Our New Willingness to Trade More
Earlier today we recommended two trades, both of them put options on ETFs – one tracking the S&P 500, the other reflecting oil explorers. These trades represent a change in strategy in how we apply our indicators.
Previously in making trades we employed high thresholds. The results were close to 80 percent accuracy for option trades and nearly 90 percent accuracy for trades on ETFs. In mathematics jargon, both results approach “six sigma” – i.e., the likelihood they’d occur just by chance is about one in 1 million.
Still, even six-sigma events – especially over a relatively short period of time such as several years – don’t mean you have discovered relationships that will hold true forever, especially in a dynamic world such as financial markets. For example, as we pointed out in a recent TCI update, higher oil prices, which once were a bane for the economy, have become a positive because of their role in fostering employment.
Changing relationships are one reason we update our indicators at least once every quarter, as we seek to detect any such changes and delete relationships that no longer apply, while adding new ones that do. In our most recent review, the most important change we made was to add several variables associated with China. While China has been the global economy’s prime mover for a while, many of the relevant variables haven’t been easily usable because they have been under the government’s control. But since 2015 China’s government has been gradually opening up its markets, making it easier to include some of these important variables. So we start out this quarter with a slightly revised set of indicators.
We also start out with a greater willingness to make more trades. That’s not because of the revisions in our indicators, however; rather, it’s because we are willing to tolerate a lower win percentage in exchange for greater trading activity and, we hope, greater overall profits despite the lower win number.
While our entry thresholds will be lower, our exit thresholds will be higher. We expect the result will be smaller losses when we’re wrong and still-decent gains when we’re right, meaning that the higher number of trades will lead to greater profits.
We want to say emphatically that – despite past results – we’re offering no promises and no guarantees. Buying naked calls and puts is one of the hardest ways to make money consistently. Academic studies have indicated about a 25 percent probability of success.
And that brings us to another topic. These same indicators could also be used, and probably with a greater chance of success, in trading futures, where spreads and time value are much less important. We are not going to follow futures, but we would be remiss if we didn’t tell you that the indicators are better suited for futures than anything else.
We will continue to report the weekly numbers on the same five-point scale, i.e.,
-2; -1; 0; +1; and +2. For entry points we no longer will insist on -2 or +2. Also, we will not have more than three trades open at any one time. Our latest indicator readings are: SPY, -1; Gold, -1; Gold Stocks, -1; Oil, -1; Oil Stocks, -2; Bonds, +2; and Dollar, +1.