The Laws of Nature, Managing Risk, Common Sense and Infinite Patience

It’s been quite a while since I’ve made a post to this blog.

In July of 2010 my last post was a series of questions I asked myself to get a sense of which way I wanted to position myself in the market given the historically weak US economy. My focus has been and continues to be the RUT for swing and longer term positions and the TF (E-mini Russell 200 Future) for intraday trading. I enjoy this Index because of it’s high volatility and the relatively high premiums on the RUT options.

For the last 18 months, 95% of my trading has been intra-day TF futures as I did not understand what the daily and weekly charts were doing. If I don't understand it, I don't trade it. Moving down to a shorter time frame in my case gave me better clarity and the ability to better manage risk.

After answering those questions I decided that I would continue to wait, watch the charts and wait for my signals to give me an entry signal short. After the RUT found support in the 600 area in late Aug 2010, it has been grinding higher ever since. Thus, no entries short yet. I have put on some very small positions short in some over extended areas after some topping tails, but nothing significant yet as the charts are still uber-bullish.

Tomorrow I’ll put up some charts and talk about some interesting observations, but today I want to take a few steps back from the technical analysis perspective and share some of the real world observations I’ve had over the past 2 years and how they’ve affected the way I see the markets now.

The Laws of Nature:
Paraphrasing the Hellen Keller quote, “Security does not exist in nature.”

As I look back at world events of the last couple of years, I have observed that not only does security not exist in nature, but it’s “non-existence” is more a law of nature. Closely related is the “Law of Constant Change.”

In 2008 the US economy was on the brink of collapse and was postponed only by a last minute infusion from the Fed.

In 2008 Fannie Mae needed a bailout by the US Government

In 2008 Freddie Mac needed a bailout by the US Government

In 2008 AIG needed a bailout by the US Government

In 2008 GM needed a bailout by the US government

In 2008 the US stock market crashed.

In 2008 the US housing market crashed.

In 2010 the Haiti Earthquake cost loss of life and property damage on a grand scale.

In 2010 the BP oil spill devastated the gulf region.

In 2011 the Japan Earthquake, Tsunami and Nuclear disaster has devastated the region.

In 2011 the US Midwest was riddled with Storms and Tornadoes costing loss of life and property large scale.

In 2011 the US Mississippi River Floods costs loss of life and property on a grand scale.


Natural Disasters vs. Man-Made Disasters
Of those major events listed, they can be split into the two main categories of Nature Disasters and Man Made Disasters.

There is no security in nature, but fortunately man is equip with the ability to think, reason and apply risk management techniques to increase the odds of his survival. This could also be called “Common Sense.”

In the case of the man made disasters above, ALL were avoidable, but occurred anyway because those in charge ignored common sense, and did not manage risk.

In the case of the natural disasters, in many cases the historical data was not available to put into place the necessary risk management techniques to avoid the dangers. The flooding along the Mississippi for example hasn’t been this bad for over 80 years in some cases, so the latest generations that built in those areas were unaware of the potential dangers. That being said, there is new data as of today that signal very clearly that it is NOT SAFE to rebuild in those areas. Should that new data be ignored they are likely to suffer the same fate at sometime in the future. A better alternative is to build in a non-flood zone.

We will never be able to avoid danger completely, but we must be aware of those that pack the highest degree of punishment so we can manage the risk of those events. Even with all those risk managed, we could step outside tomorrow and be hit by a falling piece of the space station, that’s part of the risk of just being a human and walking around. A good life is the balance of being a good risk manager without becoming overly paranoid.

Multiple Black Swans
One of the reason I wanted to mention all of those events is because just 5 years ago the odds of those events happening would have probably been less then 1%, most certainly in the case of the man-made disasters. In other words, they were all “Black Swan” events. Nevertheless, because they didn't plan on the events, they caught everyone completely off guard the degree of punishment was EXTREMELY HIGH.

More Black Swans Ahead:
Moving forward and applying the Law of Constant Change, there is a very high probability that we will again experience several more man-made Black Swan events in the next few years. I see this probability as extremely high because again there is an absence of common sense and risk management at the FED were the failure of their plan will inflect great punishment and trigger a domino effect of more Black Swan events. As we see above, looking at our man-made disasters, when risk management is ignored the probabilities are substantially increased for a failure of their desired result. While the FED hopes for long term stability, their actions will surely produce the exact opposite result because they have lost complete sight of true risk management just as Greenspan did.

Infinite Patience:
I was fortunate to learn early in my trading career that patience is one of the cornerstones of trading discipline. Tomorrow I’ll talk more about patience and risk management as it applies to setting up some longer term positions with the current market conditions and VIX levels.

Disclaimer:
The following is a disclaimer to advise the reader or viewer of any charts, trade set-ups or comments from this blog by Alanpuri Trading. The information and opinions expressed here are for educational purposes only and are not intended as investment advice or an offer or solicitation for the purchase or sale of any financial instrument.

Trading the market involves inherent risks and investors can lose money investing in the markets. Individuals trading in the market are encouraged to seek professional advice, before investing.  Those that do trade must do their own due diligence and research to determine whether their investment choices are appropriate for their investment needs. The individual reading these comments and opinions by Alanpuri Trading or its authors are fully responsible for their own trading decisions.  Alanpuri Trading and its authors will accept no responsibility for any trading losses of any kind.