Thursday, October 14, 2010

An update on allocation...

I received a few emails over the last weeks from some hedge fund managers who seem to be close to blowing up, curious market participants and from some individuals asking about whether or not I am short. I want to answer a different question. The reality is that if it is necessary to ask someone regarding a position or trade then one is most likely looking for support or rationalization regarding a position and it likely over allocated. Without question the primary issue that I see for traders is over rationalization, allocation or concentration. The markets are not rational and nor are they very forgiving. 

I do not trade that way. Let me give you an example. If I trade a weekly strategy, I know that my average winning trade is going to be around 110 SP points, I also know that building a position may result in scaling into an average of 35 points but up to 80 points. The question how much I am going to risk not how much I am going to make. Additionally, the best risk management of all is NOT stops, its proper allocation. So, where I may trade a 15% allocation of risk capital in one system for a daily chart, I know that the average risk is 15 points and up to 45 points, therefore, I can trade for a 1.75% risk to 3% risk depending on how aggressive I am. If I am going to achieve that result with a weekly system I may have to trade at a 7% allocation. Trading just 7% of your money in one strategy may not seem like a lot, but the rabbit rarely wins the race. In the markets its about doing the opposite of what you think and want to do and doing the disciplined and practical thing. People are rarely practical about losing money and exceptionally rarely disciplined about it.But those are precisely the things that will make us successful. So we must think about our weaknesses and capitalize on them. My experience is that the market is about hitting base hits not home runs.

So, in response to whether I am short or not, I have Weekly systems that have built short positions in some major markets and now some dailies, however, I also trade intraday long and short across quite a few markets, so, its important not overreach. I am not short 50% of assets, probably more like 8% of assets right now. Keep in mind that the maximum avererage allocation percent I will take is around 20% and that generates a very hefty return. If the market rallies, intraday longs and shorts will be taken without regard to my opinion of the market or any long-term positions - they will  be taken as appropriate with strict risk rules. As a note, I regard a break of 1122.5 as a key confirmation of a larger short move.

I hope that answers the question and gets people asks some questions of themselves too...
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