The Teeter-Totter of Performance

Given the multiplicity of market participants simultaneously holding bets of an opposing nature, there will always be an unhappy party regardless of market direction.  All price movements are applauded by some while being scorned by others.  No doubt the 17% rise in the S&P 500 Index this month has been viewed as a godsend by bulls, a devilish trick by bears, and a move entirely too one directional by neutral players.  Lest the bulls become too smug with their good fortune of late, however, allow me to inject a dose of reality into the mix.  While a continued rise in the markets at a pace of 17% a month would certainly be reminiscent of the 90′s boom and a veritable profit fest for anyone with a bullish tilt to their portfolio, it is altogether unlikely.  But, perhaps I’m stating the obvious.

An outlier in one month is more likely to be followed by a return to normal the next month as opposed to yet another outlier.  Put another way, the 17% rip experienced this month is much more likely to be followed by a month of smaller gains, sideways chop, or even downward movement. But, again, perhaps I’m stating the obvious as the term “outlier” implies we don’t see them that often.  If an outlier was followed by yet another outlier which was followed by more outliers, we wouldn’t call them outliers now would we?  They would be referred to as “normal”.

Here’s how it affects your trading.

The performance of most successful trading strategies is cyclical.  It teeter-totters back and forth between periods of under-performance and those of out-performance.  The trick is to stay committed in difficult times when returns are less than ideal so that you’re in the game during the inevitable return to out-performance.  Those who throw in the towel during drawdown periods fail to participate when favorable conditions return.

Say you’re a neutral trader actively employing iron condors or butterflies.  Given that most neutral trades aren’t designed to handle a 17% rise in three weeks, I suspect most traders faced more than a little difficulty managing the incessant market rise this month.  I know I lost money on my RUT butterfly strategy.  In other words, this month was unfavorable for neutral traders.  While this period of difficulty maybe leading some to abandon their perfectly legitimate neutral strategies, I remain confident that better returns lie on the horizon.

Though October invited a fat kid to park himself on the under-performance side of my teeter-totter, I’ve hidden some twinkies and ding dongs in plain view to lure him away.  And with that my performance should tilt back in the proper direction.