Trading Epic Fury (Part 11)

Today I want to tie up a couple loose ends from Part 9.

In the fourth paragraph, I said “’last thing I expected’ events happening on an all-too-frequent basis are one thing that make trading difficult.” As improbable as that one-day rally was, any number of such improbable events could have also caused large losses and the chance of encountering one of many is not so small. This likely explains why unexpected events seem all too frequent: they actually are.

Mar 31 actually wasn’t as improbable as I initially thought. The index rallied 2.91%. The previous VIX level of 30.61 equates to an expected move of 1.93% making for a 1.51 standard deviation (SD) move on the day. The probability of 1.51 SD is 6.55% or about once every three weeks. If I were contemplating potential market moves for the next day, then I should cover at least 2 SD, which has a roughly 4.6% chance to occur (2.3% up and 2.3% down).

If “last-thing-I-expected” events seem to be common, then events I should expect more are really no surprise.

One thing not currently part of my routine is a “fire drill” for the next trading day. Using modeling software, the fire drill can expose potential vulnerabilities by looking at changes in profit/loss based on extreme moves. One approach is to look up and down 2 SD on the index with volatility 10 points lower and higher, respectively. If either results in a loss beyond my risk tolerance, then consider making a preemptive adjustment today to prevent a disruptive result tomorrow.

Incorporating a fire drill would change my EOD trading checklist but is definitely worthy of consideration.

I want to revisit the first red flag from Part 9. I saw the extreme gamma and thought “but it’s really just for one trading day.”

Believing I can sneak something past Mr. Market is foolish because it’s never just me thinking that way. Although debatable, it is my opinion from the past 18 years that no ideas are new ideas. Certainly anything I come up with is not going to be unique to the countless trading participants across time and space. If many are thinking the same way, then it’s logical to believe contrarians will also notice and attempt to profit. That can be a threat.

Bottom line: don’t feel emboldened by a short time. It’s much more difficult when others are thinking the same thing.

I may sound like a conspiracy theorist with all this. Whether true or not, one thing I know is that it did not work on Mar 31.

Next time I will talk about Mar 30 and revenge trading.