Want To Know How To Trade Your Account Potentially Better Than A Hedge Fund?

Summary

• What is the current Market Cycle Trend, and where might the capital markets go from here in the short term?
• Want to know how to trade your account potentially better than a hedge fund?
• Final thoughts on the capital markets, and what am I thinking for this weeks trading?

Bears out pace the bulls last week as price action ends down on a week over week basis as the broad markets lose ground from its 3363.56 Monday gap higher open to a 3319.47 Friday close for 44.09 point decrease on the week.

This decrease last week was a 13.18 point increase in its range from the prior weeks range on the SPX broad market index.

Last week, we started off Monday where we saw the broad markets gap up 22.59 points to start the session from its prior close, only to move higher most of the day. We had opening gaps higher on both Tuesday and Wednesday as well, but by Thursday the bulls had all but ran out of steam with what I would call a significant gap lower taking out all hopes of a current bottom in play. By Friday the sellers came back in a big way to close the week lower under its 50 period simple moving average.

By Fridays close, when the dust had settled, looking back on the week, we had 3 out of 5 trading days where the close < open. You may want to take a close look at the chart above. As of Fridays close, we now have 8 continuous down market cycle signal bars in the current market cycle trend.

How much lower will we go before we can find a bottom?

The question now becomes, where will the markets go from here?

a few days of selling does not make a bear market, but what we have going on is that the market are clearly getting more volatile on a week over week basis. Only the self directed traders and investors that realize this are able to adjust their positions, and accounts accordingly to keep from having potentially larger drawdowns than those that do not.

What can the intraday data of the broad markets now tell us?

And what might be a potential game plan for the coming week?

As you can see from the chart above, underneath the hood, on an intraday basis, as self directed traders, we want to take note as to how the market is performing to base our decisions accordingly.

Wednesday we traded right up to a recent resistance area, only to trade lower from there the rest of Wednesday with a large gap down into Thursday continuing into Friday market action.

What does this mean?

According to our intraday chart, based upon technical analysis that we have, we may go lower from here. Keep an eye for how price acts here at the 50 period moving average for confirmation one way or the other.

How to trade potentially better than a hedge fund manager?

Back some years ago, I use to fool myself into thinking that I could easily beat the markets by simply finding an online service or trade advisor to follow. I mean, c'mon with the Internet these days, surely there is someone that knows more than I about the capital markets, right?

Now don't get me wrong, there are some good firms out there, with some being exceptional, but the majority can not beat the markets on a consistent basis for an extended period of time, and then... Well, some just mess up in a very big way, or worse yet go totally bust.

It can and does happen. Thinking worse case the name Madoff comes to mind, and then there are others, that maybe just make a catastrophic mistake for whatever the reason.

Maybe they don't have trading plans that take into account the potential black swan, or red herring event? Or can one of these events, or large outliers even be avoided?

Let's look at a real life example where one such firm went bust. What were the market conditions leading up to the bust, and what can we learn? A few years ago, a gentleman by the name of Mr. James Cordier, a well funded hedge fund manager, went bust. On November 16h, 2018 Mr. Cordier issues a video apology to his clients for losing their portfolios.

Could this financial disaster have been avoided for his firm, and his clients? And if so, how?

As you can see from the chart above, on November 16, 2018, when Mr. James Cordier issues a video apology to his hedge fund clients for losing their portfolios at some point during the prior week, was marked by a period of down market cycle.

October 4th, 2018 - January 7th, 2019 marked a period of higher volatility down trend in the financial capital markets, relative to recent past. While the video apology, and the loss of funds for everyone involved is not to be made light of, perhaps there were tell tale signs that were missed, which led to the demise?

When looking at the chart above, on October 4th, more than a month early, from the announcement of the firm going bust, the market cycle trend went from green to yellow, a potential transitioning state. Then a few days later, red, a day prior before the down trend really took off with a vengeance on October 10th.

Hindsight is always 20/20, but cash is a position.

How would this have worked out if Mr. Cordier's fund been in cash?

Or if not fully in cash, perhaps modified the dynamics of his trading style to take into account what was now a down trend lasting for an extended period of time (more than a month) might the financial catastrophe been avoided?

If I were to guess, since from what I understand, he was generating gains primarily as an option seller, his fund may have taken on too much risk to the portfolios through short put options either naked or through bullish put diagonal spreads, both of which can be very popular option strategies in bullish market environments, but also can produce devastating losses in a prolonged bearish down market cycle.

Whenever a put diagonal spread is going, it only works out long term when your underlying asset moves sideways to up going forward into the future.

Since the future can never be predicted with absolute certainty, there is always a risk of potential loss on any one position.

I have not found these types of strategies to have an edge that I can easily manage in a more prolonged volatile down market on a position by position basis. The only way I can think of possibly doing them is when markets are more volatile and bearish, is by doing some other additional portfolio hedge thereby adding more negative delta to the overall portfolio to compensate which may be worth further exploration, but even then it would tie up capital unnecessarily for a prolonged period for those more delta positive positions to work out.

Additionally, if you have naked puts in play in a down market, the risk here is that, since you can be put your stock at a lower cost basis, only to have the stock sink even lower before turning around (if and when they ever do?) which is opportunity cost of the capital, meaning, is this the best use of your capital, and can there be better opportunity with a different trading strategy?

What happened exactly?

I am not privy to the specifics any more than what the publicly available video provides, but maybe there is a lesson to be learned so that the calamity has less than likely chance to be repeatable.

Perhaps taking into account the market dynamics, to be trading with the current market cycle trend, and by adjusting trading strategies to either be in cash or more delta neutral to negative, when the market cycle trend is flashing yellow, and / or red, is a more prudent approach to consider when we are in a more volatile down trend is something to consider and more prudent approach to trading the markets?

It certainly appears to be a more viable approach than whatever trading strategies this particular hedge fund had in place during the same time period from our thoughtful analysis.

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When the markets start acting wild, or different from what you are expecting, or have been experiencing, as a self directed trader, sometimes it may be better to simply step to the side as a capital preservation measure, unless your experience level or trading plan dictate otherwise.

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Trade Ideas for Next Week

What are my final thoughts, and how I am planning to work the markets in the coming week ahead?

Just like in life, the markets are dynamic, and ever changing. As a self directed trader, one has to bring fresh ideas and be prepared to go to battle every market day. To be a winning trader, one has to have an known edge that he understands how to duplicate, know when he doesn't, and be able to quickly discern when the two are at a cross roads.

A gold nugget of wisdom that I came across some years ago, that has stuck with me, goes something like this:

"When you don't know what the markets are doing, get out."

that piece of advice has stuck with me, and has come to serve me well, especially in down markets. I have come to realize that no matter how smart or prepared I think am, or want to be, sometimes I just don't know what I don't know, and by simply getting out of the capital markets, it allows me to regroup, protect my capital, to be ready for trading them when the opportunities are better to produce winning trades that are in my wheel house and comfort level.

Three weeks ago, I went to 100% cash on Friday.

Since then, I am primarily doing some credit spreads on an intraday basis on the SPY on days of expiration. This type of trading requires much attention to the markets while the trade is going, but does take advantage of higher volatility, and has the potential to produce a winning edge, but you have to be able to get the direction correct for the most part and also on an intraday basis. You have to also be prepared to get out, closing the position down, if the trade is not working out, otherwise losses can get exceptionally large, which is what I am typically trying to avoid first and foremost with my trading.

With the market cycle trend now red for over a week, becoming more volatile in a down trend week over week basis, I won't be in any hurry to put on any new bullish positions until the markets are decidedly less volatile and have found a bottom at some potential support level.

With the increased volatility we are seeing, I will primarily be looking to continue to write credit spreads on the SPY, for the most part on an intraday basis, until the markets can find a bottom, and look more promising to go higher again.

Thanks for reading...

Today, I wrote about the current state of the markets, including the current market cycle trend using my proprietary trading tools, how to potentially trade better than a hedge fund, and discussed a game plan for the upcoming week.

Questions, or comments? Send me an email, I would love hearing from you!