Position Sizing & Correlations

Discussion in 'Risk Management' started by daniel_tysen, Sep 27, 2010.

  1. Hi there,

    I'm swing-trading currencies, being in a trade for 2-5 days usually.

    I like to get in trending markets when they pullback.

    I'd like to risk 1% per trade.

    Now very often I get interested in not only one but quite a few markets because they're highly correlated like AUD/USD, NZD/USD, GBP/USD, EUR/USD might all do a pullback on the same day.

    Or AUD/NZD, AUD/CAD, AUD/JPY, AUD/USD last week...they're all correlated to AUD.

    In the past I liked to pick the one I liked best, place my limit-order in that market and forget about the rest.

    It has worked out okay so far but what happens often is:

    - The market I've chose is the one that performs worst...
    - My limit order doesn't get filled in the chosen market, but would have in one of the others...they all run without me now...

    So in other words I think it might be more logical to try to get in all of those markets...since trying to pick "the best" usually is a stupid idea...also if you think about it, it's a bit too much prediction...

    But of course if I'd place orders in all "interesting markets", I'd have to deal with correlations. Highly correlated markets, medium correlated markets etc...

    Now I don't have much experience in this, how do you handle it?

    Best thing that came to my mind is:

    Let's say I want to risk 1% on the trade, meaning I have to split up that risk if I trade more but highly correlated markets. I spot 3 of those markets and place my orders

    - Fit my position size to risk 1% in every market, since I don't know if all 3 orders will get filled.
    - When the first order gets filled, I modify the not yet filled 2 orders in the other markets cutting the position size down to 50% (0.5% risk).
    - If one of those 2 orders get actually filled, I close 1/2 of the first position.
    - If the third order get's filled, I'm okay because 1.5% risk instead of 1% seems okay to having split of the risk a little by being in three markets.

    How do you handle this? Any better ideas? :)

  2. Anyone? Cmon you must have to deal with correlations, too! :)
  3. You could use an OCA - one cancels all order. I know Interactive Brokers supports this order type. With it you can place all 3 orders and when/if one is filled the others are canceled. From there you can enter the other positions, or not.
  4. Hi Peter,

    not a bad idea, thanks for the reply!

  5. minmike


    Limit orders not getting filled is part of life when using a limit order.

    The trade off is where the benefit of placing a limit order is greater than the risk of not getting filled. Corrolations or not.

    I think with the OCA orders you run the risk of always picking the worst pair.

    I think you are just trying to get too cute. Focus on 4-5 pairs that have as little correlation as possible, get to know them and don't worry what would have happened in some of the others. It isn't important to you until you develop a profitable way to objectively choose between all of the options.
  6. Hi Mike,

    thanks for your reply.

    Well to focus on a couple of pairs or trying to pick the best is what I've been doing in the past. It just seems to make less sense to me with the experience I have now...the result of my thoughts is that I want to diversify, instead of having 1 trade running, have 3 running and not try to "pick the best" because that's bullshit...you never know which one the right is :)

    So I'm really looking for a solution how to get this done properly. How to handle it, what's the best way...

    Take care,

  7. minmike


    I don't think I said anything about trying to pick the best. Like I said I think you are trying to get to cute.

    I don't believe that having three highly correlated pairs gives you any degree of diversification.

    Pick a base currency. ex USD. now look at every other currency vs the USD. say you want to short the AUD/USD and get long the JPY/USD. You synthetically got a long JPY/AUD. It picked for you.

    Again I don't think geting any more in depth is going to improve your results. If it does, let me know.
  8. Hi Mike,

    well it's kinda funny because I really think the other way. For me taking only one trade in one pair instead of three trades in three pairs is "to cute". But maybe I'm wrong who knows.

    Let's say you trade NZD AUD and CAD against the USD. Those markets are often highly correlated, but sometimes not or you have at least one market that moves a lot better than the other two. Like AUD did lately...but you picked the NZD - tried to be cute :)

    But thanks for your input!