Executive Summary
The Story So Far
Why This Matters
Who Thinks What?
Tom Basso, founder of enjoytheride.world and author of The All-Weather Trader, recently discussed strategies for mitigating market risks during volatile periods. Speaking on Investor’s Business Daily’s “Investing with IBD” podcast, Basso advocated for a dynamic approach that combines short-term and long-term trend analysis to adjust portfolio exposure and manage risk effectively.
Rethinking Risk Management
Basso challenged the common practice of defining risk as a predetermined percentage of a portfolio, describing it as “backward.” He argued that investors should instead use their existing positions and current market conditions to adjust for risk as their portfolio evolves.
His method involves daily measurement of a position’s risk against a preset level. By taking profits from holdings that exceed this level, traders can build a cash cushion and reduce their overall market exposure, thereby preventing significant losses during downturns.
Leveraging Donchian Indicators
A key component of Basso’s risk mitigation strategy involves the use of Donchian channels to identify market trends. These trend indicators, similar to Bollinger Bands, plot a stock chart’s highest and lowest prices over a specified period to form upper and lower bands. The middle line represents the average price over the same period.
Basso suggests combining a 21-day Donchian indicator with a three-day Donchian to assess market direction. When both short-term and long-term indicators trend upward, he advises investors to be fully invested, capitalizing on strong upward moves. Conversely, a strong downtrend is indicated when both indicators move downward, prompting investors to lock in profits.
In scenarios where a long-term trend is upward but a short-term, three-day trend turns downward, Basso noted that having corresponding long-term and short-term positions can effectively neutralize each other. This mixed signal, he explained, suggests a period for investors to remain patient as the market determines its next direction.
Key Takeaways
Basso’s framework emphasizes a proactive and adaptable approach to market risk management. By integrating dynamic risk limits and utilizing trend analysis tools such as Donchian channels, investors can navigate market fluctuations and protect their portfolios from excessive exposure.
