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Track record 2015 – 05 – 22

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Nothing speaks louder than a track record. There is no shortage of interesting indicators, strategies, ideas, but in the end, we trust only one thing: track-record. Track record sheds a crude light over two things: robustness of the strategy and quality of execution. Here are the things I have committed to:
  • run this strategy live with real money: 3/4 of my life savings
  • publish the track record on our website
Week in review: May 22nd
Attached is a pdf of the track record:  Track Record 2015 – 05 – 22
Forex impact:
Cash deposits are held in Euro, GBP and JPY. Base currency is denominated in USD. Converting everything into USD would eliminate the currency risk. Forex is however one more tool in the toolbox. EUR and GBP trends have turned bullish against USD. This may juice up NAV growth. This week, it detracted -0.6% from performance.
Performance analysis:
Performance excluding Forex impact was +1.01% inception and month to date. It was +0.48% YTD, inclusive of Forex impact. Both Long and Short books have contributed. Portfolio is still in ramp-up phase. No open position has been either reduced or closed yet. Hit ratio is 32% and 67% on the Long and Short sides, respectively.
Risk:
Cumulative risk is -6.69% to the equity. Risk-per-trade remain below budget (-0.68%) at -0.24% and -0.3% on the Long and Short side, respectively.
Customised metrics measure risk. Sharpe, Sortino, Treynor are the right mathematical answers to the wrong question: volatility is not the enemy. Formulas of the Common Sense ratio, amygdala index and other risk measures will be disclosed in ulterior articles.
Exposures
Net exposure is +60%. Directionality is intentional. Correlation between ETFs is low. For example, correlation between uranium long and Dow Jones Transportation short is low. If securities were correlated, i-e constituents of an index, then relative instead of absolute series would be traded. This would collapse the net exposure to +/-20%.
Signals are taken as they appear. The vast majority of signals are longs for now. Short signals with expensive borrow (>5% ) are rejected.
Gross exposure is now +138%. It will rise as long as the quality of performance (measured by the amygdala index) warrants it. The amygdala index is an asynchronous version of the ulcer index.
Productivity
 A time-sheet keeps precise record of time and activities. This week, it took 2 hours 49 minutes to reconcile trades, process signals and trade. Friction can be further reduced.
Time invested to build the file is not recorded (approximately 29 hours 38 minutes), as it will be amortised over the lifetime of the spreadsheet.
Strategy synopsis
This strategy was developed on the short side in order to underperform the longest bear market in modern history: Japan equities. It follows a philosophy of essential simplicity: complexity is a form of laziness.
The strategy is composed of two modules: entry/exit signals and money management.
Signal Module
Entry and re-Entry conditions are simple. It is easy to get in, but hard to stay in. Entry is a choice, exit is a necessity
  1. Regime definition for all constituents in the universe
    1. Bullish: higher highs & higher lows
    2. Bearish: lower lows & lower highs
  2. Entry: “Buy on Weakness” (Bullish Weakness) and “Short on Strength” (Bearish Strength)
    1. Long: enter the day after a swing low has been recorded && dominant trend remains bullish, “Bullish weakness”
    2. Short: enter the day after a swing high has been recorded && dominant trend remains bearish, “Bearish Strength”
  3. Exits: There are three types of exits:
    1. Isometric staircase stop loss: all open positions are simultaneously closed. Stop Loss is calculated as the swing value +/- an allowance for volatility in Average True Range (ATR).
    2. Trend reversal: if a trend reverses from bullish to bearish, all Long open positions are closed. This is the highest possible point at which positions can be logically closed. Symmetrical rules apply on the short side when a trend reverses from bearish to bullish
    3. Risk reduction: our primary concern is risk. Every new position adds risk. So, the priority is to reduce. We have developed a proprietary adaptive exit threshold (AET) algorithm that optimizes the quantity to be closed, while reducing risk to near zero level
  4. Re-Entry: re-entries are allowed only after a partial exit has taken place. Re-entries are only possible along the trend
  5. Stock selection and order priority:
    1. Signals: every day, signals on ETFs, Forex and major indices are published on our website. Candidates come exclusively from that list. The exact same information is available to everyone, including myself.
    2. Priority: Candidates are ranked by position size: the bigger, the better. Borrow check happens before position sizing. Thin expensive borrow is an indication of how crowded trades are. All trades with borrowing fee above 5% are rejected. This is the only difference between Longs & Shorts.
Money Management
Money is made in the money management module. Risk is not an abstract debate over an investment thesis. Risk is a series of numbers, made visual so as to stay painfully compelling at all times. Our basic philosophy is: profits look big only to the extent that losses are kept small. Tomorrow’s reward cannot be predicted, but risk can be managed today. Our Alpha Secure proprietary position sizing algorithm responsively manages risk (per trade and in aggregate), exposures (Gross/Net), position sizes in real time.
  1. Alpha Secure: This proprietary position sizing algorithm is so impressive that the company was named after it. This tool weathers drawdowns and re-accelerate during winning streaks.
  2. Net exposure:
    • This is an absolute directional Long and Short model: both sides are expected to generate alpha. Directionality (Net +/-100%) is only tolerated because of the low correlation between constituents (ETFs). If the universe was composed of stocks within a index, we would run relative series and collapse net exposure to +/- 20%
    • Net exposure is a direct function of signal generation. For now, the vast majority of signals are bullish. I woke up -100% net short every day for 8 years. So, net exposure will go deeply net negative when needed.
  3. Gross exposure: Gross exposure will be limited to less than 400% so as to avoid margin calls. Gross exposure is a function of market’s money and the Alpha Secure algorithm
  4. Cash deposits: Cash is maintained in various currencies. Forex is another tool in the toolbox to increase equity
Objectives
When managers say “I want to make as much money as possible”, it usually means “I have no risk-control in place”. Expressing objectives in terms of absolute performance percentage points falls into the outcome bias trap. This is a process driven portfolio. Accordingly, objectives are expressed in risk metrics
  1. Reward to risk ratio above 3 for risk management
  2. Common Sense Ratio between 1.8 to 2.1 for robustness
  3. System will be deemed bankrupt if maximum drawdown reaches -20%.
Chart examples:
Charts published every day contain the same information as the ones traded, but presented in a different fashion.

The first chart shows over-imposition of the Buy/Sell strategy over the public chart. They contain rigorously the same information. The only difference is the order logic component, absent in the public display chart, so as not to constitute a Buy/Sell strategy.
  • Stop Loss is the dotted line below each swing Low
  • Numbers preceded by the # sign (for example:#7.6%) are a rudimentary position sizing algorithm that assumes -1% loss to the equity if a position was entered at the Close of the day when the signal happens and stopped at the lower dotted line on the Long side (upper dotted line on the short side)
  • The upper dotted line is a level at which closing half (50%) the position would ensure the trade breaks even thereafter
Black triangles symbolise entries. Stacked black triangles represent single entry but multiple/split exits
Red/Green inverted triangles symbolise exits. Stacked triangles represent final exits. In the example above, the four triangles show the final exit of 4 open positions. Trend reversed from bullish to bearish.
 This is the public version of the same chart. Numbers are rigorously the same. Any smart trader can figure out for herself. In fact, the public version has the advantage of giving free will back to traders. It leads itself to multiple permutations, free from the “mechanical” constraint of a systematic strategy. For example, sideways periods can be used to accumulate stocks, or stay out of the markets.
Below are examples on the short side, with both the “weaponized” and public versions of the same chart. Strategy is symmetrical. It was developed on the short side and then translated to the Long side.
 
The key to being successful on the short side is to take risk off the table. and top-up successful positions. This is exactly what this strategy does.
Charts stripped of Buy/Sell signals lend themselves to multiple combinations and permutations. For example, the three low dotted lines indicated a volatility adjusted inverse head and shoulder pattern: volatility abated and as a result, stop loss moved higher, a movement that preceded a trend reversal.
Call to action
Please opt-in on our website. You will receive daily/weekly signals on equity indices, ETFs and Forex. The same signals on ETFs go into the portfolio.
You will also receive research on money management, trading strategies and trading psychology.
In addition, You will receive codes on C#, free Excel files. Those tools and utilities are not available to non-subscribers.
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Amygdala and the neurophysiology of Greed and Fear

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Going into a combat mission without an exit plan is suicide. In fact, the only soldiers who nevamyg400er bother with exit plans are kamikaze. On the other hand, market participants routinely enter positions without a clear exit plan. The problem is that as soon as we enter a position, our emotions impair our ability to make rational decisions. Greed and fear have a chemical signature. This is the first article of a series of four about exits and emotional mastery.

Dopamine and cortisol: the chemical brothers of Greed and Fear
When there is no exit plan, there is uncertainty about what to do next. A mild level of uncertainty can be exciting. A region of the brain Nucleus Accumbens (NAc) gets activated. This triggers the mesolimbic reward circuitry, often referred to as the dopamine reward circuitry. Dopamine is released. People take on more risk. By the way, cocaine, opiates and nicotine activate dopamine transmission. This is why just watching the portfolio feels a bit addictive sometimes. As Kuhnen and Knutson showed, risk seeking behaviors are often associated with NAc activation and high level of dopamine. In other words, Dopamine is the chemical signature of greed.
When a few positions “go against us”, uncertainty turns from thrill to mild discomfort. We are more vigilant and come back to reality. When performance starts to suffer, uncertainty morphs into stress. Stress triggers the amygdala, located in a primitive part of the brain called the limbic brain. Its primary function is to keep us alive at all times at any cost.  It is always on. The problem with the amygdala is that it cannot discern between real danger and an imagined threat, between a saber tooth tiger and a -1% dent in the portfolio. At higher levels of stress, the amygdala activates the pituitary gland that releases cortisol. When cortisol is released, the neo-cortex or thinking brain is hijacked, game over.
In his latest research, Daniel Goleman, author of Emotional Intelligence and focus, goes one step further. He describes a state of prolonged high stress as neurobiological frazzle: the thinking brain shuts down and physical health deteriorates. This is what we call burn-out. Bottom line, uncertainty has a destructive physiological signature.
Uncertainty: get comfortable with discomfort
Uncertainty cannot be eliminated whether in life or in the markets. We can learn to 1) manage it and 2) reduce it.
1) Getting comfortable with discomfort literally determines the quality of our lives. This is the subject of a future article
2) Reducing uncertainty simply comes down to  having plans and rituals or habits. One of the most important plans is the exit plan.
The three questions that will notably reduce stress:
When everyone else is stressed out, every bit of clarity counts. Unfortunately, every decision is an additional stressor. Every bit of stress reduces the mental bandwidth. This depletes the thinking rain of its capacity to make good decisions. This is called decision fatigue. Willpower is a muscle.
An interesting study was done in Israel about parole decisions made by judges. Convicts examined before lunch were 2/3 more likely to be denied parole than after lunch break.
Bottom line: if we do not want to look like deers in the headlights, we must plan our exits before entry. Experienced traders often say that the best time to put on a stop loss is 5 minutes before entry.
There are only three possibilities after entry: either a stock goes up, down or nowhere. So, an exit strategy must answer those three questions
  1. Price goes down, there is a loss: at what price do we reduce risk ? How much do we need to exit ?
  2. Profit goes up, there is profit: At what price do we take risk/money off the table ?  How much do we need to exit ?
  3. Price goes nowhere: how many days after entry ? How much do we need to exit ?
Note also that exits do not have to be binary 0-100%. This is the subject of the next two articles.
Note that there is no room for interpretation. This is not the time for abstract debates on valuations, long-term prospects, or any other rationalization that our amygdala fueled inner idiot will throw at us. It has to be an unambiguous IF…THEN sequence.
The good news is that unless any stock triggers any of those landmines, there is no need for action. It helps achieve three things:
  1. It reduces the need for constant monitoring: market participants often stay glued in front of their monitors expecting the markets to telegraph a compelling call to action
  2. It helps navigate volatility. Volatility often tempts us into action. Having a plan and sticking to it helps reduce the urge
  3. It frees up mental space that can be used for higher cognitive functions: research and planning.
Everyone knows that the key to success is to cut losers and ride winners. The problem is that no-one has ever come up with a formula. If You want a clear method to accomplish this, while maintaining your conviction, then the game of two halves is for you.
Call To Action:
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Daily #Indices signals

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Thought of the day: “The world is full of magical things waiting for our wits to grow sharper”, Bertrand Russell, Happy Birthday

  • Great traders are not smarter, they have smarter trading habits
  • If You are interested in short-selling, trading systems, position sizing, trading psychology, visit us at: www.alphasecurecapital.com
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  • Bullish weakness: Longer-term trend is bullish. There has been some temporary weakness, but the uptrend is likely to resume
  • Bearish strength: Longer-term trend is bearish. There has been some temporary rally, but the downtrend is likely to resume
  • Volatility Channels (Horizontal dotted lines) : Markets often retest swings. This is a volatility buffer to allow wiggle room.
  • Volatility Channel: Think of the other side of a volatility channel of the distance it would take to close half the position to break even if the remainder was to hit the stop loss
  • #n%: Think of it as a rudimentary equity at risk position sizing. It is 1% divided by the distance from the day the swing is recorded to the volatility channel
  • Disclaimer: this is neither a solicitation, nor an investment advice