PORTFOLIO UPDATE: HITTING THE EMERGENCY BUTTON…..TWICE
During the trading day, I tweeted the following:
Any good risk manager (and that is what any of you who have interest in the markets are) should have multiple layers of risk control. I often find that instead of focusing on these layers, investors will focus too much on reward. There are all kinds of contingencies and plans made for rewarding trades, but very few, other than your run of the mill stop protection, for the risk. True professionals, who outperform over the long-term, are risk managers. All others are reward managers. The market will quickly call you out for what you are if you play the game on a consistent basis.
I used to be a reward manager. I am very familiar with the practice of focusing squarely on reward and accepting drawdowns as a necessary part of the game. The primary issue with being a reward manager is that you can have multiple years of winning streaks, but it will only take one small miscalculation to take back all those years and then some. You can never slip. Keep in mind, that the financial markets, at some point or another, will create an abusive environment for every strategy ever developed by man or machine. The reward manager, therefore, won't survive over the long-term by design.
The risk manager, on the other hand, controls the environment by having multiple layers of risk control, as I mentioned earlier. When one defensive wall fails, the other springs up to stop the onslaught. The risk manager realizes that the key to prospering in the game is to remain viable. You remain viable by never suffering a drawdown that will be too cumbersome for your strategy to overcome. The risk manager is good enough at their craft to know that large sums of money can be made when the environment is favorable. There is no need to risk the entire portfolio in an environment that is questionable when patience is the only thing required to reach a point when a significant streak of profitability can occur.
I have mentioned my tactical asset allocation strategy that utilizes a short, intermediate and long-term trend following/reversal system to dictate my long exposure to the market many times. What I haven't mentioned is the other layers I utilize to control risk.
One of those layers is a mandatory performance stop that slices positions in half when a certain performance threshold is breached. For me, that threshold is a 5% performance decline during any month. I haven't had to mention this risk control measure because I haven't suffered anything close to a 5% down month at anytime in 2012. October has changed that.
I still haven't finished with my changes to the portfolio. The only position I am not trimming is WMIH since it has no correlation to the popular averages and is such a unique situation.
In addition, my short-term trend indicator will be on "sell" as of tomorrow morning. I typically don't front run the signal as I did today. However, I believe that given all the evidence I am seeing, this time it was a wise move. The sell signal on my short-term indicator caused me to move the portfolio into a net neutral position via a long position in TZA (inverse 3X small cap ETF).
This is as defensive and tight as I have played the markets all year...and I believe it is for good reason. Watch your step, the rocks have suddenly become slippery.
Holding PXLW, UPIP, SPNS, WMIH, TZA and lots of cash. I'll have more portfolio updates as the week progresses.
