VEGAS TRADES GOLD IMAGE

VEGAS TRADES GOLD IMAGE

Thursday, December 15, 2011

DEALING WITH TAIL RISK



                                Be Careful: It’s Waiting For You

Before you even make your first demo trade, you must give some serious thought to those events that have a low, to very low, probability of happening in the marketplace. Does your algorithm consider such events? If no, why not? If so, how?

                       Risk? What Risk? Account Balance = $ 0.00

Can you survive a day in which gold has a range of $150? How about a double or triple reversal day where prices cascade lower not once but maybe two or three times?

                        When SHTF, Where are You On This Chart?

It can come twice in a week, and then not be seen for 15 years. It may never happen in your trading career, or it may happen on your very first trading day. It can’t be predicted, but it can be dealt with effectively.

Your highest priority, as a professional trader, is to make sure you will be here tomorrow. No one trade “makes or breaks" you. No one day is going to have your "retirement” trade in it.

                                    When You Meet Tail Risk?

In my 30 + years of trading I have personally seen too many traders become ex-traders because of poor planning of [probability distribution] tail risk.

It is specifically because of tail risk that “The Vegas BFSG Algorithm” does the following:
1)      trades from the side of the highest probability of success, on any given day, where it is determined momentum is greatest based on a very long trading history,
2)      makes every initial opening trade based on intermediate money flows with the highest probability of success [money > information],
3)      places our trade at a crucial juncture in terms of time and price,
4)      forces us to sit on our hands and not risk capital when it is determined the probability of success is not in our favor [ less than 50%], and
5)      Always trades with stops in place. ALWAYS!!

Having said this, it doesn’t mean we never lose money. It means we manage risk and most importantly TAIL RISK.

In an environment of rapidly falling prices yesterday, where gold was down over $50 / oz., we still managed to make money from the long side. The fact that we missed the down move doesn’t concern me: it was an opportunity cost, not a real loss. All we lost was an opportunity, and those are infinite in scope.

Today’s Action & Wrap Up

The algorithm has very specific criteria that initiate “buy mode” and “sell mode”, along probabilistic distributions. We came into the day in “buy mode”. The Asian session had some very mild short covering to start the day, but very quickly prices started to drift lower in choppy trade.

Our first buy signal came at 12:10 AM [Chicago time] at 1568.50. I placed a very tight stop at 1565.50 and it got taken out a few candlesticks later. Loss on that first trade was
$ 3.00 / oz.

Our second buy signal came at 1:00 AM [Chicago time] at 1567. I placed the stop at 1563.90. At 2:20 AM [Chicago time] we got a confirmation top [discussed in the manual and Appendix III] at 1582. Gain on this trade of $15 / oz.

So, for the day we had net profits of $ 12.00 / oz.

Altogether now, Ka-Chingggggggggggggg  [Again]

And because I felt like yesterday was a loser, even though the algorithm scratched out a meager buck, let’s do it again because it feels good to do it twice:

Ka-Chinggggggggggggggggg !! [Oh yea, it does feel good the second time too.]

I got a lot of emails late yesterday, questioning the “buy mode” status of the algorithm. I sum them up as follows:
“I don’t know vegas, stuff looks terrible on the charts. We’re in “buy mode”? Ohh boy.”
Or,
“Man, we’re missing big moves on the downside by not being short; are you sure we should be buying?”

                                     I'm Shocked!! Who Knew?

My response to all was just follow the algorithm. Stop thinking and just follow it. This is where your profits are, not in thinking on the proverbial fly so to speak. What I think, what you think, doesn’t mean squat. Reality doesn’t care!

The power of the algorithm rests in its ability to garner profits from the day, not in any single trade. By itself, any given one trade is not the “load-the-boat-here-we-go trade” for the day. I don’t believe the algorithm has the ability to make that specific of a call. It is the total trades for the day that make the probabilistic argument for profits.

Whether we have to trade once, twice, three times or more, in and of itself simply does not matter. By using proper leverage and stop placement, we are never faced with the prospect of large losses from trading. It simply is not part of the game plan, and this one fact keeps people from destroying themselves while thinking about the market.

Given the results of the day, I rest my case.

Have a good day everyone.
-vegas

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