We received a few e-mails in regards to our last post where we discussed our performance. One of the things that was brought up a few times was why we have self-admittedly taken on too little risk. The simple answer is that we don’t like to lose money. Drawdowns are not something that we enjoy that much.

For a better explanation, let us first explain how we trade. Our basic method of scaling risk is described in the Stanley Druckenmiller interview in The New Market Wizards by Jack Schwager and is further explained in the interview with Christian Siva-Jothy in the book Inside The House Of Money by Steven Drobny. You start out by generating positive returns, and once you are up enough for the year, you can start taking on more risk. For example, if we are up 20%, we don’t mind taking on a risk that could potentially take us down 5%. We’d still be up 15% for the year. On the other hand, if we are only at 0% for the year a -5% hit would be really bad. So basically we trade away with strict loss limits until we are up enough to start raising our risk limits.

We strive to deliver good trading ideas on an absolute and on a risk-adjusted basis. A 50% gain is great, but if you had to risk 100% to get there, then it doesn’t look too good anymore. In that case, being wrong once blows up your account.

You can find more of the same in several other newsletters. For instance, if you pick up a copy of the Hulbert Financial Digest, you can find scores of newsletters that manage to have one 100%+ year and then proceed to lose -87% the next year, -37% the year after that, and so on. Trade like that and you’ll be lucky to have a whopping $10 bucks left in your account.

Happy Trading,

The Macro Trader

Here at TheMacroTrader.com we use several different strategies across several asset classes. Why do we do this? For several reasons not the least of which is so that we can find and exploit as many of the best risk to reward situations as possible. If you tie yourself to one strategy or one asset class you are limiting your potential opportunites.

In this article we will focus on using systems. As we have already mentioned we use several systems. Some are purely automatic. If they say buy we will go and buy if they say to sell we will sell. We also have several systems that leave us a lot of discretion as to what we do. We look at many different variables depending on the asset class and time horizon. For instance in some of our short term systems we only use prices of the actual instrument to determine buys and sells. On some of our longer term systems we use economic data such as interest rates, market valuations, technical studies, inflation, competing yields, etc.

Right now we have several systems for domestic and foreign equities, domestic bonds (treasuries, corporates, and junk), precious metals, currencies, commodities, volatility trading, and asset allocation. All of the systems we use have historically beaten their benchmarks with less risk. So over time we can expect to outperform.

As noted earlier we also have systems that leave us with varying amounts of discretion. Some of the systems are only used to alert us of a potential trade. We then go in and look to see if we feel it is worth doing. For instance one of our systems is designed to highlight potential option trades across several different indexes. Its main variable is volatility. While we could possibly use it as a stand alone system at this point in time we think it is better used to highlight potential opportunities.

So how do we use it? We update it every week and most weeks it will show us a few different areas worth looking at. We than go in and research those potential trades to assess the situation. If the right conditions are present and we can see a catalyst we will then go in and put on the trade. If not we will continue monitoring the situation in case it changes. While we only put on about a third of the trades that it presents us we feel it is an invaluable tool because it highlights many situations that we would otherwise miss. To sum it up in one sentence it highlights promising situations. That is but one example of using a systematic process in our trading.

In summary using systematic processes in trading allow us to cover more asset classes and more countries. It allows us to spot more opportunities and to more consistently achieve above average and less correlated returns.

Happy Trading,

The Macro Trader