For an archive of The Daily Breakdown’s 5-Day Bootcamp, see the guide below:
Bootcamp Day 1: Picking a strategy
Bootcamp Day 2: Every strategy has a time and place
Bootcamp Day 3: Position sizing
Bootcamp Day 4: Trading around big events
Bootcamp Day 5: What to do during corrections
Yesterday we talked about our goals and how to figure out a strategy that works for us. Now though, we need to realize that there is a time and place for every strategy. In the finance world, it’s common to hear that “there is no holy grail in investing.”
Put another way, no strategy works 100% of the time. If there is one, I’d like to hear about it.
The market is constantly evolving. Risk is constantly changing. Stocks ebb and flow, outperforming and underperforming in various environments.
Once you have a strategy that you’re comfortable with, it’s important to realize many of them often go through what’s called a “pay-in period” and a “payback period.”
During pay-in periods, the strategies are profitable, the setups are working in our favor, and things are going pretty well. In the other phase — the payback period — none of our setups seem to be working and everything is going wrong. This is where a lot of investors give back most or all of their recent profits.
Our goal here is to recognize when the tides have turned, making adjustments so that our pay-in period can outlast the payback periods.
Knowing your environment
Because the market tides are constantly shifting, knowing which environments are good or bad for a given strategy simply takes time. A lot of investors find a strategy or style that is a good fit for them, only to completely abandon it once it stops working because the environment changed.
There’s nothing wrong with changing a strategy that you feel no longer works for you. However, if it’s simply a different landscape that’s suddenly causing the strategy to work poorly, this is something that can be mitigated.
There’s nothing wrong with recognizing that the environment is a bad one for a particular strategy and simply waiting for a better environment to materialize — even if that means waiting in cash until ideal conditions return.
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3 strikes?
Once we’re in a less favorable environment, the investor can also consider trading with a smaller position size in order to minimize the impacts of the “payback period.” For instance, if one’s normal position size is usually $1,000, they might consider a position size of $500 (or even less in some cases) until the environment improves.
A poor environment could be something as complex as macro-economics or it could be something as simple as the setups performing more poorly while the S&P 500 is below a key moving average (like the 21-day moving average, for instance).
And how do we know we’re in less ideal conditions?
One common approach is the “3 strikes method.” After taking three straight losses, investors using this method take a step back, assess the environment more closely, and consider pausing their trading or reducing their position size.
Once the environment improves and an investor’s strategy begins to work well again, then investors can build confidence as they begin to recognize the environments and patterns that accompany a well-performing strategy.