RISK ASSESSMENT WEDNESDAY: A LESSON IN CONFLICT
For those unaware, risk assessment Wednesday is one of the methods I use to control risk in the portfolio. It's a very simple concept. Basically, if positions are running at a loss, Wednesday is when I am forced to look at them on an unbiased basis. I will inevitably reduce risk in the portfolio if the trend amongst the holdings is detrimental to portfolio value. It's one more way of taming volatility and keeping a balanced mental capacity regardless of the situation.
Risk assessment Wednesday was born out of my tendency to become so convinced of my thesis with respect to the markets that literally nothing would stand between my finger and pressing the buy (or sell short) button in an effort to take on as large a position as possible. This tendency led to a stellar rise in my former hedge fund. It also led to the dismantling of that very same fund just two years after I was at the top of the game.
It is essentially my way of preventing one of my admitted weaknesses from costing me performance. I don't care how good you think you are in this business, if you haven't tailored your strategy with specific attention to minimizing the potential of your weaknesses and maximizing the potential of your individual strengths, then you already have one foot in the grave. Risk assessment Wednesday is weakness control.
With the conflicting signals I am seeing in the markets currently, risk assessment Wednesday this week was a no-brainer. The seasonal studies based on performance of the market thus far in 2011 are pointing to a market that is bound to move higher. As are various sentiment and correlation based studies.
On the other hand the price action now is officially disasterous. Far beyond any type of conceivable fake-out or normal pullback within a bull trend. And this is paired with the results of the study I published last night. The study nailed the August-October time period. I am not sure if the results will be as stellar here. However, it deserves a great level of respect given its accuracy over the past several years.
The basis of the study is grounded in the premise that oversold markets that are steeped in pessimism have a tendency to run further to the downside than most anybody expects. When markets fail to respond to deeply oversold conditions while paired with excessive levels of pessimism, it is a sign that the market mechanism (or deception mechanism as I like to call it) has broken down. This is the point when markets become the most dangerous. More or less burying the dip buyers until every last current or potential bull is rinsed.
We are playing an odds game here. There is no certainty in a dangerously bearish outcome from this point on. The markets can bottom on Friday and then move right up to 1300. However, the odds are slanted to the downside, with a distinct possibility of accelerating selling taking place over the next few weeks.
With that said, I prefer to sit this one out as of now. Cash is a position and I'm all in it.
