The GoC challenge: how would you trade this market setup?

G

Ghost of Cutten

Let's say you identify an early stage bull market. Your analysis and past experience indicates that the market will go up at least 300% in the next 5-10 years, maybe 500%+. However, it will almost certainly have 2 or 3 corrections and short (3-9 month) bear markets of 20-40% during this period, and will eventually end with a huge blowoff top and then fall 75%+ like the nasdaq in 2000-2002. Assume that you will be able to identify the ultimate top roughly when it happens - i.e. you won't be able to sell the exact top, but will know that it's getting very risky. And assume that you will only have a 50% hit rate on identifying the smaller bear markets/corrections - both when they start and end.

Overall, you think you have an 80% chance of being correct about the huge move. And you have a clear stop, which will get triggered if you are wrong. If you are wrong, you anticipating losing about 30% from the current market price, before your stop is triggered.

So, you will win 80% of the time, and when you are right you make 300%+, when wrong you lose 30%.

How would you trade it? Firstly, how much would you risk losing on this trade, as a % of your total net worth? Second, what strategy would you use to trade it?

Would you just buy, sit on it for 3, 5, 7, 10 years, then sell everything once you see the warning signs of the ultimate top, and simply ride out the 20-40% corrections and bear markets? Or would you try and time the corrections and mini-bears, even though you might not be able to do so reliably, and might risk missing a big chunk of the move by getting out too soon, or exiting at a good time but failing to get back in? Maybe you'd put some money in as a "buy and hold", and then have another chunk where you add some size into the 20-40% corrections to juice your returns? If so, how much would you allocate to each?

What would be your approach?
 
Quote from Ghost of Cutten:

So, you will win 80% of the time, and when you are right you make 300%+, when wrong you lose 30%.

How would you trade it? Firstly, how much would you risk losing on this trade, as a % of your total net worth?
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If the system is really that good then, I would risk 90% of the net worth. 70% of the fund would be to follow this system, 20% would be to hedge against for the bull/bear rallies. The other 10% of your net worth should be used as rainy day funds; just in case the trading system fails.
 
Sorry Cutten, I think the reason for the low participation in this thread is that most traders (myself included) don't think on such lengthy time horizons!

<i>'Identify an early stage bull market that I think will go up at least 300% in the next 5-10 years, maybe 500%'</i>, put on the position and sit quietly for a decade? I don't generally even try to accomplish that (buying bullion in 2001 was a special-case exception, and in hindsight I didn't put on anywhere near the proper size I should have). But if I think coffee or oats are fundamentally undervalued by a great margin, I'm not even going to try to design a 5-10 year long futures position around that. Maybe I should start?

The U.S. long-bond yield went all the way below 3%, less than two years ago. Obviously it had no where to go but up... but did I short 30-year treasury futures then? Nope, because I didn't know how long I'd have to sit before bonds dropped/yields rose to more sane levels. I was more concerned with shorter-term trades. Another error on my part in hindsight, of course.
 
long chunk of ones life. No way you can get this type of stat. I am bulish of resources since '97 and was in and out and not too much to show for it :(

more realistic to target couple of months swings as real time stat easier to get.

I split idea in 10-40% of budget straight in, 10% traded on shorter term.

Other 50- 90% added once get good move in my direction and then retracemet depending on strength of setup.

get about 10 signals a year.

In this state I can think clearly which is important when adding or abandoning idea. Also have a life :)
 
Quote from Rearden Metal:

Sorry Cutten, I think the reason for the low participation in this thread is that most traders (myself included) don't think on such lengthy time horizons!

<i>'Identify an early stage bull market that I think will go up at least 300% in the next 5-10 years, maybe 500%'</i>, put on the position and sit quietly for a decade? I don't generally even try to accomplish that (buying bullion in 2001 was a special-case exception, and in hindsight I didn't put on anywhere near the proper size I should have). But if I think coffee or oats are fundamentally undervalued by a great margin, I'm not even going to try to design a 5-10 year long futures position around that. Maybe I should start?

The U.S. long-bond yield went all the way below 3%, less than two years ago. Obviously it had no where to go but up... but did I short 30-year treasury futures then? Nope, because I didn't know how long I'd have to sit before bonds dropped/yields rose to more sane levels. I was more concerned with shorter-term trades. Another error on my part in hindsight, of course.
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Maybe the fact that no one has answered is actually a sign that this is a good approach to use.

Ok, here is the case for trading (maybe "speculating" is a better term) this way. What is your typical risk/reward and win rate on short-term and medium-term trades? I'm talking from a few days to a few months. Things like your recent silver trade, or your financials trade in summer 2008, or even your oil shorts in 2006 and 2008 (which were medium-term over a few weeks/months IIRC?). Or even the recent bond call - another medium-term (not long-term) trade (by the way, part of the reason that is not as good a trade is just because you are losing 3% or 4% per annum to be short the bond, so if it takes 3 years to drop 20%, you're only making 8-11% total. 10% upside, when you could easily see a further 10% move against you, is not a great risk/reward. It was a decent trade but not one to retire on, unless you bet the ranch on it and take a huge risk). I'm guessing you made about 3 times what you risked? That's good, but the risk/reward on these longer-term moves looks a lot better:

Gold from 300 to 1350, max drawdown 35%, gain of 350%, a 10:1 R/R. Wheat from 300 to 1200 in under 2 years, max drawdown was around 15-20% IIRC, a 300% gain, for a 15-20:1 R/R. Oil from 25 to 145 etc. Or some of the stocks in late 2008/early 2009 to present day, insane R/R ratios. Furthermore, these were moves you could anticipate, high probability moves that were probably 75% likely (or more) to happen as foreseen. And the "failed" trades often don't lose even 20-30%, many of them just go nowhere and breakeven, or stop a little, some even go up a bit. The only way to really get short-term risk/reward ratios like that is to use options, but then your win rate drops dramatically as they can expire worthless even if you are right, and you have to pay up for premium during volatile reversal points. I have had 10x, 20x, 30x winners in options, but not 75% of the time, I'd consider myself lucky to get that 7.5% of the time lol.

Basically, the long-term compounding effect just gives you a much better risk-reward. If something goes up 500%, even if it was a rank speculation that could have gone to zero, you still made 5 times your risk. Whereas if something went up 50%...well you could have lost 20% if it kept going against you. Odds are just no way near as good. And the win rate is as high as your prediction record is good. IMO it's possible to be right 3 times out of 4, or 4 times out of 5, on these secular trends.

So, that's my motivation for trying to get the ideal method for trading these. For a long time I thought that trying to time the moves and avoid the periodic major corrections was the better approach, but more recently I'm thinking that perhaps the "dumb" but simple approach of stay in until the whole move has taken place years later, is really the only way to make big scores on these kinds of moves.
 
Quote from macroman:

long chunk of ones life. No way you can get this type of stat. I am bulish of resources since '97 and was in and out and not too much to show for it :(

more realistic to target couple of months swings as real time stat easier to get.

I split idea in 10-40% of budget straight in, 10% traded on shorter term.

Other 50- 90% added once get good move in my direction and then retracemet depending on strength of setup.

get about 10 signals a year.

In this state I can think clearly which is important when adding or abandoning idea. Also have a life :)
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I disagree, why is it not realistic to sit on something that is going up 5-fold in 5 years? You can still trade short-term while you wait. With futures, you don't even tie up much capital.

Just one of these moves can make 5 times your money, with risk of 0.2-0.3 times your money. Get 5 ideas a decade and you are looking at a pretty impressive compound rate, and this is totally unleveraged too. Then by all means make your multiple short-term and medium-term trades each year on top of that, this will juice the returns even further.
 
Quote from Rearden Metal:


<i>'Identify an early stage bull market that I think will go up at least 300% in the next 5-10 years, maybe 500%'</i>, put on the position and sit quietly for a decade?

......

But if I think coffee or oats are fundamentally undervalued by a great margin, I'm not even going to try to design a 5-10 year long futures position around that. Maybe I should start?
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Well, putting on the position and sitting is definitely one approach. I've avoided that so far because if I see a 15-30% correction coming, I dislike the idea of staying long during it. What usually happens is I spot the correction and sell a bit early or a bit late, the market goes down about another 10-15% from my sale point, and then that is the bottom. The market makes no obvious "buy signal", and either fucks around for a year slowly creeping back up without me going long, or rapidly rebounds, looking overbought the whole way back up, and I end up buying a smaller position back at higher prices, or missing my re-entry entirely (got better at avoiding that though).

So at the time, sitting looks unattractive...but usually within a year, I wish I had just "sat". Lol.

As for your second point I quoted - it's not so much about trading fundamentally. Yes, fundamentals are usually there as well. But it's more about just noticing that the market is "ready" to make a big move. For example in 2004-05 I felt grains might "catch up" with the other commodities that already had big moves. I was early but no major price declines occurred while waiting, and eventually a huge move did happen. I repeated my usual pattern of being early, not buying enough, making decent but not big money, then exiting too soon in an attempt to avoid a moderate 20% correction, and not getting back in.

It doesn't usually take 5-10 years, a lot of the moves actually resolve in 1-3 years. For example the grain bull run was about 2 years IIRC, ending early 2008 with a huge blowoff top. Stocks took only 1 year to go up 85% from the 2009 lows, and most stock bull markets end within about 4-5 years tops. But the very few "secular" trends, like tech in the 90s, housing in the late 90s to mid 2000s, and gold 2001 to present, last longer, so why not play them until they end?

And yes, I think you should try to do it. 90% of these moves will only require 2-3 years of holding, and there's nothing saying you have to go 100% long. Even a mere 10% position, if sat on for 3 years, and you are right, will make a 40-50% profit. You can still do your other trading independently of these long-term positions.

Anyway, at the moment I am trying to solve the issue by having a smaller "core" position which I will hold until the move is at an end, and will ride out any corrections along the way. It's annoying to lose money when corrections that I foresaw come along, but that is the only way I can think of (so far) to ensure that I participate in the whole move. Ideally I'd like a way to avoid the bigger corrections whilst still participating at all other times - kind of like a buy and hold with a bit of tactical timing to avoid the worst drawdowns. Maybe that's wanting to have my cake and eat it, but I thought I'd cast around for some ideas here first.
 
I just thought of this so it may be totally off base but ....

How about a conservative options pyramid. A 370% price increase = 30% five times in succession, but you are going to use options to gain 60% five times = 1000% profit.

The obvious risk is that a drawdown could blow the whole thing up. So go CONSERVATIVE, maybe keep rolling into deep ITM at least a year out. For example GLD, the Jan '12 65 calls are selling for $68.70. This gives you about 2:1 leverage and you only start to blow up on drawdowns lasting more than 1 year. You are only paying $1.50 premium for the magic of compound, pyramiding profits.

Maybe leverage up with a more aggressive strike price, and use deep OTM puts as a hedge. Still the same idea - linear costs (deep OTM puts) against compounding profits.

Either way = filthy lucre.
 
I'd put close to 100% of my networth there. Can't see anything better to put on given these numbers. As that bull rode on I would have to decrease that % as the expectation is looking less attractive
 
Quote from promagma:

I just thought of this so it may be totally off base but ....

How about a conservative options pyramid. A 370% price increase = 30% five times in succession, but you are going to use options to gain 60% five times = 1000% profit.
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Time decay. Options can definitely be used to improve entry and exit, but you are still stuck with the eternal risk tradeoff. You simply cannot profit from a massive move without accepting the risk of either i) holding on for the long-haul and suffering numerous big drawdowns, or even a huge drawdown if you are wrong and a bear market occurs ii) trying to time the drawdowns, and then either getting chopped up whilst doing so, or exiting and not getting back in etc iii) using options to hedge your risk, and seeing your premium evaporate as the market churns back and forth. Premium payments also subtract from your profit.

No real solution I can see except to either i) be right, and be able to hold on ii) be a great market timer - both on exit AND re-entry.
 
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