diversification. In other words, why did I take so many trades in one particular industry or sector?
Recently I faced a similar issue which I raised around the problem trade with Puda Coal. This wasn’t specifically about industry, but about foreign stocks. Should I filter them out? Should I have special rules for them?
As discussed in this post, I’ve done a fair amount of backtesting in this area. My conclusion is that filters and limits around industry, sector, country, and most other criteria do more harm than good. I admit it’s scary and feels risky to take more trades in a specific group. It’s important to realize, however, that mean reversion tendencies work on groupings of stocks, just as they do on individual stocks. In fact, groups (such as industries) are generally more mean reverting that individual stocks, which can be affected by isolated company issues.
For example, when coal companies tanked in early April, I bought Puda Coal (Ouch! Don’t remind me). The coal industry as a whole snapped back quite nicely, but Puda never did, due to company specific shenanigans pulled by the CEO. Here’s one instance when I wish I had bought five coal companies instead of just this one.
How do you feel about your trades during these last losses?
I hate losing money as much as the next guy. Believe me, it’s always painful. That being said, I will stay the course. I have a tremendous amount of confidence in my trading approach and the engineering behind it.
One of the reasons I like being a quantitative trader is because I can look back and effectively decide if I made the right decisions. The right trading decisions are not emotional. The rules I follow are backed up by extensive research and data (literally millions of trades). Probabilities fail us sometimes, especially in shorter time spans; but over the long haul I will side with the edge.
Good Trading…
When it comes to industry diversification, I can see benefits of owning more than one coal company at the same time. But why would you want to enter several ETFs in the same space (3 silver ETFs: DBS, SIVR, and SLV on 5/3/2011)?
ReplyDeleteMark
Mark,
ReplyDeleteYou make a fair point. All ETF's of a sector do not trigger at the same time, but they can correlate closely, especially during violent moves - which is what we saw here. The point I made above still applies, however. When there are strong moves in an industry group the probability of mean reversion for the group is very high. VERY strong moves might trigger multiple ETFs from the group, but have proportionately high chances of reversion.
Is there a place for limiting exposure to a single ETF in a given industry? Absolutely. I have not specifically tested this with silver, but where I have tested in other industry groups one would generally see lower returns, simply due to less trades. The probability and return of each individual position doesn't change much.
In an isolated "bad" scenario, like I recently participated in, it seems better, but over thousands of trades it really isn't. Therefore, you could take that approach, accepting lower returns, in return for less impact during the "gray swan" event (not quite "black swan"); but I have chosen the slightly more aggressive approach based on the longer term probabilities for higher returns.
I hope that is helpful.
Bill