FOR THE DOUBTING THOMASES
Before I get to today's post I need to do a little housekeeping first. In my response as to who I consider to be the top traders question, I left out one prominent name who has had a bad year according to recent reporting, John Henry. It is my understanding that his approach is somewhat like that of Richard Dennis, so it is understandable why in a year like this, the returns have been sub par. I am not going to harp on this much, "judge not lest ye be judged." I only made the point the other day that this was a tough year as evidenced by good traders having sub par years, to attempt to make those who might be frustrated to cut themselves a bit of slack.
It also demonstrates one other point. You just absolutely must be flexible in how you trade. If you find yourself in an environment where what you are doing is not matching up with the price action, you need to change what you are doing. When you run a large fund like John Henry does, this is not so simple. You cannot be nearly as nimble as smaller traders like me. This hampers returns greatly in volatile environments like this. All of this leads into today's topic, correlations.
I mentioned yesterday the basic logic of what was bothering me about all the long trades I saw setting up, and that was that the stock market on a short term basis was extremely overbought. Paraphrasing what I said, it was along the lines of thinking that since the short term bias had to be down for stock indexes, and that would be a problem for long trades in other markets. I had very good legitimate long signals in many places, trades I should have been in quite frankly. This morning as I watched Gold and Silver, the Aussie going up, and the ES at that point up another 5 points, I began to wonder if the reversion would happen, and also how much money I might have left on the table by not being in those trades.
Then all of the sudden, just two decent sized down bars on the tick charts in the ES and boom, every market in town went down most much more than the ES did. Even the Cotton market declined on the report, go figure! You can see I have the Silver market and the Euro as well as Cotton on the chart above, below the ES. Every one of those trades had I been in them would have been stopped out for a loss now. So what can we learn from this? This is a perfect example of what I mentioned above, when things change we have to change. I went back and looked at the last several signals in the Gold market just to see whether or not the ES would have confirmed those trades had I used it as a filter.
You can see the last 3 Gold setups for me, 2 sells marked with red arrows, and one buy with a green one in the middle. Ironically, in each of these situations, the correct filter would have been the ES. In the first instance, a sell, we had a similar situation to what we have now, a very over bought stock market that was under it's 200 day moving average. Viola, once the reversion started, Gold went down sharply. In the second instance, I have a very clear buy signal with my proprietary indicators ( not shown ), in the ES at the very same time the Gold buy showed up. In the third instance, I also had a clear sell in the ES with my proprietary tools, and boom, down we went. Now currently we have the very overbought short term condition in the stock market, really right at the 200 day moving average. At this same time I had a short term buy signal, not on the chart actually, but it indicated a buy at 1737 on 12/7. So by the logic at hand, this recent buy should not be done with the current state of the stock market. So far that trade would be upside down by a good bit.
This is why I did not do the trade in Gold or Silver, or the Aussie or the Euro, or anything else for that matter. I have no idea at all whether or not on an ongoing basis this logic will continue to work as a filter. However, what I have learned over the years is that when something is nagging at me like this correlation stuff has been lately, I listen to these inner thoughts. This is a very unusual time in history, and although the opportunities are tremendous, it is also very tricky. I think you have to think on your feet like what I have discussed here today. For all I know the PPT shows up again like it did yesterday and reverses things once again back up. However, these trades had I taken them would have already stopped me out except Gold. That stop would have been 1705, so that level has not been hit yet.
I am content that this logic has been the proper logic and I am glad that I have preserved the capital that would have been gone. I am still stuck in this crappy SPY trade, which is upside down by a tad at press time. I will trade that out to it's end for better or worse. I am looking just for a short term oversold condition to develop and I will exit when it does. Reversion trades are always tricky to time and this is just typical of how these trades are unfortunately. Heck look at Gold, how would you like to have been trying to time the reversion in that sucker? That has been overextended for 2 years statistically. Reversion trading is not for the faint of heart. You have to trade small size since you have to give the trades a ton of room, so the percentage returns you get doing it are not as high as narrowly defined short term trades, which are the ones I typically do.
I am not sure how most readers feel, but for me I always get a great feeling of relief when I have steered clear of a bunch of bad trades like I did here. Maybe that is a negative quality, who knows? This all could change in a day or two if we get some type of reversion in the stock market, then the buys will have the green light again.