Risk Management. A Must For Every Investor. [Weight of…

Weight of Evidence: Part 1 | Part 2 | Part 3 | Part 4 | Part 5 | Part 6 | Part 7

If price is the most important piece of evidence in identifying opportunities, then risk management is the most important part of taking advantage of those opportunities. From a risk management perspective, technical analysis is ideal for identifying when any trade thesis is wrong. Knowing when you’re wrong or knowing when to exit is crucial to successful trading. We don’t care about being right. We care about being on the right side of the trade. Technical analysis allows us to do that on a consistent basis.

Technical analysis allows us to identify logical entry and exit points to maximize gains and limit loss. Every time we enter into a trade, we must have an exit plan – both for locking in gains and stopping any losses. Too often, investors will enter into a trade without a game plan. That is, without targets and stop losses. This is like entering an unknown and crowded room without identifying any exits or escape routes. Not wise. At 360 Investment Research, we try to identify the most logical entry and exit points before entering any trade. For each investor, entry and exit points will vary based on risk tolerance and individual styles and preferences. Regardless of the aforementioned, all traders, including you, should know exactly when your current trade is wrong. We don’t want to get into a psychological game of chicken with the investment of choice. If/then game planning allows us to remove emotion from the trading process and eliminate as much bias as possible. How do we this? Some examples of setting up if/then scenarios can be found in two great trades we shared with our readers this year: Nike (NKE) and Russia (RSX).

For another example of game planning and risk management, we can look at the current state of the S&P 500. We like to use ETFs to capture markets, sectors, or segments. In this case, we’re long the S&P 500 using the ETF, SPY, as our vehicle. As we’ve previously highlighted in parts 1-5 of this series, we’re seeing some negative evidence appear that is causing us to watch price (the most important piece of evidence) very closely. So we’re long the S&P 500 with some warning signs that need to resolve. What’s our game plan? Where is our exit (which can also be an entry going short)? Let’s take a look. The chart below is of SPY. As you can see, price has been steadily making higher highs and higher lows within the green upward channel. The exceptions being lower lows in February and October, which were subsequently countered with new higher highs. So the trend is up and we are long this market. What will it take to change our long stance? Simple. Breakdowns below previous areas of likely demand (aka previous highs) and below the green price channel. As annotated on the chart, our game plan is to change from long to short (using SH) with a daily close below 204.00. This is our if/then line. We are long above it, short below it. If price moves below 204.00, we would add to our short position with a close below 200.00. Each of the shaded areas and the lower green trend line would be logical places to reassess what price is doing and either add to our short position or change back to long. At each of those levels, we’ll analyze price and make adjustments as needed. With risk management, no game plan is static. We continually reassess our game plan to minimize loss and maximize gain. This game plan is not for everyone. We’re not saying going short is right for you. But, cash is a position too. And for right now, the lines in the sand are pretty clear.

Trade safe and stay curious, investor.

Weight of Evidence: Part 1 | Part 2 | Part 3 | Part 4 | Part 5 | Part 6 | Part 7