08-26-2020: It is not Magic... It is just Math

Year-to-Date Strategy Stats as of COB today:

+ 40.21% : Turner Quant Advantage (TQA)

+ 13.95% : Tactical Growth (TG)

+ 3.53% : Diversified Income (DIS)

+ 16.10% : Aggressive Growth (AG)

+ 0.09% : Total Market (TM)

+ 7.67% : S&P 500

After my latest blog (yesterday), I got some comments from inquiring minds... One inquiring mind, in particular, asked a very important question. He said he is reticent to use stops before he sees what the market is doing; that he doesn't want to take the risk of stopping out when his better judgment would be to stay, even if the stop is hit.

His question was this? "How do you calculate your stops so that if they were all suddenly triggered you do not lose half of the year's gains?"

Well... as simple as that question is, the answer is not so simple.

For example, in my Tactical Growth portfolio, we are up about 14% for the year and if all the stops we have in place right now (soon to change) triggered at the same time, we would, indeed, lose about half of the year's gains. While it is theoretically possible for all the stops to trigger at the same time, I have never seen it happen or even get close to happening unless (here comes 'some' of the hard part to explain) I wanted all of them to trigger. And, lest we forget... if the market were to drop enough to trigger all the stops, it is quite likely that it would have moved from being up nearly 8% ytd, to down for the year. If we can be up 7% while the market is down for the year is not a bad result.

But, the inquiring mind still has a point... we lost half of the year's gains... if you assume all the stops triggered and, as I said, I have never seen it happen with 'normal' stops in place. Let me give you an example: We bought CRM (salesforce.com) in the Tactical Growth portfolio 13 days ago. Today, it went exponential and skyrocketed up more than 25%. Because I am in a 'go-to-cash' investment mindset (see prior blog for an explanation as to why), I raised my stop on CRM to 1EM below where it was trading today (near its high). 1EM is approximately one standard deviation of normal volatility for CRM on a weekly basis. As such my stop was at $264.15. About an hour before the close today, CRM bounced down and triggered our stop. We sold our position and netted a smooth-rolling +34.45% in just 13 days. And, at this point, I don't care if it zooms higher. Remember... I am in a go-to-cash mindset.

Did all the stops trigger? No... not even close. All that triggered today was CRM.

And, I have raised stops again on the 19 remaining holdings, after the market close today. And, just so there is no confusion, I do not have one stop for all holdings. Each holding has its own EM and its own stop.

The market is only about 1EM from triggering an "Overbought" (OB) condition. This is not a guess. It is a mathematically derived level that indicates the odds of a correction are much higher than the odds that the market will continue to boom higher. The "market" EM is huge... right now it is 7.75%. That means the market would have to move up by almost 8% before the OB is triggered. Upon the triggering of the OB, I will move stops to 0.25EMs of each holding below their previous day's closing price. A 0.25EM is a tiny percentage and means that almost any wiggle in a stock's price will cause it to sell. But, we are not there... not yet, anyway. And, I have the option to invest 15% of capital into a contrarian play via inverse ETFs.

Assuming the market doesn't fall off a cliff by this Friday's close, I will be raising stops to 0.5EM on Monday. Why? Because I have a go-to-cash investment mindset and I want to sell and I want to capture profits... but... I do not want to get off of this rocket ship market until I have to. The market could go a LOT higher; or, it could collapse at any time.

I am of the opinion (aka, "I am guessing") that the market will gyrate wildly before the election and if you-know-who, wins, the market could crash on November 4 (that's assuming we even know who the next president will be on November 4). As such, I would be happy to be sitting 100% in cash before the election. The key is timing when to effect that move to 100% cash. I am doing this with, what I call, intelligent stop loss strategies. These stops include:

  1. The relative volatility of market, and

  2. The position of the market relative to its 200-day moving average, and

  3. The relative volatility of each holding, and

  4. The investment bias, including how bullish, bearish or neutral the data are, and

  5. How often the investment bias dictates the frequency of adjusting stops higher.

The above 5 items are all in play as we set stops. As I have said many times, the easy part is buying... the hard (really hard) part is knowing when to sell. Using the above algos make the process of selling far more mechanical than emotional; which is a good thing.

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