Special high risk market announcement

[Gary Stone]

I felt it essential to communicate with our customers the importance of now reducing exposure with the recent SPA3 high market risk signal. For those unaware, SPA3 triggered a volatility signal on the XAO sending SPA3 into high risk last night (6/5/10).

Rather than staying exposed to the market you have a personal decision to make about the way you decrease exposure to the high market risk signal. This depends on your appetite for risk. While internally we trade the Share Wealth Systems portfolios using risk profile 2, there are other more risk averse options that you may consider adding to your trading plan. These options are clearly outlined in the SPA3 Reference manual and Trading Plan video located in the Share Wealth Systems Education Centre.

SPA3
For simplicity, I’m going to share with you the two most used risk profiles which can also be modified to include additional rules.

Risk Profile 1
Risk profile 1 is the most conservative SPA3 risk profile. Typically, this investor is risk averse, may have limited capital or maybe just trying to reduce drawdown from their portfolio. Risk profile 1 endeavours to expose 100% of capital in a SPA3 low market risk and when a high market risk signal occurs, 100% of capital is removed from the market and moved into cash. Risk profile 1 customers become inactive in a SPA3 high market risk and instead wait to re-engage the market on the next SPA3 low market risk signal. If you chose to trade risk profile 1, now would be the time to move your capital into cash by manually exiting all positions from the market.
Money Management rules associated with risk profile 1
1.   Money management rules allow for 100% position sizes to be traded in a SPA3 low market risk and SPA3 low sector risk.
2.   Money management rules reduce new entry positions by 33% in a high sector risk when the market is low risk.
3.   Risk profile 1 users move 100% into cash when a high market risk signal is triggered and re-engage the market upon the next low market risk.

Risk Profile 2
Risk profile 2 is the most popular SPA3 risk profile and the one that the Share Wealth Systems public portfolios use. By following the standard SPA3 process, risk profile 2 investors trade under all market conditions. In a SPA3 low market risk, risk profile 2 will endeavour to expose 100% of capital to the market. When the risk of the market changes to high, three important factors need to be considered:
1.   Are you going to reduce exposure to the market by staying fulling invested while waiting for individual exit signals
2.   Are you going to move part of your capital into cash immediately
And / Or
3.   Are you going to hedge your portfolio
The answer to these questions is personal as some investors feel comfortable shorting the index while others don’t.

Money management rules associated with risk profile 2
1.   100% position sizes are traded in a SPA3 low market risk and low sector risk
2.   Money management rules reduce new position sizes by 33% in a high market risk
3.   Money management rules reduce new entry positions by 33% in a high sector risk
4.   Money management rules reduce new entry positions by 50% in a high market and high sector risk.

There are modified rules that can be added to your trading plan if you would like to run a hybrid of risk profile 2. They include.
1.   In a high market risk no new trades are taken in a high sector risk
2.   Immediately upon a high market risk signal capital exposed to the market can be automatically reduced by 33% if the sector is low risk
3.   Immediately upon a high market risk signal capital exposure to the market can be reduced by 50% if the market and sector are high risk

These rules are a hybrid to risk profile 2 and can help reduce drawdown in a SPA3 high market risk. Whilst these rules are designed to reduce drawdown you must be aware that they can reduce profits if the market was to sharply rise.

SPA3 Hedge
Upon a high market risk signal occurring in GPS, SPA3 risk profile 2 customers have the option to hedge the value of their portfolios. The hedging strategy is achieved by short selling the ASX200 with a CFD. If you decide that hedging is not for you we would suggest that you consider trading either risk profile 1 or a hybrid of risk profile 2 where you reduce exposure immediately upon the high market risk signal. Training on the Hedge can be accessed in the SPA3 Reference manual or SPA3 Education Centre.

Adapting  SPA3
Although SPA3 is a mechanical system its exact operation is not prescribed. Its operation is very flexible. Customers have the ability to change the component parameters and therefore the performance in relation to their trading style and the market conditions. We know that different money management and technical indicator combinations will outperform others in different market conditions. This has been highlighted throughout the manuals and in recent forum postings. For example, smaller SIROC settings of 8:5 would have performed significantly better in recent market conditions since October 2009. Prior to this and in many other market conditions they would have under performed, producing increased trading with more brokerage costs and multiple smaller losses. So the issue is not so much if SPA3 can be adapted to a market condition but when and how to adapt it; without the aid of hindsight.

Research
Research is a core business at Share Wealth Systems and we often need something or someone external and impartial to provide us with a reason to ask questions. The market does that very well. The dramatically different market action has provided impetus for SWS to ask the questions and immediately refocus its resources into new research to answer them. The large ranging sideways market has challenged SPA3 and is definitely challenging SWS. Could we predict this type of market earlier on? Can we improve the performance in this market type without breaking it in others? How do we reduce draw-down and not affect run-up? Over the coming weeks we will conduct and release the research results as they become available.

Regards,
 
Gary Stone

[Ivan]

HI Gary,

without opening the whole debate covered in other recent threads about where the resources should be mostly spent at the  moment (indicators vs the rest etc). One thing I meant to mention to you at the recent UGM (and I know it's on the "to do" list), but I think a priority should be placed on getting the back testing/research capability installed in GPS so we can again start to have a look for ourselves at the effects of changing params , risk profiles etc.

I know this is slightly off topic to this thread, but you did mention different SIROC settings and their recent performance, but at present we don't have an "easy" way of evaluating this for ourselves.

I know some back testing can be achieved by manually hacking around the xls and using the old TM, but to be honest, I gave up after repeatedly mucking around, I thought I'd wait until you guys got it back in and working in GPS.

So in light of the recent market activity, could I ask that the priority for this  capability be raised up the flagpole a little....

thanks
Ivan

[Fiona]

I would be very grateful for that to be restored also.  The workarounds to use the old TM were cumbersome, and now I've upgraded my computer I don't have it any more.  Would really love to do some backtesting.

[Grantmac]

My hand is up for this too.... I would have used it to test small SIROC settings for this market, as earlier entry and exit seemed to make sense.  As it was - I've been out of SPA since November, but started again when ASX went over 5000... maybe I should have waited another day or two 
Please - this backtesting tool was valuable to me before - I'd love to see it again in a hurry...
Thanks

[Ralph]

Special thanks to you Gary and all the team for all the work I am sure you all are putting in behind the scenes.
Although it may seem bleak at the moment I know that we will all benefit from the research being done and SPA will emerge even better

[Grantmac]

Yeah - I agree with Ralph - thanks.  I was downright excited when we went from Trademaster to GPS, and things look like they will get even better!

[Adrian]

Ivan,
While you're waiting for the SWS guys to get this going again, I have a spreadsheet which will do a reasonable job of this for you. I'll upload it tomorrow after I tidy it up a bit and provide some instructions. You don't need to be an excel guru, but you do need to be able to use the sort facility.
Rgds Adrian

[Ivan]

Hey Adrian,

thanks very much, I think many others will also appreciate it !

regards
Ivan