By: Tom Gentile
on December 20th, 2023
Originally published via our newsletter previously. Subscribe for early access!
The Fed’s decision to keep interest rates steady and Chairman Powell’s commentary in his following news conference seems to have been a pivot in the Fed’s approach. They seem to be saying they now have inflation under control.
The Dow closed at All-Time highs, over $37,000 for the first time ever, showing that there is more to the markets than just the Magnificent-7.
I say that because, though most of those 7 were higher today, they weren’t screaming higher nor were they the % leaders on the day, even though the Dow set its all-time closing mark.
This gives me reason to believe there is more upside available in the markets, even though it would not surprise me to see some profit taking, but enough to reverse this momentum.
Market in Focus: SPDR Dow Jones Industrial Average ETF Trust (DIA)
Chairman Powell was deemed or at least his commentary was deemed dovish.
As you can see by the markets reaction and price action that propelled the markets higher. I am pleased with this move and where the Dow is at, but I don’t want to ever drop my guard and get too complacent.
Call it the contrarian in me, but I have to be aware this rally will eventually come to an end.
Now when you hear that… and you will hear it from others. To me that doesn’t mean the markets will then DROP significantly. It may go in to a sideways trend or consolidation and then regain momentum.
I also don’t like to fight the tape, so for now I will remain bullish until the markets give me reason to be otherwise.
From the Desk of a CMT – Money Management Part 2
Money management is a key element of any trading plan and includes:
- Total dollars allocated to trading
- Total dollars/percent allocated to different markets – we’ll assume 100% to stock market and access fixed income, commodities, and currencies via ETFs
- Total dollars/percent allocated to a single position
- Total dollars/percent allocated to like positions
It’s important to determine the first two items at the onset of trading and fine tune things along the way. You may or may not allocate dollars to all financial markets, but if you are using ETF proxies for those different markets, you have to understand how it moves (volatility and trend strength).
For this reason, we continue to focus on the impact of volatility via beta for different underlying’s by using a set trade size for all positions. The ETFs selected and their betas are:
- HIBL, Direxion Daily S&P Hi Beta (@ 4.48)
- CWEB, Direxion Daily CSI China Internet 2x Bull (@ 2.39)
- XLK, Technology Select Sector SPDR (@ 1.27)
- XLB, Materials Select Sector SPDR (@ 0.98)
- EWH, iShares MSCI Hong Kong Index (@ 0.56)
- TLT, iShares Barclays 20+ Year Treasury (@ 0.19)
Assuming an approximate $3,000 investment in each from 12/7/2022 to 12/6/2023, figure 1 displays a return chart for the period. The dark blue line displays the portfolio returns for the period (-1.5%) with the scale on the right axis.
It feels like I’m making a case for a diversified portfolio, but that’s not the focus. Look at the volatility for HIBL (blue) and CWEB (orange). With a guidelines approach, how are you going to manage that position? What about the portfolio?
The returns for HIBL and CWEB were +17.2% and -35.3% respectively, but it was HIBL that started bearish, then bullish (then bearish, and so on). Figure 2 reduces position size for the two higher beta ETFs to $759 (~25%) and CWEB to $2,002 (~65%), which means you’re more likely going to be able to risk manage both.
Skeptical? After using the ranker, I just pulled different ETFs at varying beta levels. They were random but it’s easy to see the challenging environment a trader could face. Let’s think about HIBL.
- Using our standard $500 max loss for risk management, we would have been forced to exit HIBL by Dec 28, 2022, at a loss of $585, or 19% (we probably would have reduced that high risk value for the exit since the capital at risk is higher).
- The reduced trade size for HIBL allowed us to hold the position for the entire year and book the gain.
Again, we don’t risk manage this way, but reducing trade size allows you to maintain a position on those higher volatility stocks/ETFs when you haven’t gotten the timing perfect. What about CWEB?
- The stronger start kept us in the position until April 21, 2023, when a loss of $507 occurred.
- The reduced size would have been stopped-out on May 23, 2023, for a loss of $591.
In our case studies we use a dollar value for risk management, partially for ease. Many traders reasonably use a percent loss for risk management, but it’s still about that dollar loss that can mess with your discipline. These two positions and the changes they create to the portfolio can take you on an unnecessary wild ride. As an added consideration, how do you feel about CWEB initially taking off then settling into losses? Would you ever think, “it could come back?”
Granted, an actual trading approach doesn’t say, “invest $3,000 and just hold it for a year without managing the risk”, but is it safe to say the movement of these two ETFs could pose a problem for actually taking action to close a position?
I hope you can relate to some of the comments made because this article will bring more value to you if that’s the case. I’ve been there and reducing the distraction of a single volatile or high beta position that was sized like my other positions helped me a lot.
I hope it can be one portion of your money management assessment and planning for the year ahead.
I did limit the scope of this money management discussion to the highest level, so if you’ve already mapped out your trade allocations and follow your plan with discipline, explore the Trades > Portfolio > Charts tool this month.
Despite a stock market that has recently had better returns, it’s tough out there on a lot of fronts. I hope you and your loved ones can have time away from it all to simply enjoy one another during the holidays. Happy holidays to you all.
Clare White, CMT
— Tom Gentile
C1P: Chief 1-Percenter
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