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When I review my trading systems each week, I look at a number of charts. The first charts are all related to risk, because I believe managing risk is the key to long-term investment success.There's a mathematical reason to make risk a priority: You need asymmetric wins to recover from any loss.If you lose 50% of your $10,000 account value, the investment falls to $5,000 and you will need a 100% gain just to get back to even. A 10% loss sends a $10,000 to $9,000, and a full recovery requires an 11% gain.The required percentage gain to breakeven will always be greater than the loss that you endure.
In the chart, the 26-week ROC of IVV has fallen below its 20-week moving average. This has happened 46 times in the past -- an average of four times a year -- and IVV has fallen 56.5% of the time in the week after this signal occurs.This signal usually only highlights a short-term pullback and stocks generally recover within a month of the signal. For comparison, there is a 39.6% chance of a decline in any month over the entire trading history of IVV.Because this is a short-term signal, no action is required in my long-term 26-week ROC system.This signal is, however, a warning that the long-awaited pullback in the stock market could be near. The S&P 500 has now gone 43 weeks without a 10% pullback. The index went 44 weeks without a 10% correction before topping in 2011, the last time we had an extended run-up in prices.The charts are now saying that we could see a better price for new stock buys shortly. Of course, stocks could also continue higher without pulling back… but with a 56% probability of a pullback in the next month, it seems best to hold off on adding to positions in the stock market.While I would not add to any positions at this time, the ETFs that are already in the 26-week ROC portfolio should continue to be held. There are only three positions and risk remains too high for bonds and precious metals.
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