In the 9 chapters leading up to this chapter, I covered a lot. Specifically, I explored how modern investing works (aka buy and hold), the inherent bets people are making when using buy and hold, and how market timing can provide an alternative which solves for some of the less desirable aspects of buy and hold. In this chapter, I get into the method that I use which I call “Tradexing”.
Before we get into the weeds, I feel compelled to say that I’m not going to tell you exactly what I do for a few reasons:
If you’re a do-it-yourself (DIY) type, knowing my specific approach won’t help you as you will have to tailor your approach to your own goals/temperament. As 1970s/80s trading legend Richard Dennis once said, he could publish his trading rules in the newspaper and no one would follow them exactly as people have a pesky tendency to lose faith and abandon ship when the going gets tough.
Tradexing adapts.
I’m trying to find clients! Yep, I’m a capitalist with a money management business and this entire publication is ultimately educational marketing. If you’re interested in talking to me about managing your money, please reach out.
These points established, in this and upcoming posts I will provide enough detail on Tradexing to make you dangerous as they say. Let’s get to it.
Stated plainly, Tradexing combines trading principles (trad) and indexing (exing).
Beyond that, it is important to know that Tradexing has three primary goals relative to buy and hold investing:
More stable outcomes aka less volatility in returns
Lower drawdowns (ex. ideally down 25% instead of down 50%)
More return for the risk (as measured by MAR ratio)
Let’s unpack Tradexing further starting with the easier indexing portion.
Despite what I said in chapters 1 through 3, I am currently willing to make the bet that the U.S. stock and bond markets will continue to be positive outliers based on two things:
For now, I believe that the American approach to capitalism (method, rule of law, etc.) is the best approach and want to align my Tradexing accordingly.
Perhaps more importantly, the retirement “machine” throws a lot of money at stocks and bonds. Per my online research, a half trillion dollars or more flows into stocks and bonds each year. Based on my related research on capital flows, I like to align with tailwinds and a half trillion dollars per year headed in one direction is a healthy tailwind.
Given this, Tradexing maintains some constant “baseline” buy and hold index exposure to stocks and/or bonds. As to how much of Tradexing is indexing - it varies (more on this later).
So, if I believe the points above (which I do) why not just buy and hold? There are two main reasons why I do not just buy and hold. First, I don’t have the temperament to handle the big drawdowns that come with just buy and hold. Second, based on my research I do not have enough faith that the next 20+ years in America will look like the past ~100 years.
Regarding the potential for the future to not manifest in a favorable way, I like to hedge my bets. In fact, I view not hedging against a possibly unpleasant future as irresponsible. Enter the trader principle portion of Tradexing.
So how does the trader principle portion of Tradexing work?
Regarding underlying theory, the trader principles part of Tradexing comes from my research on the greatest traders of the past 100+ years. There are three key principles that differentiate great traders from everyone else - great traders:
Respect price action/Follow price trends
Stick with winning positions
Cut losing positions
These three principles are the “secret sauce” that allow me to achieve my Tradexing goals (outlined above).
As stated above, I’m not going to give you the exact formula for Tradexing (maybe if you allocate big money). However, simplistically, a good place to start is with the timing model from chapter 6. If you combine the model from chapter 6 with indexing you get a simple version of Tradexing. If you’re having a hard time visualizing this, worry not as I will provide a simulation of Tradexing in a coming chapter.
To reiterate it succinctly, Tradexing is the combination of buy and hold indexing and trader principle driven models (aka timing models).
So, what does Tradexing do that buy and hold doesn’t?
It adjusts exposure up and down allowing for more stable outcomes.
It reduces exposure during difficult market periods minimizing drawdowns.
By reducing exposure, it provides a solution to an unpleasant future - if the next ~100 years look like the opposite of the last ~100 years in stocks and bonds, Tradexing will have a lot less exposure to said markets than buy and hold.
What doesn’t Tradexing do?
It cannot predict the future.
It may not outperform buy and hold when looking at just returns (as opposed to risk adjusted returns)
As stated multiple times, I’m trying to keep these chapters relatively short to avoid causing anyone’s eyes to glaze over so I will end this one here. In coming chapters, I will talk about how I pick the models, how Tradexing adapts, and more.
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Interesting post. Looking forward to reading the next chapters.