THE 4 PILLARS OF INVESTING Risk Management: Module 4 · bark is worse than its bite. We can buy the CTF and have actually make money the down market by going long, the dog, instead

Risk Management: Module 4THE 4 PILLARS OF INVESTING

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The 4 Pillars of Investing | Risk Management : Module 4

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Ok this is a big deal and this is really cool. Some people don’t think about it a lot. This is called correlating assets, non-correlating assets right? Inverse correlation on the assets and correlation just means how they correlate, they kind of run together and lock step. I had a guy send me an email, a good, good guy, student, brand new though and he just wanted to ask technical analysis questions on his, you know on his mutual funds that he had and so he sent me a list of these mutual funds that he had.

And so he sent me a list of you know these mutual funds just to look at charts you know I can’t give financial advice so I don’t but you know look in at his charts and you know within myself I kind of mused and thought this is all the same, here he’s got all these mutual funds. S&P is down about 9.6 on the year right now at this taping. His fund was down 9.7 and, and I think 8.9 so you know just basically, you know as I went through them, there the same, the same stuff.

Well, think about it. You know, we might go in and here’s the problem with that, maybe we go in to do some straights here and here I have the SPX and I want to do a you know bow point credit spread which means I’m going to get paid two hundred dollars to take this trade and bow means I want it to go up of course right and I’m going to get credit for the spread. Now, notice that, let’s just do the trade quick. I buy one well let’s first do the income, I sell one September 1165 strike put which simply means you know I have an obligation now to those guys to let them sell me this index.

Now this is European cash settled index but you get it I’m going to get some income here from this baby right here. Now, also right here were going to buy, and this isn’t a trade I would do it’s just one I threw up for an example, I didn’t have time to research a really good one but for risk management, for correlation it really doesn’t matter so don’t go out and think that these are great trades because this is not a good trade right here ok this is not one that I would like, so especially in this market because it’s got a you know kind of volatile and had a dent but let’s just manage the risk.

RISK MANAGEMENTMODULE 1 2

A transcription of

The 4 Pillars of Investing

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So, we’re going to sell this put for income ok and we’re going to make fifty, forty bucks then what we’re going to do is we’re going to buy some protection down here at the 1160 level put so that means that if this guy wants to sell it to us at 1165 were going to be able to sell it for some other guy at 1160 right and so my risk on this is 292. Now, why not 500? Well because I’m earning some money on this spread right here right. I’m getting a credit of $210 here if you see the difference between 38 and 40.70 is $2.10 times 100 shares per contract which means I’m going to get $210 here ok.

So that’s 210, you take that 210 500 oh my gosh look at that right on the 290. So the most I can lose on this trade is 290 and the most I can make on this trade is 200. Obviously I want it to go up hence bow put credit. Obviously I make $210 credit between these two. I receive 470. I’m paying out 360 for the insurance but I want you to understand two things. Number one I’m buying, I’m buying this for insurance so if this goes down and down, down there’s a limit to what I can lose ok. But here’s. Here’s your thing. Let’s say I do the same thing with the Russell 2000 ok. RUT. And I load that one up. Same trade, we’ll do a bow put credit spread. Same thing here right. I’m making money.

Once it drops 680 I start losing money lose, lose, lose and it caps here. Let’s say I do it on the, on the NASDAQ you know the Q’s let’s do it on the exchange. Traded funds. Kind of an ugly one here but same idea though. Down we lose, up we win. It’s just, it’s just how it goes here. So it doesn’t matter whether I’m doing you know any of these it’s all correlated, all correlated. If I could type it would work even better. Ok so let’s get that in there. Go ahead. Ok so check this out right here. Let’s go back to this right here. Well I could lose no matter which one I do there lockstep. If I do all four of them and I’ve seen guys do this they’ll do you know iron condors or spread trades like that.

They’ll do one in the Russell, one in the NASDAQ, one in the SP and I’ve done it as well. I can understand where you do some for different premiums and different times but the fact of the matter is if the thing drops this is dropping too. And and they’re all correlated together. If the market drops you’re exposed. So what a person might do is do some non-correlating assets. Now notice this right here. If you’re in the S&P and you drop like 15% here your doubling on your VXX. Well this is called the VXX. This is something that I use from time to time. You want to be careful of this because it will lose money over time because of how its set up which is important to know.

But let’s just get rid of this here and let’s bring up you know the VXX here. This is the VX the actual index. And then this is its ETF right here. And this is the S&P 100. Notice the inverse correlation. When this is down, this is up. When this is up, this is down. Well when the market fell apart here I actually had some of this, I was in a trade in the SPX right here that I put on right here expecting it to sidewise figuring they get the debt ceiling thing figured out you know I knew they would buckle.

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What I didn’t think was S&P would really downgrade its share. I thought they would wait a little longer before it got a little uglier.

So when this fell I’m losing money here but luckily what I’ve done is since this got closer and closer and the news on the S&P down grade being possibly bigger and you know I thought I’m going to buy some of this just in case. So when this drops you know in this particular trade I lost like 1200 bucks. You know and I’m not mad you know it’s just one trade but this one right here it sored.

And I made thousands of dollars on this one. Look at this. This one went from an index of 20 to 45. So this again falls twenty percent this doubles. So check this out. Let’s go to the risk graph again. Get rid of this. Don’t want to confuse anybody.

And let’s go to the SPY. And this is not the trade I had mine was more complex but I don’t want to take the time to build it right now. You still get the principle and that’s all we’re teaching. And let’s go with a you know bowl point credit spread were we get credit and again we see, let’s get rid of that baby, we see that if this goes down we lose. Well I can have two layers of protection here two layers of hedge. Number one I again I sell this one for income. I buy this one for protection. So the put I buy puts a line in the sand here were I can’t lose any more so again I buy notice the point at 1160 1160 put. Right. The most I can make is 1165 so everything above here is the same.

So it looks like I’ve got a profit potential here at 2.10. Right. I can drop it down here it moves up to 2.90 and that makes sense because I receive 2.10 five, five dollar per spread here times a hundred five a hundred dollars, so great. But I don’t want to lose this 2.90. So if this falls I’ve got and you know if if this falls I decide to exit the trade right here you know I’ve lost 98 bucks, if I exit I’ve lost 178. So look. I can go out and buy some of that VXX if I want to. Right. And this explodes in value if this one goes down whatsoever. And what’s nice is is this will deteriorate over time because of how its set up but in the short term if I see turbulence it explodes in value man so maybe I buy a little of it.

If this stays high great I get to sell it close to what I bought if for. Maybe I write a covered call and maybe get paid. Right. Get paid for buying my insurance or for holding my insurance. Maybe I even write a put to me you know if I have enough time but the point is this explodes in value just like an insurance policy. And that’s what we’re talking about right. We’re talking about hedging, talking about managing risk. So these are non-correlating. These are inverse correlating. Speaking of inverse correlation. Check this out. Here you got the Dow Jones Industrial Average. You don’t want to go short. Fine. Buy its inverse ETF. Inverse correlation.

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Notice these are exact mirrors of each other. Aren’t they? And so how sweet is that. This is the Dow Jones Industrial Average. DIA. They call it the diamonds for short. This is hilarious. They name its inverse the dog. So when the markets acting like an old dog howling away, barking. Hey its bark is worse than its bite. We can buy the CTF and have actually make money the down market by going long, the dog, instead of going short. This over here is the IYF. It’s the a financials. And this is really cool called the FIZ and this is three times leverage so now again notice the hedging potential. A couple things we can do here to hedge.

Let’s say you’re in the financials ok and it’s stinking for you. What could you do? Well you’re in this at fifty dollars well a thousand shares, that’s fifty grand. You want to, you want to waste fifty grand? What do you do? Look at this. This falls like 3 bucks from maybe 49 to 46 right, we’ll call it 49 to 46 falls 3 bucks. 3 dollars down here. Look at this 12 dollars up here. 51:63. So this is 3:1 leverage. If it falls 4 dollars here it will rise 12 dollars here which means you buy less of this to hedge this or better yet if you’re nervous and you know something coming up that’s kind of scary or a wacky announcement or whatever by a call. Cheat. Buy a call.

It’s leveraged. Right. Three times. Buy a little cheat call. If this, if this a tanks this goes to the roof and you have leverage on their call. So again you know I don’t care that you understand these individual trades. That’s not what this is for. What I care about is that you just kind of get the idea so yeah hey you know what I can use these options to manage risk. Options are largely inexpensive. They don’t cost thousands of dollars. You know a few hundred bucks you can really hedge something like that. So you’ve got correlating, non-correlating, inverse correlating. And I do non-correlating all the time. Check this out. Here you’ve got some non-correlating assets. Right. You’ve got SLB for example.

Maybe what I want to do is this. Maybe I want to do one of these trades on SLB. Right. And so I go here and and get rid of this and fix and get rid of this VSL and I just got SLV. And I say hey I think it’s going higher. I want to get paid right here. I want to make this you know 48 bucks. I want to you know make this $50 risk 1:1 on this and if it goes down I start losing. If this is my breakeven point you know at zero. If it goes below 40, 50 I’m really in trouble. So you know what do I want? Maybe I want to hedge that. Right? But here’s what’s cool. If the Dow goes down, this can still win. That’s what’s really cool. Is I can be in this one but if the Dow goes down it doesn’t pull this down. Why?

Cause it’s non-correlated. See if we look at the chart and the Dow or the S&P drops this still can rock and roll. Look at the 3 or 4 weeks here. You know look at the 3 or 4 weeks here. This is going up while this is going down. Right. Another thing is look here’s the US dollar. Ok. Actually it’s the inverse of the US dollar. So while this Dow Jones tanks you know maybe the dollar you know sometimes it tanks sometimes it doesn’t. Usually when this tanks the dollar gets stronger. So I

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can go a dollar or I can go with this inverse of the dollar. Or I’ve got commodities. Again the Dows going down and this is the dollars kind of flat but the corn is going up. And so I can have a trade like this, I’ll show you.

I could build a trade on every one of these. I could build one on the S&P that looks like this. I could build one on corn that looks like this. I can build one on the dollar that looks like this. I can build one on and I could have the same cash flow on time decay right cause that’s all this is letting these these options have the same cash flow and time decay. But if I had all of my time decay correlating the underlying of one I’m getting crushed on all of them. Here the time decay gives me a better chance of having only one or two drop. And I can hedge those as well. But you get the idea of what the risk management correlating, non-correlating.

Very cool concept. We’ll learn more about it as you get further along. Position sizing. Casinos are smart. Don’t you think? I mean, you know all these kids say I want to go in there and the dad says look at the size of those building. They must know what they are doing. They get a lot of money. So you’re in black jack. You know the thing they do is is there’s a couple things that they’ve got to watch out for. Number one. What if someone comes in there with serious cash. He’s a gambler, he loves to gamble. You know drops millions of dollars down there, gets one lucky thing and walks out. Gets one lucky hand and walks out. Wipes out there whole week. Wipes out there whole week.

You can’t have the high roller coming in, dropping big time cash on one spin of the wheel get a thrill and walking out with a million bucks. Two million bucks. Can’t have that if you’re a casino. You’ve got to put a limit on what they do. Make them spread it out. Make them spread it out with smaller bets over time where your numbers can work for you more and more and more. Right. Put a table limit on it. Make them spread it out. Another problem that casinos have is this: doubling down. If you go in and you bet, let’s say five dollars and you lose. Well maybe you put down ten next time and if you win you get your five back plus more. Oh ok.

You lose that, and now you’re down fifteen. Great. Bet thirty and if you win you get it back plus more right. You just keep doubling down and you can go one hundred dollars, two hundred dollars, five hundred dollars, one thousand dollars, ten thousand dollars. As long as you keep betting bigger and bigger each time, sooner or later you’re going to win and get all the money you lost back plus more. Well they got to put a stop to that so they put a table limit on their which means ok we’ll let you go from five to ten, ten to twenty, twenty to thirty, or twenty to forty, forty to eighty but were not going to let you go past one hundred.

That way when the casino gets on their little run which they do and they win five hands in a row and cleans the guy out huge, the best thing that ever happens to a casino when a guy, when a

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casino sees a guy doubling down they know they’re going to get rich. They’re going to get rich huge. Why? They put a limit on how much they could lose in each hand. Why don’t we do the same with each trade? Why don’t we put a limit? Look check roulette out. Roulette has two basic things that we can look and see and make it work. They’re more than win loss percentage. They’re going to win more than they lose. Bet on 18, you’ve got twenty chances to lose.

If you bet on black. Bet on red you’ve got twenty chances to lose you bet on red you bet on green you can beat the odds thirty six chance to lose. Yeah so they’re going to win more then they’ll lose. Yeah they’ll win some but they’ll win more than they lose. Combine that with a table limit you know a hundred bucks, five hundred bucks whatever it is. If the table limit is five hundred the minimum bet is going to be one hundred. If the table limit you know they’ll just mess with those numbers man it gives them an advantage and that means earnings. We can do that. Yeah we’re not casinos but we can do it. How do we get our win loss percentage increased? Fundamental technical analysis.

Let’s learn charts. Let’s see what’s most likely. Let’s learn the ascending triangle double bottom you know. Cup and handle. Stuff like that. Let’s find trades that are high probability likely trades. Let’s trade with the trade with the trends. Let’s trade with good fundamentals and then let’s get ourselves a tolerance of position size. Now this is just an example. I can’t give financial advice and 1% is just arbitrary here’s my 2% might be a half percent. But let’s just look at this. Let’s draw some numbers on the screen shall we. Ok let’s look at one side here. Let’s say you’ve got an account, let’s put it in blue, let’s say you’ve got an account of a hundred grand. Ok. That’s your account. You’ve got a hundred thousand dollar account.

And you decide that your risk tolerance is 1% which means the most you’re going to be able to risk in a trade as far as stop loss is concerned is going to be a thousand bucks. Ok. So let’s look at the down side first. Let’s say that we’ve got an entry at 39 and an exit at 37. So that means you could lose 2 dollars in this trade. We’ll if the most you could lose is one trade is a thousand then let’s put our position size at 500 shares that way if we lose 2 dollars on 500 shares we’ve only lost what? A thousand dollars.

And so now I know that that matches my tolerance which means the most I can do and I don’t have to do 500 but the most I can do in my account is 500 shares because if it doesn’t work out I’m going to lose a thousand dollars. That’s going to leave me what? That’s going to leave me an account that has ninety nine thousand dollars in it minus commissions right. Which is pretty close to what I had in the first place and I can go out and trade another day. Now ok so when I lose my account looks like this. Here’s the thing, check this out. Let’s go to green. Let’s say that I hit my target.

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That means I’m going to make six dollars and how much was my position size? 500 bucks. Right. And so that’s going to be three grand. I do believe right three grand because $6 times $500 going to be $3,000 so my account will look like or your account will look like 103 grand. Right. And so, this is survival this is happiness. You do this one ten different ones. Non-correlated. See if I do this one ten that are correlated then there all going to lose. This works better when you have good fundamentals, good technicals, and your non-correlated. Very cool stuff. Don’t you think? I think this is cool stuff.

That way if your non-correlated and we have good fundamentals and good technical we get more of this then we get over here like this so very cool stuff to begin the study. Of course if I didn’t have all this stuff on the screen you know what let’s just get rid of it all. There we go. Ok. So it’s non-correlated. Correlated and position sizing. Very cool. Ok. So this is our risk management tool box. Are there others? Oh man. Delta hedging. It just sounds cool. Does it sound complex? Yeah. Is it? A little bit. But nothing you can’t learn. Delta neutral or neutral delta, delta neutral trading rebalancing it every day using your delta, very cool stuff.

You know at this point I hope after you’ve had a little trust in some of the things we teach. Got to get our education. Got to get our education. Learn it. Delta hedging. Awesome. Let’s talk about education. The traditional thought and there’s truth to this don’t get me wrong is that you know here you’ve got your cash. You know your treasuries. Here you’ve got your in fact treasuries probably more conservative than cash because it at least gets something that’s supposedly guaranteed so cross cash out. Here you’ve got your treasuries. Here you’ve got your mutual funds. Here you’ve got your stock. Here you’ve got your option.

Here you’ve got your Forex market. And they’re saying hey in order to get these big leverage rewards you know I got to be way up here on the risk scale. That’s what they think. But like I say it’s not the vehicle man. Who’s flying, who’s flying the plane? Who’s trading the Forex? There’s some people that don’t know what systemic risk is trading mutual funds. Other people know all the risk trade in Forex. These guys will probably have a greater chance at getting home on their, on their trades than these guys will. They’re getting more reward but they have less risk cause they know how to hedge. They know how to do it.

So very very important to know that ignorance does play a role in this in my opinion. Plays a big role in it in my opinion. The more education we get I think we can manage that risk effectively. That’s just my view and I I you know you can agree or disagree. But I love education. I hope you know I love teaching these. This is fun. I’ve enjoyed it tremendously. So education. That’s your big one. Holy cow. Congratulations. You are now no longer, no longer ignorant. No. We’re just going to

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cross this whole thing out right now. You are aware and now you get to move to competent. Let me tell you a little bit about some of this advanced stuff if you have an interest you can contact me.

You know I’m thinking of doing a class just on education and just say hey. You know here is how this works. So if you have an interest in that email me and I’ll build a little class like this that shows people. This is more involved. I’ll tell you that right now. They’re there’s a higher tuition. Is it worth it? Yes. And most of these classes are taught by the people who have taught me that I can hook you up with. I have people that teach them for us. Great alliances. Great stuff. But these are taught live. You know this stuff this stuff here we can do with these recordings ok. This stuff here we’ve got to have a little Q&A don’t you think.

You’ve got to have a little interaction. Is that right. And these advance classes they go about six weeks and they’re held all over the United States. They’re held online. You can do it online. Or do it live and we have stuff we can get together for stuff like this we can hook you up with mentors and market labs. It’s time we have to do this stuff live cause you know it’s it’s really where you get specifics in the training so if you have an interest in doing stuff like that and if you say hey is it more expensive? Yeah, it is. And is it worth it?

Yeah, it is. It’s less than going to college and stuff like that but you know hopefully in these four basic classes you’ve got a taste for what can be done a little bit more aware of some of the strategies. Now it’s time to get these strategies down pat and get to proficiencies so you know if you have an interest in some of this stuff go ahead and email me. I can set you up with kind of we can do a little consultation. We can see where you’re at. You know maybe you’ve got a little money behind you, you want to make it grow or preserve it. Learn a little bit more so you can talk to your broker better.

Maybe you’re starting out at square one it doesn’t matter we can get you a consultation and help you with whatever your education needs are, your budget, your goals, whatever you need. So hope you enjoy how we do the training. I certainly enjoy it and we’ll look forward to speaking with you live next time. Get to know you even better in phase two competence. Phase three proficiency. Look for some great return on investment with your education. Awesome stuff. Congratulations. You have just completed basic risk management. Hey way to go. I had a lot of fun. Have a good one.

END OF RISK MANAGEMENT – MODULE 4

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THE 4 PILLARS OF INVESTING Risk Management: Module 4 · bark is worse than its bite. We can buy the CTF and have actually make money the down market by going long, the dog, instead