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Trading Strategies, Sizing & Risk Management During Bear Markets | Simon Ree

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QUESTION 1: Are we in a bear market rally? What is your outlook for next year?

So let's jump into it. The market reached a short-term bottom in mid-October and the S&P 500 has rallied more than 15% since then.

Do you believe that we are experiencing a bear market rally or not?

And what is your outlook for next year?


- data suggest that we are in a bear market rally and probably at the latter stage of it.

- the outlook for next year is not full of optimism. Looking at the housing market, and the deeply inverted yield curve, we might assume that a hard recession is coming.

- the next decade could look similar to the 1970s with high economic volatility which increases market volatility


I think all of the indications are this is a bear market rally rather than a resumption of a new bull market. There are a bunch of, I guess, signals that we can take into account.

Things like the inversion of nearly all of the yield curves.The 2-10 yield curve has been inverted for a while. I think every yield curve from basically the Fed funds rate up to ten years is now inverted.

And that has been a pretty strong sell for recessions over the last 50 odd years.

Look at things like the housing market in the US is really starting to show some cracks. That's often a good forewarning of recession.

A number of data suggest that next year is not going to be a year full of strong growth and optimism. That said, markets never move in one direction all the time.

And I think what we're in at the moment is a bear market rally.

Probably the latter stages of that bear market rally, in my opinion.

And I think, I'm not suggesting the market is going to crash or anything like that, but I think we could see the next decade looking someone somewhat like what we saw in the 70s with a lot of economic volatility leading to a lot of financial market volatility.

QUESTION 2: Macro VS Price & Momentum

Something I have heard you saying in previous interviews is that while macro is important because it tells you in which direction the wind is blowing, ultimately you base your trade decisions on price action. Why is that?


- macro doesn't inform my trading decisions, price and momentum do.

- macro is really hard, but fortunately, it's not crucial to make money in the markets

- macro is useful because it tells you in which direction the wind is blowing


I follow macro. It just doesn't inform my trading decisions. I think macro is useful because it tells you which way the wind is blowing. But macro is really hard.

I mean, there are really, really smart guys out there, guys like Stanley Druckenmiller who are forecasting a decade of high inflation and high economic volatility. And that is a scenario that I feel a high degree of sympathy with.

But there are equally smart guys out there worried about deflation, all right? And trying to get this right. Is it inflation? Is it deflation?

I mean, that's just one example of a macro argument that is, as far as I'm concerned, it's above my pay grade. Trying to get those big questions right today. Not only is it really difficult, it's actually not necessary if you're looking to make money in the market.

So there's the age-old saying, do you want to be right or do you want to make money?

I'm in the markets to make money. And from that perspective, price and momentum really tell me everything I need to know.

QUESTION 3: Trend following

Now, talking about trend following, in your book The Tao of Trading, you explain the importance of trend following.

Why is it important to follow the trend? And how can traders learn to recognize a trend?


- if you are following a trend you have the wind at your back.

- trends are the path of least resistance.

- trends tend to last more than people think.

- Using the 21 EMA can help spot short-term trends

- Using the 50 SMA can help find points of support and resistance

- Using the 200 SMA can help find important points of support and resistance & determining the long-term trend


Trend following makes trading somewhat easy, because if you're following the trend, you've got the wind at your back. You're following the path of least resistance. And identifying a strong trend is useful because trends tend to have persistency. They tend to go on longer than people think possible a lot of the time.

Now, that's not to say that trends go on forever. We know they don't. And the old saying, the trend is your friend until it ends.

But I've found that over the years, following a trend does put the odds in your favor, and it's the easiest way of putting the odds in your favor. And it's really simple to do. I mean, if you just use some simple moving averages. My favorite ones are, if I was to put three moving averages on my chart, I'd put the 21 exponential moving average, the 50 simple and the 200 simple.

The 21 exponential moving average tells you the direction of the short term trend, and the 50 and the 200 give you some pretty good potential levels of support and resistance as well as identifying the longer term trend.

QUESTION 4: S&P 500 in a bear market?

Absolutely. And for example, if we look at the S&P 500 and its 200-day simple moving average, it tells us that we are in a bear market.

Would you agree with that or not?


- yes, the market is currently in a bear market as it's under the 200-day SMA line.

- when the market is below the 200-day SMA, volatility increases and counter-trend moves tend to be more violent

- during bull markets, counter-trend moves could be ignored, as they are milder.


Yeah, When a market is trading above its 200-day moving average, it tends to be a happy board by every kind of a market. And they tend to be slower, a bit more ponderous, and certainly easier to trade.

When a market crosses below the 200-day moving average, it's almost as if it's taken a bottle of serum or something. The personality changes, becomes a lot more volatile, and intraday moves become much bigger. In fact, so do the countertrend moves.

When you're in a bull market, you can pretty much ignore countertrend moves. The pullbacks. You don't have to trade them. You can just wait for them to finish and then buy the dip.

In a bear market, or when prices are below the 200-day moving average, you can't ignore those countertrend rallies because they can be significant.

QUESTION 5: Going long during bear market rallies

And in that case, do you go long doing bear market rallies, or do you just close your short positions and wait it out?


- during bear market rallies you can't hold onto the short positions

- learning to play both long and short during bear markets is crucial


No, I trade both sides. The first thing you can't do, you can't just hold on to short positions during a bear market rally, or at least I can't with my risk tolerance. It's just too painful.

If you look at what happened during the tech wreck in 2000 to 2002, the Nasdaq had seven bear market rallies greater than 24% during that two year period. And in fact, the final bear market rally was a 59% rally, and the market still went on to make new lows even after that. Right?

So you've got to learn how to trade both sides of the market, long and short. It's not as easy as just shorting everything or buying loads of puts and hoping for the best.

And I think in a bear market, that's where counter trend trading becomes really, really useful. Now, we talked about the benefits of trend trading a minute ago. Trend trading works beautifully in a bull market. It also works in a bear market, but you'll find fewer opportunities because trends change more quickly. They don't become established, and being able to identify turning points becomes an additional very useful skill in a bear market.

QUESTION 6: Risk management during bear market rallies

So when you go long in a bear market rally, do you change your risk management approach?

Let's say maybe you keep a tighter stop loss or something like that?


- you need to be careful when going long during a bear market rally as it is a counter-trend move and it could end in 100 different ways.

- selling a put credit spread could be a good way to profit during a bear market rally, as it's less directional than buying a call and time decay is in your favor.


The tricky thing with a bear market rally, because it's a counter-trend move, there are 100 different ways the move can fail because it's got a lot of baggage to get through. There are a lot of people looking at the price and saying, oh, if it can just rally to X level, I'll be able to get out and not lose money. And, you know, there are constantly opportunities for people to cut losses or take profits. There's a lot of historical resistance to get to a breakthrough. So you need to watch your positions more closely because the

the first sign of failure, I tend to get out.

The other thing that I tend to do to trade a bear market rallies instead of trading it directionally, by buying call options or a call debit spread, I'll do it less directionally. I'll often trade a put credit spread. Okay.

When you buy calls, you're really expecting something to move up. You're expecting a sharp upward move in the underlying. When you sell a put spread, you're not necessarily expecting it to go up. You're just not expecting it to fall much further.

So they're more forgiving to trade. And that way, even if the ticker symbol just goes sideways for a couple of weeks, you can still make money on a put credit spread. So they tend to be a lot more forgiving to trade. And particularly in a high volatility environment, if you're seeing the VIX at 30 or above, that tends to be a really good time to put trades on for a credit rather than that for a debit.


Okay, so you like to do both. In some cases you would buy options, and in others you would sell options for a credit and I guess it may depend on the VIX level, right?


The VIX, it's kind of a barometer of the weather in the world, if you like.

So it kind of gives you a bit of a temperature check of what the weather is doing in the world of the stock market.

But you've also got to remember that the weather in different parts of the world can look and feel quite different as well.

So the VIX is a good kind of overall barometer, but you also need to check what the implied volatility of these are doing in the individual stocks or symbols that you're trading.

QUESTION 8: Why are options superior?

Now, talking about options, of course in your book and even earlier, you said that you trade options and you like them. Why do you think that options are superior for the average trader?


- options offer leverage with asymmetry. The downside is capped to the premium paid for the options contract, while the upside is uncapped.

- options are the easiest way to turn a small amount of capital into a bigger amount of capital

- trading options allows to not be 100% invested at all times.

- Wallstreet want people to buy and hold stocks for the long term as they earn commissions

- putting 100% of the capital at risk all the time, is unnecessary and stressful


Options are the easiest way to turn a small amount of capital into a bigger amount of capital because they offer leverage, but they offer leverage with asymmetry. And this is the real feature of options. Asymmetry simply means not symmetrical. And in options we're talking about the upside looking different from the downside.

You've got uncapped up side, whereas your downside risk, if you're buying a directional option like a call or a put is very much capped, the most you can lose is the option premium that you pay up front. And that's really attractive for a trader.

Now, options have some other features as well. One that traders need to be careful of is that they are a wasting asset. Options have an expiration date, a date beyond which they literally cease to exist. So when you're trading options, it's really crucial to get your timing right.

So my default position as an options trader is actually cash. And what I'm always looking for is high probability moments in time to expose my cash to risk. I'll do that. I'll expose myself to risk by buying options again for that asymmetry and that leverage. It's a very different approach from just sticking your money in a long term portfolio, crossing your fingers and hoping for the best, which is what most people do.

And I think the reason most people do it is because it's what Wall Street has told them to do all their life. And Wall Street wants to keep people invested because Wall Street earns fees on keeping people invested, right? And they'll tell you things like you can't time the market and you can't beat the market. And these are all just a bunch of rumors that have been invented by Wall Street to basically disempower people.

But I just find that this idea of exposing your money to risk all of the time and just writing those ups and downs, not only is it stressful, it's completely unnecessary.

QUESTION 9: How many DTE do you choose?

It makes total sense. Now, diving deeper into your trading strategy, of course, you talked about the decaying part of an option so that the price of an option contract declines as it approaches expiration.

So when you choose to buy an option, how many days until expiration do you prefer going for?


- 60 DTE and with a 60 to 70 delta is the sweet spot


So normally I'll buy an option that expires at least, at least twice as long as what I expect I'll be in a position for. So if I think a move is going to happen over the next three weeks, I'll buy an option with at least six weeks to expiration. And the longer the better, really.

I always say to people by the longest dated, most in the money option you can afford, and that will be the most forgiving trade. You've also got to check things like open interest and liquidity.

But generally if I'm buying an option with about two months to go with the delta of somewhere between 60 and 70, that's probably my sweet spot. That's where I'll generally start looking.

QUESTION 10: Asset classes

Now, regarding the asset classes, what asset classes do you trade most?Do you ever use ETFs like GLD to trade gold or other ETFs to get exposure to commodities, or do you mainly trade stocks and indexes?


I focus very much on trading any options over US listed stocks and ETFs. So if I want to get exposure to gold, I mean, occasionally I do trade futures, but really it's quite a small part of my trading. Now, options is absolutely the lion's share.

Instruments like futures also offer leverage, but with the futures contract, the leverage is a double-edged sword. You've got leverage to the upside and to the downside, whereas with options, as we talked about, you've got that very nice asymmetry with

uncapped upside and capped downside.

So yeah, I do trade options the vast majority of the time. But to your point, yeah, I use options on indices, individual stocks and ETFs.

QUESTION 11: Sizing and risk management

Now, talking about sizing and risk management, most beginner traders blow up their accounts because they have poor risk management and sizing. What is your risk management approach and what is the average size of your trades?


So in a bull market, I would say the average size of my trades or per position would be 5% of my NLV, my net liquidating value of my portfolio per position. And generally I'll have a maximum of ten positions on any one time, usually less than that. But I'll never be more than 50% invested, I'll never have more than 50% of my trading capital at risk any one time.

In a bear market, I'm generally finding out I'll default to two and a half percent of my NLV per position just because the win rate tends to be a little bit lower, things tend to be a little more volatile. And I just find that having that smaller position size keeps me on an even more keel emotionally.

QUESTION 13: Risk management and stop loss

And about risk management, do you have a specific approach that you follow? Let's say, for example, that you buy a call option and then a week goes by, and now the call is worth 75% of what you paid for, and then another week goes by, and now the call is worth 50% of what you paid.

What do you do? Do you close the option for a loss or do you wait?

How do you manage it?


So I have what I call my OMG stop loss level, and that's 50%. All right?

So if an option loses 50% of its premium that I paid, I just get out, no questions asked. That's it done.

Usually I will try and get out well before that happens, and it's less of a price based stop and more of just analyzing the technical situation.

So if I expect the stock to move up and what I expected to happen isn't happening, I'll tend to get out and ask questions later.

Usually I'll need four or five reasons to get into a position. I generally only need one reason to get out of a position.

QUESTION 14: Portfolio risk management

And regarding risk management, do you have a risk management approach for your whole portfolio?


So, I have what I call a portfolio stop loss as well.

If my NLV and NLV just stands for Net Liquidating Value, it's what the value of your trading account would be if everything was turned into cash.

If my NLV ever drops by 15% from a high watermark, I close out everything and go to cash for a minimum of 24 hours.

Fortunately, that hasn't happened to me for probably about three or four years now, because the positional risk management is working pretty well.

But, yeah, if ever my portfolio drops 15% from a high watermark, I go to cash. And the reason I do that is because if my portfolio's down 15%, I only need to make back 17.5% to get back to breakeven.

And I know I can do that. I've got every confidence in that.

Given my trading experience, if I let my portfolio drop by 50%, I've got to make 100% back just to get back to breakeven. And that's an awful task.

Having to make 100% return just to get back to where you were, that can really put you in a very deep, dark psychological hole. And it can be very difficult to trade out of a situation like that.

QUESTION 15: Parallels between martial arts and trading:

I believe everybody should have a system like this in place, because sometimes we just need to stop for a while, bring down the stress level, and then go at it again with a clear mind.

Now, talking about the mind, from your book, I've learned that you are a Jeet Kunde Do instructor. Do you see a lot of parallels between what it takes to become a good trader and learning a martial art?


The biggest one is emotional control. All right? When you're sparring with somebody, the first few times you spar, you can get pretty excited.

Your emotions get heightened, you take a blow that kind of hurts a little bit more than what you're used to, and all you can think about is hitting that person back harder. It's like a revenge trade. That stock hurt me, I'm going to double down and really try to make my money back on it.

I think martial arts help you to not take things so personally, realize that the blows will come and go, and it's how you manage the risk, how you avoid revenge trading, avoiding just getting hurt is really important in both.

That's what keeps you going for the long term. And yes, I think there are several good parallels, but the most important one to me is just that emotional control, not getting excited.


Yeah, I completely agree. Mindset is really crucial many times is when our emotions overwhelm us that we make our worst decisions, which many times means blowing up accounts. And it's what usually beginners do.


Not only beginners, there are people who have been trying to do this for years who still keep blowing up accounts. And there's this perception in trading that I just need the magic indicator or I just need the Holy Grail entry system and I'll be fine.

Truly, what most traders need is just some fairly basic tools and techniques, and then it becomes a question of self mastery.

QUESTION 16: trading frequency

Now, going back a little bit to your trading style, I wanted to ask you about trading frequency. How many trades do you do in an average year?


Yeah, probably somewhere around 200.

QUESTION 17: Win rate and probabilities

Okay, so you trade quite often, which is crucial because let's say you have a 60% win rate, which means that 40% of the trades don't work out. In this case, it's not a common to see to have five or six trades in a row that turn out to be losers. But when you do it over a large number of trades, like 200, as you said, then the 60% win rate allows you to have a profitable year. Could you dive deeper into this concept?


So trading is all about having a probabilistic edge. All a probabilistic edge means the probabilities are in your favor. Now, we kind of grow up, and most people grow up in an education system that teaches deterministic thinking. It's a bit like Newtonian physics. If A happens, B will happen. That doesn't work in trading. We've got to have the approach of if A happens, B is more likely to happen, but anything can happen. And that's why risk management is so important.

But it takes a large number of trials for probability to be able to work its magic. All right, so if you're assessing your performance as a trader based on the last five trades, you're really not getting the full picture. That said, if I have five losing trades in a row, it probably shows me that I am a little bit out of sync with the markets and that maybe I need to just take 24, 48 hours off, have a little break, have a breather and just approach the market with perhaps a fresh pair of eyes.

Yes. I mean, with a 60% win rate, you're absolutely going to have losing streaks of five, six, seven trades in a row. That's absolutely on the cards, well, within probability. But I think it's also a little bit of a warning that, hey, you're a little bit out of sync here. Just have a break and reapproach the markets with a fresh perspective.

QUESTION 18: trading journal

Now, talking about something that could help new traders as well as advanced ones, do you keep a trading journal in which you analyze past trades, and how important is it?


I think it's really important, particularly in your first couple of years, so that there are two things I do. I keep a fairly simple spreadsheet of all of my trades. What was the trade? What were the reasons? What my edges on that trade? What were the edges that I identified that made me think this was a situation where I had a probabilistic edge?

The other thing I do is I print out my charts. So when I see, because I'm a technical trader, I'm looking for technical setups, I'll print the chart out in color, and I'll scribble on it. I'll write on it, I'll draw on it. I'll kind of highlight what I'm looking at, write a few notes, and then at the end of each month and then at the end of each quarter, I'll go through and review them.

And that's a really nice method of tracking your trading progress. And the other thing that happens is you start to recognize what winning setups look like compared to losing setups. All right. Neurons in your brain just seem to connect differently when you're doing it visually like that, rather than just looking at a spreadsheet. At least that's what I found.

So that's a big tip I give to new traders. Print out your charts.

QUESTION 19: Key elements that make a good trader

Thank you for this tip. Now, if you look back at your career, what are the key elements that make a good trader? If you had to point out maybe one or two things, what are the most important things somebody should focus on to become a better trader?


Consistency is number one. Just showing up every day and just following and honoring your process is really, really key.

The second one is just finding that right balance between ego and humility. I mean, you've got to have enough ego to give you the confidence to put trades on in the first place. But you've got to have the humility to respect the market, respect that you're going to be wrong a decent percentage of the time and have that mental flexibility to accept that if you're wrong in a trade, you're wrong in a trade.

The thing is, right, you can be wrong in trading 40% of the time and still make a really good living. There aren't many jobs that allow for that.

If you're in a traditional corporate job, and you're wrong 40% of the time, you're probably going to be kicked out of your job pretty quickly.

The trading world is very different. You can't expect to be right 100% of the time. Trading losses are part of the game. And what I say to people is they are just an operating expense, the cost of doing business.

Now, like any good business, you want to minimize your operating expenses, but you're never going to eliminate them completely.

QUESTION 20: Managing the ego during a winning streak

Now, talking about mindset again and talking about the 60% win rate, sometimes you could have five or six losing trades in a row, but other times you could have 15 winning trades in a row.

It's just the rules of the large numbers, which could trick some investors into becoming overconfident. How do you manage your emotional state when you're having a good winning streak?


Really good question. I have a little sticky note on my computer. It says no high fives. If ever I feel like highfiving myself on how good a trader I am, it's time to go to cash, all right. Because I just know from experience, as soon as I feel like patting myself on the back or high fiving myself because I'm such a great trader, I am about to be taught a lesson. I've gotten pretty good at recognizing that feeling in myself. Now when I feel it surfacing, it's time to go back to cash.

QUESTION 21: Averaging up or down on trades?

Now, talking about confidence, do you ever double down on a trade Would you average down on a losing trade, or would you average up on a winning trade?


I never averaged down. I love that Paul Tudor Jones quote, only losers average losers.

But I'll average up. So if a trade is already moving in my favor, I will consider adding to a winning position. But no, I'll never add to a losing position. If a position is underwater, I'm much more thinking about, when do I cut this? Not when do I add to it? Right?


And I guess a lot of people struggle with this because they tend to average down trying to, let's say, get a better entry price, but they often wouldn't average up because they think they're getting a worse entry price.


You want to nurture your best employees, and you want to sack your worst employees, and you want to sack them quickly. In the world of trading, the positions that are underwater, they're the employees that you're not getting anything out of them. Right. So they're the ones that should be on the chopping block

QUESTION 22: Exit strategy

And talking about nurturing your good employees. Once the trade goes in your favor, do you put a stop loss, or do you have a take profit price level already mind? How do you approach the exit? Do you ever scale out of a position?


I don't scale out of a position. Occasionally I will, but normally I will just exit a position once it hits a level and that level really depends on the setup. It could just be a level of historical support resistance, it could be a Fibonacci level. It could be when I get to two to three average true ranges above a certain level. So it depends on the setup. But yeah, it's technical based, the exit. So if I'm trading a spread, generally I'll exit it.

If I'm trading a debit spread, I'll generally try and exit it to 70 to the width of the spread.

Trading spreads is nice because trading a debit spread has got a really nice kind of feature about it, in that your profit targets become very, very what's the word? Objective.

So if I'm trading a spread that's, for example, $10 wide, I'll look to come out of that spread or take profit at it once it gets to seven or $8 in value, usually 80% of the width of the spread is the most I'm looking to make.

So if a spread is $5 wide, I'm looking to get out of that once it hits $4 in value. So spreads are really easy in terms of setting profit targets. If you're just trading a long call or a long put, there's a little bit more subjectivity. But my exits will generally be technical based.

QUESTION 23: Exiting credit spreads

instead talking about credit spreads. So the ones you receive a credit for, would you still close them once they reach 80% of the profit or no,

maybe you close them at 50% or less?


So with the credit spread, I'll generally get out at once I can harvest between 50% and 80% of the premium that I've received.

So if I receive $2 upfront premium, I'll look to buy it back if it drops, to say, one dollar or $0.60 or something like that.

QUESTION 24: Do you ever roll options to the next month?

Okay, and do you ever roll a position to the next month, or you just close it out?


If a position isn't working, I prefer to close it out and move on rather than try and rescue it. I know some traders will try and repair a position. I think this is often a little bit of ego kind of getting in the way of, dammit, I want to be right, I'm right, the market is wrong, and I'm going to prove to everyone that I'm right.

I'd rather just cut the position and move on and recycle the capital into

something that has definitely got an edge.

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