A Dash of Insight: The Importance of Trading Feel

November 01, 2007

The Importance of Trading Feel

In developing our trading methods, we pay careful attention to various measures of risk and volatility --beta, the Sharpe ratio, the Ulcer Index (Vince's favorite), and others. These measures must all be compared to another important approach, the trader's "feel" for the position.

How Does One Develop "Feel"

Developing a feel for one's position is difficult to explain to those who have not experienced it. It is always wonderful when you are making money. What happens when you are losing?

Let us suppose that the S&P 500 is your benchmark, and you have been beating your benchmark nicely. This can occur for two very different reasons:

Your positions have "edge" as we have described it in past articles. You can expect them to outperform the market in most circumstances; or,
You have a high beta position which will make more in a rising market but lose more in a decline.

You can often tell the difference by watching intra-day trading. If the swings make you uncomfortable, specifically with respect to your investors' needs and goals, the position is too big. It may not be too big in dollar terms, but it is in beta terms. This "gut check" became part of our method for building risk tolerance into trading systems.

Big Market Declines and the ETF Trader

Those following an ETF system like our sector-oriented TCA-ETF approach, which combines trend, cycles, and anticipation, should pay careful attention to major market declines. On days like today, there were few winners. If your system has been outperforming on the upside, the test is to keep it about even on the downside. This is how we determine whether the position is "too big" and you should do the same. Remember this important principle:

Choose size based upon what you can afford to risk, not on what you want to gain.

Educational Sources

Each week we are impressed by the gatekeeper work of Abnormal Returns, where there is an ETF category for easy searching, and The Kirk Report. Both have a nice touch for guiding readers to the topics of interest for them. This recent post had plenty of ETF educational material.

A good starting point for ETF investors is the Seeking Alpha ETF guide.

Position Update

At "A Dash" we are trying to show readers the advantage of using a system with some technical criteria for ETF trading. Prior articles in the series, which covers several important topics for ETF investors, can be found via our index. While the results have been excellent so far, we know from testing that there will be trying times, and we report the outcome with that knowledge in mind. Following both good times and bad is how we learn.

The summary is always done based upon Wednesday's close, so the table does not reflect today's trading. Our losses were roughly in line with the market, confirming our feel for position size. Regular readers will note some position changes. Results for closed positions, including losers, are also reported.