how to cut losses as a global macro trader?

Discussion in 'Risk Management' started by SethArb, Mar 3, 2009.

  1. According to the "House of Money" - as far as my recollection goes - many global macro managers use directional option positions to express their bets, thus have a "built in" stop loss -- when the options expire worthless.
  2. You can use options, you can use diversification, you can do many things, but the best way to reduce PNL volatility is to have deep pockets (or size the trade accordingly, which is the same thing). That's the only way to do it, in my view.

    I'd argue that PNL volatility is part of the job description if you're a macro trader.
  3. Your title says how to cut losses, your post says how to handle swings, which is it?

    The way to handle swings is to reduce your size small enough that normal market fluctuations do not lose you enough money to bother you, or to use options to limit your maximum loss to an acceptable amount.

    As for cutting losses, which I understand as exiting once you realise you are wrong, you need to first define what would prove your position to be incorrect. If that thing then occurs, you're probably wrong and should exit. Make sure you trade small enough, or are sufficiently hedged with options, that the amount of loss in this event is acceptable to you.

    In my opinion, it is pretty hard to make more than 2 or 3 times your risk on an annual basis trading global macro style, and most good traders don't get much above 1:1. So if you are gunning for 30% then you should be prepared for 20-30% drawdowns too on occasion.

    To get an idea of the volatility vs returns, just look at any major macro move. For example, the move in oil from $30 to $147 and back. Both on the way up and the way down, there were significant pullbacks - many of 10%, some of 20%, and the rally had a pullback from 77 to 49 (36% pullback). So you had a 390% gain, with maximum 36% pullback, a very nice 11:1 ratio. In reality though you would never buy the low and sell the high. More likely, even the best traders got long maybe somewhere in the 40s and sold either in the 90s or maybe 120something. Or the true believers were long from 30 and got stopped out on the way back down at 90 or 80 or 70. So the real ratios were probably more like 150% or 200% profit with a 36% drawdown, a 5.5:1 ratio. Still very nice, most trades aren't that good.

    Here are some other examples from the last year or so:

    Short pound, from 2.00 to 1.40 = 30% return, max pullback was 11%. slightly under 3:1 ratio.

    Short S&P, from 1500 down to 700 =53% profit, maximum drawdown was 27%. Roughly 2:1 ratio.

    Short oil from 147 to 40. 73% profit, max DD was about 25-30%. 2.5:1 ratio.

    So as you can see, even excellent macro trades generally have profit only 2-3 times the maximum pullback. Some rare trades are better than that, but most will be in the 2-3 range. So IF you can select these good trades and avoid bad ones, you could get 2-3 times your risk on a portfolio basis. If you select multiple trades, your DD will be lower due to diversification. In the real world, you won't ride every, or even most, macro trade opportunities to the full. You will miss some, you will be on the wrong side of some, you will exit prematurely or enter later on others etc. So although theoretically a perfect macro portfolio could make 5-10 times its risk, in the real world it's more like 1 times as a reasonable goal, and 2 or 3 times would be superstar performance.

    George Soros for example has averaged 30-40% over various long periods, and he has had occasional peak-valley drawdowns of similar amounts (although his calendar year results are better in terms of risk, it's peak/valley that matters).

    IMO, macro trading is all about risking 1, 2, 3% per trade and making 3, 6, 9% when you are right on the trade, doing that 3-10 times per year, and aiming for 15%-50%, whilst keeping drawdowns to 10% or less ideally, and definitely below 20%. If you have a good run, compounding equity allows you to turn a good 4-5 month run into potentially a 50%+ year. It is tempting to trade bigger and try to score 20-30% on a single trade, but except a few rare options trading opportunities (e.g. calling a market crash in advance), that is very hard to do without taking commensurately large risk. Remember our 2.5:1 ratio. If you are trying to score 25% on a trade, your risk is likely to be 10%. A 10% drawdown is something you should strive to avoid in any given year. Losing that on one single trade is insane. So keep your size down.
  4. Daal


    Most macro traders I studied seem to use the following methods
    -News/fundamental stop, a piece of news come outs that they dont like it they get out as soon as possible. Or as they reanalyze existing data and change their mind regarding valuation, they exit immediatly.
    -As the position goes against you, you cut back. You keep cutting back till the position is no longer a big deal while making sure you are right on your analisys

    The third way would be hard/technical stops but I dont know many who use this, I dont personally use this either(except for daytrading where its a must)
  5. It seems the answer has been clearly stated in the article already:
    " Then we have the true global macro traders who use a bit from all of these styles in order to have lower drawdowns and higher returns. "

    imo, Perhaps that is the main reason for CTAs usually cannot perform better than some major global macro traders.
  6. I trade many different futures and options markets-index, Treasuries, currencies, grains, metals. A big, big problem is since the "crash" the correlation between every market under the sun is pretty virtual. For example I've had sell signals for a few days in ES, currencies and grains. I can only take one because in reality they're ALL THE SAME TRADE. Charts of the Dow, Pound, crude, soybeans are indistinguishable from one another.

    So if a diversified manager takes 6 different positions chances are unless he's spread within a class, he may be 6x more asset short than prudent or 6x more inflation worried than prudent. There are times when commodities are completely anti-correlated to stocks as well so the hard part is knowing when they're decoupling which of course will happen again soon enough.
  7. imo, Not entirely true in the long term when applying re-investing of profits, in order to get a preferably smooth equity curve.
  8. l always scale into my positions, always.

    For each asset you trade you simply have to find out who the major players are, where their pressure points are, how they can squeeze your balls, who controls them and their location.

    Example:- Gold producers, South Africa, when you have a short position on futures and you are keeping updated daily on South African news, then you hear they are having electricity shortages or power failures, then hedge on which ever market is open and scale out of your position.

    With Global Macro whenever you open a position you should have 2 alternate hedging instruments on different exchanges in totally different time zones. Though nowadays we have electronic exchanges and a near 24/7 trading, just play it safe.

    Lessons (?? losses ) are part of our profession, what you often have to fight within yourself, particularly with Global Macro is a desire to go all in ( it stems from having done quasi academic research for each trade, therefore you tend to get too confident) I wanted to do that with carry trade last year, but was chicken l suppose :D

    P.S. Global Macro will give you:

    A life of failed relationships (3 am calls to check an IPO in Hong Kong),

    Stomach Ulcers (multiple Central Bank decisions every month)

    Computer screen will fry your eyes when reading that 400 page report into price of goat skins in Uzeberkistan:p :p
  9. Over the long term I agree. Strongly and clearly. But in the past six months everything has been correlated, just of differing magnitudes.

    #10     Jun 3, 2009