How to Fail as a Trader

The two biggest causes of failure among new traders are bad trading systems and unfettered emotions. Signalee exists to help new traders solve both problems.

Bad Trading Systems

Trading is a game of probabilities and sequence of returns. Systems run the gamut from trend following and breakout systems on one end that have low win rates but (hopefully!) big winners to short-term mean reversion systems that have lots of small wins with losses that aren’t too large. Stanley Druckenmiller said he only targets trades that will return 5x his money so he only has to be right slightly more than 20 percent of the time to make money. But the only way a system like this works is if he has a bunch of small trades going at the same time so he doesn’t get wiped out with losses while waiting for that 5x trade to happen. Too many traders accept small wins and big losses. They trade positions that can permanently go to zero and they compound the issue by using stop losses purely based on price. Even if 90 percent of your trades are profitable, the remaining 10 percent of trades that are losses can more than wipe out your gains.

While Signalee’s core position trading focuses on compounding lots of small wins, we use fundamental analysis and diversification to ensure our positions never go to zero. We further enhance our risk profile by only investing in things that generate consistent cash flows and pays dividends. At the end of the day, a consistent cash flow will always have value and creates a floor for price.


The second most common cause of failure for new traders is decisions made because of panic or euphoria. If a trader’s position goes against him, oftentimes a new trader will sell out at a loss just to see the trade bounce back. To be a successful, a trader has to have a plan to manage the position no matter if it goes up or down, and be able to stick with the plan no matter what.

Euphoria is just as bad as panic. Occasionally a trader will find himself in a situation where seemingly everything he touches turns to gold. Profits are easy and account balances grow. Instead of taking the good fortune in stride, knowing that the hot hand will eventually end, he increases his position sizes, uses leverage, or goes outside his area of expertise. The end result is easily anticipated as the new trader circles back to panic.

Emotions can be tamed in two ways:

  • Trade small until you can handle the losses that will inevitably happen on any single trade. Slowly increase the size of the trade and the size of the losses that you incur. If you panic sell, lose sleep, or want to check prices every 30 minutes then your position size is too big.
  • Instead of trying to come up with your own system or edge when you’re first starting out use the free core position trading system from Signalee. Buy and sell signals are posted when they happen so you can have the confidence that you won’t blow up your account.


Core Position Trading

There are a million ways to make money in the stock market and a million more ways to lose it all. Signalee uses core position trading to grind out profits over the long-term. We don’t use leverage. We don’t speculate in structured derivatives. We just stick to the boring basics: buying low, selling high, repeating ad nauseum.

Signalee’s Core Positions

There’s not a lot out there right now that’s enticing from a long-term returns perspective. The US stock market is priced to perfection and bonds are almost guaranteed to only beat inflation by 1 percent or less for the next 10 years. As a result, alternatives are often touted as a way to generate non-correlated returns that will help dampen the overall portfolio volatility in the current low-return regime. Larry Swedroe suggested the AQR Style Premia Alternative Fund, LENDX, which does alternative lending to small businesses along with consumer and student loans, SRRIX, a reinsurance fund, and AVRPX, which is a fund that sells volatility insurance across stocks, bonds, currencies and commodities.

I have a few objections to those potential sources of alternative returns:

  • “Alternative Lending” is often predatory and focuses on high-risk borrowers, so hard pass.
  • Given the likely increase in global warming related natural disasters it’s hard to get excited about taking on catastrophe risk.
  • Since we have historically low volatility it’s not really a great time to pile into premium selling.
  • AQR’s Style Premia Alternative fund isn’t exploiting any inefficiencies that the market doesn’t already know about and has likely priced accordingly.

So what opportunities are left for a non-institutional trader? Signalee is currently focusing on the following:

South Korea

Emerging markets are the “cheapest” asset class if you look at research from GMO, Research Affiliates, and StarCapital (which you should!). But stop to think about which emerging markets you actually want to own. A lot of them are focused on resource extraction; a lot of them are terribly corrupt with significant rule of law issues; and a number of them have gone too far down the socialist continuum to where taxes and government are too much of a burden on local business [Note: before you misread this comment, I’m a big fan of social safety nets provided by the government. Capitalism is the best system for resource allocation and improving lives but only if you have a prudent government as a counterbalance to its worst excesses.]

While emerging markets are the cheapest, you have to be selective about which emerging markets you own. For Signalee, that means South Korea as the risk of war is overblown.

ex-US Developed Nations

Relying on GMO, Research Affiliates, and StarCapital’s research again, developed markets ex-US are projected to have the second best returns of all the equity classes. Since you generally don’t have the rule of law issues with developed nations that plague emerging markets and developed nations are called that because their economy is reasonably diversified, the only thing that is causing depressed prices for ex-US developed nations is more socialistic governments and aging demographics.

For us, since there aren’t as many surprises lurking in developed markets, we typically just own super-cheap market-cap indexes and use that as the basis for our core position trading.

US Real Estate

US real estate might seem like an odd core position to include in a rising interest rate environment. And for the YTD period an owner of VNQ would be sitting on an ~10 percent loss without any opportunities to trade around it to reduce the total loss. But two factors argue for its inclusion:

  • An improving economic situation typically causes rents to rise enough to offset the pressure from increasing interest rates.
  • A simple estimate for long-term real estate returns is simply to take the dividend yield and add the rate of inflation (this assumes GDP is positive over the long-term). So the real return of real estate is the dividend yield. For VNQ that yield is currently 4.4 percent, which is better than most alternative options.


The only caveat to REIT holdings is that too severe of a depression can cause massive losses in a core position given its inherent leverage. As long as you maintain dry powder to trade around the ups and downs then it’s less of a problem.


Commodities probably won’t be as long a holding as the other three core positions listed above since they’re typically mean reverting. Some people have even argued that the real return of commodities is zero. While that’s a little oversimplistic, it’s an easy mental place to start from. So the question becomes why do I have commodities as a core position and how do I expect to make money from it?

Commodities are sensitive to the economic cycle and since the entire world is in expansion mode, the demand for commodities is increasing, which is why you’re seeing prices increase. Owning commodities in an expansionary economic environment is the first and easiest way to make money. Of course, this requires selling them before the economic expansion ends to keep the money.

The second way to make money is to buy ETFs that are structured to take advantage of contango. One research paper estimated that 2/3rd of the total return for commodities over any given period comes from contango. [Note: Contango is a situation where the forward price of a commodity futures contract is above the spot price. To calculate a forward futures price you take the spot price and then do some nifty calculations that includes the cost of financing the purchase, storage, shrinkage, and any other costs particular to that commodity. Normal markets operate in contango because it minimizes arbitrage opportunities.]

The third way to profit from commodities is to periodically rebalance a portfolio as it inevitably goes through the cycles. We’re not looking to have a permanent commodity sleeve in the portfolio but we are looking to take advantage of the global economic expansion and to trade around it as it fluctuates.

Never go all in

While the above four core positions are pretty diversified, it’s not a complete portfolio. Since it’s not a complete portfolio a trader should never go all in on just the above. The four core positions I’ve listed represent good opportunities for long-term value and even better opportunities to trade around. So always keep some dry powder for when the short-term price movements put the odds of trading around the core in your favor.

Appearances vs Reality

Or why core position trading works.

I recently had a conversation with my wife about what options exist to solve the mass shooting crisis in America. She’s come a long way from being 100 percent anti-guns when we met to meeting me halfway in the middle. We’ve both learned from each other – I grew up in the country where hunting and shooting sports were common and she did not.

What I never understood about anti-gunners was their fear. For me and my friends, gun safety and gun handling were drilled into us at a young age. I assumed that everyone had gun safety drilled into them. My wife assumed that no one did. I started turning her around on guns when she agreed to go to a shooting range with me and I spent the 30 minute car ride explaining gun safety, gun handling, and range etiquette to her. And then spent another 15 minutes at the range repeating it.

But even with her becoming more comfortable with guns she said she was still in favor of an outright ban on AR15s. She was in favor because they look scary.

My response to her was that you needed to ban capabilities and not appearances as a Ruger Ranch rifle shot the same bullet, had the same magazine capacity, a similar size and weight, and was just as lethal.

And just in case any firearm aficionados or armchair commandos happen to stumble upon this by accident: please save me the hassle of filling up my inbox saying an AR15 is superior to a Ruger Ranch rifle. That isn’t the point.

Banning an AR15 but not a Ruger Ranch rifle makes no sense. Same thing for any of the other common military rifles that are easily obtainable like the AK47, SKS, SCAR, IWI Tavor, Steyr Aug, or PS90. These rifles obviously fit in the same category but there hasn’t been a single mention in the news about adding them to a ban.

Core Position Trading: Appearance vs Reality

This conversation got me thinking about how to explain why core position trading works. The public has been brainwashed to believe that volatility is bad and mark-to-market losses are even worse. Hedge fund managers live and die by promising investors smooth returns. It’s the appearance of the investments they hold that drive behavior, not the reality of the value of the investments.

What’s really going on?

My best guess is that investors look at the account value and make plans for its uses. When they see the account balance go down they imagine all the uses quickly slipping out of reach. As a result, they liquidate holdings to try to stem the bleeding. This creates a virtuous cycle that forces prices lower and lower as more and more people sell more and more to avoid the nominal loss in their account.

The reality is that the underlying fundamentals of an investment haven’t changed nearly as much as the price volatility makes it seem. Assuming an investor isn’t chasing a bubble, and has realistic expectations of cyclical industries, the fundamental value of the holding is much less volatile than the price would indicate. Eventually enough investors figure this out and pile back in and bid up the now undervalued asset. This causes prices to climb back up and the whole process eventually repeats itself.

This is where someone who ignores price volatility can repeatedly make money using core position trading. Core position trading relies on reality instead of appearances to consistently grind out profits in volatile markets.

Savings vs Returns vs Trades

Signalee is ostensibly about core position trading. But there’s a second point that is important to make for anyone trying to build a $1 million trading account: adding a relatively small amount of money on a periodic basis to your account initially “compounds” the value of your account faster than the core position trading strategy we use.

Using simple math, if a trader starts with $1,000 and compounds the account by 5 percent per trade, then after 142 trades she’ll have $1 million. However, if the trader deposits $100 every two weeks into the account from a paycheck then that deposit is just as good as a successful trade.

The first $100 deposit will knock out 2 of the 142 trades needed to get to $1 million. Now, the number of trades that can be knocked out with a $100 deposit will get smaller and smaller as time passes and the account grows, because, you know, math. But at the end of the first year of a trader’s road to $1 million, even if she doesn’t make a dime from trading, she’ll have knocked out 26 of the 142 trades. By the end of Year 2 she’ll have knocked out another 11 trades and have 105 trades remaining with an account value of $6,200. Still a long ways to go until $1 million, but in 2 years she has reduced the number of trades needed to get to her goal by 26 percent. She’ll be a quarter of the way there.

Savings vs Returns vs Time

Building a large account balance is a function of savings, returns, and time. Increasing the amount of any of them has a fairly drastic impact on the final balance with a long enough time horizon. Consider the following scenarios:

Scenario #1:

  • $10,000 starting balance
  • $1,000 added annually
  • 6 percent return
  • $71,064 ending balance after 20 years

Scenario #2:

  • $10,000 starting balance
  • $1,000 added annually
  • 10 percent return
  • $130,278 ending balance after 20 years

Scenario #3:

  • $10,000 starting balance
  • $5,000 added annually
  • 4 percent return
  • $176,757 ending balance after 20 years

You’ll notice that Scenario #3 has the highest ending balance after 20 years even though it has the lowest annual return. It’s not until you get past 20 years that the 10 percent annual returns in Scenario #2 start to overcome the higher savings rate of Scenario #3.

What’s the point?

Of the three variables tweaked above, savings rate, returns, and time, which do you have the most control over?

South Korea (EWY)

The next core position trade for Signalee is the iShares South Korea ETF (EWY). It has about $4.2B of assets with an average trading spread of 0.01% and daily volume in excess of $200 million. So it’s easy to get into and out of. Furthermore, its price to earnings ratio is only 13x, it has a distribution yield just shy of 3 percent (so we get paid to wait for price to go up or down), and it primarily holds technology, financial, and consumer cyclical stocks.

Screenshot 2018-02-20 at 4.26.46 PM

The only downside is its 20 percent concentration in Samsung Electronics. Not a dealbreaker as Samsung is a global juggernaut with a diverse product set, but Signalee typically tries to avoid concentrated positions.

Screenshot 2018-02-20 at 4.31.06 PM.png

Core Position Trading
One of the main tenants of core position trading is to buy the dip (#BTFD). EWY, like the rest of the market, got caught up in the sharp selloff that occurred at the beginning of February. Since core position trading relies on volatility, this was a relief as markets that go straight up for long stretches of time are infuriating for us. As prices stabilized and returned to its prior uptrend, we’re starting a position under the assumption that it’ll continue to grind higher.

If we’re wrong and price drops down to $64, then depending on the economic backdrop and other fundamental trading factors, we’ll re-evaluate the core trading position and determine whether to add to EWY or sell it entirely. I realize this seems vague and unhelpful, but traders who rely purely on price stops for exits often miss out on profitable opportunities when they blindly sell.

Why is South Korea cheap?
The most obvious reason why South Korea is trading at a discounted valuation to peers is because of the constant threat of war from its neighbor to the north. Even ignoring the nuclear threat, a massed artillery barrage into the heart of Seoul is always a hair trigger away.

The less obvious reasons why South Korea trades at a discount is because of the conglomerate structure of many of its companies, the clubby nature of the families that own and run them, and all the corporate governance issues that go along with a clubby structure.

However, the reason this will likely be a good core position trade for Signalee is that South Korea is a profit-seeking culture with an Ease of Business rank of #4. Its business landscape is diversified and doesn’t rely on natural resource extraction. Lastly, the threat of war is overblown. The North Korean regime wants to survive and stay in power. If it attacks South Korea in such a way that threatens its total destruction then the US would be forced to respond in a way that eliminates the North Korean regime.

In the meantime, the threat of war creates volatility and depressed valuations, which is where we come in to grind out some profits.

XIV – A Friendly Reminder

This past Tuesday, February 6th, one of the hottest trades for the past two years, the so-called easy money trade, blew up in a most spectacular fashion. After peaking around $145 halfway through January, XIV started to slide until it closed at $99 by the end of the day on Monday, February 5th. The next morning it opened just above $10, fell some more, then was liquidated by Credit Suisse.

If you had initiated the position at the start of 2016, when XIV was trading around $20, then by February 6th you had only lost 75 percent of your position by the end of the day. If you had waited until halfway through 2017 to start playing, then you lost 95 percent.

Kid Dynamite has the best explanation of what happened if you’re curious. Cullen Roche at has the best quote from the XIV prospectus, which he notes that almost no one reads:

“The long term expected value of your ETNs is zero. If you hold your ETNs as a long term investment, it is likely that you will lose all or a substantial portion of your investment.”

The first thing that line in the prospectus tells you is that XIV is not a long-term investment to just buy and hold. It’s meant to be traded. However, even if you fully understood the product before you traded it there’s only three ways you could have protected yourself from the 90 percent gap down:

1. Buy OTM put options to limit losses. This isn’t a great option because the premium would severely eat into any trading gains to the point where generating positive expected value is questionable.

2. Position sizing: if you’re trading a derivative that has an asymmetric risk-return profile (e.g., the VIX was trading at sub-10 levels but could easily spike up to 30 or more, hence at least a 3 to 1 risk return profile), make sure the position size is small enough that the whole thing can go to zero without blowing up your account.

3. Don’t trade the derivative. Stick to trading assets that generate value by serving a widespread and reasonably useful purpose in society.

XIV is just the latest reminder of one of the truths of trading or investing: there are a lot of relatively easy ways to quickly make a little money but it is extremely hard to quickly make obscene amounts of money. When traders or investors try the latter, they often fail like XIV: in a most spectacular fashion.

Oh, Breakout!

Most of the ideas featured on Signalee are short-term mean reversion trades based on core position trading. For good reason: the opportunities happen fairly frequently throughout the year. However, every now and then markets go straight up without pulling back (like now!). If a trader only uses one strategy then they’re stuck on the sidelines while all their trader-friends make money. Worse, they have to listen to their colleague boast about how much money he’s making on the leftover bitcoin he bought three years ago to buy drugs online and then forgot about until just a month ago.

Commodities: the next major trend

Everywhere you look in the world today asset classes are hitting new highs, all the major economies are all growing, and hot money is chasing asset prices higher and higher. Only one asset class is late to the party: commodities. Commodities slumped in 2014 and fell like a stone through 2015 before bottoming and rebounding at the beginning of 2016.

The massive decline was sparked by the Saudi-led price war in energy. Their goal was to bankrupt as many shale oil drillers as possible in the US in an effort to cripple our domestic energy industry. The long-term thinking was that investors would hesitate to commit to marginal shale projects if they knew the Saudis would pump up supplies and depress prices to the point where the marginal projects were unprofitable. Since energy is a major component of the manufacture of industrial metals and a lot of agriculture inputs, the entire commodity space tanked.

The two limiting factors on the Saudis’ success was the need to finance their own socialist welfare state as well as improvements in US shale drilling technology that lowered the breakeven price point. Combine that with a global economy that is experiencing synchronized growth for the first time since the start of the 2007 financial crisis, and commodity prices are finally on a tear.

But is it sustainable?

The hard part about making macro bets is being right (thank you John Madden). It’s incredibly hard to identify the conditions, in real-time, that’ll lead to a big sustained price move in an asset’s price. So this is why we use core position trading.


The chart below shows DJP breaking out of its two-year base. I don’t know if the breakout will hold – that’s always the risk of any new trade.

But to mitigate that risk I’m using core position trading. By only risking a third of my total potential position size, then I mitigate the losses if the trade immediately moves against me. Additionally, with the remaining two-thirds of the position as dry powder I can trade around the inevitable short-term ups and downs.