Leaving a Miserable Trade and How to Avoid Future Problems

On July 30 of last year, I recommended taking a long position in the market as I considered it oversold on a short-term basis (using the CRB Stock Market Momentum Indicator), and was anticipating a bear market rally. As it turned out, the market was just in the beginning stages of a massive collapse, and the trade turned out to be a miserable one. A closing signal for this trade finally came after the close on June 17. During the 323 days the trade lasted, the S&P 500 fell 27.4%. A graph with entry and exit points for this trade is shown below as well as a table with historical results from this momentum trading strategy.

Time to play defense

We now have two consecutive unprofitable signals. To keep that in context, these signals have come during what has been one of the most vicious bear markets in the last hundred years. I have not lost faith in the usefulness of this momentum indicator as a timing tool, but to avoid blunders of this magnitude in the future, I will be using a stop-loss rule for the trade. Furthermore, given the current oversold conditions, I think this is a good time to close some long positions or perhaps sell near-the- money call options on existing long positions with expiration anywhere between July and October.

Comments

[prairiedog555:]

At what % would you put your stop/loss, or trailing stop?

Jun 19 08:38 AM

[CPST1:]

VZ is a good near the money call example as of late. But, the question of balance or that within the context of stop/loss if in regards to(selling covered) is as questioned above the percentage to institute a measure, which rolling options. eg. VZ june 30's into july 30's. quote.morningstar.com/... whereby the ex-div date is July 10 at $.47 sh. From the perspective of the graph the general rule of thumb, is to watch the appearance of the entire market window when the point made is to make a stop + loss position. The error within the VZ example is simply VOD is the better value. Therefore, it is the equity of the position that needs to be weighed, as a function of the stop/loss measure. Or given that with a covered call sets are made to limit the downside risk while attempting to optimize the long term gain.

Jun 19 09:51 AM

[Arnbjorn In...:]

As it is a momentum trade, it makes sense to keep a fairly tight stop-loss. I would say 7% or less from the purchase price.

Jun 19 10:11 AM

[Arnbjorn In...:]

The last paragraph is meant to read "...given the current overbought conditions...", in reference to the rally that started in March. I mistakenly wrote "oversold". I just fixed this on my blog.

Jun 19 10:22 AM

[User 434014:]

No mention of the fact that the drawdown was 50%

When the signal occured, you said it was a short to medium term trade -- 323 days later? No discipline.

You have "not lost faith in your timing tool"? I would suggest anything that is static --in a dynamic, changing market place -- be questioned rigoursly. If you dont adapt you die.

Jun 19 11:01 AM

[Arnbjorn In...:]

No mention? I show a graph of the S&P 500 with the entry and exit points. It is plain to see how much the market fell in the meantime. I also acknowledge that it was a mistake not to use a stop-loss -- had I done that the trade would have been stopped in early September. Essentially, the whole point of this post is to own up to a mistake. However, I did have the discipline to stick to my original plan, which was to close the trade when the sell signal came, so I consider the results of that method much more meaningful than the maximum drawdown.

Please keep the context of my original recommendation in mind. I expected another leg down in the market, as I stated in my blog post, although it came sooner than I expected. For that reason I kept a substantial amount of cash on the sidelines.

As for continuing to monitor the SMMI, it is just one tool in the toolbox. I believe it can be useful, although of course not infallible, as long as you understand how it works.

Jun 19 12:37 PM

[AnnaH:]

User 434014, so you would call holding a position for 323 days long term investing? If so, I disagree. Also, when the predetermined rule was to exit on the sell signal and there was no stop loss rule in place, how would abandoning the predetermined rule and making up a new one midway through be more disciplined?

Jun 19 12:55 PM

[whatanorder!:]

I admire your acknowledging the trade...
:-)Shawn

Jun 19 03:31 PM

[Nyetnichevo:]

Market timing is a recipe for surefire failure. What happens is you end up buying high/selling low...easier to DCA over time into equities you do like for the long haul. How many short term traders fail to understand that simple principle?

Jun 19 05:45 PM