Monday, November 27, 2023

SPX Update: It's All About Risk, Not Reward

So, briefly (because I want to get into this next part), SPX invalidated the micro impulse discussed in the last update.  This does not preclude a top (near-term or otherwise), it simply means that first apparent micro impulse was invalidated.  There's an option here for a return toward 4500-20, but it's mainly speculative at this point.

With that, let's get something out of the way:  I am not 100% accurate.  I am not 99% accurate, nor 95%, nor 90%.  If anyone is under the impression that I'm always going to be right, let me disabuse them of that notion right now.  This is not an exact science.  If one trades as if it is, or anything approaching one, then one will end up in trouble.

I've written before that my only goal is to be right more often than I'm wrong, and I do believe I've achieved that for many years running.  The thing is, even if I tend to be right with some degree of regularity, it's simply never going to be anything approaching 100% accuracy, so properly managing risk in your trades is always the most critical part of the equation.  

Let's unpack that a bit using an illustration:

Let's say you've developed a revolutionary new system that is right an astounding 90% of the time and you earn an amazing 100% return each time you're right.  Can't do much better than that, right?  The problem is, if you don't manage risk extremely well, you're going to go broke anyway, even with that miraculous prediction system.  Here's how:  On trade 1, you risk 100% of your account (because you don't manage risk well!) and you're right, so you've doubled your account.  On trade 2, same thing.  Trades 3, 4, 5, 6, 7, 8, and 9 -- same thing.  If you started with only $5K, you have now amassed an impressive $2.5 million.

But on trade 10, it all goes wrong, and you end up like this guy:

I've written many times that risk management is more important than any system that attempts to predict future market states, and that is why.  If your risk management is poor, then it only takes ONE SINGLE mistake, and your entire account can be flushed.  

If your risk management is just subpar, then it might take half a dozen or a dozen mistakes instead of just one -- but you're ultimately headed for the same place, just not as quickly.  The best "prediction" system in the world cannot compensate for all the losses that will invariably follow from poor risk management.

Part of risk management is knowing when not to act -- and then having the discipline to do nothing.

Part of it is understanding the nuances of the predictive system itself (one must understand these to understand the relative risk if one does decide to act).  

For example, at the October bottom, all my SPX charts were clearly labeled 3/C -- they were labeled that way before the bottom was even reached, when it was reached, and after it was reached.  Here's where the nuance comes in:  In EWT, the C-wave of a decline marks the very bottom of a correction, and the market rallies back up to new highs from there.  

That's a risk, and it's a risk that was clearly illustrated on the charts -- and if one knows the system, then one understands the C-label means there's a risk the market isn't going back down.  One understands that risk whether I talk about it repeatedly or not at all.  And one must then manage that risk accordingly.  Because, really, there's only so much I can do (we'll get to that in a second).  In the most recent example:  I not only accurately identified the existence of the risk in the first place, but I also accurately identified the exact price point at which that risk markedly increased.  

Most systems are hard-pressed to do that much -- much less any better than that.  If there's a system out there that does more than that, then I've never heard of it.  

The reality is, if you need me (or anyone else) to discuss every detail of managing risk/trading strategy/etc., then you probably shouldn't be trading at all yet.  Because I can't do it. Literally. To simply cover all the ins and outs of risk management alone in the depth required each time isn't practically possible. These are not detailed discussions of trading strategy or analysis of each and every risk management strategy and/or how they apply to your account, your finances, and your trading goals, they're just "here's where I think the market might possibly be headed." 

Anyway, referring back to the October low again:  Yes, I leaned toward the bears eventually "getting it done" in the end and maybe I was wrong about that (TBD), but:

  1. On October 30, I laid out the options and listed the very first option as: "SPX has captured its Wave 5 target and does not need to go any lower. It could form a decent bounce from here (plus or minus a little). If one has been following these updates, then one already has hundreds of points of profit and may not feel the need to get overly greedy (not trading advice). Maybe it's that simple." 
  2. At the same time, the charts implied that if 5 of 3/C had indeed completed, then we should be looking for a decent bounce (even the bear count suggested we'd probably get a fourth wave 100-point bounce).  Then when we captured that ~100 points, I adjusted everything and was still looking higher.
  3. Around the time I adjusted everything higher, I clearly stated that my "not trading advice" for bears was to take NO ACTION until there was an impulse down.  See, to my thinking, bears should not have been heavily short by this point, having closed a bunch of profit on or around October 30, so that would allow them the option of non-action -- so I wrote that because I saw the risk of a meaningful C-wave bottom and was uncomfortable with it.  But that's just my approach, and my approach isn't always right.  If you took action anyway, then you did your own thing, despite my warnings.  Which you should always do, since nothing I write is trading advice, plus, as I said: My approach isn't always right.  It happened to be right in this case.
Could I have discussed that potential C-wave in more detail? Obviously -- anything can be discussed in more detail, which is part of the logistics problem I'm getting at here. Should I have? I dunno, but I do regret not discussing it more, because it seems that would have helped people. 

The bottom line is:  We're all pretty good at assessing potential rewards.  Maybe too good at it, since we can become blind to risk by the thought of rewards -- that's exactly the tendency that makes casinos such big business.  But one will go broke trying to trade the market without a realistic assessment of the risks and a good system to manage them.  

This is one of several reasons that NOTHING I WRITE IS TRADING ADVICE.  Because what I write can never and will never be enough information.  There are literal books-worth of information that lay the groundwork and serve as important context for even the simplest trade.  There's also a big difference between "what I may expect is reasonably likely to happen from an analytical standpoint" and when and how I might actually be willing to execute any trade at all based on that expectation.  The "expectation" isn't enough, nor is it the entire picture.

In the end, while Elliott Wave can seem like a crystal ball at times, it is not infallible nor an exact science.  Nor is any other form of market analysis or prediction.  Every system out there will go off the rails sometimes, and they'll do so with some degree of regularity.  Plan around that.  Because it's what you do at those times that will make or break your account in the long run.


With that out of the way, let's take a look at three charts.  The first is a chart of COMPQ, which I published a couple weeks ago, illustrating what seems like the reasonable bull case.  Is it possible for it to be more bullish than this?  Obviously.  But for many fundamental reasons, some of which I've covered here recently, I presently have a hard time believing in those.  I'm not being "stubborn" with that belief; I'm just assessing the data as best I can.  (Further, the second chart will add another, more technical, reason.)

The next chart is SPX going back to the 1870s, and one of the reasons I have suspected we're either at or approaching a significant bear market.  Can that red (5) extend?  Sure, always possible.  Forget the emotion du jour triggered by the recent rally, and the recency bias that engenders, and think about what you know to be true fundamentally.  Then ask:  Does an extended fifth rally presently seem very likely to you?

Finally, the close up of the chart above, focusing on the move since the 2009 low:

The chart above implies that a "double retrace" back toward the 3300s is not an option that should be entirely dismissed.  In fact, double retraces retest the prior high (which we're getting into the ballpark of doing), THEN form their second legs down.  Can I guarantee that?  NO.  But it's certainly an option.

Anyway, I'm pretty drained now.  Trade safe.

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