Most of the time, our daily commentary of The Wagner Daily focuses on technical analysis of the broad market and specific ETFs. However, today we will shift gears by diving into something different -- a discussion on basic risk management. Over the nearly eight-year period since we first began writing The Wagner Daily, the model portfolio account of the newsletter has had many winning months, as well as many losing months. The long-term performance of The Wagner Daily speaks for itself; overall, the model portfolio presently has an overall cumulative percentage gain that is nearly four times greater than the benchmark S&P 500 Index during the same period. We believe the biggest reason for the newsletter's long-term outperformance of the S&P 500 has been a strict discipline to follow sound risk management guidelines, rather than a huge percentage of winning trades. As such, we were quite concerned when a subscriber e-mailed us yesterday, telling us about a big problem with risk management in their account. Upon reflection, we decided new traders could benefit from some tips on risk management, while the same discussion would serve as a friendly reminder to experienced traders as well.
This particular subscriber e-mailed us after UltraShort Nasdaq 100 ProShares (PSQ), an inversely correlated "short ETF," sold off to trigger our protective stop price yesterday (to refresh your mind, we bought PSQ as the Nasdaq bumped into major resistance of its 50-day moving average and 61.8% Fibonacci retracement from its January high to February low). While PSQ hit its protective stop, our long position in iShares Xinhua 25 China (FXI) cruised to a sizeable unrealized gain yesterday. Because we were intentionally hedged with only one short position and one long position going into yesterday, there was no harm done to the bottom line of our model ETF portfolio account. Nevertheless, we received an e-mail from a frustrated subscriber, complaining that because of the PSQ position hitting its stop, along with other losing trades of the past month, his trading account had "taken a beating." Now, this was most surprising to us, as the model portfolio was actually net profitable last month (with four winning trades and four smaller losing trades). Therefore, considering his account was apparently down, while the model account was up, a bit of probing was necessary to find out what was causing the sharp profit/loss divergence.
Upon further e-mail communication with our subscriber, we quickly learned the reasons his account was showing a loss, despite The Wagner Daily showing a gain over the past month. Specifically, two major problems jumped out at us. The first, and most alarming, issue was that he was sizing each position for an approximate capital loss of 8% of total account value if a trade hit its stop price. This was way out of line, as most professionals advise risking no more than 1 to 2% of account value for any given trade, depending on one's personal risk tolerance. In the model portfolio of The Wagner Daily, we typically size each trade for a maximum loss of 1% (about $500 for the $50,000 model account). Furthermore, we always take overall market conditions into account, which sometimes causes us to reduce risk even further, such as by taking "half" positions in indecisive or choppy environments. But with risking a whopping 8% per trade, it's no wonder our dear subscriber was distressed. With just four losing trades, his account was down more than 30%! Obviously, taking such crazy risk is a surefire way to make one's account quickly disappear when the law of averages inevitably turns negative (ie. a temporary losing streak).
The second issue plaguing our subscriber was his inability to maintain a consistent capital risk from one trade to the next. Excepting the occasional adjustment for unusual market conditions, we size all positions to take approximately the same risk of 1% per trade. We don't play favorites and take greater risk on one trade than another just because we think "this is the play of the century." Quite frequently, the trades we have the lowest expectations for at the time of entry go on to be the biggest winners. Conversely, trade setups that look "perfect" at the time of entry often become nothing more than duds. As such, we learned a long time ago that picking and choosing the amount of capital risk per trade is not a winning strategy for our methodology. Rather, we take the same risk for every trade, and just let the law of averages work in our favor year after year. Our average winning ratio (batting average) is only around 50%, but the dollar amount of our average winning trade is roughly 1.5 to 2 times the size of our average losing trade. Over the long-term, such math simply leads to a proven system of profitability, albeit one we continually strive to improve upon. In the case of our subscriber, he was haphazardly guessing which trades to have "heavy" share size and which to have lighter size. As such, he unfortunately took the most risk on our biggest losing trade last month (EWJ - loss of $615 in model account) and had the least risk exposure on our biggest winning trade (UUP - gain of $1,343).
Combining his lack of consistency in risk exposure with an extreme capital account risk of 8% per trade, it became very easy to see why our subscriber's account printed a substantial loss, even as our model account showed a gain for the month. But the good news is he assures us he now "sees the light," and his account can still be turned around with a bit of discipline. Hopefully, we have helped set him on the path to undertaking trading as a professional business, rather than a roll of the dice or spin of the wheel. For those who just want to gamble, there's always Vegas and a myriad of other places to blow your dough. However, it's to people who are serious about long-term profitability with a disciplined system of controlled risk that we dedicate every day's issue of this newsletter.
The following commentary appeared in the March 1 issue of The Wagner Daily, and is being republished for subscribers of The Wagner Weekly. Enjoy. . .
Going into last Friday's session, we were positioned in UltraShort Emerging Markets ProShares (EEV), an ETF inversely correlated to a portfolio of emerging markets. We bought EEV on February 23, after it gapped above a tight, four-day range at support of its 50-day moving average. Two days later, the trade was showing a solid gain on the open, but EEV moved steadily lower as the broad market rallied, leaving us with a smaller unrealized gain. We then re-assessed the charts of various emerging markets ETFs, and came to the conclusion the pullback off their January highs may be reaching a terminus. Despite higher initial expectations for the trade, we therefore made a judgment call to sell our EEV position last Friday, locking in a small profit. Furthermore, we then essentially reversed the trade by subsequently buying iShares Xinhua 25 China (FXI).
Although we rarely become bullish on a trade the same day we close it as a bearish trade, we noticed the formation of a bullish inverse "head and shoulders" pattern on the daily chart of iShares BRIC Index (BKF), which coincided with the ETF breaking out above its downtrend line from the January 2010 high. The "head" of the pattern also "undercut" its 200-day moving average, which makes the pattern more attractive. This setup is annotated on the chart below:
The "BRIC" Index represents stocks from the following countries: Brazil, Russia, India, and China. Therefore, rather than simply buying BKF, we assessed the charts of ETFs individually devoted to each of those countries (EWZ, RSX, INP, and FXI, respectively). In doing so, we noticed developing relative strength in several of the Chinese ETFs, which is why we chose to buy FXI. However, we also like the daily chart of iPath India Index (INP), shown below:
The performance of all international ETFs is at least somewhat correlated to the direction of the U.S. markets. Nevertheless, we like that international ETFs also have the ability to be out of sync with the domestic markets, thereby setting a trend of their own. In this case, the domestic markets have already been rallying off their pullback lows since February 5, while most of the emerging markets ETFs are now starting to move higher as the U.S. markets chop around in a range. Though FXI and other emerging markets ETFs may not recover back to their January highs anytime soon, they now look ripe for a decent, tradeable rally. If the bounce develops into something more, as we trail our stops higher, all the better.
If you wish to learn about Morpheus Trading Group's ETF trade entries on the same day they occur, sign up for a free trial to The Wagner Daily or other MTG services by clicking here (limit one per household). Also, remember that all previously published issues of both The Wagner Daily and The Wagner Weekly are available in the MTG archives. If you are new to our services or wish to broaden your knowledge of ETF trading or our general trading style, we recommend you browse the archives because it is educational and free! Click here to visit the Wagner Daily archives or here to visit the Wagner Weekly archives.
Morpheus Trading Group is pleased to announce their new membership on Twitter, a free service that keeps you informed of happenings with short text messages. In addition to selectively providing key market analysis, a heads-up of market-moving stocks is also provided from time to time. Yesterday, for example, we alerted of a potential day trade entry in AMZN, which was not an "official" play in any of our newsletters, but it subsequently ran nearly five points intraday. If you'd like to receive these alerts whenever they are sent, please sign up to follow us at http://www.twitter.com/morpheustrading.
By the way, don't worry about us overloading you with a flood of messages. We know your time is valuable and respect that.
In this column, MTG presents you with a FREE, actual trade setup that we are stalking for entry at some point during the week. Note that, unlike the daily guidance that regular Stalk Sheet subscribers receive, this free Stalk of the Week does not take into account overall broad market conditions that can easily affect the trade over the next several days.
This week's free Stalk of the Week is a "charts to watch" session. Here are a few stocks we are currently monitoring for potential buy entries this week:
Click to receive your free 1-month trial to The MTG Stalk Sheet so that you can receive an average of one to three trade ideas such as this one on a daily basis (limit one free trial per household). Subscribers are always provided with detailed entry, stop, and target prices for each trade, and intraday e-mail alerts are sent as needed.
Below is the weekly commentary that accompanied the most recent ETF Portfolio Tracker, e-mailed to subscribers last weekend. The Morpheus ETF Portfolio Tracker, a perfect supplement to The Wagner Daily, as a "long-only" user-friendly weekly report, including the new "short ETFs," that provides a replicable model ETF portfolio. Specific share size, entry, and stop prices, as well as annotated charts, are provided for all positions, and results of all trades are also tracked after the positions are closed. This information is e-mailed to subscribers weekly, and intraweek alerts are provided on an as-needed basis.
Commentary:Taking a rest after two weeks of solid gains, the broad market lost a bit of ground last week. In doing so, the major indices formed "swing high" resistance levels, most of which converged with resistance of their 50-day moving averages. Some may see this as lower "swing high" levels, relative to the January highs, and may interpret this pattern as bearish. However, if the markets firm up and stage another rally, the breakouts from these last "swing high" levels will be good entry levels, particularly if the breakouts take place above the 50-day MAs. The January 2010 highs remain formidable resistance the main stock market indexes may soon contend with. As such, be on the lookout for choppy price action in the near-term, which could take a toll on trading profits.
Some industries performed well last week and posted nice gains. The Transportation Index (IYT) made a nice move above its 50-day MA, and is a few percentage points away from the January resistance. Real Estate (IYR) held its gains from the previous week and edged higher. Retail ETFs, such as XRT, XLY, and RTH were among the first ETFs to move above January highs.
In other markets, the British Pound (FXB) accelerated lower, as the US Dollar (UUP) remained steady. The Japanese Yen (FXY) rallied well off the previous week's low, recovering previous losses and testing the "swing high" of its current ascending trend. The Euro (FXE) may be trying to find a short-term bottom, but we view any significant bounce as a chance to initiate a new short position. Subscribers will see we're stalking the Euro "short ETF" (DRR) for entry on a pullback.
The US Treasury Bond ETFs rallied, and are up against prior highs. If momentum carries through into next week, the fixed-income ETFs will see trend reversals. The Inflation Treasuries (TIP) only had a marginal gain and was relatively weak.
If you've not already had a trial to this dynamic "long-only" newsletter, designed to assist in managing long-term investment accounts such as IRAs, click to give it a test drive, free of charge for a month. If you decide to continue your subscription after the complimentary one-month trial, you may do so at the "no nonsense" rate of just $39 per month. You may also view actual past issues of the Morpheus ETF Portfolio Tracker by visiting our online archives.
Morpheus Trading Group is pleased to present you with a complimentary copy of the recently updated Morpheus ETF Roundup (v 3.0). Initially launched in May of 2006, the ETF Roundup is a user-friendly reference tool that groups all the ETFs by sector and sub-sector, then allows you to easily compare the various fund families that offer a product within each group. Confused by the approximately 800 different exchange traded funds on the market? Do you wish there was a quick and easy way to group all the different ETF families by sector and sub-sector? Want a speedy and efficient way to learn more about a particular ETF, such as the heaviest weighted underlying stocks? If so, we are confident you will appreciate that we at Morpheus Trading Group have already done the hard work for you!
With the Morpheus ETF Roundup, we have taken the entire universe of ETFs we trade (those with an average daily volume of at least 100,000 shares), and assembled them into this user-friendly, quick-reference database. With this guide, traders and investors can easily compare the various ETF fund families that are correlated to a particular sector or industry. Want to learn more about a particular ETF on the guide, such as the heaviest weighted underlying stocks? Simply click on any ticker symbol to jump to the web page for that fund. The Morpheus ETF Roundup is updated on an as-needed basis, in order to keep you abreast of major groupings of new ETFs as they are launched. The best part is. . .it's free!
If you experience any difficulties downloading the Morpheus ETF Roundup, please read the following troubleshooting tips:
Below are highlights of new additions to version 3.0 of the ETF Roundup:
We are confident you will find the newly updated Morpheus ETF Roundup to be a great reference tool. If you have any questions or comments on it, please send us an e-mail.
Enjoy! | Published by Bloomberg Press,
Wagner's new book dives into his ETF trading strategies. Learn how to profit from ETF trading in both up and down markets! |
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If you like my style of ETF trading and investing, but always wanted to know more about it, this book's definitely for you. Within the book, I detail my entire "top-down" ETF sector trading strategy, discuss entries and exit strategies, and even walk through twenty real-life examples of ETF trades I've taken over the years (ten long, ten short). The book is now available in most retail bookstores, but can be ordered through Amazon.com at a discounted rate.
I'm quite confident you'll enjoy and learn a lot from the book, and I'm more than happy to personally address any questions you have upon reading it. Just shoot me an e-mail. By the way, if you enjoy the book (or even if you don't, ha ha), I sure would appreciate you posting a sincere review on Amazon.com.