Thoughts on money management.

Discussion in 'Risk Management' started by SpellingPolice, Mar 10, 2006.

  1. I'm looking for thoughts from experienced traders on a way to minimize risk in trading.

    Lets say your system is pretty good when a technical indicator turns up or turns down with a specific target in mind.

    Now instead of having a stop loss, and taking the loss, I'm wondering about something I will call equilization.

    Let's say your indicator has changed direction before your target was met. Now instead of taking a loss, you take an equal position in the new direction with the change in the indicator, the same as you wouldve done anyway, even if your original target had been met. By doing this, you have stopped any bleeding from getting worse. You will neither gain or loose from this point on. Then at this point , you would resume your normal system.

    For example: Let's say you are trading bonds. Your system's indicator suggests going long, so you do, one contract. Then before your target is reached, your indicator goes short. Let's say your long pos has bled 8 pts already. So now you go short 1 contract like you normally would, with the same target you normally would, but this time, you add an equilizer short contract to freeze the bleeding to 8 pts on that original long pos. (I do hope you are still able to follow this so far.)

    Now that the bleeding cant get any worse and is frozen at 8 pts., you are able to just carry on with your system, gaining points along the way, just as you wouldve, but never taking the loss, and never closing the losing open position until that day arrives when it is break-even again. Now I'm thinking this should work if your system is only wrong every once in a while of course, like 1 in 10 , just to pick a ratio. So in that case, because you were equalized, you had 9 more successes supposedly, and that 8 pt. deficite may have actually been erradicated, because you were able to carry on with your system.

    Does this make sense? Is it possible? I did a lot of writing, but I think its a simple concept. I know one cant be long and short on the 10 year bond for instance, so one would take the opposing position with the 30 yr for example.


  2. One way to experiment with your idea, is to implement it using fully mechanical trading systems. If you do this, you can test out the idea (on past history) and see how well or how poorly it would have worked. The past isn't a perfect map of the future, of course, but it may be better than nothing. Many people believe so.
  3. If you are long the 10yr and short the 30yr you are not "freezing" your loss, your 10 yr position and 30yr position will still make/loss money. You are using two correlated instruments, but the 30yr is more volatile. After entering you new position if the 10yrs and 30 yrs go up you will lose more with your short 1 30yr than you will make on your long 1 10yr, because it is an imperfect hedge. (The instruments are not 1:1 corraelated, this is a spread trade) Also there are times where these 2 instruments won't move in sinc, the 10yr goes down and the 30yr goes up. The only way to do this is to get out of your position.
  4. gkishot


    Taking an equal position in the opposite direction is effectively the same as closing the original position. There's no advantage or disadvantage in this method over the closing the intial position outright except it would require an additional capital.
  5. Ok, I see. Thanks for your response. I am aware that the 10yr and 30 yrs minimum fluctuations are different. I was looking at an intraday chart for a couple of weeks and the two charts seemed to be identical. I wasn't aware that they diverge sometimes.

    I didn't really know what a spread trade is actually.

    Is there such a thing as a perfect hedge though? I'm just wondering if all hedging is imperfect anyway, but helpful nonetheless?

    So it wouldn't help to maybe take 2 10yr for every 30 yr ? Especially since they can diverge anyway? I wonder how often or how badly they do diverge.

    Thanks again for your help. I think I will read up on spread trading today.

  6. You have doubled your margins and brokerage for no possible gain.

    Sorry old son, it is back to the drawing board for you.
  7. Hi gkishot,

    I know what you are saying, but I'm looking for a way to keep the position open, but have a hedge in the same account, to come as close as possible to stop any bleeding, like a different bond, for example. I guess I need to research how spread trading works. Ultimately, I suppose I'm looking for a way to have simultaneously opposing positions in the same account. Maybe I'm looking at the wrong instrument, maybe this is only done with stocks?

    thanks for your reply,

  8. gkishot


    You can hedge your long position with put options.
  9. Ok, thanks. I realize this is probably basic stuff for many of you.

    Thanks again,

  10. I think the best understanding, and acceptance, that you can have here is that you can't avoid accepting a loss. The best defense sometimes is to yield. You're in the beginning of your plan and already you're doubling costs. You're planning that ultimate hedge of the hedge of the hedge that will somehow negate the loss. That's already been done. It's called the next good trade! :)
    #10     Mar 10, 2006