How We Manage Risk

It’s been a year where risk management is a major topic. As we addressed in prior email blogs, in terms of volatility and drawdowns, 2020 is in line with Black Monday 1987 and the Great Financial Crisis of 2008. Having watched our TVIX holding gyrate by as much as 40% earlier this week, we thought it would make sense to outline our strategy for managing risk as a key component for meeting our four overriding goals:

1) Preserve capital

2) Avoid a drawdown greater than 20%

3) Earn a return above average benchmarks such as the S&P 500

4) Be uncorrelated to the general stock market and economy

As a general rule, we’ll never put more than 2% of the account at risk for any given trade. Before we enter a trade, we know the buy price and the stop loss price (the price at which we would sell the position if the price were to fall below a certain level). For instance, if we get a buy signal and the current price is $100 and the stop loss is calculated at $90, we know the maximum price drop risk is $10. If an account has $100,000 and our max risk is 2%, or $2,000, then the investment size would be $2,000 / $100 = 20 shares. So, we would size the investment based on the 2% max-loss constraint and the price spread between the current price and the stop loss.

Also, based on our historical models, our trading strategies are in cash around 40-70% of the time, so the risk exposure is also proportionally reduced by these percentages. The sell signals are either driven by the stop loss value or by rapid changes in price volatility. As shown in prior analysis, there is a strong correlation between market sell-offs and sizable increases in price fluctuations. Lastly, we trade symbols that are somewhat uncorrelated to provide a measure of diversification.

Forte Strategy Update

The equity markets finally dropped to a level where all models are active. We executed nine trades using the Nasdaq 3X leveraged ETF (TQQQ) and the TVIX ETF (2X leveraged VIX futures) for a net gain of 0.8% (based on closing out any open positions from last week and any open positions at the end of this week). Our YTD net results so far equal a 1.5% loss compared to a 4.1% YTD loss for the S&P 500. Our YTD maximum drawdown is 9.5% versus 33.9% for the S&P 500.

More details about our trading activity can be found by registering on the Collective2 website and searching for Forte Strategy. A running list of these email blogs and general information about Maestro Capital Research can be found at maestrocapitalresearch.com.

Leave a Reply

Your email address will not be published. Required fields are marked *