January 19, 2015
We all have a love/hate relationship with this basic investment element. Most misunderstand or misapply it. Few truly have mastered it.
Because, without risk…there is no reward!
However we want the best of both worlds… A low risk, high reward opportunity.
There are many types of risks in the markets to be defended against. When buying and selling in the world's financial markets, whether for the short or long term, the longer you trade, the higher the chances become that you will have to deal with each of these types of risk.
Other than the risk of your trade’s failure, you have the risk of slippage on entry or exit, gap risk if you hold overnight, risk that your broker or another third party could go bankrupt, exogenous risks from world events, coups, wars, terror, and acts of God.
Many traders just assume that there is nothing they can do about the risks perceived as “systemic,” such as unscheduled news or world political events. The reality is that each type of risk CAN be mitigated with proper strategy.
We have systematically attacked each type of risk, and here are our solutions:
Turning our focus inward to the intra-day session allows us to reduce the risk of a news event occurring while the markets are closed which might produce a violent “disaster gap” opening the next day.
The drastically reduced time exposure of an intra-day position makes it extremely unlikely that we would have an open position if/when a shock event hits the markets.
By measuring and objectively being able to identify where liquidity pools will form, we greatly reduce the chances for missed fills or slippage.
To avoid hidden counter party risks, we choose our brokers well. These brokers weathered the recent shock event well when the SNB (Swiss National Bank) lifted the Franc’s peg to the Euro. This caused a total panic in the market, where many traders got their stops filled after the franc produced a sudden and immediate 30% gap.
These uncontrolled losses have caused one forex broker to file for bankruptcy, and strongly affected other top forex brokers, many of whom have needed to seek outside capital infusion to keep them afloat.
Ross Ditlove, CEO of MB Trading, our choice for trading FX, had this to say after the dust settled…
“Our Forex customers on all of our integrated platforms, including our own MBT Desktop Pro platform, cTrader, and MetaTrader, saw almost no lapses in trading availability. There were definitely fast market conditions in pairs like the USD/CHF and EUR/CHF that caused price gaps for some customer orders, but overall, the impact was immaterial.”
MB Trading also reported that only a small percentage of customer accounts were negatively impacted and that there was no consequential effect on the firm's net capital requirements due to the news.
And the other broker, Interactive Brokers, who is our choice for stocks, futures, and options, took a loss of $120 million, which amounted to just 2.5% of their net worth. Obviously, this reflects how well diversified they are (a critical factor when choosing a broker).
While no risk management effort can ever be 100%, we sleep well at night knowing that the odds are minuscule that any losses will come outside of our normal procedural losses during trading operations.
By focusing on minimizing risk, you can outperform your peers just by avoiding a few of the surprise losses that many of those you compete against will have taken.
Remember, every loss you can avoid through proper actions has the same impact on your bottom line as a winning trade…Don’t believe this can be true?
Imagine that you are up 10% for the year. You see a trade, but choose to pass on the opportunity because you know that there is an important central bank meeting. The results of that meeting cause a knee jerk reaction in the markets, which would have triggered your stop loss had you taken the trade.
The 1%-2% you avoided losing, puts you ahead of all of your peers who got suckered in and took a loss on that trade. The next winning trade they get will have to fill in the hole of that loss before any new performance levels can be hit, while you get to immediately add your profits to the bottom line.
With our "manage risk first" focus, we substantially reduce the risk to our capital, so we never wake up at night with a nightmare of getting “the call” that tells you your net worth has sustained a financial disaster. We look for the special situations that deliver to us our alpha, and trade with calm and without stress as we know our money is on the best possible path to growth.
The Swiss Franc debacle has already taken its toll on a number of brokers, and now the news of the macro hedge fund’s losses are coming in.
One company went from 800 million under management to a total disaster after losing nearly all their capital on just one “blow up”. This highlights the hidden “risk of ruin” that lurks inside many traditional leveraged hedge or pair based strategies.
Our strategies all seek to avoid risks of this nature by trading only AFTER a market has reached an extreme in order flow. By interacting with markets that have ALREADY exhausted themselves, it radically reduces the odds that there is any substantial liquidity lurking out of market to sweep in and cause an uncontrolled loss.
And to those who excuse their losses by blaming them on “manipulation,” I would challenge them to look deeper at their own edges. We live in the time of quantitative easing by the world’s central banks…OF COURSE there is manipulation…the banks are deliberately and openly injecting liquidity in an attempt to keep the markets up during this time of economic crisis.
Why wouldn’t you plan for that force in the market and exploit it’s predictive and cyclical nature?
No one perhaps is better at “gaming government policies” than Goldman Sachs. Much has been written about the ex-Goldman folks who are in leadership positions within the Federal Reserve and the Government. In spite of this advantage, Goldman just reported that their profits from trading operations is down 12% compared to last year’s performance, which indicates to me that perhaps the “crony capitalism” edge is eroding as we come to the end of the QE era.
For market participants utilizing the power of 3D Apex Predictive Failure Technology™, a “bad market” is simply a boring market without many qualified setups. Case in point is the action so far this January. It has been thin and by any objective standard has been pretty terrible.
Yet our proprietary operations continue to produce; albeit, we are trading a bit slower and less frequently than we would in a “good market.”
Of all the trading opportunities we have uncovered this month (at the time of this writing), only three setups have survived our rigorous qualification process.
All three of these trades produced a healthy profit which combined has generated double-digit returns, and our capital was exposed to market risk for a grand total of 131 minutes out of the 4,680 minutes that we have been on the charts this month (in other words, we've only been exposed 2.8% of the time the markets have been open so far for January).
That leaves us sitting on our hands 97.2% of the time. This is horrifically boring, true, but you can’t argue with the results that choosing quality over quantity constantly delivers to us no matter what the current condition of the markets.
Having the emotional maturity to be that choosy is something that sets us far apart from the majority of other market participants. This gives our capital a level of protection from risk that is available to all, but that few ever target deliberately or enjoy, thanks to 3D Apex Predictive Failure Technology™.
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