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What Now?

|Includes: ProShares Short VIX Short-Term Futures ETF (SVXY), XIV

Losses stink and no one wants to have them. But it is a part of life when you try to tame the bucking bull that I call the VIX cycle. My portfolio is down at least 6% so far this year. If you can't deal with losses and stay calm under the pressure of the drawdowns then you are in the wrong trade my friends!

You Are Down - For Now

When the cycle turns and we start heading up again you will more than make up for any losses you have. To me it is very important to preserve capital when you are taking such high risks in something like (NYSEARCA:SVXY) or (NASDAQ:XIV). That is why I didn't hesitate to liquidate 80% of my holding at about 5% lower than I bought in. You are much more likely to have a positive outcome selling at a loss and buying back once you get a confirmed bottom.

This chart shows the delta between holding after I went all in @ $63.03 = 12% drawdown and selling 80% SVXY @ $60.05 = 16.2% drawdown + buying it all back at different drawdowns. The -4.2% is the loss I took by selling 80% of my position early. Why is it so important to sell for capital preservation? See for yourself. (Forgive the chart, it isn't the simplest to read but all the relevant info is there)

TOP SVXY $71.63          
20% Buy $ $63.03 $63.03 $63.03 $63.03 $63.03 $63.03
20% Draw % 12.0% 12.0% 12.0% 12.0% 12.0% 12.0%
80% Sale $ $60.05 $60.05 $60.05 $60.05 $60.05 $60.05
80% Draw % 16.2% 16.2% 16.2% 16.2% 16.2% 16.2%
80% Buy $ $46.56 $50.14 $53.72 $57.30 $60.89 $65.18
80% Draw % 35% 30% 25% 20% 15% 9%
AVG Buy $ $49.85 $52.72 $55.58 $58.45 $61.31 $64.75
AVG Draw % 30.4% 26.4% 22.4% 18.4% 14.4% 9.6%
% PROFIT TO $71.63 43.7% 35.9% 28.9% 22.6% 16.8% 10.6%
% Profit Without Selling 13.6% 13.6% 13.6% 13.6% 13.6% 13.6%
Delta - 4.2% "Loss" 25.8% 18.0% 11.0% 4.7% -1.0% -7.2%

Focus on the 80% Draw % row and then work up and down from there. I am pretending I bought back my 80% position at 9%, 15%, 20%, 25%, etc. drawdown and comparing that outcome to if I just held on 100% @ $63.03 purchase price = 12% drawdown.

Notice that I come out ahead (Delta Row) by selling when I did in all examples except the 9% and the 15% drawdown buy price. And the 15% buy is only off by -1% if I held it all at my 12% draw original buy price. Basically a wash. So only if i was way off on my sale day and the SVXY moved swiftly in the positive direction would I have "lost money" by selling and buying back at a much lower drawdown. Worst case scenario I would have made at least 6% profit including my loss on the earlier trade. Most people would take a 6% profit for 2 months of trading.

Now look at the left side column extremes. If you held while we had a drawdown of 30% you would be waiting for the SVXY to go up 36% and you only get to capture 13.6% of that gain. Not only that before we moved up you were starring at a nearly 20% "loss" of red....And the human tendency is to sell when the pain gets high - at the absolute worst time to sell...Can you hold on starring at a 20% loss if you were "fully invested" in SVXY?? Most people would not hold out.

Two questions are probably going through your head right now - even if I agree with you doesn't that mean you should have sold it all? Why keep 20%, why not 10% or 40%?? I am stricking a balance between two investment strategies, limiting my downside risk AND keeping some skin in the game to keep me honest.

#1 - If I have no skin in the game (sold it all) I am less likely to stay on top of the trade and get in at the right time. I learn quicker this way.

#2 - If I am way off on my sell timing and SVXY went higher quickly so I decided to go 50% SVXY and 50% UPRO or TQQQ then the SVXY 20% buy level is still less than half (20% of 50%) of the total amount of SVXY I want to own (hope that makes sense).

The psychology of the sale is very important. Being prudent by admitting you were wrong and selling early to look for a better entry point will save you many more times than it will hurt you. Just think how screwed you would be if this was in fact the big one like 2011 - that was a 74% draw down and it took 16.5 months for you to get back to even had you bought at the top!

If you used my sell 80% when you mess up calling the bottom strategy and entered using my buy signals you would have gotten back in 80% at the 72.51% draw down level. Even if you bought that first 20% at the top you would be at an average 58% drawdown buy price minus whatever loss you took before you sold that 80%. Much MUCH better situation. You would have been back to making money in January 2012 just 3 months after the bottom vice sitting on a loss for 15 months!


Friday Vratio indicator might be showing us the bottom....Or we could have one more break to the downside Monday to shake out the scared hands. I just don't know if this will last past Friday's jobs #. Emerging markets problem is not likely to snowball, S&P earnings are actually really good, P/E of stocks have gone way down since last quarter. The economy is growing in the US (even if it is mostly Fed driven) we have to keep this in mind. This is not major pullback conditions unless something else is triggered in China or another problem that hasn't shown itself yet.

Bill Luby published an article on Friday that stated he was
"Disclosure: Short VIX and VXX at time of writing". That guy has forgotten more about volatility then all of combined know about volatility!

I am going to stay 20% long SVXY and wait until 3 indicators are in the green and then add ~50% to my SVXY position. Then I will wait until it looks like we will close below VIX 15 to add the rest of my position - that position may be UPRO or TQQQ depending on where SVXY is compared to stocks.

Enjoy your Superbowl Sunday!

Disclosure: I am long SVXY, SPY.

Additional disclosure: 20% Long SVXY trade account and 100% Long S&P 500 in 401k