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I’m attacking the risk, not trying to avoid it

Tallinn Old Town 2022The title is a quote I heard from Tom Basso, a semi-retired trader featured in “The New Market Wizards” book that was published in 1992. According to his idea, risk is something you can’t get away from if you want to earn excess returns. No matter how much you try to optimize the entry / exit engine, risk will find its way to your trading system. Instead of trying to avoid the risk, attack it by diversifying across different markets and timeframes with strategies of different return streams. It also means betting on both directions, long and short. Position sizing plays an important role as well. No single trade should break the bank. Putting it all together, a trader needs to constantly be placing odds in his or her favor in a systematic manner.

The US stock market had its worst start of the year since 1929

This is as far as my data goes. I’ve seen headlines that it’s been the worst start ever in US stock market history. I can’t confirm, but January put some pressure to my own portfolio and the month ended down -8,5% for me. It’s now in a drawdown of -10,9% since the end of November. Drawdowns happen and are a normal part of any investing or trading activity that puts money at risk. It may look steep from aside, but most of the drawdown has been open profit giveback of long-term trend-following. That is fine if I want to stay in uptrends as long as they run. I can never nail the top but need to wait for confirmation of a possible reversal, otherwise I’d need to sell every new top and statistically underperform due to high cash exposure or the need to always seek for new risk. After almost two years of exceptional uptrend and performance, a temporary setback shouldn’t come as a surprise.

Nothing needs to be changed

I went over my risk management process and rules to see if anything needs improvement in the face of sudden volatility expansions, but the system has been built to gradually reduce risk when the market starts going against me and slowly put risk back when things start to work again, so nothing to change on the risk management side at this point. I don’t see too much open risk taken, especially if the long-term goal is to outperform the market average. Nobody’s going to change the S&P 500 index when it goes into a drawdown. This applies to my own system as long as it’s behaving in the expected range.

It takes mental fortitude to follow a trading system without hesitation in the long run. It’s important to manage risk and limit losses, but focusing only on avoiding risk won’t offer excess risk premium. In fact, looking back at January, I’m satisfied how the portfolio didn’t panic sell into short-term bottoms, but slowly unloaded stocks. I remain 50% invested in US equities with most of the exposure being long and about 5% of it short. I keep rolling with the punches and focus on the next 100 trades.

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