Thank goodness it was a busy day at work so I didn’t have time to stew on this unfortunate knee-capping when the FDA blindsided ALKS.
As this was a top PDS pick, the system performance will be significantly impacted. The 2% Risk, 10% Stop model was up about 17% year-to-date as of yesterday.
I have warned that even diligent usage of stops will never prevent the loss from a significant gap-down. I hate to have been holding long the stock that provides the example.
***Update*** Here is the research that resulted from this trade: Effect of the Pharma/Biotech Sector on a Dip-Buying System.
Yet another Biotech Explosive Arm Removal (BEAR) event, brought to you by Black Swan, Inc.
Maybe a snapback for a couple of points?
BEAR- that is a good one!
Yeah, I think it’ll get a bounce.
If it’s any consolation, it caught the rest of the street off guard, too.
Between the (impossible to automate) task of identifying conferences at which pivotal results are often released, as well as the (merely difficult to automate) task of linking securities to advisory committee panels and PDUFA decisions – events which have known dates but unknowable consequences – if I were building a system for trading, I’d exclude the entire sector from the screening universe.
If one was to attempt to automate some date-detection logic, I’d start by looking at implied volatility in options. The heuristic I’d look for would be either egregious IV (greater than historical volatility) in the front month, or lower IV in the front month, followed by markedly-higher IV in some future month: that is, the options market pricing in event risk and telling you when the hand grenade is scheduled to blow someone’s arms off.
Disclosure: Just call me stumpy. 🙂
Eq, thanks for your input, and sorry for your loss 😉
I like your idea of examining the IV for clues.
I think I could exclude biotechs from testing as long as they belonged to an index. I have considered that, but in the end did not because biotechs also provide some outstanding winners.
I will put it on the to-do list, to exclude all biotechs, and see how it would have affected past results.
The good news is that the system is showing ~10% gains YTD, even after today’s knee-capping.
Sorry it happened to you, Wood.
Best —
Thanks. Its all part of the game. As I’m sure Fly knows, its worse when there are other people involved and you feel a measure of responsibility.
Happens to the best of us. All of us if we’re using proper risk management. So we live to trade another day.
So all ya have to do, is like they do in Olympic judging of ice skaters; toss out your best & worst …. voila, er I mean presto! .. the pain of ALKS is not relevant to your market beating system.
lol…that is the solution!
Actually, some system developers do this very thing to handicap a system…except they may throw out the 3 best and keep the 3 worst…
So sorry to hear this….. I find these biotech stocks are pretty much all grenades waiting to explode. Some will, some won’t, but do you dare pick it up?
Thanks Marshall.
I intend to keep picking them up. However, I am going to see what happens if I exclude them from trading. Maybe a good thing? We won’t know until I try.
Everyone has those http://chzgifs.files.wordpress.com/2010/10/womenbeshoppingp1.gif moments! Makes life all the more interesting I say. Hat off to you for highlighting a trade that has gone wayward. Your honesty is all too rare in this industry.
Respect
Derry
You’ve probably done a study on this(?), but I’ll ask anyway…what kind of returns would the PDS produce for just a daytrade (buy: at the open, sell: at the close) and using the 1-2% risk and 1-3 ATR stops? Just curious. Thx Woodshedder!
I try to avoid pharma stocks when any advisory panel decision looms. They are just too unpredictable. The possible upside doesn’t outweigh the potential downside, at least mentally for me. My pullback system got into ARNA a few weeks back, took a 50% hit. It also triggered ALXA, which I bought then sold before my exit signal hit just because a FDA decision came out the next day. That dropped 50% too. It seems that avoiding these stocks will smooth out portfolio volatility over the long term.
One time in the mid-late1990’s, I bought a bunch of Gemstar (of VCR plus fame) at around $70 a share. Less than 30 minutes later, in mid-day no less!, they came out with real bad news and the stock dropped 10-20%.
Sometimes the tickets of admission to this activity we call financial trading are quite expensive.
On the other side of the ledger…I’m rarely short, but I had a number of short positions the day of 9/11. Hate to make it that way, but…..helps make up for the blindsided losses
Sorry, but it should never be a surprise when this happens in biotech. You have to expect a gap one way or the other (probably down) about once a quarter.
Jason, I looked into this issue…in depth. It is more complicated (and easy) than you might expect.
http://ibankcoin.com/woodshedderblog/2010/10/24/effect-of-the-pharmabiotech-sector-on-a-dip-buying-system/
Didn’t see that you looked at this with your specific system, and my observation was more anecdotal. I guess the short trade length and the nature of the entry criteria mitigate this risk somewhat. I still wouldn’t want to explain to an investor why we had losses in a system because of an FDA decision. Sometimes with negative skew systems, I discount the historicals.
How would you explain to an investor that a loss was due to a decision by the Federal Reserve? By a flash crash?
The difference is that the investor will have the intuition that many of us had, that the blowup was avoidable, regardless of what the historicals showed.
Take another example: you have a fund that just trades RSI2. This fund did well in the 2008 crisis, but in the next market crash, it blows up. Your investor says, I don’t care what the historicals were, you were buying weakness, what did you expect? Now I guess you could make that sort of argument about a lot of systems, but the idiosyncrasy of the markets gets me extra nervous here.