Advice for 2010: Capital preservation

I just finished updating my spreadsheets for the year’s end. My primary system is a trend following system which has been in use for 2 years now (started at the beginning of January 2008). It uses 10 ETFs and goes long…short…and periodically uses margin. The use of margin is controlled by a separate set of rules to implement the margin in a conservative manner and minimize drawdowns. As I reported here last week around Christmas, my system gave the signal…an “early warning” if you will… to remove all margin, which I did this past Monday. I’m still 100% long….just took off the margin.

At the close of this week, the system generated a signal to close out one of the long positions and go short, which I will be doing on Monday. As I said, this is a trend following system and the “triggers” for each of the 10 ETFs are set at different frequencies to phase you in and out of the market…again, to minimize drawdowns. This is by no means a “Sell the Market” signal (I’ll still be 90% long with just 10% short) but it should be considered another “early warning”.

On another front, my COT system has been performing very well. The COT system is based solely on volume, whereas my primary system is based solely on price. The interesting thing about the COT system is the activity that has been generated recently. Over the three years of data I have for the COT system, it has generated a total of 33 trades or LESS than 1 trade per month on average. Since going live and real time here on the boards back in mid-October, the system has generated 7 trade signals….far more active than normal. The only other period with this much activity in a 2 ½ month period occurred between mid/late-November 2008 and early/mid-February 2009. With benefit of hindsight we know this was very close to the end of the downtrend. So, a little food for thought….is the increased activity in the COT system a harbinger of an upcoming trend change? I sure don’t know…it did signal a trend change before, but I don’t know that 3 years of data is enough to say with a high degree of confidence that the increased activity is signaling a trend change this time….just a little something to think about.

When you put the pieces together….two “early warning” signals from from my primary price-based system and a POSSIBLE trend-change signal from the volume-based COT system, perhaps a little extra caution is warranted going forward.

Be careful my friends as we move into the New Year and remember….capital preservation is one of the most critical elements of a successful long-term strategy…..always harder to make it back after you lose it.

- Vics

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