When building or planning a trading system to help you make decisions in the market, you make a lot of assumptions about how things might turn out and how you will respond. That’s why it’s important to continually check if your hypotheses hold true. When the event your trading plan prepared for happens, is it what you thought would happen? 

My trading plan is prepared for how it should respond when the market is volatile, like a sudden correction during an uptrend, or before it turns into a bear market. Remember, nobody rings a bell at the top or the bottom of a market. 

When volatility strikes

When the market gets volatile and goes against what has been the prevailing trend, one of two things is happening. The market is either correcting and it will eventually continue where it was going. Or it’s changing direction. 

The question we always tend to ask is which of the two is happening. But the question you should ask concerns your assumptions about your system’s response to both.

For example, in a correction, my system will go light on equities and sometimes 100% cash. In a turn to a bear market, it will go into cash. Why? Because every stock in my portfolio will pass through a stop on its way down. Stop loss is the only way out. 

So when I try to figure out what is happening in the market, I simply look at how my system is reacting. In the past couple of months, it has sent my portfolio mostly into cash. The market has been volatile, with some markets entering what would be regarded as a bear market (more than 20% down), and some are in the correction stage (10%-20% down).

So what happened? Is it correcting or changing direction? Based on the few positions that remain, they are correcting. Or they could just be the last ones at the door. Time will tell. If the rest goes and never come back then I’ll know it was a turn at the top. 

So far my assumptions hold true. All things considered, my system works and acted as expected when the market turned volatile.

Assuming returns

On returns, my assumption follows a football analogy. You can win the game without the ball just as long you bang in more than you concede. I assumed I could win with a low hit rate just as long as my hits are big enough. 

When the final whistle blew after two years, I had all the data needed for experiential proof. And only now can I do a post-match analysis.

With an average return of 3.65% and an average loss of -0.57%, the required win rate was 13.51% to break even. We managed 25.59% exceeding the required win rate by 89% resulting in a +105.13% total return. 

Looking back

It was a good plan and the hypothesis is holding true with live data. To further reduce the average loss I will now only add to my positions after the profit secured on the trade exceeds 2%. The assumption is that the number of losses will be reduced and consequently improve the net hit rate and lower the average loss size.

I also assumed I will never get out at the top. And I didn’t. 

It was a solid defensive performance with an even better attack. One of the lessons I learned from the game is that when you miss those few opportunities where you can really swing for the fence, costs might be too high to bear. But if I remove the top 3 trades the picture changes completely. 

My assumption for the year ahead

Check out this tweet from 18 January 2022.

And I’m still ahead of the benchmark…

You can find more information and resources for trading on this page.

Traders share a peculiar characteristic: they’re fiercely competitive, but only with themselves. In practice this means that they see every outcome as an opportunity to learn, and they’re brutally honest about both their failures and successes. This also means that they’re hungry for knowledge. They don’t sleep easy with unanswered questions. And they’re seldom satisfied with just one answer.

Njabulo Nsibande is a founder of Village Trader, and Sakha Ingcebo investment club. His interest in trading began in 2016, alongside a rash of Instagram ‘fx traders’…

Find him on Twitter: @njabulo_goje.