Risky Business

Keeping one's head while others are losing theirs

It has been a crazy week. Market Jiujitsu is not about specific market conditions or trades, I do think that offering some general thoughts about dealing with difficult markets seems like a reasonable thing to do. After all, 25-standard deviation events happen with a regularity far more frequent than a normal distribution might suggest (see David Viniar of Goldman Sachs in 2007). Rolling with the punches is something that traders and investors need to do.

Here are a few ideas that I hope will pass as wisdom:

1. Plan the trade, then trade the plan. What plan did you have? What financial/economic/geopolitical context did it assume? Is your plan sound and you are good with it, then great. Steady as she goes.

2. Are you able to think clearly about your position? If the answer is “no”, then that ought to be the first thing to be addressed. There is a lot of noise out there (a LOT). Turn it off. Meditate. Take a nap. Listen to Mozart. Do what you need to do. Still can’t think straight about it? Think about the rule of half. Every trader has something similar — I talked about this in a podcast appearance (my first ever!). Kick out of half of your position and see how you feel about it. You can always pay the spread and get back in.

3. Always, always, always, make sure you are in business tomorrow. Volatility dialed up? Levered? Do what you know needs doing. Again, can always step back in if that is the right move.

4. Size matters. Especially when the volatility gets jacked up. If your size was 10 contracts at 11 vol, then at 33 vol, it should be something like 1/3 of your original size to have the same targeted pnl profile. As Harley Bassman or my long time collaborator Paul Sacks say: “Sizing matters more than entry level”.

5. Risk management is about knowing that you don’t know. Trading psychology is being okay with managing risk, stopping out, and the consequences thereof. Look, I know that stops generally are negative expectation (see Euan Sinclair’s Positional Options Trading). Addressing the trade when it goes wrong-way is part of the trading plan. Also, see idea #2.

6. I can’t tell you what is going to happen next. I can refer you to something that someone relevant has said. Bessent has said openly that stock market corrections are normal. They are, but to the best of my knowledge in many years of trading that is the first time that I’ve heard that from the Treasury Secretary. In a way, it is akin to “the dollar is our currency but your problem”. Just 2 days ago, Bessent noted that 88% of stocks owned by the top 10% whereas he is talking to food banks with working families “topping up” because they cannot afford all of the food they need. Let me be clear: I don’t care what you think of him or the policy; Bessent is communicating very clearly about how he sees the stock market, i.e., as either an instrument of flattening the wealth divide or simply as collateral damage toward that end. To make this more general, pay attention to what the US Treasury Secretary and key central bank heads say about risk.

7. I have never seen such uniform scorn for a policy and its related calculations as I have the last few days. At least on X/twitter. It is so important in times like this not to get caught up in righteous rage and to keep your wits about you in as neutral an attitude as possible. Clearly economic orthodoxy always pushes towards lower tariffs. Note to yourself the track record of economic orthodoxy, particularly over the past 20 years. Michael Pettis reminds us to keep in mind that tariffs just hit differently depending on whether you are a source of demand (consumption) or a source of supply (production). I highly recommend that you listen to Brent Johnson speak with Michael Every on Grand Macro Strategy. Mr. Every explains that there is economic policy and there is economic statecraft. Even thought it is from Nov 2024, well before these tax policies were publicized, I made a point of watching it today as I felt it was relevant. It is. Watch it. Again, I don’t care whether you agree or disagree. You need to watch to get an idea of the framework of the policy makers. Also, helps create and/or expand your own framework.

8. I wrote a similar post for Brexit in 2016 and I think it held up pretty well. Check it out on EliteTrader (I can’t find the original on Trading Technologies blog). A couple of highlights:

   1. Suddenly the future seems far less predictable than two days ago. Just remember it was not predictable then, either. Just now it is priced as though it is far less predictable.

   2. Stretch out your time horizon. Although there is uncertainty, value may present itself for the long run. It is very worth remembering Buffet’s advice when short term fluctuations occur: “Price is what you pay; value is what you get.”

And closing with a few, possibly practical ideas:

1. Portfolio construction is, itself, a trade. 60-40, risk parity, short volatility, and other similar constructions have made many portfolios optimized to the past 30-40 years or so of market action. These portfolios work well in an environment of financial asset appreciation — essentially low or negative real interest rates, i.e., easy monetary policy and low inflation. This has been the environment since the extremes of the late 70’s and then early 80’s which then benefited from the “peace dividend” global economy of the 90’s and 2000’s.

2. Putting money to work requires some thought overall and some opinion on what sort of regime that we are in. There is also the idea of making a portfolio robust on an equal basis to all the dangers of what can go wrong and yet still earn returns (especially including the anticipated rebalancing). Harry Browne’s permanent portfolio was one of the first. The idea being, roughly: 25% equities, 25% bonds, 25% gold, 25% cash. Chris Cole of Artemis promoted the Dragon Portfolio and Jason Buck of Mutiny Funds, the Cockroach portfolio. I also recommend reading or listening/watching both of them.

3. Another idea is diversification via strategy rather than asset class. Or perhaps one should consider “just dump money blindly into assets and leave it there” as one strategy. I purposefully wrote that to be extreme/controversial not because of my opinions, but to try to force you to realize that one can have static or dynamic strategies. So be intentional about your strategy. Static is fine so long as you know that it is and have a very good reason for that.

Kris Abdelmessih offers some good thoughts via his email earlier today (also notes that it takes him 7 hours to write his pieces so now I don’t feel so bad about taking all day long). My recommendation here is to sign up for his email if you have not already!