Incorporating market conditions into your trading rules

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• 0:00Speaker 00

  Hey everybody, it's Michael Martin. Good question came in about market conditions when you're trying to set up your trading plan. So, you know, I think understanding market conditions is something that's going to take some time. But you can start today. This speaks to, you know, when you're planning, something we refer to as robustness. And the more robust, you know, your model or your trading system, the better it will serve you. That's the general theory. What does that mean? So let's just say you're buying 10-day breakouts and selling 20-day breakouts, whatever it might be, buying crossovers. The reason why most of us would suggest that you test that over 10-plus years is because

• 0:45Speaker 00

  you'll have different market regimes over that window of time, right? You'll also want to know and go back and see if, you know, how did it do in '07, '08? How did it do in 2022? How did it handle 9/11? How did it handle COVID? So these types of things are kind of shocks to the system as a lot of people can't anticipate, especially the black swans. So since we know ahead of time, we can't predict what's going to happen through the end of the close today, right? Despite having, you might have an amazing feel, you can't really tell what that's going to look like.

• 1:25Speaker 00

  And so when we speak to the market environment or market conditions, those are things that you can backtest, you can stress test. Now, the simulators are getting much better, especially with the advent of AI. I don't typically like to test one instrument at a time because it doesn't really tell me how the rest of my portfolio is going to do. So this is the point where if you're just trading MNQ, you can probably click off the video. I don't want to waste your time. You know, because if you're like risk on, risk off with one instrument, that's really not what we're talking about here. We're talking about having several ideas in your portfolio at the same time, pulling your weeds and letting your flowers bloom with the money that you get stopped out on, right?

• 2:10Speaker 00

  When you get stopped on something with a protective stop, you have cash, that now can become dry powder as an asset class itself, or you can do like I do typically reinvest some of that into the names that are winning when you look at specific continuation patterns, right? So for your particular style of swing trading, you'll want to know like, okay, when the markets are challenging for investors, will this perform well? So that's why it's important to go back and say, okay, here's my style, I'm doing well now. Let me go back and see when the markets were challenging, to say the least, and see how my rules would have fared during that window of time. That does a couple of things.

• 2:52Speaker 00

  One, it helps you understand if you have duress in your system or in your body, sometimes they're both, you know, what would you do to cut risk? We talked about portfolio heat last week, right? This can help you trade baskets or learn to exit some of your positions with a basket. Meaning, if you see that your equity is pulled back, say two full percentage points based on your overall account balance, you might say, I'm puking out the whole portfolio and go into cash. That's what I mean. And a lot of pro traders do that. They manage risk by baskets. I think it go back to that video that Paul Tudor Jones did a month or two ago, and the guy asked him about a specific, what names do you like?

• 3:36Speaker 00

  And he's like, I think in terms of baskets. So basically, in that case, and I used to do this a while back when I cleared my equities through Goldman, they had a product called Ready Plus, R-E-D-I, which I think originated in Spearleeds Kellogg, and then they kind of took it over when they bought SLK. And you could upload a little CSV file that would have the tickers and the prices and the quantity, and then kind of create your own little index fund, your own little basket. And you could trade that basket yourself. It's very clever. So that might be, you know, if you're into semiconductors, or if you think software's going to keep moving, you might be able to put in, you know, 1,000 shares of this or 10 shares. It doesn't matter what the quantity is.

• 4:20Speaker 00

  The idea is that you're not going to live and die by one particular name, right? Because when the institutions buy, that's kind of what they're doing. They're looking for representation in a particular sector and/or industry perhaps. So if you can get really, really good at that, you don't have to buy calls on SMH, you can dig a little deeper and say, okay, what are the components that are actually working here? If you wanted to take that a step further in terms of robustness, you could do like an index deleting strategy, which people have been doing for quite some time. I certainly didn't come up with this. But let's just say that, let's look at the Dow because it's easy, right? You already got 30 names, 30 tickers in the Dow industrials. So when you think about what the Dow is doing, or the, you know, the DIA, if you're trading

• 5:04Speaker 00

  that, it's usually the net performance on the day, right? It's probably rare that all 30 names are going up at the same time. There might be five to 10 out of the 30 that are really ramping up, but there's others that are kind of lagging or might be flat. So one of the things that some pairs traders do is they think about going long, the ones that are actually moving up, and they'll be short the ones that are going down. So you can do that yourself. But going back to the market conditions, you can look, don't forget, there was a great time through the 2000s and even to the 2010s where we were basically in a zero interest rate environment.

• 5:45Speaker 00

  So, you know, that has an enormous impact on stocks if their borrowing costs are as low as possible, right? So go back and see, okay, how did my, how did my strategies perform in an interest rate rise, a rising interest rate environment? That will help you understand better how you can perform, and especially calibrate your emotional constitution with what happens in those windows of time. So it's not predictive, but it helps you, you know, understand who you are as a person if you were going to perform in a certain environment and ask a lot of your money. So you can do that with or without leverage, but I think that's important.

• 6:27Speaker 00

  Now, this is a skill that's going to grow over time because you can backtest till you're blue in the face, but it doesn't really mean anything until you're committing real capital. I believe in using the simulator because it gives you an idea that at least you're on to something, right? That's evidence that, okay, well, this did work over a 20-year window of time, so now let me try it with real money. But you can cover a lot of ground with the simulator and at least give yourself a little confidence that you're not stepping into something completely blind. And having a lot of confidence in life and anything that you do is going to sometimes carry the day when you could otherwise be full of self-doubt, which, you know, it's hard to, it's hard to succeed in anything, whether you're an actor, an athlete, if you're full of self-doubt.

• 7:10Speaker 00

  You know, you have to take the long-term view on this and just say like, hey, this is the way it is today. This is just one chapter in the book. It's not going to be this way forever, and I'm going to test my metal and put this stuff to work, and I'm going to be a successful trader. I would actually say it this way, I am a successful trader regardless of the market regime, regardless of market conditions. Say things like that in the present tense because if you say like, one day, I'm going to be a successful trader, you kind of, A, let yourself off the hook because when is one someday? When is that? When is that? It doesn't exist, right? I used to say, you know, we used to say in the trading tribe, like, you know, the only thing that matters is right now. What are you doing to manage your risk in the ever-evolving moment of right now?

• 7:55Speaker 00

  So the future doesn't exist. So when you set goals, start thinking and talk, even if you don't have the school, have the skills, you have to fake it till you make it. And, you know, as you're building out your model and you're testing out its robustness for various market conditions, various market regimes, like, and to give you an idea of where you can take this to the nth degree, a lot of this is what Renaissance does. They understand where the regimes are, not just for the overall market, but for individual names. And that's how they calculate everything, right? They understand what the regime is for any particular name, and then they bet accordingly. So you can get as sophisticated as you want with this, but ultimately, in a general sense,

• 8:40Speaker 00

  you should definitely do some backtesting and see how your trading rules worked under various environments. Because that'll at least, if nothing else, give you, again, a hypothetical expected value for all your work. And two, with that data, you can approach real-time trading with real money with a certain level of confidence. There's more videos like this. If you click the box here, I had created a list for you, and don't forget to look and click the link below to join the cohort. Thanks for being here, and I'll see you tomorrow.