Markets are simply the markets. We let them do whatever they want to do. Instead of figuring them out, we observe them and go with their flow. Observing markets at a 30,000-foot view allows us to think clearly about what we see and what to do.

Investing success depends on following common sense principles – 1) Going with the flow; 2) Sticking with what works; 3) Rejecting what doesn’t work; 4) Managing risk; and 5) Maintaining a positive attitude at all times.

We adapt to and ride market trends. Trend-Following is a life strategy first that we apply to trading markets.

We understand and accept these rules as part of the deal. We don’t allow frustration, impatience, anxiety or any other feelings inhibit our ability to follow the rules. Doing so would be a death sentence. For example, investors take big losses when they let hope stand in the way of cutting losing positions. Hope (and other feelings) disrupt their logic disallowing them to observe the markets clearly.

At Melissinos Trading, our emotions support our discipline. During winning periods, greed does not derail us; neither does frustration during losing periods. We do not set out to only build an investment strategy that makes money, but also aligns with our emotional tolerance.

We believe this holistic approach gives us a superior edge over our competitors. We place a priority on generating solid performance rather than money-raising; see here – Priorities of a Fund Manager.

Past Performance is Not Necessarily Indicative of Future Results

Selection Process
• Correlation, volatility and trend-strength filter
• Markets breaking out of long-term ranges
• Filter out directionless markets

We use simple time-tested parameters to identify and capture price trends. We stick with persistent trends and try to stay out of sideways choppy trends that do not offer much opportunity for profit.

See more of our content on this subject: Aligning with Trends is Natural and Healthy and Everything Moves.

Persistent Trends

Persistent Trends Sugar

Persistent Trends Soybeans

Persistent Trends Feeder

Inconsistent (Sideways) Trends (Whipsaws)

Inconstant Trends (Whipsaws) SP 500

Inconstant Trends (Whipsaws) Cotton

Limiting Losses
• Define risk tolerance and set the budget
• Make identical fixed fractional percentage bets on every trade
• Measure open risk on a daily basis
• Adjust position sizes and exit points depending on each market’s trend and volatility

We monitor portfolio positions daily and calculate how much capital we have at risk in every position, each sector and the portfolio overall.

Our risk control process adapts with market conditions. In general, we reduce risk in volatile markets and increase it during calm periods. To protect us when we’re wrong, we implement a protective stop-loss order on every position we take; once placed, it trails the market’s trend (for long positions, it trails underneath; for shorts, it trails above) continuously reducing risk.

This risk control process intends to protect capital and limit losses.

1) Define Risk Budget: We bet a fixed-fraction of our equity per trade. This makes us indifferent to any particular trade. We do not play favorites or risk more on certain trades because of hunches, personal biases or new flashes in financial media. However, after we take a position, we do play favorites by holding the ones that produce profits and cutting the ones that do not.

2) Deploy Risk Budget: When our system signals to enter a market, we divide our risk budget (~1% x Total Equity) by the difference between the entry and exit points. In volatile markets, the gap between the two points are wider than when markets are calmer. Naturally, we can afford to take bigger positions in calmer markets (when price ranges compress) than in more volatile markets (when ranges expand).

3) Measure Portfolio Risk: Every day, we calculate how much capital is exposed in each position, sector and the portfolio overall. We impose risk exposure thresholds to limit losses when positions move against us.

4) Adjust Position Sizes: If and when risk exposure limits get breached, we simply reduce our position sizes in order to reduce the odds of incurring losses outside of our budget. To reduce risk, we simply cut down position sizes; not hedging it by taking additional “protective” positions. The ultimate hedge, in our view, is to reduce or cut the position directly. See an example in Lean Hogs.

Lean Hogs