Mistakes are part of the dues one pays for a full life.
The focus of this week’s commentary is a look back at some of the key lessons I have learned and the overall performance of The Whaley Report since it’s inception in December 2012.
I thought using a quote from Sophia Loren for the title of this week’s report was appropriate as a jumping off point.
I always find it advantageous to routinely evaluate the process I use to initiate trade ideas in order to determine if there are ways I can improve the overall performance and the risk profile of those trade ideas. It’s a painstaking process and it requires that I honestly evaluate all of my trades, most importantly the trades that turned out to be wrong.
Generally speaking, 50 - 60% of my trades are losers. The trade ideas in The Whaley Report over the last year and a half are no different. Here are the trade statistics for The Whaley Report as of the close of business on Friday, June 13, 2014:
Cumulative Performance (since inception on December 17, 2012): 45.5%
Percentage of Winning Trade Ideas (CLOSED): 46.0%
Average Profit of Winning Trade Ideas (CLOSED): 2.8%
Percentage of Winning Trade Ideas (CLOSED): 54.0%
Average Profit of Winning Trade Ideas (CLOSED): 1.4%
Average Number of Trades Each Week: 1.0
Percentage of Winning Weeks: 59.0%
Percentage of Losing Weeks: 41.0%
I’m quite pleased with the overall performance and the individual trade stats that TWR has produced since I began publishing it. Given the steep learning curve associated with not being able to intervene during the week; I think the future performance of TWR will continue to improve.
The one trade stat that I’m not pleased with is the ratio of average profit per winning trade ideas to the average loss of losing trade ideas, which is approximately 2-to-1. This ratio should be at a minimum 3-to-1 and ideally would be closer to 4-to-1.
Lesson #1: I let losing trade ideas stay open longer than I originally planned.
This happens to the best of us. You have strong conviction in a trade that is going against you and so, you stay in the trade beyond your original risk price. This occurred twice in 2013, both with Gold (GLD).
The first time was the SHORT trade idea at the end of July, which closed with a 6.09% loss. The second time was the LONG trade idea at the end of October, which closed with a loss of just over 4%. When you’re average loss per losing trade idea is 1.5%, it’s easy to spot outliers like these two GLD trade ideas.
You simply can’t afford to deviate from your process as I did with these trade ideas. With only 80 total trades since inception, these two trade ideas represent 2.5% of all trade ideas.
You can’t afford to have losing trade ideas that are 3-4 times as large as your average, especially when you are only trading once a week. In fact, those two trade ideas negated most of the gains from the three previous winning GLD trade ideas, leaving us with a net gain on all GLD trade ideas for that year of just 1.1%.
So far in 2014, I’ve gotten better at keeping the risks of trade ideas closer to the long run average of 1.5%. There have only been four trades all year that have lost more than our long run average. The losses on those four trades ranged from -1.76% to -2.51%.
Solution: Set your risk price prior to initiating the trade idea and STICK TO IT!
Lesson #2: 80/20 rule in full effect.
I discussed the idea of the 80/20 rule in an earlier report and I think it’s valuable to revisit the subject matter here. Here is a breakdown of each Focus Market in descending order of the net returns provided by the trade ideas for each market:
1. China = 43.97%
2. US Treasuries = 6.28%
3. US Equities = 4.45%
4. US Investment Grade Corporate Bonds = 2.17%
5. OIL = -2.11%
6. US Dollar = -2.47%
7. Euro = -2.84%
8. Gold = -4.07%
From the breakdown above, you can see that 12 trade ideas in the Chinese Equity Focus Market provided us with 97% of our trade idea returns. So, in this instance, 13% of our Focus Markets and only 15% (12 out of 80) of our total trade ideas provided all but a very small portion of our cumulative returns. This means the other 7 Focus Markets provided a net return of 1.53%.
Lesson #3: Initiate multiple trade ideas at one time for HIGH CONVICTION markets.
I am comfortable holding up to 3 trade ideas for a single Focus Market at a time. However, so far in publishing TWR, I haven’t yet initiated multiple trade ideas at a single time.
I’m going to change this in the future.
If I see a high-quality entry price for a particular Focus Market that I have a high conviction in, I’m going to initiate multiple trade ideas at the target prices, should they be breached during the week. This will give us 2-3X the upside potential in our very best ideas.
Obviously, I will manage the increased downside risks accordingly. Clearly there is a lot of room for improvement as we move forward.
We’ve already discussed how I could have improved the returns for Gold (GLD). I haven’t traded the currency markets well at all and the same goes for Oil (OIL).
I started 2013 with four consecutive losers and could never find my groove. Since that time, I’ve been break-even at best when trading black gold. That said, the tide may be turning as our current OIL trade idea is up just over 4%.
In addition to these three markets, we had limited participation in the bull run of U.S. Equities, this is too be expected given my core principle of buying weakness and selling strength. U.S. equities (SPY) never showed enough weakness after last August for me to feel comfortable re-initiating a new trade idea.
I need to do a better job of recognizing when a market is unusually strong and adjusting my entry philosophy accordingly.
Having said all of that, I’m very pleased with the overall performance of The Whaley Report. I’m exceptionally pleased that we were able to perform this well with only 1 trade each week. The best part is that there is room for improvement upon our already outstanding performance. The best is truly yet to come!