Trading a Black Swan
Shortly after the close on Monday, the Brazilian Government announced they would be taxing certain stock and bond transactions. This is the first time a major country with an underlying ETF has done something like this. It was a Black Swan event.
Yesterday EWZ dropped sharply as you would expect. By the end of the day the decline was approximately 3% and depending upon the type of overbought and oversold indicators you use, you potentially had a buy signal triggering on the close.
So what do you do? Do you take the signal, knowing that in the historical back testing, this event has never occurred before? Or do you pass, knowing that there is no precedence to model from and therefore you step aside.
Unfortunately, there is no perfect answer and I know successful traders who would take the trade and others who would not.
Those who would take the trade simply are trading a model that says “see the trade, take the trade”, no matter what. They look at EWZ being oversold above the 200-day and they’d either buy it fully or start scaling-in.
Those who would not take the trade have a rule in place that states that whenever an event occurs that is outside the realms of the model, they override the model and pass on the trade. This is what some of the better traders I know did last October before the market plunged. They were getting readings on the market that they had never seen before. We were in uncharted territory and they thought it was smarter to stand aside and let things play themselves out for a short period of time (they were correct in this situation).
Ultimately this trading decision comes down to yourself. Decide ahead of time whether you will take all the trades that trigger no matter what happens in the world. Or decide ahead of time that when a Black Swan appears, like it did Monday afternoon, you’ll override your model and step aside, and focus on the many other signals that occur that that are within the realms of normal trading. In my opinion this is a personal decision based upon your risk tolerance. They main key is to be consistent in your decision making.
Special Note – I’ll be holding a special one-day seminar at the end of the month teaching how to systematically trade ETFs both on a short-term basis and on a day-trading basis. All the strategies taught are backed by historical test results and include the same strategies used by the Daily Battle Plan Model Portfolio. If you’d like to attend a free presentation on the seminar, please click here for details.
Larry Connors is CEO and Founder of TradingMarkets.com and Connors Research.