Friday, July 22, 2011

Managing Black Swan Risks

Just took a glimpse at Woodshedder's Blog around S&P500 moves following 1.5% up days, and we could see how utilizing these stats alone would have done OK trading the SPY, until 2008. This is a pretty clear cut example for risk management techniques on top of exploiting a money making logic.

Ways to manage risks

1) Options: If the expected net profits are large enough, the trader could use SPY/index/VIX options to hedge against significant moves against the positions. Check out the CBOE tutorial if you're not familiar with these.

2) Hard Stop Exit: Taking a loss earlier is always better if it improves the over all expected return per trade. So where should be stop price levels be? Empirical optimization is probably the most practical manner of getting the answer.

3) Never holding position over session breaks: Yes, intra-session trading holds LESS risk than holding positions overnight (for someone who knows what they're doing), due to the simple fact that positions could be closed without any surprise moves from lunch/overnight gaps.

0 Reflections: