I use that definition everyday when I trade and when I talk to other traders when discussing markets and assessing the portfolio of our proprietary trading desk. Now it might seem an impossible outcome of how can one make money when their trade view is wrong but the reality it is not. It’s exactly the same as great athlete who can still win when not performing well.
The key is to cover as many different possible outcomes as possible (and even more advanced different trading strategies). Too many traders assess markets and their trades on an individual basis and in a one dimensional fashion. That is good when you are learning and new to trading however to evolve to the next level, trades need to be viewed in conjunction with each other and how they relate and correlate depending on a variety of different market moves.
I remember a few years ago listening into a quarterly earnings conference call for Goldman Sachs and hearing that their trading desks made money every single day of the quarter. Not a single loss. I reviewed our prop trading desk’s performance and we didn’t have the same success rate. I wasn’t impressed I was outdone and my approach has since been even more focused on improving our performance no matter what markets deliver.
So while I have been bearish equity markets since late last year, I have also been bullish several stocks. As noted previously, the bearish trend is very macro-related and many of our shorts are related to a global growth slowdown, credit crisis in China and a consumer drunk on debt. As a result we are generally long gold, long US Treasuries, short equity indices.
Then how during this bear market rally is it still possible to be make money? The key is in having trades that will benefit from a market rally in case there is one. Put another way it can be viewed as insurance. But not insurance like put options acting as protection against a portfolio, but outright positions that will have a capital appreciation. Remember I said the short focus is from a macro perspective but the long side will be focused on company specific, bottom-up themes. So naturally during a bear market rally these trades generate strong profits that more than offset the losses in being short equity indices.
Despite the rally in equities, gold prices as we discussed have surged strongly with an even stronger performance from gold producers. This is a good example of a trade that evolved from a bearish equity market view, which has performed while equity markets fell and even better when they rallied back.
The important thing is to stress test your trades and portfolios. It is important to ensure that every trade or position is not positively correlated as all this means is that all your positions will make money and lose money together at the same time. It amplifies the returns both positively and negatively which is good when you’re right, but disastrous when you are wrong.
Not enough, in fact very few traders run a matrix on potential market outcomes and what their own profit and loss will be. I tell you now, if they did, they will quickly have an appreciation for risk! When we run our matrix each day, we look at each point and query what can be done to improve the profit or minimize the loss. We sometimes notice that in circumstances where we are 100% correct with the desired market reaction and our profit size is tiny. This triggers us to review our trading size and or our trading instrument – that is, will it be better to structure an options trade instead of just a direct vanilla position. This works in reverse too, we realize we are carrying too much risk and our profits will be far larger than expected. Naturally we adjust.
It is important that traders begin to assess their portfolios and their trades in more sophisticated terms than tradition basic technical analysis techniques with simple stops. Markets gap through stops and they can often correlate aggressively during bear markets. Make sure you understand your risk and start thinking in terms of how can I make money even if my bullish or bearish view proves wrong both in the short and long-term.
