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ZYX METHOD TRADE MANAGEMENT GUIDELINES

Trade management is crucial to making money, especially for the smaller time frame trades.  The following are the basic tenets of trade management as called for by The ZYX Change Method.

                                                                                      Time Frame

The ZYX Change Method is equally profitable for very short term and very long term trades.  The research at "The Arora Report" shows that risk adjusted returns are maximized by focusing on short term trades during periods of high volatility and longer term trades during periods of low volatility.

We provide ideas for very long term, long term, medium term, short term, very short term, and very very short term trades. The table shows the length of each time frame. 

Very long-term                               3 years                                                                  

Long-term                                       1 – 3 years

Medium-term                                  6 – 12 months

Short-term                                      2 – 6 months

Very short-term                             2 - 8 weeks

Very very short-term                    0 - 2 weeks

If a post does not mention time frame, the default time frame is medium-term.

Research at The Arora Report shows that most investors can increase their risk adjusted returns by diversifying among various time frames.

                                                                                 Scaling In Entries

The ZYX Change Method calls for scaling in entries in small tranches or installments.  Research at The Arora Report shows that the optimum smallest increment for scaling is about 5% of the full position size. For smaller accounts, where 5% increments are not practical, 20% increments are suggested. Our readers may note that the conventional wisdom of  difficulty in getting  good fills on odd lots (less than 100 shares) is no longer true. These days, through most broker, odd lot fills are as good as fills for larger quantities.

As an example if an investor has decided  that  suitable full position size  of company ABC is 2,000 shares, then a 10% tranche equals 200 shares. The investor may start  the position by buying  10% tranche or 200 shares near the top of the entry zone, then the investor buys a 10% tranche or 200 shares near the mid point of the entry zone, and buys a 30% trance or 600 shares near the bottom of the  entry zone.  Now the stock traces out a bullish technical pattern and the investor buys another  10% tranche or 200 shares. Right afterwards a bullish news comes in and the investor buys a 20% tranche or 400 shares. Now with the stock firmly in up trend, on pullbacks, the investor buys two more tranches of 10% each. 

In the above example, the investor ends up owning 2000 shares with a great average price, took less risk  compared to buying 2000 shares in one shot,  was not shaken out of the position when the stock went down and most importantly the investor slept well because of the control exerted by the investor. If the trade was not working out or there was adverse news or overall market conditions degraded,  the investor could have stopped adding tranches and thus limited the loss.

A mention of '20% tranche' does not mean 20% of the portfolio or total capital. It means 20% of the full position size for one stock that  an investor intends to acquire or sell.

Always use limit orders to get the best fills.

How quickly and in how many tranches  a trade is scaled in is a function of conviction, volatility, and time frame.  The ZYX Change Method will typically look for buying on  down spikes as  stops placed based on traditional technical analysis by weak longs are taken out and selling on  up spikes when stops placed  based on traditional technical analysis by weak shorts are taken out.

If a stock moves below the lower band of the Buy Zone, it is no longer a buy. An incursion below the buy zone means that something fundamental may have changed. Below the buy zone, attention  should be focused on the Stop Zone and the focus should be on exiting.

For short trades, please simply reverse the above.

                                                                                    Scaling Out Exits

The ZYX Change Method calls for scaling out of positions similar to scaling in for entries. Research at The Arora Report has concluded   that a proper mixture of scaling out at pre-determined prices and trailing stops produces optimum returns over a long period.

It is best to put in limit orders in small tranches to scale out of the position ahead of time
. It is common  for a stock to spike, take out the limit orders and then fall back. An investor who has not pre entered limit orders to exit may not get the high price of the spike.

For short trades, please simply reverse the above.

The method also calls for never losing more than 20% of  a large unrealized gain. For smaller gains, the guideline is to never lose more than 65% of the gain. Never let a winning position turn into a loss.

                                                                                                Zones

Based on technical analysis and quantitative analysis, entry zones, target zones, and stop zones are predetermined before entering a trade.  The key points are to scale in or out within the zones and ahead of the crowd.

A zone is simply a range of prices for a certain action. For example, an entry zone may be from $18 to $20. If the stock has recently been higher than $20 and the plan is to buy on the dip, dip the toe at $20 with a quantity of 10% of the full position size and become more aggressive in buying near the lower boundary of the zone.

The goal is to obtain an average price as close to the lower boundary of the zone as possible when buying. When selling, the goal is to obtain an average price as close to the top of the target zone as possible.  The markets are very dynamic and do not always give an opportunity to accomplish the foregoing.  This is where an investor needs to determine where the investor belongs in the spectrum ranging from ultra conservative to ultra aggressive.  An ultra conservative investor would want to focus on getting the best average price even at the risk of totally missing the opportunity.  On the other hand,  an ultra aggressive investor would be more concerned about not missing the opportunity and less concerned about the price.

At times we offer suggested points within the buy zone.  These suggested points are suitable for a middle of the road investor.  These points are also helpful for GTC orders to be placed in advance.  This way an investor does not have to constantly watch the market.

If a security falls below the lower band of the buy zone, it should not be accumulated. 

It is important to pay special attention to stop zones  and start exiting when a stop zone is hit. Some losses are a part and parcel of any  investment method. In times of  severe overall market upheaval, stops on individual securities may be temporarily suspended and substituted by hedging or simply selling the stocks and raising  substantial cash. In such periods, only those investors may even consider suspending stops,  without hedging, who are willing to hold securities   through a major downturn and are comfortable with significant losses. Further, in such periods, investors  should drastically reduce the quantities they hold and should primarily be in a defensive mode.

Full Core Position Size

Full core position size simply means the desired total size of a position when all scaling in is done.  Full core position size is determined by desired diversification and desired risk control.  Here are two examples:

Small Account:

In this example we consider a small account of $50,000.  Diversification desired is five different positions.  The dollar amount allocated to each position is $10,000.  If a stock is priced at $10.00, the full core position size is 1000 shares. 

Based on the preference of the account, the full core position size should be further adjusted based on the maximum risk desired per position.

Large Account:

In this example we consider a large account of $1,000,000,000.  Diversification desired is fifty different positions.  The dollar amount allocated to each position is $20,000,000.  If a stock is priced at $10.00, the full core position size is 2,000,000 shares.

Based on the preference of the account, the full core position size should be further adjusted based on the maximum risk desired per position.

Large accounts should also set up different full core position sizes based on the number of shares in the float and liquidity desired in a stock. 

Trade Around Position

A trade around position simply refers to a shorter-term position separate and distinct from a longer-term position already being held.  Trade around positions are designed to enhance the total return on a position by as much as 50-100%.

A trade around position size is specified as a percentage of the full core position size.  Here is an example: 

Let us assume that the full core position size is 10,000 shares and it is a long position with an average buy price of $20.00.   The target for the core position is $30.00.  The stock moves to $22.00 and a great piece of new news comes in resulting in a high confidence that the stock will swing to $25.00 in a very short time.  At this time, we may enter a trade around position of 5,000 shares with the objective of exiting these additional shares at $25.00.  This trade around position is referred to as 50% of full core position size trade around position. 

As another example, let us assume that 30% of the full core position size is being held for the very long-term from $16 and the very long-term target is $35.  The company reports better than expected earnings when the stock is at $21.  A short-term trade around position may be entered at $21 with a separate target of $25.  The stock reaches $25 and the profit is taken on the short-term position entered at $21 leaving the longer-term position untouched.

The First Line of Risk Control

The first line of risk control is the quantity of the position.  Here are two examples:

Let us assume we are entering a high risk position.  To control the risk we may limit the maximum quantity to 25% of the full core position size. 

As another example, let us assume we own 100% of the full core position size.   News comes that increases the risk.  To reduce the risk we may exit 25% of the position leaving us with 75% of the full core position size.

The Second Line of Risk Control

The second line of risk control is stop loss orders.  The method uses stop loss zones as described above.  The advantage of using the zones is that the positions become less susceptible to stop hunting.  After a stop is hit, there are no new posts on that position because the trade is over. However, the stock or the ETF stays in our universe and continues to be analyzed for future signals.   It is important to not hang onto a position after stops have hit.  Learning to take losses is an important part of wealth generation.  There is a lot of truth to clichés of investors becoming wealthy by being only 51% right.  The nature of markets is such that some losses are unavoidable. 

At times, a post may say no stop for the time being.  The reason typically is market volatility.  Using stops in highly volatile situations can result in whipsaws that can accumulate to significant losses over a long period of time. However, this approach is suitable only for experienced investors who can withstand significant drawdowns.  The posts are written for experienced investors.  Those who are still building experience or cannot handle significant drawdowns should always use stop zones.  If no stop is given in a post, and a subscriber is not an experienced investor who can handle drawdowns, by default the investor should enter a stop loss 10-15% below the low band of the buy zone.  In some situations a single entry point is given instead of a buy zone for entering a small tranche.  In such cases, stops should be entered 15-20% below the entry price.

All investors have different risk tolerances.  Therefore, based on one's own risk tolerance, investors should override the foregoing and enter stops that are commensurate with their own personal risk tolerance.  It is an investors personal responsibility to control losses with stop losses and to override posts in accordance with one's own preferences related to risk.

Most subscribers should consider entering hard stops at the time of their fills. Only those who are experienced may consider mental stops and use of alarms.  After stops are hit on all quantities, the trade is over.  Unless there are exceptional reasons, for routine stop hitting there will not be a post on the Real Time Feed. 

Diversification

The ZYX Change Method calls for five different types of diversifications. 

  • Diversify by time frame.  As an example, an investor may hold two positions that are appropriate for very long-term, one position for long-term, one position for medium-term, one position for short-term and one position for very short-term.

  • Diversify by strategies.  As an example, a large account may employ over 10 different strategies.  Even small accounts should employ at least three different strategies. 

    Long only accounts are sometimes under the misconception that since they can not go short, they do not have a choice of strategies.  There are 10 plus proven strategies that long only accounts can use to diversify.

  •  Diversify between asset classes, i.e., stocks, fixed income, currencies, commodities, and real estate.

  • Diversify by industries.  Even small accounts should hold positions in at least four different industries.  Large accounts should diversify at least across 10 different industries.

    It is best to diversify between industries that are least correlated.

  • Diversify between geographical regions.  In the age of globalization most regions tend to move together, but still certain sectors in certain countries tend to show less correlation with global movements.

Signals

There are two different variations of the ZYX Change Method that lead to actionable signals.  The first variation is macro oriented and applies to ZYX Global Multi Asset Allocation Alert and ZYX Emerging Markets ETF Alert.  The second variation applies to individual trades.

The ZYX Change Method has six screens for the individual trades.  When a signal meets all six screens, it is the strongest signal.  Signals are never given if less than four screens are met.  A majority of the signals given meet five of the six screens.

Posts marked 'for information only' typically with the words 'Information On' as well as "Intelligence On" do not meet the minimum criteria of four screens.  Such posts are not official recommendations, and are not consistently followed.  The point of these posts is to simply provide information that some subscribers can use to generate profits.

Speculative Positions

All investors ranging from ultra-conservative to ultra-aggressive can benefit by investing in speculative stocks provided they follow the following guidelines. 

  • Ultra-conservative investors may not devote more than 10% of their portfolio to speculative positions. 

  • Ultra-aggressive investors may not devote more than 30% of their portfolio to speculative positions.

  • It is best to keep quantity of each speculative position small and diversify among a large number of speculative positions.  Investors may not enter a speculative position without first being prepared for the position to go to zero.  Most positions will not go to zero, but by being prepared for a position to go to zero, investors will find themselves making better decisions.

    Here is an example to illustrate the point.  An investor invests in 10 speculative positions.  Two go to zero.  Two lose half of their value, two break even, two return 500% each, and two return 1000% each.  In this example, the investor will experience a gain of 270% even though two of the positions went to zero. 

Accelerating Wealth Generation

It has been proven again and again under both bull and bear market conditions that investors who chose to properly divide their assets between ZYX Buy Change Alert, ZYX Global Multi Asset Allocation Alert, ZYX Short Sell Change Alert and ZYX Emerging Markets ETF Alert dramatically accelerate wealth generation while lowering the risk profile of their portfolio. 

Proper division is  too diverse for a one-size-fits-all solution.  The following guidelines may be used as a starting point:

  • Starting point for conservative investors. 

    ZYX Buy Change Alert                                        30%

    ZYX Global Multi Asset Allocation Alert         50%

    ZYX Short Sell Change Alert                               10%

    ZYX Emerging Markets ETF Alert                      10%

  • Starting point for aggressive investors. 

    ZYX Buy Change Alert                                          40%

    ZYX Global Multi Asset Allocation Alert           20%      

    ZYX Short Sell Change Alert                                 20%

    ZYX Emerging Markets ETF Alert                        20%

 

Based on personal preferences, objectives, and market conditions, a division between the four services should be periodically adjusted.  

Caution: Under most market conditions, it is a mistake to structure a portfolio with half longs and half shorts.

Should you need consulting to accelerate wealth generation, please feel free to email us at
Consulting@TheAroraReport.com


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