Friday was a very interesting trading day for me, and I thought I’d share my memories of it since I think it is instructive about both risk and emotional management.
As most of you would probably guess, I came into the day completely short. But I wasn’t just short: I was Herve Villechaize short. So short I could jump off a nickel. You get the idea.
In spite of the fact that Monday registered the highest closing price in the 13 billion year history of the universe for many indexes, including the now-Apple-laden Dow 30 Industrial Average, I’m a dauntless bear, and I spent the week shorting, shorting, and then shorting some more.
Before I go further, I should explain a couple of elements of my trading that are important to this story. First off, since I’m a constant-as-the-Northern-Star permabear, I judge my own performance inversely. If the market is down, I certainly want to be up. And if the market is up, I know I have to tolerate being down.
More important than that is my relative performance. If my correlation to the market was always -1.0, well, I might as well just put everything into a simple inverse ETF like symbol SH. With all the time I spend picking out individual equity positions, what I would greatly prefer is, during “up” downs, being down less than the market is up, and on “down” days, being up more than the market is down.
For instance, what I’d love to see is, on any given Monday, the market is up .5% and I’m down .3%, and on the next day, the market is down .5% and I’m up .8%. In other words, take on less damage but reap more benefits.
The other thing to know about my trading is that I very deliberately put myself into many, many individual equity positions as opposed to just a few big “core” positions. There are several good reasons for doing this: first of all, particularly in times like these, there are so many good-looking short setups, I want to take advantage of as many of them as I can. Second, I want to spread my risk. There has been more than one occasion that I’ve had my stomach turn into a knot when a given short position was up 15% pre-market, and I know I was looking at a big loss. If that’s just 1 out of 100 positions, though, it’s not that huge a deal.
The principal reason, though, has to do with me personally. I know myself well enough to know how capricious I can be (and how easily I can freak out). If, for instance, my trading was all with one huge SPY position, I’m very prone to bailing out of the position at the first sign of trouble. With 100 positions (which, literally, is how many I have right now), I don’t have that luxury. In other words, my portfolio is deliberately set up to be unwieldy.
Now I am well-acquainted with an English word known as “correlation”, and I recognize that, whether it’s 100 positions or 3, if the market is raging higher, I’m going to get hurt. Almost all stocks tend to move with the market as a whole. People dismiss the Dow 30 since it’s only 30 out of 10,000 stocks, but if you tell me the Dow is up or down a meaningful amount on a given day, it’s pretty like that any of the other 9,970 stocks out there moved the exact same direction.
So, back to my “Friday” story. I was naturally nervous about the jobs report coming out, and as is normally the case, the ES was not budging all night long prior to the report’s release. I slept a few minutes after the report was out, and at about 5:35 a.m. (PST), I nervously fired up my iPad and saw that, although the market (by way of the ES) had briefly jumped a few points higher, it was now down 2 points. Not fantastic, but hey, at least it wasn’t up 20. Red is red, right, fellow bears?
I surmised that the jobs report had been strong, and sure enough, it had been blow-out strong. I was heartened to see the ES down 3 points, then 4, then 5………..it seemed the market was not going to have one of those awful “fake-out” moves. It was, instead, steadily easing lower. Good. It was going to be an easy-to-manage day. Maybe even a really good day.
So I took Mojave, my youngest dog, on his regular early morning walk, figuring I could get back home a little bit into the trading day without much cause for concern. I had a leisurely walk, got home, unleashed him, and went to my home office. The market was still down (although not by too much), and my portfolio was a profitable green.
However, I was pissed. I was deep into margin territory (about 150% of my portfolio), and I was entirely short, but my portfolio was up a relatively small amount. I don’t remember the exact figure, but it was something like the market was down .6% and I was up .2%. Not good. Not good at all.
Worse yet, that profit starting sinking. It was a few thousand. Then a few hundred. And then – Holy God – it went red! I couldn’t believe my eyes. Here I was, perfectly positioned for the market to drop, and the market was dropping, and I was losing money! Good God!
I saw a big reason for this: plenty of my stocks were financials, and that sector was benefiting from the surge in interest rates, so I started covering my nastier losers such as RF. There were only a handful of these, however, so it was still perplexing, and I didn’t have a single big loser. My stomach was turning, however: I had been spared a surge in the ES, and yet I was still in the red. Damn it! What if the market starts strengthening? Then I’m really screwed!
(As you might guess, this is precisely the time I would have closed a huge SPY short in disgust and taken a loss for the day. As explained earlier, however, I had no such option).
I started systematically going through my stocks, one by one, examining the charts and updating their stop-loss prices. And what did I find? That the charts were still damned good short setups. Not a single one of them merited closing. At the same time, the market started getting weaker still, and I was back in the green. Before long, my profit started getting larger than it was at the opening bell, and it just kept growing from there.
More importantly, the “spread” between how much the market was down and how much I was up kept getting bigger. As the minutes ticked on, I reached parity (in other words, I was up .7% versus the market being down .7%), and then my virtual horse pulled ahead in the race. Deep into the day, I was ahead by a full 100 basis points (I don’t remember the exact figure, but it was something like my portfolio being up 2.05% versus the market overall being down 1.05%, which, for me, is fantastic).
By day’s end, I had one of the most profitable days of 2015 and definitely a good, solid day. What was more important to me, however, was that how the organism known as my portfolio, made about 100 different virtual body parts, had behaved. Sure, it was beaten down earlier. But like a prize fighter with real grit, it didn’t fall to the mat, but instead rallied its strength and, at the end, stood triumphant over its defeated foe. In my mind’s eye, I see my champion lowering his Everlast shorts and peeing on the face of Janet Yellen, lying prone on the filthy mat of the market’s square circle. But I digress.
In any event, I hope this little tale has given you some insight as to how I operate and how it pays to tough things out and give your plan time to work. It certainly could have gone the other way, but if it had, it would have done so within the guidelines of the rules I have tried to establish for myself.
On a wholly unrelated note, here’s a raising of the virtual glass toasting the brave souls who faced down evil on the Edmund Pettus bridge exactly fifty years ago today. Reason, solidarity, and justice triumphing over ignorance, hate, and violence? Yeah, I know which side Slopers would fall on. God Bless.