Rebel Traders 059 : Dealing with Drawdown

Dealing with draw down, panicking about your portfolio when things are not going your way? Well, let’s see what we can do to give you the right moves to get back ahead...

Everyone has to deal with draw downs and take a hit in their portfolios every now and then, just like ANY business. However, we have strategies and approaches that we use to minimize those harder times and approach portfolio management it in a very different way.

So, let’s show you what we do, how we do it and and how you can minimize the negative affects of a draw down or down turn in your strategies performance.

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Sean Donahoe: Dealing with downturn? Panicking on your portfolio? Let's fix it. Let's do it.
Automated: Rebel Traders takes you inside the world of two underground master traders, who take an entertaining and contrarian look at the markets to cut through the noise of Wall Street and help you navigate the trading minefield. Together, Sean Donahoe and Phil Newton are on a mission to give you the unfair advantage of a rebel trader, and now here are your hosts Sean Donahoe and Mr. Phil Newton.
Sean Donahoe: Hey, hey, hey, this is Sean Donahoe and as ever I am joined by my partner in portfolio podcasting, Mr. Phil Newton. How are you doing, sir?
Phil Newton: I'm pretty good. I thought you were going to go on about Downtown Abbey for a moment there, but, no, it was drawdown, drawdowns we were going for.
Sean Donahoe: Yeah, I was ...
Phil Newton: I thought you were going to be caught ringing the little bell for the butler.
Sean Donahoe: Absolutely, well, bring me a cup of tea, sir, and we'll be all good to go.
Phil Newton: As you wish.
Sean Donahoe: No, we are talking about downturns and drawdowns and panicking in your portfolio and everything else. Basically, everyone deals with this.
Every now and then you're going to get a negative turn in your overall capital. There's not going to be much that you could do about it, but we're going to be talking about how to deal with it, how to recover from it, how to manage not only your portfolio but also your state of mind so that you can get back on track where you want to be.
Phil Newton: Can I get an early soapbox comment in there? Just like any other business!
Sean Donahoe: Absolutely, we knew that was coming.
Phil Newton: You knew it was coming with the subject of this week. Anyway, we've also got our Rebel Trader mail bank. We've got some interesting questions this week. I'm sure that we'll find some even more interesting answers. We've also got the bullshit of the week, my continued favorite section.
We get at the hype of all the shenanigans, the nonsense, the general idiocy and tomfoolery of the industry, and somewhere amongst our own nonsense we're going to try and answer the core question of where is the trade.
Sean Donahoe: All sorts of stuff.
Okay, well, let's get right to it because, again, we just need to establish one prime thing, okay? Everyone experiences drawdown in their portfolio and their capital. Everyone deals with bad weeks, bad months, and sometimes even bad years. That's extreme but, you know what, it can be a severe kick in the emotional gonads. It really is a time and a place, so to speak, where you start reevaluating a lot of the things that you're doing.
First, I just want to start with the end in mind. Deal with it.
Phil Newton: Yeah, get on with it. It happens. You're absolutely right. I think everyone's looking for that 100% success rate, and we've touched on it from the point of view of strike rates in the past. This is the same thing, it's the same argument, it's the same vein of conversation, and that is literally the fact that no strategy is perfect.
I experienced this when I started. I wanted every trader to be a winner. Is the next one going to be one that stops me out? Is it going to be another loss? As soon as you get past, well, it might or it might not be, and stop worrying about the monetary outcome as your ultimate objective and it has to be a positive dollar amount, that would be one objective for the position. If you can follow your trading plan with consistency and shift your focus, then you're less focused on that drawdown phase.
Again, just to how to deal with that, you are going to have a monetary drawdown. Again, notice the word that I'm using. It's not a "loss." A losing position is something very different to a monetary loss in my book. A losing trade or a losing position, for me, is one where I didn't do everything I said I was going to do. With that different perspective in mind, my viewpoint in a losing trade today is very different from when I first started out, because I was chasing that monetary ...
Sean Donahoe: Greed.
Phil Newton: I was chasing that monetary gain just like everyone else.
That's why we're doing it, to make money, but why do we have that in the first place? Well, maybe it's fear, maybe it's just lack of experience, maybe it's just emotional immaturity when it comes to the trading realm. What's your perspective on that, then? Because I think it's an interesting talking point.
Sean Donahoe: No, absolutely. Yeah, we have to really define and, again, I think this is another drum that we take for granted. You and I take this for granted.
Just as a sidebar, and this is, because I find myself doing this, is when I'm agreeing with you. I'm going, mm-hmm (affirmative), yeah, and everything else. I got told the other day that we're like the trading equivalent of Diamond and Silk. I don't know if you've heard of those two YouTube ladies that go on and, again, agree with each other and they have their little ranty moments.
Phil Newton: Yes, they ... My dad gave me the best piece of advice on my wedding day. He basically said, "You only need to remember one thing, son. It's this phrase, and it will get you out of everything that ever could possibly happen." He said, "Just remember this one phrase," and he leaned down and he whispered into my ear and he went, "Just say this, 'Yes, dear,' and you will never go wrong."
Sean Donahoe: You know, maybe I should learn how to do that.
Phil Newton: Is it something along those lines? "Yes, dear."
Sean Donahoe: Not quite, but go check them out, Diamond and Silk. They're a couple of YouTube people that get on their rant and agree with each other all the way, reinforce each other, and we have to bang these drums every now and then. We get on these little rants and we take a lot of things for granted, because we have this opinion about what is a "losing trade" versus a "monetary loss."
I think it's something that we really need to reiterate a lot. It's because a lot of it comes down to the ...
Phil Newton: I don't hear people talk about it that often, to be honest. In all the years that I've been doing this, I don't hear people make that distinction.
Sean Donahoe: Yeah, I think that's one of the tactical, strategic advantages that we have is, part of our mindset is ...
Phil Newton: I was just going to say, it is a mindset thing. It's such a simple thing, a simple shift in perspective, and it makes a whole world of difference.
Sean Donahoe: It really does. If we consider that we are consistent with the application of our strategy, whatever that may be, there are going to be particular times when the environment that we're in is not going to be ideal for that strategy's maximum success, or there's just going to be, again, Sod's law, Murphy's law, random chance where things are just not going to work out. They should, they all line up with the numbers and everything else, but the same with anything.
If you're playing perfect strategy or if you're playing, say, if you've just got a coin toss, flipping the coin 50/50 chance it's going to land on heads, going to land on tails, there's going to be periods where it's going to be, if you're betting only on tails, the law of averages says that you will hit roundabout 50%.
Phil Newton: You have win streaks.
Sean Donahoe: You have winning streaks where it will seem like it's only coming up with, say, heads, and you're betting on heads, boom, and you're getting heads all the time, all the time, all the time. However, there's also going to be periods and streaks where there's going to be just tails and you're like, "What the hell is this?"
Again, part of this is the psychology, the fear of loss that makes you start panicking. Especially when you're gaining, hey, you're all elated and it seems like you can't do anything wrong because you just happen to be in one of those streaks where everything just seems to be aligning. The stars have aligned, the choruses are opening up, there's angels, aah, hallelujah.
Phil Newton: Beaming down on you. It's all so true as well.
Sean Donahoe: Absolutely, everything is fantastic.
Phil Newton: Exactly, yeah, it's emotionally destabilizing because you start to, as you said earlier, you start to question, "Why am I doing this? Is it right?"
This is where having that confidence in the strategy, confidence in the research, confidence in the results that you've got this average expectation, if you've got a very large either historical actual result set to fall back on or at least from a research point of view, if you've got enough data, then you can sit through that storm, as it were. This is what've spoken about and touched on in the past. It's that, if you hit the losing streak, any strategy that makes money is a good strategy as far as I'm concerned, but whether you continue to use it is when you hit that losing streak.
When you've gone from the highest high in your equity to the lowest low in the strategy drawdown phase, that losing streak, it's that ability to trade through that, when the times are tough, that's going to determine whether you're on the trade when the strategy turns around, when the conditions are right, when everything's more in line, because anyone can trade when the trend is there. We've got a nine-year bull market for crying out loud. Anyone can trade in that, really.
Sean Donahoe: Most people should be making money, have made money, during the last nine years.
Phil Newton: Most people should have, but a short term example of when it's not working out is the last three or four months. For trending strategies, the markets have not been trending. Most of what I do is directional trading. I've got some bullish, some bearish, but the market's not trending, if that makes sense.
As such, generalizing, my strategy is not performing, but then the market's not going anywhere. Well, then, that's normal for a trending strategy. Your research will tell you that, okay, well, you've got the longest period from a time point of view. You've got from a money point of view what the longest period of peak-to-valley drawdown is.
When you're armed with that knowledge, you can say, "Okay, well, I know that this is on average going to last X number of days, X number of weeks, X number of trades," whatever your research says. Then there's going to be those anomalies like, "Right. Now, I think I'm in an anomaly with my own strategy because we've got this extended period of the market going sideways."
Again, for a trending strategy, again, it's not fantastic. Again, there's pockets of good trades and bad trades but I've got to admit, I'm around break even. I'm holding my head above water, I'm on the right side of positive, thankfully, but they're not exceptional returns at the moment. I am outperforming the markets, but then the market's not really doing anything. Say what you will with that, it's literally a head-above-water situation.
It's that ability, falling back on the research, to know what your expectation is in the worst period of your strategy. When you're armed with that knowledge, you can say, okay, well, because of that experience, because of that peak-to-valley drawdown, because of that worst-case scenario, let's call it that for now, what's the worst-case scenario is I'm going to have, say, a 15% or a 20% drawdown from the highest high in my equity to the retracement in your equity from bad market conditions, bad strategy conditions, whatever you want to call it, that worst-case scenario.
When you're armed with that, you can start to account for it in preparation for your day-to-day trading. That's what I do. I account for what's the worst that can happen. Again, you've heard us say it many times before, always be in business tomorrow. One of the ways that I do that is I account for that drawdown when I'm working out my position size. I take 20% off the top, just in this, keeping the numbers in the example. Whatever my equity is, I'll take 20% off the top and then work out my position size.
That 20% buffer of what is my worst-case scenario, that's factored into the equation. I'll never experience a 20% drawdown, because I've taken it off the top and worked out my position size. The reason why I'm doing that is I don't want to reduce my position size in a poor trading period. Let me just pause there and just let you absorb that. Does that make sense where we're up to, Sean, because I get excited when I talk about these things.
Sean Donahoe: This is something we've skimmed over before. We've not talked about this in-depth, but go through that one more time just so people get this big thing.
Phil Newton: It was step by step, yeah.
Sean Donahoe: Because this is something that I do and, again, it was a suggestion by Phil that he's been trading for a long time. It's something I do now is I base my position size minus that 20%, but explain that in a little more detail for everyone there, because this, ladies and gentlemen, is pure bloody gold when you start understanding how this helps you with drawdown periods.
Phil Newton: I think what I'll do is I'll take a step back to explain why I'm doing this in the first place.
Conventional money managements and account management and portfolio, whatever management, conventional money management says that you should, as soon as you can adjust your position size, you should. Traditionally, you would risk a certain percentage per trade of your account equity, and you work that out every time you put a trade on. You're compounding your position size with your account growth when times are good, and you're reducing your position size when times are bad.
What that means is, if you have a worst-case scenario and you have an extended period of drawdown in your strategy and you have a bear market in your accounts, just to paint the picture, you have a little bit of a drawndown, that means that at the lowest points of that drawdown phase you're trading with the smallest position size so that when the good times happen you're trading with small position size, so that it takes longer to then compound up and compound up and then break new equity highs.
What I want to do is I want to be able to trade with the largest position size that I last was able to trade with at that drawdown phase. Does that point make sense before I move on?
Sean Donahoe: I believe so, yes.
Phil Newton: Okay, when the good times happen, so you're in the worst-case scenario, I'm not reducing my position size during a drawdown phase. Then when the good times happen, I'm at my biggest position size that I could trade based on my current situation, so that when the good times happen I speed up, I accelerate out of the drawdown faster than I got into it. That's what I'm aiming for.
By doing that, it allows me to get the best of both capital preservation and account growth. One of the ways that I enable myself to do that is, before I work out position size, and I do it once a month, I trade fixed. I'm a little bit lazy, but I don't want to work out every day, so I'm working out for the month for reference as well. Whatever my position is, sorry, my equity is at the end of the month, or the beginning of the month for the sake of a date depending on your viewpoint, but at the end of the month whatever my position size is I'm going to take a chunk off the top, the tip of the iceberg, if you like, because that chunk is my worst-case scenario, my worst expectation of what could happen.
Again, we're just floating around, if your strategy says peak to valley, the worst that you can experience with X number of percentage as a per-trade risk, it might work out to then be a 20% drawdown in your equity. If that's your absolute worst-case scenario, that is the worst performing expectation based on your strategy and research or your actual experience, if that's the worst-case scenario, then let's account for it right at the beginning.
I'm going to take that off the top and then work out my position size, because that means, then, I'll have this buffer of 20%, surprisingly. I'll have this cash buffer, if you like, that means that I can take a drawdown in my account without reducing position size. I can have a 20% drawdown in my equity without reducing position size so that when the good times come I'm going to accelerate out and probably break new equity highs when the good phase of the strategy start to unfold.
Sean Donahoe: Let's take that in real numbers. Say that you've got $100,000 portfolio. Take your 20% off the top, you're trading at 1% positions, that's $800. That way you've got your buffer, your drawdown buffer built right in.
Phil Newton: Yeah, again, this is more to do with overall account management as opposed to individual position sizing, but they can evolve very linked to each other. I'll work out the overall equity size, take 20% off, and then work out my position size based on that reduced overall equity.
Again, that acts as a buffer so that I have that like, think about it like a cash reserve that if I hit a drawdown or, more specifically, when I hit a drawdown phase, I've accounted for the worst-case scenario so that if I experience it, again, I never want to reduce my position size ever. That's what I'm trying to do so that I'm accounting for this, it's almost like I'm being quite aggressive because, again, conventional money management says you should be reducing your position size. I would argue that you don't want to do that, because you want to have your biggest position size at the worst possible points because when the strategy turns around, when the market conditions are favorable, that's when you want to fill your boots.
By accounting for that up front, I'm not reducing my position size and you've got this buffer that allows you to weather the storm. Again, it's a wonderful place to be, because when the good times happen the good times are going to be better than the bad times because of the way that we manage our positions. Our risk is limited and defined on every trade, and our potential upside can be in the many multiples of mid to high double-digits and low to mid triple-digit returns on the option return on capital.
We've got the opportunity for many multiple return on our per-trade capital invested, and we have this very fast acceleration out of a drawdown phase.
Sean Donahoe: Yeah, you come out of it like a bloody ...
Phil Newton: Absolutely.
Sean Donahoe: I've experienced this a couple of times using this, so I'm glad we mentioned that.
Phil Newton: It's phenomenal. It goes, surprisingly, Sean, it goes counter to everything of what everyone does, hence the name "Rebels." We're doing the exact opposite to what everyone else is doing.
Sean Donahoe: We very much do. Guys, just to reaffirm, this is why we put this together, because we're not just counter, we're not counter-trend traders. I don't want to, although I do do that, we have talked about that, but we are counter to a lot of what is conventional wisdom, conventional teaching which puts, again, most people in the poor house.
We look at things as, okay, how can we be the most efficient, most profitable, but also conservative with our risk traders, which is counter to what a lot of people do. That's why we do what we do. It's why we teach what we do. It's why we actually do what we teach. How's that for a novel fricking concept? That is why we put this show together, to share this kind of stuff with you.
One thing that you mentioned there which, again, is coming out of that drawdown phase is, yeah, you are primed, positioned, and optimized for accelerating out of that, but when you're down in that pit there is one point that I think everyone goes through, and, again, this is more shifting towards the mindset stuff, is where you question, is this strategy the right strategy?
Now, again, we're confident in what we do, our strategies and everything else. We've been through drawdown periods, we know our average expectancy, our positive expectancy over time. We've got the data to back it up and that gives us confidence, but a lot of traders out there ...
Phil Newton: Don't have that, yeah.
Sean Donahoe: Don't have that strategy.
Phil Newton: Or don't believe the numbers.
Sean Donahoe: Or don't believe the numbers, or haven't tracked everything. Obviously, we can go into that barrel of fish if we wanted to, but when is a good point to question that strategy and say, "You know what? I need a change," because, again, we've got, obviously like I said, we've got the numbers, we've got the data, we know what we're doing, and we're consistent.
That's what we've, we've taken that sword into the forge and hammered it many times and we know that the blade is good. For most people, they're dealing with rusty iron and they don't know that the sword is going to handle a big battle if it comes.
Phil Newton: Yeah, well, that leans onto the second part of this overall strategy and, again, it's something else that we've also touched on in the past. That's the overall how to deal with the account as a whole and make sure that you've got the right position size when the times are good.
Then the second part, second prong, is to reduce your position size for the reasons that you just mentioned, because chances are, if you've got the research and everything else to back it up, the only thing that's preventing you from deploying the strategy is your emotions. It's your psychology, it's, "Am I doing the right thing? I'm in this drawdown phase," and it's difficult to put the next trade on when the last 10 trades have been negative from a dollar amount.
Shift your perspective is the first thing that we've done. It's redefine what you call a winning trade. Did I do everything I said I was going to do? Yes. Again, you'll know that the market conditions don't look great. Now, I made the decision a long time ago to trade through periods of drawdown for all issues, because I don't know when the good times are going to start again. I don't have a crystal ball, and I've tried to time it. I've tried to figure out, "Okay, well, when there's a bad period of drawdown and stopped trading," and it never works out. It really never works out.
I made the decision to trade through, so I have to shift my perspective on what I consider a winning trade. It's when I follow my trading plan, which is separate from the monetary outcome, so that was the first thing. The second thing is to take a percentage off the top and to ensure that I've got the maximum positioning size at the worst possible points of my strategy's performance so that when the good times happen I'm going to accelerate out of that drawdown phase quicker.
The third part to all of this, the trifecta, if you like, is to make sure that you're not overextending yourself on the individual per-trade. Surprisingly, Sean, it's something we've mentioned once or twice in the past, I'll just remind everyone, is reduce your position size. Again, conventional knowledge suggest that we trade with somewhere around 2%. That's what most of the textbooks suggest, 2% of your overall account equity per trade for the individual risk. I personally think that is way too big, but from a practical point of view it's fine.
To deal with the emotional baggage that's preventing you from putting the next trade on, your emotional bank balance is probably very different from your practical bank balance. Again, I've seen many multi-millionaires cry over a $50 loss, because practically they've got the money but emotionally they're not longtime traders. They've not weathered, they're not old hats at it, so their emotional bank balance is very different from their physical net worth and those two things don't marry up.
To help with that, to help with being able to put the next trade on, reduce your position size, I typically advocate about a half-percent of your overall account size percentage as a per-trade risk. It's a quarter of what the textbooks typically suggest, and then the second prong to that, can you guess what I'm going to say next, Sean? Trade more frequently.
You trade more frequently with smaller position size and you're at the maximum amount of position size per trade, anyway. You're never going to experience that monumental drawdown. You've got reduced per-trade risk, so when you hit the drawdown phase it's not going to be as dramatic as what you might've thought during the research phase of your strategy because, again, you're probably going to be with less position size than what you were because you're probably following what the textbook suggested, 1-2%.
Go for the half-percent, and then that means, again, you can accelerate out. You get the benefit of portfolio, you get the benefit of large numbers. You're not stressed over individual positions. You're not worried about the per-trade risk because you've got the portfolio handled. You've taken a percentage off the top, so you'll never ever experience the worst-case scenario. You're also trading probably a quarter of your position size that the textbooks say, so that 20% drawdown is going to be, what, 5% drawdown peak to valley because the position size is all different.
You get all of these benefits from those three simple things. Now, the third part is in two parts, so there's four things that we can do to really never experience a monumental catastrophic drawdown that helps practically grow your accounts, preserve capital, and means that you're in business to put the next trade on regardless of what the previous 10 positions have done.
Sean Donahoe: Abso-bloody-lutely. Basically, you've got your armor, you've got your shield, and you've got a hell of a sword and you're ready for battle.
That's the whole thing. A lot of people don't consider all of these aspects. They don't have all of these bases covered, so to speak, and they go into the markets basically with a rusty sword and they're pretty much naked to the markets, which is why they get killed pretty quickly. We don't like that.
Phil Newton: Again, well, what most traders do is they might have, let's just assume they've got the same strategy. Just for a moment, let's just assume it. They're trading with as big a position size as possible, they're adjusting the position size as soon as they can or as soon as they should relative to whether they're making money or losing money on the last trade, and it's a rollercoaster. It's an emotional rollercoaster.
On a daily basis, maybe even a weekly basis, you're adjusting your position size up and down, up and down, up and down. What can happen is, the same strategy, because you're making all these minor course corrections, is your strategy can flatline because of crappy money managements.
Sean Donahoe: Yeah, that is a point that I think ...
Phil Newton: Yeah, it's the same strategy. Just don't touch it. Just leave it alone.
Sean Donahoe: Yeah.
Phil Newton: I used to be a pilot, but one of the problems that I had was I would be constantly making course corrections. I would have the control column and I would be pushing on the control column, pulling it, little bit left, little bit right. If I just trimmed the airplane correctly so that I didn't have to apply pressure on the control column to keep the angle, the nose up, pitch down, whatever you're trying to achieve when you're navigating around the skies, I didn't trim the airplane correctly so I'm constantly fighting against the controls making course corrections.
The reality is, if I just set everything up correctly to start with, set the compass, set the trim, do everything that you're supposed to do and just let go and don't worry about those minor little things, the minor course corrections, because they're inconsequential. I don't need to apply pressure one way or the other. I just need to navigate the skies. I just need to point in the right direction and make sure that I'm staying on track.
That's what you need to do with your trading accounts as well, it's, don't worry about those little minor course corrections. An extra few dollars risk or a few dollars, it just doesn't fucking matter. It really doesn't. You're going to make more money this way than you will trying to trade with as big a position size as possible adjusting your position size as soon as you can either up or down depending on what phase your strategy is in.
You're going to give yourself an aneurysm, you're going to give yourself sleepless nights. You're probably not going to have that portfolio experience. You're probably going to be trading two or three positions and stressing over each and every up tick or down tick in the markets. Yeah, it's a horrible, horrible experience. There's better ways of doing it. The better way has just been explained.
It sounds so counter-intuitive what we've done, but you're going to make more money that way with more positions, less position size, trading consistently, than trading as much as you can as soon as you can on two or three positions. It just doesn't make sense sometimes, but that's what the novice does. They're trying to trade as big a position size as possible as soon as they can and, surprisingly, Sean, they're trying to swing for the fence.
Sean Donahoe: Haven't we talked about that before. No, at the end of the day ...
Phil Newton: There's a method to the madness. Twenty years later we're still here, Sean.
Sean Donahoe: Exactly, still profitable, still rocking and rolling. That's the whole point of this is you can imagine that in 20 years you've seen every kind of market environment, to put it politely, every kind of shit storm that could be thrown at us.
Phil Newton: Seen quite a few things, been quite fortunate. It's been a good time to be a trader in that period, because we've seen a few bubbles, we've seen a couple of market crashes. From an education viewpoint of having variety, the last 20 years has been wonderful to study. Certainly to have traded through it, you start to get conditioned. I've seen it all before.
Sean Donahoe: Absolutely, you get a little resilient, and that's one thing that you need as well. You need mental toughness and resilience.
Phil Newton: Until you get there, I think being aloof is a good attribute to have, being detached from the outcome. This is what we said earlier. You're not worried about the dollar monetary gain or monetary loss, how much money did you make. You're focused so much more on, did I do the thing that I said I was going to do when I said I was going to do it. That's a winning trade. How can it not be?
Sean Donahoe: Yeah, exactly. The one thing, though, for me is the discipline to be consistent with the application. That's the one thing, the one danger factor I see for a lot of people. Now, you can reduce that. Again, we talk about portfolio and money management, portfolio risk and monetary risk and having all the management elements in place outside of just trading and putting positions on. It's managing and minimizing the risk in your portfolio.
The one thing that I think is as critical as anything else is the mental discipline to keep putting on those trades even though you're experiencing that downturn. I've been giving you some great options and solutions there to minimize the mental anguish part of it. It's still, it's like even if you're in a boxing fight you get knocked down, you just got to get the hell back up again and throw the next punch.
Phil Newton: Yeah, I think what we've done there is we've given you the tools. You've got the practical roadmap to be able to get back up when you've been knocked down.
Sean Donahoe: Mm-hmm (affirmative), absolutely.
Phil Newton: I think that's the difference, because so many people just say, "Oh, you've just got to brush it off. You've just got to get on with it." Well, it's like, I always think back to the movie Cocktail with Tom Cruise when he gets that job in, surprisingly, the cocktail bar. Yeah, it's his first day on the job. He doesn't know his backside from his elbow, and someone asks him for a martini and they ask what's in it. He says, "It's a cocktail." He doesn't know what he doesn't know.
When you're in that situation, what do you do? How do you do that is the point. What we've just given you is the blueprint to be able to go, "Well, how do I put the next trade on when my emotions are delicate and sensitive and I'm questioning the strategy? I know practically what the numbers say. How do I put the trade on, still?" That's how I do it, so that means that I can be aloof. It means that I can be not be attached to the monetary outcome because I'm thinking about applying the strategy. I'm trading with small enough position size to not stress over the one trade and put the next trade on, and the one after and the one after that.
Then I'm not worried about the drawdown and dealing with the inevitable drawdown phase, because I know what the worst-case scenario is. It all starts with that research and the strategy. I know that's what the worst-case scenario is, so how can I not experience ever the worst-case scenario?
Sean Donahoe: Absolutely.
Phil Newton: That was what I was trying to answer when I was working this out. This didn't happen overnight, for reference, Sean. This has been Frankensteined over many years. It ultimately stems from how do I not experience my worst-case scenario, because guess what, Sean, I experienced my worst-case scenario twice.
Sean Donahoe: Exactly.
Phil Newton: The question was, how do I not experience that again?
Sean Donahoe: Indeed, yes.
Phil Newton: At the same time, the condition while still benefiting from, how do I benefit from capital preservation like the pros do? How do I preserve and protect my capital?
At the same time, how do I get the benefit from account growth when the good times happen, and this was the solution that I came up with and it's a wonderful solution, I've got to admit. I've explained it to many an institutional trader and hedge fund dude and they're literally just shaking their heads, "Why has no one explained this to me," because they either do one or the other but they're never trying to do both at the same time.
I think when you blend them, fuse the two things and try and answer those two questions, on face value if you look at the numbers, on face value it doesn't seem like it's great. When it's not running the numbers through the process, it's like it makes more money. Why isn't everyone doing it?
Sean Donahoe: Exactly, that's a very, very, very important thing. Hey, that's why we're here, that's why we do this, and there you go. That's how to handle and deal with drawdowns, downturns, and portfolio crushes. With that being said, let's rock the hell on.
Automated: Now, it's time for the Rebel Trader tip of the week, brought to you by tradecanyon.com. Ready to take your trading game to the next level? Discover where smarter traders come to get coached by the best and learning to trade just got way easier. Trade Canyon, smarter traders live here.
Sean Donahoe: Okay, Rebel Trader tip of the week, and this one, we will call this one and put it in quotes, "Is the writing on the wall?"
Now, we have been talking in the Happening Now Report about a lot of red flags that we're seeing, everything from the mergers and acquisitions activity to yield curves to all sorts of other things that are bearish signals. Now, we're not quite there yet, but we are starting to see an acceleration of these bearish situations, these "the wind coming out of the sails." Phil and I were talking the other day ...
Phil Newton: The winds have changed, as we've talked about in the past.
Sean Donahoe: Oh, yes, play the Scorpions song, we are, hoping there's a few rock monsters out there.
Phil Newton: Or it's the opening scenes of Mary Poppins where the weather vane spins around.
Sean Donahoe: Indeed, if Phil comes down from the sky with an umbrella, we're all in trouble.
Okay, Phil, you've seen a few writings on the wall this week with earnings over the last couple weeks with some big names posting bad earnings or, should I say, reasonable earnings but still the market's not liking what they see. What are you seeing? What's your opinion? What's your take?
Phil Newton: Well, I think this is where the talking heads are doing us a favor, because while most of the time they talk absolute and utter nonsense they are pointing out the extremes of the markets. What they're talking about is that the headlines, the household name stocks, and because we're in earning season they're talking about earnings announcements and obviously the extreme movements.
What I'm seeing is that the headlines names, the Netflixes, the General Motors, was what we talked about the other week as well ...
Sean Donahoe: Oh, by the way, should we do an update on that one in a moment? Remind me.
Phil Newton: We can do an update on that in a moment because it's tied in, but it's these headline stocks, the household names, the ones that we're all familiar with is the point I'm trying to get to. "The blue chip stocks," that was the phrase I was looking for, Sean, the blue chip type stocks. They're the ones that the talking heads are mentioning that it's 8% down. I think Facebook was a good example. It was something like 20% off, for lots of other reasons as well, but we're seeing high single, low double-digit figure movements down on these headline stocks.
Now, individually it's just the way it is. It's going to happen, but what I'm seeing is this cascade of several of these household name stocks starting to come through. Now, obviously there's a few going the other way as well where they're up single and low double-digit figures on the back of the earnings, but I'm seeing more negative movements from these household names than positive just purely from the news and media headlines as you skim through and scroll through the news headlines.
That's all I do, I'm not reading in-depth, but I'm just trying to keep a finger on the pulse. It bores me to read the articles, but just skim through the headlines. You just get a feel for what's going on. The pulse of the market is with these negative movements of these big blue chip names. That's the observation, Sean. Does that make sense? Sometimes ...
Sean Donahoe: Yes.
Phil Newton: Because it's not my area of expertise. I just like to put out there that I usually try to stay intentionally ignorant about this subject, but this is what raises the red flag for me. It's when those headline stocks are down on back of earnings in a bull market. There's the condition.
The bullshit almost is that the headline, I'm sorry, the talking heads are saying how wonderful the economy is, how wonderful the stock market is, but the stock's reactions on the back of earnings are telling us a very different story. Those two things now blend together. You see what I'm saying, yeah?
Sean Donahoe: Yes, yeah, I see what you're saying. Again, with the analysts who are looking at the raw numbers versus what the actual talking heads are talking about.
Phil Newton: The talking heads are saying, "It's wonderful! The water's lovely, come on in!" Surprisingly, this is what they were saying in 2003. After two years prior to the financial crash in 2008, they were saying, "Yeah, the water's fine! Come on it, it's all fine. Yeah, nothing wrong, no sharks or anything like that." That's what we're starting to see now.
This is, it's not anything to be alarmed about. It's nothing to, "Oh, my God, the financial markets are going to crash tomorrow." I'm not saying that. I'm saying this is just, "Hold on a moment." It's like the meerkat on the distance just perked its ears up and it's looking around. It's heard a funny noise. That's what we're doing here. Something different is happening. The narrative that the talking heads is saying in the media is very different to how price is behaving on the individual stocks, particularly the blue chips.
That is the warning shot, the red flag being raised, because something different is going on. The narrative is different from reality. Surprisingly, Sean, the narrative's different from reality. Well, the talking heads are saying one thing and my immediate reaction is to automatically think the other, but now I've got evidence that the other is actually happening. That's the connection I'm trying to emphasize here. Price is behaving the opposite to the talking heads. The sentiment is different from what the media is talking about.
This is my first red flag, and the things that we're talking about we've given examples in the past of what to look for. This makes me sit up like the meerkat and start to look around. You've got a whiff of something, you've heard a funny noise on the Sahara, and you're looking around and you start looking. This is, for me, the time where I'm going to start paying attention to fundamentals.
Yes, you heard it here first, folks. You heard it here. This is when I start to sit up and start to pay a little bit more attention, because most of the time you know my viewpoint, Sean. It doesn't matter, I don't care, but this is the time when I'm going to start reading the figures. I'm going to read the fundamentals, I'm going to be paying attention to the reports, because price is telling me to say something different's happening here.
We've compared it to an ocean liner trying to turn around in a canal. This is that first kind of, maybe the ocean liner is just starting to slow down. It's not yet turning, but it's just starting to lose a little bit of pace. The engines are slowing down, they're idling, the ocean liner's slowing down a little bit. Maybe we're going to see it start to turn around, but this is not a first signal that something might be happening. I can't say that it will or it won't, but it might be happening.
I'm just going to say that this is a red flag for me. These are the things that I look for. It's a little bit abstract and I hopefully have painted the picture of why I've connected all these points together, but all it's doing is making me sit up and pay attention. There's no action to take, but this is what it looks like in realtime.
This is when I sit up and pay attention, is when I'm going to start paying attention a bit more closely to the detail in the fundamentals and start to try and put that piece together and say, okay, is this a turn, is it something to worry about, should I start making strategic adjustments, should I start trying to play this turn? They're the questions you want to start answering and this is just the first warning shot to say, sit up and pay attention, Phil, something different is happening.
Sean Donahoe: Now, it's very interesting, because we have had some positive news. We've talked about this in the Happening Now Report with GDP numbers coming out of 4.1%, with consumer price spending or consumer spending up as well in the Fed, basically saying, no, we're going to continue to raise rates like we've said and committed to because the numbers are good.
What we're seeing is certainly with the earnings is a lot of forward guidance being declined because of trade concerns, certainly with the blue chips, the very ones you're talking about.
Phil Newton: We know that they've been doing creative accounting and share buybacks to make their company look better than what it actually was. Again, we know that. Step off the soap ... step away from the soap box.
Sean Donahoe: Yes, indeed.
Phil Newton: We know it's happening, but now price is actually, a little bit of reality is coming into price behavior compared to the narrative and the talking heads. They've not got their eyes open. They're still saying, "Yeah, well, it's fine. Yeah, you should buy. You should hold forever. Just buy anything." When that's happening ...
Sean Donahoe: Yeah, it's going to be Q3 and Q4 are going to be the real telltales.
Right now we've got our awareness piqued up. We're seeing a few red flags in different areas, and we've been talking about this, like I said, happening now a lot with more and more red flags that we're seeing. When Phil's starting to say he's going to check fundamentals, that's a huge red flag right there.
Phil Newton: Yeah, mark it down or you don't, when you start seeing the magazines and the newspapers that don't normally comment on finance, like Time magazine. I always cite this one, because this is when my eye opened, my eyes were opened to this sentiment shift in the public arena. I think it was when Time magazine said now is the time to invest in real estate, and it literally was just prior to the financial crash and the swan dive that the housing bubble burst, essentially.
Time magazine does not report on it, but they cannot, they were jumping on the bandwagon. The public is the last to know. The media is representative of the general public, they're always last to know. Why would you want to pay attention to them? That's why my default reaction is the opposite, and now we're seeing some evidence to suggest, well, the opposite. There is actually the opposite happening. It's not just my default reaction. It's, well, there's now some evidence to suggest that I should pay attention.
That's all this is. It's just my awareness is being raised and I'm starting to pay attention, but this is what it looks like in realtime, yeah.
Sean Donahoe: There you go, so there you go. Rebel Trader tip of the week, start looking, but, just to throw something at the end of this, we did talk about literally as it was unfolding because we recorded last week's show on Wednesday. We're recording this one funnily enough on Tuesday. We're actually recording this show early. Looking at GM, we said, oh, this looks like one that could be unfolding, we'll keep an eye on it, and I did place the trade.
Phil Newton: On the day we recorded it, it did unfold as we expected. We gave a little bit of, well, I certainly said what I wanted and you had your, I think you were going to look at an intraday. I don't know, I didn't want to do that.
Sean Donahoe: I actually had an intraday.
Phil Newton: Yeah.
Sean Donahoe: I was a little more speculative because I was going to be at home, and I thought this one smells ...
Phil Newton: Hey, why not?
Sean Donahoe: This one smells. Plus, it showed up on one of my algorithms as a turnaround target, which it did during the day quite nicely and made quite a few bucks off of that one. Also, at the end of the day, I had to start selling some options on this one, sold some puts at $36 and turned out rather, rather nice, because this one turned around.
Phil Newton: To be fair, as we recorded it happened on the day. I would've liked to have seen it unfold a little bit slower, just because of the delay way we recorded it, just so we could get it out there. At the same time, what we speculated on that we were waiting to happen, because I think we talked about it as the production line was the focus of how we were explaining it. We were waiting for "this needs to happen," "that needs to happen," when that's happened, that this type of trade's probably going to go.
That's what we were expecting to happen, and that happened on the day, which is quite interesting. Now as we're talking just a few days later, it's starting to push a little bit higher. Maybe we're going to see a move up to $40. It wasn't a directional trade in my book. It was more of, "I don't think it's going go down anymore," which is why, I think, we were talking about selling puts.
Sean Donahoe: I think, yeah, we both, I think. Did you sell puts on that one as well?
Phil Newton: I was a little bit more conservative. I actually did some put spreads.
Sean Donahoe: Okay, yeah, I just did some singles on this one, but I was a little more, I tend to be a little more aggressive sometimes.
Phil Newton: Well, this goes down to our, you have a little bit more time and you were planning on being around, so that allows you the ability to monitor that. Me, I'm put the trade on, walk away, so that's why I chose the spreads. I'm always going to do risk-defined trades.
If you've got more time to keep an eye on it, then, yeah, the singles, the naked positions. Why not? It comes down to situations and personal preferences. There's no reason why yours is better than mine. Let's not go there.
Sean Donahoe: You keep telling yourself that.
Phil Newton: It's just one of those things, it's just that situation. I think I don't want to have that emotional response to the position that dictates how I put my trades on. It doesn't mean that I will never place naked positions. It just means that I don't want to worry about that position again. I've got Crohn's disease. I want to minimize stress in an already stressful career.
Sean Donahoe: Indeed.
Phil Newton: That does color and flavor a lot of the things that I do and the way that I do things so that I can literally sleep at night and not make myself ill. That is a very realistic possible outcome if I do things that are out of the that risk profile that I've defined for myself.
Sean Donahoe: No, absolutely. At the end of the day, we're all right because it worked, so it's all good.
Phil Newton: Yeah, it's the same, no, but it's the same trade. All I'm trying to highlight is it doesn't matter. There was no "yours is better than mine." It's just two traders doing the same trade in different ways relative to their personal profile. I just think it's an interesting observation more than anything.
Sean Donahoe: Abso-bloody-lutely. With that being said, let's rock on.
Automated: If you've got questions, they've got answers. Sean and Phil dive into the virtual mailbag for this week's Rebel Traders quickfire round.
Sean Donahoe: Okay, rummaging around in the mailbag here in the sock drawer, top drawer, avoiding all the girlie magazines that Phil tends to keep in his sock drawer, we will ...
Phil Newton: Oh, behave. I've got subscriptions for that.
Sean Donahoe: Indeed, indeed. You had a question this morning from a student about selling options. What was that question and what was your answer?
Phil Newton: Well, it was on the back of some initial advice. I was having a conversation with a potential student, and essentially they were more math inclined and less charting orientated, which meant that they were looking more at the probabilities that we talk about quite a lot. It was more heavily focused on the math and the probability and more of an algorithm type solution and less worried about what the chart looked like.
Again, I like to look at the charts. I'm usually quite directional most of the time, so I just suggested, "Well, maybe you should focus on selling options," because he had this strategy and he was trying to figure out how was the best way to implement the execution of that trade idea. He couldn't quite make the numbers work from a directional viewpoint, because he's not got the timing and the charting elements in there to back up the research that he's doing, at this stage anyway of his trading career.
He couldn't quite figure that out. I said, "Well, while you're figuring that part out, why don't you, instead of buying options, why don't you be a seller of options? Then you don't need to be right on the direction, you just need to take the opposite side of it. Maybe instead of being bullish, it doesn't matter if the stock goes up, you're just like with General Motors. It's not going up, I'm just, sorry, I don't think it will go up. I'm saying that it won't go down anymore." That was our reason for selling puts, so that's what I suggested potential students.
On the back of that, I got back a question, "Do you mean that when you're selling options you're going to buy an option and then sell an option and profit from the difference?" I think what he was getting confused about was an arbitrage type strategy. You buy an option and sell an option, and what he thought was that you would profit from the difference.
That was essentially the question. "What do you mean by selling options?" Then he posed that, "Does it mean when you buy an option and you sell an option at a different strike, does that mean that you profit from the difference," because that's what I suggested. I suggested a spread, and that is to set up a spread but you profit, yes, you profit from the difference but not automatically, if that makes sense.
Let's just pause there. Have I articulated that correctly, Sean? Does that make sense so far? Okay, cool.
Sean Donahoe: I believe so, yes, yes, yes. I think it's pretty clear.
Phil Newton: Right, because I worry sometimes, Sean. Again, I'm feeling I'm quite excitable today and sketching around some of the details on the things that we're talking about. Well, there we go. That's just how I feel. Maybe reality is different. It's all about perception, as we keep saying.
I suggested selling options is the long and short of it, and they were confusing selling an option as a spread with an arbitrage type setup. What's arbitrage? Essentially you're buying on one market and you sell on another because there's a price difference, shall we say. Does that make sense?
Sean Donahoe: Mm-hmm (affirmative).
Phil Newton: That's usually what an arbitrage is.
Sean Donahoe: Yes, yes.
Phil Newton: The way that he asked me for more information, that's what he thought it meant, that the wording, the phrasing, he thought that we were talking about an arbitrage type trade.
What is an option spread, in particular when it comes to selling puts? The way that I do it is I'm going to sell an option that's out the money. Then to define the risk, I'm going to buy an option further out the money. Let me say that again. I'm going to buy, I'll say that again. I'm going to sell an option out the money and buy an option further out the money. That defines the risk, so the overall transaction cost is for a credit.
Now, I don't profit the difference, meaning that the stock has to go between the two strikes. They don't need that, because it's a credit spread. What I want in this situation is I want the stock to not go past the strike that I've sold. Let's put a more detailed example on. If I'm bullish on General Motors and I would like the stock to either stay still or maybe it goes higher, what I don't want to happen is for it to go lower with that bullish to neutral viewpoint.
I would sell puts, but then to protect the downside risk I'm going to spread it off. I sell a put, one strike, let's just say that's at $36, and then I'm going to buy an option at $35 so that I've got this little window of opportunity and the overall transaction cost is for a credit. That's what I meant by selling an option spread.
What that means is the stock can go up, I'll get paid, the credit received. It can go sideways, I'll get paid, which the credit received. It can even go down a little bit. It's currently at $38 in this hypothetical example, so the stock can actually go down all the way to the strike that I sold, which in this example was $36. As long as it stays above $36, I'll get paid, and that's what makes it a non-directional trade.
It might go up, but I don't need the stock to go up to get paid. As long as it doesn't go down below or past the strike that I sold, I'll get paid, and that's what makes credit spreads or just selling options generally, that's what makes them quite unique or interesting. You can take the other side of the position.
If you're worried about the stock not going higher, which is what we were talking about last week, again, it wasn't that I was bullish on General Motors. It was just that I didn't think it was going down anymore, so I can place that trade and the way that we do that is by selling options. That's how we would do it.
Sean Donahoe: Absolutely. Again, it can be very lucrative if done in the right environment.
Phil Newton: Yeah, the probability from the math point of view is it's a higher probability trade, because, think about it like this. Three things that the markets can do, it can go up, down, or sideways. To be right on direction, the market has to go up to get paid. Before we work out time or any other stuff, just keep it simple. Three things, it can go up, down, sideways, or stay still.
Directionally, to be right on direction, it's a 33% probability. If you take the other side of that trade, instead of being bullish and you think that the stock will go up, with options the exact opposite is that you don't think it's going to go down, in which case you've got two ways to make money. It can stay still or go down in this case, so you've got at the very least a 66% probability that you get to keep the credit received.
Again, you can do things to enhance and augment the trade and usually it's around 65-75% depending on how you set it up, but the probability is more favorable from a mathematics point of view than being directional. Just think about this.
Sean Donahoe: Absolutely.
Phil Newton: That's why you would do it. The probability is there.
Sean Donahoe: No, I love that, I love that. That's actually one of the things that we do on a regular basis here.
Phil Newton: I like to blend the two, to be honest, and for maximum impact.
Sean Donahoe: Yeah.
Phil Newton: I'm pretty good at picking direction.
Sean Donahoe: Yeah, I was going to say some blending. I was going to say exactly the same thing, blending the two gives you a lot of different options on the punt.
Phil Newton: Yeah, if you get the directional trade, yeah, boom, boom. If you get the directional trade, you get paid a bit quicker. That's how I see it. If it doesn't move in your direction, as long as it doesn't go down in this example that we've used then you'll get paid. It's just a great place to be.
Sean Donahoe: Yeah, absolutely, absolutely. Okay, next question, this one I got this morning and I thought it was very timely because there's been an announcement about it. Do I think that the U.S. and China are going to come back to the talks or come back and talk? Do you think those talks are continuing behind the curtains, and do you think we're going to avert a trade war?
Well, couple of things there, we've been talking about this a lot in the Happening Now Report again. Funnily enough, this morning the U.S. has announced, or China and the U.S. have reportedly started to restart the talks to avert a trade war. I'm pretty sure those conversations have been continuing. There's been a lot of saber-rattling.
Phil Newton: It's suggesting what you were suspecting by coming back to the table. You said it was a little bit of ...
Sean Donahoe: Leverage, a little bit of negotiation.
Phil Newton: Well, yeah, to use my wording, it was a little bit of schoolyard pushing and pulling.
Sean Donahoe: Yeah.
Phil Newton: It was a little bit of pushing back and forth and throwing teddy bears out the pram and, "Well, fine, I'll take my toys and go back home" type of thing.
Sean Donahoe: Yes.
Phil Newton: I'm being flippant about it, but that's essentially what you were describing over the past many months. This is just more evidence that, hey, maybe that was an accurate reflection of what the situation or what was happening with the situation as it was unfolding. Again, this is just more evidence.
Sean Donahoe: Pretty much.
Phil Newton: This is just more evidence to support, "Don't worry about it." Yes, there might be a trade war. It was looking like it was a realistic possibility, but for the moment it just looks like it's positioning. "Posturing" is, I think, the phrase that you used to describe it.
Sean Donahoe: Yeah, it's posturing. It's bringing leverage and basically a little bit of a Mexican standoff and who's got the biggest guns. Well, the problem is that a lot of this, if you look what's happened with the Chinese economy, the yuan, the GDP numbers over there have been atrocious. The bank has had to step in lending money to certain banks and everything else over there.
Phil Newton: You mean to say there's been a friendly handshake between some big businesses and banks?
Sean Donahoe: How unusual is that, and the government of all things.
Phil Newton: The government sanctioned it. What a surprise.
Sean Donahoe: Yeah, there's certainly the initial, let's say, shots across the bow and be pretty defined.
Phil Newton: We know that that doesn't end well, do we?
Sean Donahoe: Yes, never happened over here.
Phil Newton: Oh, no, but equally we know it will never end well.
Sean Donahoe: Indeed, I think with all the posturing that has been going on, all of the saber-rattling, it's now once these talks ratify I think we're going to come out, me personally, I think with the amount of rhetoric and the amount of turbulence that has been up to this point, I've really not wanted to say unlike a lot of people that we're in a trade war.
I think we've been in a trade war unofficially for a long time, but what everyone else is calling a trade war I think we're at the point where I've been ...
Phil Newton: It's more of a black ops, blacks ops war type thing. What was it?
Sean Donahoe: More so, more so ...
Phil Newton: With the America/Russia '80s? Cold War, '70s and '80s.
Sean Donahoe: Yeah, Cold War.
Phil Newton: You've got an economic cold war. Officially, we're just pointing our guns at each other. Unofficially, shit's going down behind the scenes.
Sean Donahoe: Yeah, basically. I think at the end of the day, we're not quite being at the official trade war but we certainly have been a lot of things going on behind the scenes to make people sit the hell up, pay attention. I think if we have the "continued talks," if I put that in quotes, then I think we're going to have some positive news coming out of that.
That hopefully will, for Q3 which is I'm always looking forward a few years down the line, but I'm thinking for Q3/Q4 that is going to be where we'll see some of the ramifications of that if we get positive news in the next couple of weeks. I'm optimistic, especially considering what's happening with the European tariffs and the, should we say, the ...
Phil Newton: The Brexit debacle is an ongoing multiyear saga. If you want to know what failed and negotiation talks look like, just look at what's going on with Brexit. It's just like, if it wasn't political and economic orientated, which bores the tears out of me at the best of times, if it wasn't so close to home I'd do my best to ignore it. It's just an absolute farce.
If you want to know what an economic and political comedy of errors look like, think of a Brexit. If you want to know what failed trade agreements looks like, take a look at Brexit. It's just, oh, just get on with it. It's, oh, frustrating.
Sean Donahoe: Indeed, indeed. Again, a lot of the U.S./European stuff as well has been, eh, met relatively positively. We had ...
Phil Newton: The vying for a re-vote on the whole thing, ugh.
Sean Donahoe: The whole Brexit thing has been a disaster from start to finish but, hey, you know.
Phil Newton: I'm actually in a weird situation. I'm pro- the idea of Europe. I like the philosophy behind it, but as with all things when it comes to politics in economics it's there's too many chiefs and not enough Indians to make it happen. Everyone wants their own piece of the pie and, "Well, my slice is bigger than their slice," or, "Their slice is bigger."
It's this constant maneuvering and nonsense, instead of the true philosophy behind it was open borders, open trade. We've got our own little union, kind of like what America did. The ideology behind the United States is what Europe was trying to achieve. It's going to be doomed to failure from the start, because everyone wants to run it their way, sad to say.
I'm pro- the idea of it, but the actual way that it's been ran, managed, and implemented, I'm completely anti, I was "let's leave." It was going to be, the single currency is a great idea, but it was never going to work. It really was never going to work the way that they were suggesting.
Sean Donahoe: We won't mention the ERM, yes.
Phil Newton: When I wrote a study at university about this, basically saying it was a great idea but then so was communism, communism was a great idea and in philosophy it is a good idea, but in reality it will just never work. It really will never work.
Sean Donahoe: Well, this is one thing I say about a lot of ideologies. Any ideology that doesn't take into consideration human behavior and human nature is doomed to failure.
Phil Newton: Capitalism for me has got to be the single best economic way, because capitalists drive the economy. People make things happen. All right, sure, there's money involved, but people are trying to better society by creating and driving economic measures. When politics gets in the way, it just puts a constraint on capitalism and ends up corking everything up for everyone. Well, there we go.
Sean Donahoe: Yeah, indeed, indeed, indeed. Anyway, with that being said, I think we covered a lot of ground in that one. Let's rock the hell on.
Automated: Don't forget, if you have a question you want to ask Sean and Phil, just go to tradecanyon.com/artyquestions and your question may be featured on a future show.
Uh-oh, what's that smell? It's time to call out the Wall Street shenanigans, mainstream confusion, and outright hijinks and hokum of so-called experts. Yup, it's time for bullshit of the week.
Sean Donahoe: The bullshit of the week, well, we've got a whole wide range of it this week.
Phil Newton: I know. If we've not covered it already, we've got some more for you.
Sean Donahoe: Absolutely, absolutely. There's a lot of it in this week's show that we certainly smelled on the horizon. I have to laugh because the bitcoin boys are back in town. After a recent rally ...
Phil Newton: It sounds like Backstreet Boys's poor cousin. We've got the gang back together.
Sean Donahoe: Oh, dear me. It's funny, because I thinking Thin Lizzy "The Boys Are Back in Town" but the Backstreet Boys, I think, is a better representation because, again, it's all a fad right now. We've had, the last couple of weeks we've seen rallies from $6,200 up to $8,200, not an insignificant rally. Don't get me wrong, I am not bashing bitcoin.
Phil Newton: Oh, I am. I'm prepared on the sidelines to bash it all the way, again, just the talking heads creating something out of nothing.
Sean Donahoe: Yes, well, there was a few groups of people said, "Oh, bitcoin's going to hit $50,000 by the end of the year. It's going to hit $100,000 by the end of the year. Oh, it's going to be happy days are all here again while everyone else is just crying into their Wheaties."
Phil Newton: Really? Eye roll?
Sean Donahoe: Yeah, indeed, major eye roll, but as soon as we had this recent rally from $6,200 to $7,400 and then $7,400 to $8,200 it's like, if you've been checking social media or the news networks, it's all suddenly "crypto, crypto, crypto" again, one more time.
Here's the thing. We're not seeing any of these real moves in a lot of the other cryptos. This is just pretty much isolated to bitcoin, which in itself tells me it's not based in anything other than raw speculation. There's nothing underlying, nothing really changed, per se.
Phil Newton: I would argue that the rally is not really a rally.
Sean Donahoe: I would almost say the same thing. If you look at the numbers in the last year ...
Phil Newton: Let me just put some meat on the bones. If you look at the last year, I think we commented on this the other week about saying that this rally, yes, it's rallied. As a percentage, it's a small percentage compared to what it has done historically on average, but most of this year, surprisingly, Sean, it's in a consolidation that's getting narrower and narrower and narrower.
If we were to draw trendline from the tops and the trendline connecting all the bottoms, it would be converging lines. That usually suggests a contraction in price, so this rally is not as significant from a technical point of view than what most people might think. When price moves away from that consolidation, then I'll start taking the rally that people talk about a little bit more seriously.
Sean Donahoe: Indeed.
Phil Newton: It's just more nonsense to get eyeballs on whatever narrative the author is trying to present, usually to sell some nonsense thing about how to buy bitcoin in some secret wallets that can't be hacked and whatever underground conspiracy theory they're trying to sell, because there's all sorts of nonsense going on at the moment and most of it's rubbish.
Sean Donahoe: Abso-bloody-lutely. There you go.
Phil Newton: I would just like to underscore it. Again, it sounds, due to some of the colorful wording, Sean, it sounds like that I'm bashing bitcoin. Again, I'd just like to, we could actually be talking about any instrument we've talked about.
Sean Donahoe: Yes.
Phil Newton: It just happens to be in the news again. It's unsubstantiated, it's nonsense, it's hype drum. Surprisingly, the talking heads are talking about something that's bigger than what is actually happening. The narrative is different from reality. Again, this is pretty much a common theme, and all we're talking about is that difference. The narrative is different from reality, and that's all we're pointing out here. That's why it's bullshit.
We spoke about this earlier in the segment, and I think, again, just coming back, just trying to explain why we're doing this, it's just the most recent example that we've come across. Again, it just happens to be bitcoin, but we could be talking, the other week we were talking about Facebook. We were talking about Twitter, I think we, what was the other one that we were talking about?
Sean Donahoe: Yeah, GM.
Phil Newton: Was it? No, I can't remember what it was.
Sean Donahoe: GM, again, all hype-driven. Snapchat?
Phil Newton: Yes, I think it was, the one I was thinking about was gold, wasn't it? I think, well, on the 30-minute charts. Anyway, the narrative is different from reality.
Sean Donahoe: Oh, yeah.
Phil Newton: I think that's what we're pointing out here a majority of the time in these segments. That's what we're trying to bring to the table here is, just because the talking heads say one thing, go and look for the evidence. That's what we're saying, and that's all we're doing here. We're just connecting the two points, and this is what makes it bullshit. The narrative in the media and the talking heads doesn't match reality.
When you can start to see these things on a consistent regular basis, it might provide a trading opportunity for you to do the exact opposite, which is my default stance as I keep talking about. Just open your eyes to what is actually happening and just look at, see if reality matches the narrative. You'll soon see that, usually and most of the time, they're at a mismatch to each other.
Sean Donahoe: Absolutely, couldn't agree more. There you go, bullshit of the week, ladies and gentlemen, and that is it for this week's show. We have had a corker here and, again, we are actually doing something that has been something that I think has needed to be talked about for quite a while. We've given a lot of insights into the way we trade, some of the actual specifics as well, so if you're paying attention these are things that you can apply to your trading as well.
Please, remember this show is not free. It will cost you a five-star review. Just go to tradecanyon.com/rebeltraders where you can subscribe and review and get access to a whole load of cool stuff that we have on there including training and resources and what have you. This will help us reach more traders and investors just like you.
Phil Newton: You know something, Sean? It occurs to me that I'm not a particularly social butterfly. Have you noticed that from me? I don't know if that's ever come across. I'm like that, always the grouch in Sesame Street.
Sean Donahoe: Oscar.
Phil Newton: Oscar, was it? Yeah, just wants to moan at everything. No, surprisingly, I'm quite a nice person if you care to meet me. I just don't want to meet you.
Sean Donahoe: Funny.
Phil Newton: I'm not a social butterfly is all I was trying to get across. I thought I might experiment this week, Sean, and let's try email. If you send an email, I'll get back to it pretty quickly, [email protected]
If you want to try and take your chances with social media, you can go to the same link tradecanyon.com/rebeltraders. We're on Facebook and Twitter and, again, you can take your chances there. I might see your message, but if you want to get to me directly why not send us an email?
Sean Donahoe: Absolutely.
Phil Newton: We've got lots of ... very open and accessible, so if you've got questions, if you want to have your question featured in our virtual mailbag, send it on over and we'll get it in there.
Sean Donahoe: Absolutely.
Phil Newton: I only mention that, Sean, because I've noticed a few messages that I've missed recently. I just want to make myself more accessible, because we're always talking about how accessible I am and I miss some messages, which means that I wasn't accessible.
Sean Donahoe: Funny stuff. If you want to get a hold or me on email, it's [email protected] Keep it simple, and we can rock the hell on. Yes? I'm sorry.
Phil Newton: What have we got coming up in next week's show, Sean?
Sean Donahoe: Well, I don't know. I'm going to go a little bit Mad Max. I guess this makes you Tina Turner, because we're going Thunderdome! I couldn't wait for that one. We are going to do "two trades enter, one trade," or actually "two trades leave," but we're going to be talking about different ways that we approach the same trades.
We were talking about this, oddly enough, yesterday, because unlike the GM trade ...
Phil Newton: We're having a little bit of a chortle over it, weren't we? Yeah.
Sean Donahoe: Yes, we were because, again, we came to the same trade.
Phil Newton: One trade entered, two traders still left.
Sean Donahoe: Yeah, indeed. We came to it from completely different angles with completely different approaches, but we ended up on the same damn trade. We're going to pull apart situations where this happens, validate both approaches, but we're also going to show why, funnily enough, Phil's approach was infinitely more simple. Mine was based on a completely different philosophy.
Phil Newton: Infinitely more complex.
Sean Donahoe: Infinitely more complex, based from a different angle, but got the same results. We're going to look at both angles, both aspects, pull stuff apart, and show you basically how to fast-track years and decades of experience, insights, education and analysis, and then fast-track it so that anyone can do it. We're going to do that next week, and we'll see you then. For now, take care, rock on, and enjoy.
Phil Newton: Bye for now.
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[00:07] Show Introduction

[00:00:56] Sean: We are talking about downturns, and drawdowns, and panicking in your portfolio. Everyone deals with this, every now and then you’re going to get a negative turn in your overall capital. We’re going to be talking about how to deal with it, how to recover from it, how to manage not only your portfolio but also your state of mind so you can get back on track.

[00:01:29] Phil: Just like any other business.

[00:02:03] Sean: We just need to establish one prime thing. Everyone experiences draw down in their portfolio and their capital.

[00:02:58] Phil: No strategy is perfect. I experienced this when I started out where I wanted every trade to be a winner. As soon as you stop worrying about monetary outcome as your ultimate objective and it has to be a positive dollar amount, if you can follow your trading plan consistently and shift your focus then you’re less focused on that draw down.

[00:06:05] Sean: One of the strategic advantages we have is our mindset.

[00:06:17] Sean: If we consider that we are consistent with the application of our strategy there are going to be particular times when the environment that we are in is not going to be ideal for that strategy’s maximum success.

[00:08:30] Phil: Any strategy that makes money is a good strategy as far as I’m concerned but whether you continue to use it is when you hit that losing streak. When you’ve gone from the highest high to the lowest low in your equity, it’s that ability to trade through that when times are tough that’s gonna determine whether you’re on the trade when the strategy turns around and everything’s aligned.

[00:11:24] Phil: I account for what’s the worst that could happen. Always be in business tomorrow and one of the ways that I do that is I account for that draw down when I’m working out my position size. In this example, whatever my equity is I take twenty percent off the top and then work out my position size. That twenty percent buffer is factored into the equation.

[00:12:25] Sean: This is something that I do now, I base my position size minus that twenty percent.

[00:13:50] Phil: I want to be able to trade with the largest position size that I last was able to trade with at that draw down phase. When the good times happen, I accelerate out of the draw down faster than I got into it. That allows me to get the best of capital preservation and account growth.

[00:17:32] Phil: When the market conditions are favorable that’s when you want to fill your boots so by accounting for that upfront, I’m not reducing my position size, and you’ve got this buffer that allows you to weather the storm.

[00:19:41] Sean: When you’re down in that pit, there is one point that everyone goes through where you question, is this strategy the right strategy. Now, we’re confident in what we do, out strategies, we’ve been through draw downs, we know our positive expectancy, we’ve got the data to back it up. A lot of traders out there don’t have that or haven’t tracked everything.

[00:21:39] Phil: Shift your perspective, redefine your perspective - did I do everything I said I was going to do?

[00:25:56] Sean: A lot of people don’t consider all of these aspects.

[00:29:00] Sean: You can imagine in twenty years, we’ve seen every kind of market environment.

[00:29:14] Phil: It’s been a good time to be a trader in that period because we’ve seen a few bubbles, a couple of market crashes, from an education point, the last twenty years has been wonderful to study.

[00:30:09] Sean: The one thing for me is the discipline to be consistent in the application. The mental discipline to keep putting on those trades even though you’re experiencing that down turn.

[00:32:50] Phil: It all stemmed from ‘how do I not experience my worst case scenario’, but guess what I experienced mine twice. The question was how do I not experience that again but still benefit from capital preservation like the pros do but at the same time, how do I get the benefit from account growth when the good times happen? This was the solution that I came up with.

[00:34:04] Sean: There you go, that’s how to handle and deal with draw downs, down turns, and portfolio crushes.

[00:34:14] Rebel Trader Tip of the Week

[00:34:39] Sean: ‘Is the writing is on the wall?’ We have been talking abut a lot of red flags that we’ve been seeing with mergers and acquisitions activity to yield curves to all sorts of other things. We are starting to see an acceleration of the wind coming out of the sails.

[00:36:02] Phil: This is where the talking heads are doing us a favor. While most of the time they talk utter nonsense, they are pointing out the extremes of the markets. They’re talking about earning announcements and what I’m seeing is Netflix, General Motors but it’s these households names, bluechip type stocks that the talking heads are mentioning.

[00:38:43] Sean: The analysts that are looking at the raw numbers versus what the talking heads are talking about.

[00:39:28] Phil: The narrative that the talking heads are saying is very different to how price is behaving on the individual stocks. This makes me sit up, the time where I’m going to start looking at the fundamentals! This is that first signal that something might be happening so this is a red flag for me.

[00:42:00] Sean: It’s very interesting because we have had some positive news with GDP numbers coming out at 4.1% with consumer spending up as well.

[00:43:06] Sean: Yeah Q3 and Q4 are going to be the real tells.

[00:43:28] Phil: When you start seeing the magazines that don’t normally comment on finance, like Time Magazine was saying now is the time to invest in real estate and it was literally just prior to the financial crash. They were jumping on the bandwagon, so that’s why my immediate default reaction is to look at the opposite.

[00:44:54] Sean: Looking at GM, we said this look like one that could be unfolding, we’ll keep an eye on it. I was a little more speculative and it showed up on one of my algorithms as a turnaround target which it did during the day and I made quite a few bucks off of that one. I also had to start selling some options on this one and turned out rather nice because this one turned around.

[00:46:32] Phil: I was a little more conservative. You had a little more time and you were planning on being around so that allows you the ability to monitor that, me I put the trade on walked away so that’s why I choose the spreads. It comes down to personal preferences.

[00:48:34] Quickfire Round

[00:49:02] Phil: One the back of some initial advice to a potential student and essentially they were more math-inclined and less charting-orientated. So, I suggested maybe he should look at selling options because he had this strategy and he was trying to figure out the best way to implement the execution of that trade idea and he couldn’t quite make the numbers work from a directional viewpoint because he’s not got the timing and the charting element in there to back up the research he’s doing at this stage. I suggested why not be a seller of options then you don’t need to right on the direction, you just need to take the opposite side of it.

[00:50:50] Phil: The question essentially was ‘What do you mean by selling options?’ Does it mean that you buy an option and you sell an option at a different strike, does that mean that you profit from the difference? I suggested a spread - yes, you profit from the difference but not automatically.

[00:52:03] Phil: So what is an option spread? In particular, when it comes to selling puts.

[00:52:06] Phil: So the way that I do it is I’m going to sell an option that’s out the money and then to define the risk I’ll buy the money option further out the money. The overall transaction cost is for a credit. I don’t profit the difference, meaning that the stock has to go between the two strikes - I don’t need that because it’s a cross-credit spread - what I want in this situation is I want the stock to not go past the strike that I’ve sold.

[00:54:25] Sean: And again, it can be very lucrative if done in the right environment.

[00:56:23] Sean: Do you think China and the US will come back to the negotiation table or are we now officially in a trade war?

[00:56:38] Sean: We’ve been talking about this a lot and funnily enough this morning, US has announced that US and China have reportedly restarted talks to avert a trade war.

[00:57:02] Phil: It’s suggesting what you were suspecting, by coming back to the table you said it was a little bit of…

[00:57:10] Sean: Yes, leverage and negotiation.

[00:58:56] Sean: I think with all of the posturing that’s been going on, I think personally we’ve been in a trade war unofficially for a long time and we’re at a point were a lot of things going on behind closed doors to make people sit up and pay attention. I’m thinking for Q3 and Q4 we’ll see some ramifications and I’m optimistic.

[01:03:53] Bulls**t of the Week

[01:04:27] Sean: The Bitcoin boys are back in town. Again, it’s all a fad right now. In the last couple of weeks, we’ve seen rallies from 6200 to 8200, none an insignificant rally, I am not bashing Bitcoin.

[01:05:09] Phil: It’s the talking heads creating something out of nothing.

[01:05:58] Sean: It’s not based on anything other than raw speculation, there’s nothing underlying in, nothing really changed.

[01:06:09] Phil: I would argue that the rally is not really a rally. If you look at the last year, yes it’s rallied but it’s a small percentage compared to has done typically on average but surprisingly this year it’s in a consolidation that’s getting narrower and narrower. We could actually be talking about any industry but it’s in the news again and it’s unsubstantiated.

[01:09:22] Sean: Okay, that is it for this week’s show. Thank you for listening to the show!We’ve given a lot of insights into the way we trade so these are things you can apply to your trading. Please remember that this show is not free, it will cost you a five-star review, just go to tradecanyon.com/rebeltraderswhere you can get access to previous and future shows, subscribe, and review us on your favorite way to hear the show.This will help us reach other traders just like you.

[01:10:35] Phil: If you want to send me an email I’ll get back to you pretty quickly it’s [email protected] or you can connect with us on Facebook and on Twitter also attradecanyon.com/rebeltraders

[01:11:19] Sean: If you want to get hold of me on email, it’s [email protected]

[01:11:26] Phil: What have we got coming up in next week’s show Sean?

[01:11:34] Sean: I’m going to go a little Mad Max because were going Thunderdome - we’re going to be talking about different ways we approach trades.

3 Key Takeaways From This Show

  • Everyone deals with downturn just like any business
  • Trade Smaller, trade more often
  • Base your position size based on account for the worst case scenario and take the draw down off the top

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