The Grail Timing and Trend Indicator is an integral part of how we execute in our various investment models. Here’s a look at that Grail Trading Discipline, starting with the Grail Indicator itself. To be clear, the Grail is an indicator and not a trading system. It is not a foolproof moneymaking machine, but rather one powerful component or tool to be used in executing a disciplined trading methodology.

The laws of the markets are no different than the laws of nature. The Grail is structured with two primary natural laws in mind. The first is the law of ‘regression to the mean’ and the second is the law of ‘inertia’.

Let’s look at how the first law, ‘regression to the mean’, applies to markets. If things are going much better than normal (the mean), then they tend to get worse. If they are much worse than normal, then they tend to get better.

Stocks and commodities normally trade in ranges. Those trading ranges offer
a great example of the law of ‘regression to the mean’.

First, the market diverges (moves away) from the mean, then it returns to the mean only to diverge again either in the same or opposite direction, which is followed by yet another move back to the mean. The trick is to understand what constitutes the mean, and when a significant divergence away from the mean has been achieved.

That brings us to the second law of ‘inertia’, which is basically Newton’s First Law of Motion. It may be stated as ‘an object in motion tends to remain in motion, while an object at rest tends to remain at rest, unless acted upon by an external force’. So, how does this law apply to trading and managing money?

For the most part, prices in markets are in perpetual motion. Motion away from the mean eventually slows and then stalls when highs or lows are reached. Then a change in direction begins, attempting to ‘return to the mean’. If we define motion as momentum (away from or toward the mean), then rest is defined as lack of motion or compression (oscillation in a tight band around the mean).

 So ideally, the Grail should identify four critical moments in time:

• when a market is overbought (much higher than the mean)
• when a market is oversold (much lower than the mean)
• when a market is compressed (trading around the mean)
• when a market has entered into a high-momentum trend

These four circumstances provide us with the most favorable risk/reward entry and exit points where the odds are the greatest of making a profit and minimizing our risk.

This is what the Grail Timing and Trend Indicator is designed to do. Now let’s consider how it is used within the Grail Trading Discipline.

There are five specific rules we follow:

1. Diversification: The beauty of combining stocks markets with the bond and commodity markets is that it provides us with an environment where we have multiple non-correlated markets to trade. While we do not trade commodity futures contracts, we do trade Exchanged Traded Funds and Notes (ETFs and ETNs). Nobel Prize winning studies have shown that when a portfolio includes several non-correlated asset classes, there are generally two positive results that occur.First, the volatility of the overall portfolio is generally reduced, and second, the overall return is generally enhanced. In the Grail Trading Discipline, our goal is to maintain a non-correlated portfolio by using several non-correlated or low-correlated securities.
2. Limited Leverage: Here is the classic quote concerning leverage: ‘Give me a place to stand and a lever long enough and I will move the world Archimedes, 220 BC. This may be true, but we are not trying to move the world here; our goal is to make a decent, steady return on our investment.Most of the horror stories a person may hear regarding commodity or stock account blowups, is due to excessive leverage/margin. This is generally caused either by ignorance of how leverage works, or by a foolish lack of discipline due to uncontrollable greed.In the Grail Trading Discipline, our goal is to carefully limit our use of leverage.
3. Loss Limits: Taking losses is the hardest part of any trading discipline. There is something very psychologically challenging about admitting that a signal or a fundamental bias has failed, and that the right thing to do on that trade is to take a loss. The temptation is so strong to just ignore the fact the position is losing money, or to hope that the position will eventually recover. To be successful over the long haul, a trader, or a trading system, must adhere to strict loss limits. In our Grail Discipline, we manage to a strategy that attempts to limit losses on any given position to no more than 1-3% of the total account value.  Of course markets sometimes have very dramatic moves that can produce losses beyond those amounts. To state the obvious, there are five types of trades; 1) breakeven, 2) small gain, 3) large gain, 4) small loss, and 5) large loss. If our loss limiting discipline can simply eliminate the large loss, we stand a much better chance of making money over time.
4. Discipline:”Make a plan, work the plan”; or in this case, since we have the Grail, we intend to work the Grail! This seems so obvious, yet it requires great discipline to resist the temptation to either ignore a signal (because your fundamental bias disagrees with it) or to take a trade without receiving a signal (because of a gut feel or some piece of information).
5. Patience: is the final, essential component of our Grail Trading Discipline. It may take days or even weeks for a Grail buy or sell setup to occur… which can be a lot like watching paint dry. But in many cases, trading too much can be far worse than not trading at all. Chasing markets can be deadly, while the cost of sitting on the sidelines is merely frustration and boredom. Our goal is to have the patience required to take only the best buy and sell signals for our managed portfolios. 

Disclaimer: It is important to state the following disclaimer. While we believe that we have a good ‘card counting’ system in the Grail Trend and Timing Indicator, markets do what they will regardless of what we want or expect them to do. Remember, past performance is never a guarantee of future results. There is always a risk of loss when trading any security or asset class.

Risk Disclosure: Options involve substantial risk of loss, and are not suitable for all investors. Only risk capital should be used. Margins are subject to change. Past performance is not indicative of future results.

Options Disclosure: Options involve risk and are not suitable for all investors. Prior to buying or selling an option, a person must receive a copy of Characteristics and Risks of Standardized Options, Options Disclosure Supplement, April 2008, Options Disclosure Supplement, June 2008 and the Options Disclosure Supplement, September 2008. Besides being accessible via our Web site, copies of the ODD are available from your Vision sales representative, or by calling 1-888-OPTIONS, or from The Options Clearing Corporation, One North Wacker Drive, Suite 500, Chicago, Illinois 60606.