Shadow Vega: Have a plan

One of the advantages of using a quantitative trading system is that there aren’t a lot of day-to-day decisions to make about your trading. The basic plan boils down to “see the signal, take the signal. “ However, there are still times that we must do something a little different, and when those conditions occur, it’s best to already have a plan in place.

Because the Shadow Vega (SV) strategy trades only two ETNs, there are some special situations that we need to consider. The first and most likely is the possibility of a market shock that causes volatility to spike. If we are currently holding VIXY, then an upward spike in volatility won’t be a problem, as the price of VIXY generally moves in the same direction as overall volatility. However, if we are holding SVXY, then it’s possible that our position will suffer a significant loss when volatility rises dramatically. At Tranquility Trading, our plan in this situation is to stick to the strategy, because we are comfortable with the back test metrics including historical drawdowns. You will need to decide for yourself whether there is a maximum loss that you are willing to endure.

Another situation that could occur with any ETF or ETN, including VIXY and SVXY, is that the issuer stops issuing new shares or takes other action that results in the ETN’s price being skewed or “unhinged” from its underlying index. This actually happened with TVIX in 2012 when Credit Suisse stopped issuing new units for awhile, causing the price of TVIX to soar. If this scenario should occur with VIXY or SVXY, our plan would be to exit any open positions in the affected security and wait for normal trading to resume, because there is no way to know in advance how things will play out.

Very few of us trade every single day that the market is open; we take vacations, move to a new home, attend to family matters, and participate in other activities that prevent us from trading. So what’s your plan when you’re going on vacation?

Our vacation plans usually go something like this. About a week before vacation starts, we stop taking new trades because those trades might not have time to play out before we leave. Meanwhile, we obey all exit signals for our existing positions, and then close any remaining positions on our last day of trading. That way we can leave for vacation with a flat account, and not have to worry about what the market’s doing while we’re trying to enjoy our time away.

Upon return, we have to decide whether to jump into any open positions shown by the system, or just wait for new entry signals. If the average hold time for the system is quite short, then we will usually just wait for new entries. However, if the hold times are measured in weeks or months, then we will enter positions for any open positions to realign ourselves with the system portfolio. Obviously there are more factors that you could consider here, like how long ago the entry signal occurred, how much the price has already moved and in which direction, etc.

Over time, you will discover other events that prevent you from perfectly executing the signals from a quantitative system, and that’s to be expected. The key is to have a set of rules in place that allow you to handle those situations consistently.

Make your plans now.

Matt & Cesar