If I have a long system, can I flip it and make it a short system, and will that be profitable? There’s a bit of a problem with that. For example, if we get a short signal and there’s a trend down and a trend up, the best possible outcome we can get is low. The best theoretical profit from a short trade is zero, which is 100% profit. If you think of it that way, it’s quite impossible, but it has happened before, just like in my experience for 20 years; it happened at least four to five times already. So, it’s theoretically possible. But in reality, a stock will go down and then recover at some point in the future, and this dip could be 10% to 95%. Whereas, if you flip this on its head and imagine a different scenario if you are a long trader and the stock price is going up, the best possible outcome on the long side is infinite. In reality, the stock doesn’t go to infinity, but it can go from 10 to a thousand possible. So if you think about the long side, you’ve got infinite upside potential. On the short side, you’ve got 100% maximum profit for you to have a profitable system.
On the long side, if you bought in at this same point and your trailing stock goes up, it’s easy to get 500% to 1000% possible. Because this is possible, you give a lot of room to move in a trend because you want to get those big wins. Whereas, if you give a lot of room to move on the downside and have a 30% trailing stop, it would certainly make sense in a system. If you get down to 80% in the money, and then it has to turn around and go up 30% before it hits your stop-loss, you don’t end up with that much profit. On the long side, if it goes up to 500% and drops 30% to hit your trailing stop, you are still up with a bucket load of profit.
If you think about short systems versus long systems, the asymmetry of what’s possible means most of the time, and you can’t just flip a system on its head. The longer the term a system is, the harder it is to flip it on its head. The shorter-term a system is, the easier it is to flip it and make money. So even if you’ve got a system that enters and exits in a day, it doesn’t mean that you’re going to be able to invert it, and it will be profitable. It may not because the markets fundamentally go up.
The difference is when a short system makes money; it tends to make it very quickly. Many people will think that you can make more money on the short side than you can alongside. That’s true on a per unit of time basis because market collapses happen very quick. Bear markets are short and sharp. Bull markets are long and protracted with intermediate bear markets. Because of the asymmetry of the way it moves, it’s much harder to develop a short system than a long one. And the odds, they’re in favour of the long systems compared to that. Use the bear market time to go on a holiday, recalibrate or regroup.
You can trade short, but not every system inverted will be profitable. If you’re thinking about return per unit of mental energy expanded, it’s easier to be an alongside trader and have a holiday in a bear market. Just like the dead cat bounce and margin calls, you get smashed.
Like they happen with great intensity, very quickly. And in fact, some of the biggest up days in the market occur during a bear market. It doesn’t make them good to trade because as soon as the rally’s done, it collapses back down.
If you can develop a bear market system, shorting breakouts of the downside is not profitable because you constantly get whacked by the balance. Shorting rallies in a bear market usually ends up being an easier way to go. However, trouble is at the end of the bear market; if you keep shorting all the rallies down, you get eventually whacked by a bull market.
It’s not my favourite thing in the world, but it’s helpful to have short systems that do make money – they’re just going to be different, and you want to get out quickly. Just like in a short system like slippery dip, it’s got a profit target. The reason it’s got a profit target is that it’s only a 30% odd profit target. When you’ve got some profit, you want to take it because there’s going to be a rally at some point.
If you don’t protect your profit, you’ll get whacked by the rally. Even if you’ve made 30% when there’s no rally and it keeps going down, there’s not that much money left to make. In conclusion, don’t be greedy; be quick.