Technical Analysis, Condor Options and the Lessons of 2007-09

If you do not have Condor Options on your reading list, then you are missing out on what I consider to be perhaps the most deftly written and intelligently reasoned investment blog out there. To top it off, the topics are timely, there is a liberal sprinkling of wry humor, and if you have a dictionary handy, you can usually increase your vocabulary too.

Don’t take my word for it though. Check out today’s Technical Analysis Fails to Give You a Pony and see for yourself. In what may be my favorite post of the year so far, Condor Options, provides a sharp counterpoint to Michael Tsang and Eric Martin, whose Stock Charts Fail Forecast Test in Complete S&P Miss argues that technical analysis strategies failed investors from the October 2007 peak to the March 2009 decline. The Condor critique includes a discussion of indicator selection and time frame selection. It also notes that each of eight indicators did beat S&P 500 during evaluation period.

Well done, my avian friends.

But before this starts to sound like an infomercial, I want to hop onto a tangential thought that I have been ruminating about for the last few months: what lessons should we take away from the 2007-09 bear market?

Now I know the issue of learning lessons from the recent bear market is a big subject and I have no intention of taking more than a first pass at it this time around, but since I haven’t seen it discussed at any length elsewhere, today seems like a good day to dive in.

First, consider the possibility that there are no lessons to learn from the last year or so. While this may sound heretical at first blush, it is certainly possible that the confluence of events that put the financial system and the markets in peril over the course of the last year will not be repeated during the course of my trading lifetime and perhaps yours as well. This may be a little naïve, but consider that it was 21 years between VIX spikes over 80 and more than 70 years since we have seen a bear market as aggressive as the recent one.

Another way to think about the recent bear market is to consider an analogy to an N-year flood. In preparing for an N-year flood, it may be desirable to build a dam and levee system that is capable of containing an N-year flood. On the other hand, it may make more sense to construct a system that is designed to withstand only a fraction of an N-year flood and to focus more resources on an optimal evacuation plan and communication system.

Switching metaphors, think of the big wave surfer who is comfortable riding 20 and 30 foot winter swells and might consider hopping on a 50 footer at Maverick’s if he or she thought it might win the competition. At some point, however, the waves become too big and dangerous to try to ride. At some point, we are all better off being spectators.

By the same token, it is certainly acceptable to have a trading system that reverts to all cash when certain events hit a global exit trigger. These might includes triggers such as a 20% peak to trough drawdown in the SPX, a close of greater than 50 in the VIX, the loss of 25% or more in one’s account equity, etc.

I do think there are important lessons to learn from the recent bear market, but I think the first thing most investors should consider is that they only need to play the game when the odds are in their favor.

I will have a lot more on this subject in future posts.