I hope everybody had a fantastic Thanksgiving!  I live in Asia so no turkey dinner for me unfortunately, but I did bake myself a pumpkin pie which I then promptly destroyed by myself in a single sitting so that was good.

In Wednesdays article I talked about that massive volatility spike on Black Monday October 19th, 1987 and highlighted some arguments for and against for whether it could repeat in the future.  If you missed it it’s here.  Bottom line is we don’t know, so as the old saying goes hope for the best but prepare for the worst.

The follow up question in that article was:  What can we do to protect ourselves going forward?  Here’s a short list:

1)  Constant portfolio rebalancing.  This one definitely deserves it’s own stand alone explanation so allow me to skip it for today and circle back with more detail in the future.


2)  Proper position sizing.  The truth is this one applies to all investors and all styles of investing.  There is no better first line of defense against portfolio drawdowns than simply allocating conservatively to anything that is considered risky or has in the past displayed major drawdowns.

As an example, equities.  The S&P 500 has suffered a 57% drawdown just in the last decade, and on that famous Black Monday crash the Dow dropped 22.6% in a single day.  Obviously equities have some inherent risks, so allocating conservatively to them would be advisable.

Investing in Volatility, whether that is through volatility ETPs or option trading, it also comes with some risk that needs to be taken into account.

The XIV for example saw a 74% drawdown in 2011, a 67% drawdown in 2015, and a 47% drawdown in 2014 and those are all within the context of a bull market.  It does happen and more importantly it will happen again.

It’s always important to remember that these are inherently risky products and the best first line of defense is proper position sizing.  I look at it this way:

–  If you allocate small to volatility investing and it continues to produce stellar long term performance you’ll benefit from it.

–  If you allocate small but the volatility markets fundamentally change and it stops producing, your allocation won’t be large enough to significantly derail your long term retirement plans.


3)  Diversify across multiple strategies.  The don’t put all your eggs in one basket saying applies perfectly to investing.  I can’t overstate how much safer a diversified portfolio is compared to one that over allocates to particular areas.

I know it can be tempting to chase performance of recent high flyers, but that herd mentality and the feeling of “missing out” is what causes most investors to buy high and sell low.

Investors who have a multi year mindset and diversify their portfolio over multiple strategies and multiple asset classes will be more insulated against surprises.  And despite some people or fund managers out there thinking they know what’s going to happen tomorrow, nobody does so surprises are part of investing.  Diversifying reduces their impact substantially.


4)  Conservative investing.  While it’s true that different asset classes do have different risk profiles, I always favor trading more conservatively within each category.

As an example, there are ways to trade equities aggressively and there are ways to trade them conservatively.  I always favor the conservative side.  Our VTS Tactical Balanced Strategy is our “equity” strategy, but it actually only trades equities 50% of the time.  Anytime there is ambiguity we move to safety positions to avoid extended drawdowns.

It’s not lack of gains in good times that derails investors, it’s big losses during bad times that does it.

For volatility investing there’s plenty of ways to get aggressive and chase outsized gains and in fact most people do just that.  No different than they do in forex trading or options and futures trading, but it’s amazing how consistent the pattern is in the long-run.  Aggressive traders do very well when things cooperate, then the markets have a funny way of taking it all back when the opposite is true.

It is my belief, and hopefully my long term track record proves it, that always remaining on the conservative side will have the best multi year performance.  Not always the best 1 year performance, but surely better 10 year performance.


5)  Plenty of cash positions.  It’s such a shame that cash is so under utilized by investors and fund managers.  I view cash as an active portfolio position.  It’s not something we hold because we don’t know what to buy. 

We hold cash when on balance of probabilities and taking into account all past historical data, cash may outperform other alternatives.
If the odds favor an allocation then of course we take it.  When they don’t though, we don’t take positions simply because we feel we have to utilize the cash in our portfolio.  That’s something that the financial industry does because the pay structure and survivability of a manager depends on keeping people allocated.


We don’t have to do that though.  We are nimble and free from all restrictions and norms and have the ability to only take the high probability trades.

That doesn’t always mean we’re right in the short-run.  Sometimes only taking the high probability trades and being in cash for all the rest makes us look unnecessarily conservative  (cough… 2017)  but in the long-run I have absolute confidence it’s the best way to navigate these unruly markets.

Constant rebalancing, position sizing, diversification, remaining conservative, and treating cash as an active portfolio position.

 All great ways to protect against the inevitability of future market declines.


Current VTS Total Portfolio Solution Allocations

25% VTS Tactical Volatility Strategy

50% VTS Tactical Balanced Strategy

25% VTS Iron Condor Strategy

VTS Conservative Vol Strategy  –  Optional replacement for lower risk tolerance investors


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