Avoiding Disaster

Trading isn't about targeting gigantic wins as much as it's about avoiding catastrophic losses.

My job is in disaster avoidance--I’m a manager of risk. The good times(trending markets) will come, they always do, they always will. The trick is in surviving the instances when the markets can crush you.

Ultimately, trends are what bring in the outsized wins. And you cannot participate in the trend if you can’t afford to place the bet. So my line of logic stands: cut losing trades off at the point of the predetermined exit/trailing stop so you have the chance to capitalize on future trends. In short--don't let losers become huge losers.

When you allow price to do the talking, you can ignore your inner biased narrative and shun a fundamental belief about an asset/instrument. “It has to go up in the future” is not a strategy, it's a recipe for disaster.

I entered into 2 Valient Pharmaceutical trades over the past year. I got hurt for sure, but I could have gotten killed without my system.

What could have killed me?

If instead of selling on the way down, I could have bought on the way down to average my dollar cost. This would have DECIMATED my portfolio. I ended up taking a few small losses on my VRX trades. If I allowed my losers slip further or bought on the way down, I could have easily had a double digit % drop in my entire portfolio.

What saved me from getting killed?

I Determined hard exits before I entered into the trades, which in turn lead to appropriate position sizing based on my risk parameters. I never know if I will win or lose when I enter a trade. But if I do lose, I always know how much.

Chart 1: My initial entry

Chart 2: My exit point

Chart 3: My second shot at Valeant. I entered into another small position here.

Chart 4: My partial exit. I sold 2/3rds of my shares here.

Chart 5: My complete exit from the trade.

Chart 6: Current price. No position held.

“The public ought to grasp firmly this one point: that the real reason for a protracted decline is never bear raiding. When a stock keeps on going down, you can bet that there is something wrong with it, either with the market for it or with the company.”

-Edwin Lefevre, Reminiscences of a Stock Operator

All this being said, something is rotten in the biotech sector. The prices are giving the hints. With volatility getting super low again, I’ve purchased inexpensive Put contracts on big name biotechs as a portfolio hedge/alpha generator in the upcoming months. Once volatility gets high again, premiums will get fluffy, and it will get expensive to bet on a drop in biotech.