What risk management lessons to learn from negative oil price event?

Discussion in 'Risk Management' started by helpme_please, May 1, 2020.

  1. This negative oil price event is unprecedented. It surprised even veteran oil traders with decades of experience.

    It has shaken conservative people who thought their risk management rules will protect them from financial markets.

    One popular risk management rule is not to risk more than 1% of your equity. This rule won't protect you from negative oil price if you're caught in it. Imagine on that fateful day, you bought oil at $0.10. You thought you got bargain of a lifetime and who can argue with you over that? Soon, oil slipped to -$37. Many traders were not able to get out of their positions when oil price went negative because the brokerage software got confused and did not allow orders to go through for negative prices. Gosh. You're dead many times over since you lost many times your principle. Even a well-capitalised trader putting on a small position will blow up his account.

    So, what risk management lessons do you learn from this -ve oil episode?

    What new rule would you add to your risk management rulebook to protect yourself from similar events in future?
    Last edited: May 1, 2020
  2. LanceJ


    So if I sold one contract at $1 and the price moved to -$2, my position would be -$1 even though it moved in my direction $3?
  3. ajacobson


    Understand settlement of any product you trade. I do not believe the veteran energy community was surprised - whether it's physical delivery, American options, cheapest to deliver - understand delivery. Putting a very small percentage of your portfolio into a poorly thought out idea is stupid.
    Assume the veterans and the pros are the ones that are going to use you as fodder!
  4. Alexpung


    The good old saying in poker.

    Think twice before you trade, if you think it is a bargain of a lifetime why would anyone on the other side take the opposite side of your bet?
  5. MattZ

    MattZ Sponsor

    People would not profit in any asset class if this is the prevailing thought.
  6. MattZ

    MattZ Sponsor

    And to add to your very good point about the settlement, also understand that physical commodities can go negative. I believe it was Nat Gas that was negative in a Texas hub in May 2019, and although this was not reflected in the exchange, it happened in the physical market.

    When refineries cant hold more than a certain number of barrels, I guess they will pay you to hold it for them(?).

    The lesson is not just oil, rather any physical commodity that may require storage.

    As far as risk management, you can no longer say that the downside is limited.
    murray t turtle likes this.
  7. Trading is dangerous. Period.

    There was enough notice that the contract could go negative. No one knew it would go to a stupid -50 at some point

    Only reason it did that , margin blow ups and faulty software.

    Thats y I say

    Pressing the button, is always dangerous . more or less

    in this case more.
  8. MattZ

    MattZ Sponsor

    No. Still three points
    1 to 0- $1
    0 to -2 $2
    Total three.
  9. Alexpung


    People win by having a more accurate assessment of the situation than your opponent.
    Everyone know the price of oil at $0.10. So why would it be "a bargain of a lifetime" to you but not to your opponent?

    People who think it can't be negative have an inaccurate assessment.
    People who know it CAN go negative have more accurate assessment so they sell you the contract.
  10. MattZ

    MattZ Sponsor

    These are conclusions after the fact. Even people who "Know" do not know what happens to liquidity or spreads to take advantage of such situations, in other words, when prices fall below zero.
    CL futures are trading since 1983 and never been negative, so even the traders with a better assessment (as you say) would not take the risk on such a move.

    The number of contracts that traded below zero was not high, and in my opinion, these were just shorts (hedges) from previous days or those who wanted to take delivery.
    #10     May 1, 2020