Mac Murray

Chapter III Exit the Wave Without Going Over the Falls

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Chapter I  Big Wave Coming

Chapter II  The Take Off:  Dropping In Without Wiping Out

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Chinese Blue Marble Half Slice

“The exits, not the entries, determine the outcome of our trades.”

–Chuck Lebeau

Chinese Blue Marble Half Slice

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If I had to weight the importance of entries versus exits, at least 80% would go to exits, no question.  A superb exit can make a crappy entry look superb.  A crappy exit makes a superb entry look like crap.

Why do you suppose the vast majority of “How to” material out there fixates on entries, rather than the exit?  (See Be Careful Who You Listen To) Richard Weissman of Mechanical Trading Systems concludes, “Behavioral finance proposes that one reason for lack of success in exit strategies is an irrational emphasis on entry price.”  Oops.

Intriguingly, renowned trading system developers have demonstrated you could even enter trades at random and, with the right exit strategy, consistently end up net positive.  In fact, trading results are so exit-dependent as to make it exceedingly difficult to determine the relative merit of any entry on its own.

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Nihao Mineral Resources

NI

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The Profit Target Fallacy

Imagine how strange it would be to hear a surfer declare, “Dude.  My goal is to lock in a quick 15 meter ride and I’m out.”  Wouldn’t you wonder, well what if the wave goes for 50 meters?  Or 100 meters?  Or 250 meters? What if it could have been the ride of a lifetime, but you punched out after a measly 15 meters?

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Chinese Blue Marble Half Slice

“Most traders err on the side of exiting their profitable trades much too soon.”

–Chuck Lebeau

Chinese Blue Marble Half Slice

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Oddly enough, that’s precisely what many traders have been trained to do.  To punch out after an arbitrarily established profit target, only to kick themselves when prices go ballistic and rise straight to the moon.

When pressed, traders parrot blindly accepted adages such as, “Nobody ever went broke taking profits.” While that may be true, you may lose a year’s sleep if you punch out at ten percent and miss a hundred.  Or fifteen hundred.  If the next wave you catch turns out to be the mother of all waves—wouldn’t you rather ride it for all its worth?

Every Big Wave surfer's nightmare

Every Big Wave surfer's nightmare

To be fair, it’s human nature to get out “while the gettin’ is good”.  This is due to the fear of loss overpowering the desire for gain.

In big wave surfing, due to any number of mistakes a surfer may find himself getting swept up and over into the breaking edge of the wave.  This is known as “going over the falls”.  The specter of  a 10-story body-slam then getting pile-driven fifty feet below the surface is enough to keep any big wave surfer awake at night.

For your average trader, it’s the nightmare of getting swept over the falls of collapsing prices which compels most to exit profitable trades prematurely.

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“It’s Just Emotion Takin’ Me Over”

Alas, traders are only human.  Nevertheless, over time the account equity of the emotional trader, like an airliner in the hands of a moody pilot, tends to come down a lot faster than it goes up.  Is there a way out of this dilemma?

One intriguing solution is to remove emotion from the trading process altogether.

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Rules-Governed Trading

This is best accomplished by deploying a systematic method of responding to price action that is scientific and objective.  Such a method would require predefined criteria to be satisfied first before selling part or all of your total position.  This criteria would be established in advance (i.e., in our saner moments, not in the heat of a trade), back-tested against historical prices, and codified into a set of rules which are adhered to with unyielding discipline.

Or, if discipline is wanting, programmed into a computer which transmits automated sell signals to our broker.  (See the Merits of Rules-Governed Trading and On Mechanical Trading Systems)

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Chinese Blue Marble Half Slice

“The greatest benefit of mechanical trading systems is their ability to reprogram traders away from destructive types of behavior in favor of successful trading habits.”

Richard Weissman, Mechanical Trading Systems

Chinese Blue Marble Half Slice

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Paxys, Inc.

PAXYS

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Market Dictated Investment Horizon

No one can foresee the size or duration of a wave before it happens.  Suffice to say we want to ride every stock market wave for all it’s worth.  Thus, although we’re predisposed to LTO  (i.e., a long term orientation), truth is we’ll ride the trend for as long as it lasts—whether 5 weeks, 5 months, or 5 years.  We’ll let the Market itself determine when we’re to be short-term, mid-term, or long-term investors.

This seems preferable to labeling ourselves “day traders”, “swing traders”, “long-term traders”, etc., then feeling compelled to live up to what might at times be a limiting label.

The ideal trend-following system, therefore, deploys an objective method of identifying when a trend appears to have exhausted itself and an equally systematic method of re-entry should the trend reassert itself.

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Geograce Philippines

GEOGRACE

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Big Wave Fund Management in the Philippine Stock Market

January 1 to December 31, 2008 I deployed this method, precisely as described above, on an incubator fund trading the Philippine Stock Market.  The only distinction was FDR (i.e., the fixed downside risk algorithm) was dialed to 2%.  That is to say, at no moment during the year did a single trade expose more than 2% of total assets under management to risk of loss.  The system was objectively applied to the entire stock market without prejudice to fundamentals, sector, etc.

This big wave approach to investing, incidentally, was originally conceived and engineered for emerging market hedge fund management.  However, to the extent emerging markets are heavily correlated with the majors (so much so, their respective stock charts are indistinguishable from one another), the system will likely perform favorably across Developed Markets as well.

Looking back, from the vantage point of a investment manager, 2008 may have been the worst year in history to launch a fund.  (!)  From the perspective of a trading system developer, however, it was perhaps the best time in history to fire-test the risk parameters of a then-experimental long-only mechanical trading system.

The incubator fund, by the way, outperformed every mutual fund in the United States and the Philippines, ending 2008 up a respectable 20%.  The Philippine Stock Exchange Composite Index ended the year down 48.29%.

Do the math.

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Chinese Blue Slice

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Big Wave Investing and Securing Your Financial Future

In conclusion, it all comes down to this:

  • World class investment management
  • Specifically engineered for the Philippine Stock Market and other emerging markets
  • Deployed on your behalf
  • Get Started

Chinese Blue Slice

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Mac Murray--Managed Accounts featuring Precision Controlled Risk

Mac Murray. Customized Stock Portfolios. Professional Management. Precision Controlled Risk.

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