By: Tom Gentile
on December 13th, 2023
Originally published via our newsletter previously. Subscribe for early access!
The benchmark index, the S&P 500, (SPX) gained 8.9% in November.
This is the S&P’s best monthly gain since July 2022. It is the S&P’s sixth best performance result for November going back to 1926.
In a previous newsletter written in November, I wrote the S&P 500 had only one decline in November in the past 11 years. As you can see it carried through with upward momentum for November of this year.
Here we are in 4-trading days in to December. The S&P 500 traded flat, which isn’t uncommon for the S&P 500 the first half of December.
Take a look at the chart of the trading days of the SPX.
Market in Focus: SPX S&P 500 Index
We are at a double top in the S&P. Will it drop? How far will it drop? OR will it break out to new highs?
Seasonally, the month of December tends to see the SPX weaker in the first half of the month than the last. Then their tends to comes an end of year rally.
Call it FOMO or a Santa Claus Rally or a bit of both, but the end of the month tends to act more bullish than the first half.
The bulls would like to see that happen again.
One thing I have shown in past newsletters is running a Fibonacci Retracement assessment on a trading run. If we do roll over, check Fib levels for a possible retracement price zone.
From the Desk of a CMT – Money Management Part 1
The last couple of articles looked at correlation, statistical volatility, and implied volatility for two sector ETF option strategies as an introduction to money management (trade allocations). The question of trade allocation was posed:
“… When creating a strategy that seeks to benefit from different movement for the two ETFs (correlation) consider allocating more dollars to the ETF with the lower SV and less to those that are more volatile.”
Certainly not earth shattering but worth some attention.
From a risk management perspective, how do you think about volatility for the position? Is it purely a trade size approach to limit the damage a move in the wrong direction can make? Tightening your max risk may lead to whipsaws, so how can it be balanced?
In preparation for 2024 planning, these last two articles focus on high level money management considerations.
One of my very favorite projects when working with Tom’s team many years ago was the Cornerstone project. There were many great projects, but the breadth and depth of the “build your trading plan” product was awesome. Here’s an excerpt from the money management section:
This section covers several of the most important concepts in money management while providing a series of questions that you should answer based on your own thoughts and beliefs. These questions – and more importantly your answers – will help you to formulate a trading plan geared specifically to your own strengths, weaknesses, and personal preferences. Major questions addressed include:
- How much capital do you have to trade with?
- How much will you allocate to different markets?
- How much will you allocate to individual positions
- How much will you allocate to all positions combined?
We also address how money management factors into estimating risk and reward through:
- Selecting Position Size
- Varying Position Size from Trade to Trade
- Expected Fluctuations in the Overall Portfolio
- Minimizing the Risk of Ruin
Last, a look at how money management can help you control your emotions and support a disciplined approach.
This is a nice introduction to what money management means. At Tom’s, we have a good deal of content with quantitative approaches for systems in particular (they can be shared in the future), but the reality is that most of what is posted here includes one-off, plain vanilla option strategies. $500 is used as a max risk level with trade sizing left to you. Even if guidelines trading is your style, money management matters.
Assuming a stock and ETF market portfolio only, how can you categorize the underlying’s you trade in terms of:
- Volatility or beta,
- The speed the underlying when it goes up versus down.
Can you consider trade sizing from these two perspectives to build the base of your trading plan? The best part of having a plan is you can measure its performance and adjust and build it accordingly.
I included beta in the first item so we could use a ranker in Tom’s Tools for this process. You can access it through Tom’s Movers as follows: Stocks, Stock Rankers, Toms Movers. I changed the trading days to 20, the minimum stock price to $10, and Min Hi-Lo Percent Move to 0.1% to capture as many names as possible.
To get the broadest groups of assets possible, I used the ETF’s, REITs, TRUSTS Optionable list assuming I would get some commodity, currency, and fixed income names, along with stocks.
The inverse and leveraged ETFs take up some bandwidth unfortunately so not everything is readily represented.
It contains enough variation in the 252-day beta with SPY (+4.72 to – 4.49) to think about how the underlying’s movement might impact your trade sizing.
Figure 2 displays the top 21 results when ranked by 252-day Beta with SPY.
These are working articles for your plan so consider what stock/ETF list can be ranked based on your trading style or create the list for representative securities you trade.
To provide the desired variation without reviewing 811 ETFs, six names were selected:
- HIBL, Direxion Daily S&P Hi Beta (@ 4.48)
- CWEB, Direxion Daily CSI China Inter (@ 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 investment of $3,000 in each, you can expect the wildest ride to be in HIBL and more moderate changes (drawdowns) in TLT.
I’ll pull the one-year performance for the ~$3,000 investment in each and will continue to use the $500 max risk number to see if we get stopped out of any of the positions. Our goal is to see if there is a better way of allocating dollars to these six positions when considering beta.
This exercise is not going to home in on exact beta values for trade sizing, but rather general rules for stocks/ETFs with increasing/decreasing beta levels. Reducing trade size overall means more base hits than home runs and ideally less strikes.
— Tom Gentile
C1P: Chief 1-Percenter
Stock and options trading has large potential rewards, but also large potential risk.
You must be aware of the risks and be willing to accept them in order to invest in the stock and options market. Do not trade with money you cannot afford to lose.
This is neither an offer to buy/sell/ or recommend a particular stock or option.
Hypothetical or simulated performance results have certain inherent limitations. Unlike an actual performance record, simulated results do not represent actual trading. Also, since the trades have not been actually executed, the results may have under or overcompensated for the impact, if any, of certain market factors, such as lack of liquidity. Simulated trading programs in general are also subject to the fact that they are designed with hindsight.
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