Welcome to the third and final part of this chapter.submitted by getmrmarket to Forex [link] [comments]
Thank you all for the 100s of comments and upvotes - maybe this post will take us above 1,000 for this topic!
Keep any feedback or questions coming in the replies below.
Before you read this note, please start with Part I and then Part II so it hangs together and makes sense.
Squeezes and other risksWe are going to cover three common risks that traders face: events; squeezes, asymmetric bets.
EventsEconomic releases can cause large short-term volatility. The most famous is Non Farm Payrolls, which is the most widely watched measure of US employment levels and affects the price of many instruments.On an NFP announcement currencies like EURUSD might jump (or drop) 100 pips no problem.
This is fine and there are trading strategies that one may employ around this but the key thing is to be aware of these releases.You can find economic calendars all over the internet - including on this site - and you need only check if there are any major releases each day or week.
For example, if you are trading off some intraday chart and scalping a few pips here and there it would be highly sensible to go into a known data release flat as it is pure coin-toss and not the reason for your trading. It only takes five minutes each day to plan for the day ahead so do not get caught out by this. Many retail traders get stopped out on such events when price volatility is at its peak.
SqueezesShort squeezes bring a lot of danger and perhaps some opportunity.
The story of VW and Porsche is the best short squeeze ever. Throughout these articles we've used FX examples wherever possible but in this one instance the concept (which is also highly relevant in FX) is best illustrated with an historical lesson from a different asset class.
A short squeeze is when a participant ends up in a short position they are forced to cover. Especially when the rest of the market knows that this participant can be bullied into stopping out at terrible levels, provided the market can briefly drive the price into their pain zone.
There's a reason for the car, don't worry
Hedge funds had been shorting VW stock. However the amount of VW stock available to buy in the open market was actually quite limited. The local government owned a chunk and Porsche itself had bought and locked away around 30%. Neither of these would sell to the hedge-funds so a good amount of the stock was un-buyable at any price.
If you sell or short a stock you must be prepared to buy it back to go flat at some point.
To cut a long story short, Porsche bought a lot of call options on VW stock. These options gave them the right to purchase VW stock from banks at slightly above market price.
Eventually the banks who had sold these options realised there was no VW stock to go out and buy since the German government wouldn’t sell its allocation and Porsche wouldn’t either. If Porsche called in the options the banks were in trouble.
Porsche called in the options which forced the shorts to buy stock - at whatever price they could get it.
The price squeezed higher as those that were short got massively squeezed and stopped out. For one brief moment in 2008, VW was the world’s most valuable company. Shorts were burned hard.
Porsche apparently made $11.5 billion on the trade. The BBC described Porsche as “a hedge fund with a carmaker attached.”
If this all seems exotic then know that the same thing happens in FX all the time. If everyone in the market is talking about a key level in EURUSD being 1.2050 then you can bet the market will try to push through 1.2050 just to take out any short stops at that level. Whether it then rallies higher or fails and trades back lower is a different matter entirely.
This brings us on to the matter of crowded trades. We will look at positioning in more detail in the next section. Crowded trades are dangerous for PNL. If everyone believes EURUSD is going down and has already sold EURUSD then you run the risk of a short squeeze.
For additional selling to take place you need a very good reason for people to add to their position whereas a move in the other direction could force mass buying to cover their shorts.
A trading mentor when I worked at the investment bank once advised me:
Always think about which move would cause the maximum people the maximum pain. That move is precisely what you should be watching out for at all times.
Asymmetric lossesAlso known as picking up pennies in front of a steamroller. This risk has caught out many a retail trader. Sometimes it is referred to as a "negative skew" strategy.
Ideally what you are looking for is asymmetric risk trade set-ups: that is where the downside is clearly defined and smaller than the upside. What you want to avoid is the opposite.
A famous example of this going wrong was the Swiss National Bank de-peg in 2012.
The Swiss National Bank had said they would defend the price of EURCHF so that it did not go below 1.2. Many people believed it could never go below 1.2 due to this. Many retail traders therefore opted for a strategy that some describe as ‘picking up pennies in front of a steam-roller’.
They would would buy EURCHF above the peg level and hope for a tiny rally of several pips before selling them back and keep doing this repeatedly. Often they were highly leveraged at 100:1 so that they could amplify the profit of the tiny 5-10 pip rally.
Then this happened.
Something that changed FX markets forever
The SNB suddenly did the unthinkable. They stopped defending the price. CHF jumped and so EURCHF (the number of CHF per 1 EUR) dropped to new lows very fast. Clearly, this trade had horrific risk : reward asymmetry: you risked 30% to make 0.05%.
Other strategies like naively selling options have the same result. You win a small amount of money each day and then spectacularly blow up at some point down the line.
Market positioningWe have talked about short squeezes. But how do you know what the market position is? And should you care?
Let’s start with the first. You should definitely care.
Let’s imagine the entire market is exceptionally long EURUSD and positioning reaches extreme levels. This makes EURUSD very vulnerable.
To keep the price going higher EURUSD needs to attract fresh buy orders. If everyone is already long and has no room to add, what can incentivise people to keep buying? The news flow might be good. They may believe EURUSD goes higher. But they have already bought and have their maximum position on.
On the flip side, if there’s an unexpected event and EURUSD gaps lower you will have the entire market trying to exit the position at the same time. Like a herd of cows running through a single doorway. Messy.
We are going to look at this in more detail in a later chapter, where we discuss ‘carry’ trades. For now this TRYJPY chart might provide some idea of what a rush to the exits of a crowded position looks like.
A carry trade position clear-out in action
Knowing if the market is currently at extreme levels of long or short can therefore be helpful.
The CFTC makes available a weekly report, which details the overall positions of speculative traders “Non Commercial Traders” in some of the major futures products. This includes futures tied to deliverable FX pairs such as EURUSD as well as products such as gold. The report is called “CFTC Commitments of Traders” ("COT").
This is a great benchmark. It is far more representative of the overall market than the proprietary ones offered by retail brokers as it covers a far larger cross-section of the institutional market.
Generally market participants will not pay a lot of attention to commercial hedgers, which are also detailed in the report. This data is worth tracking but these folks are simply hedging real-world transactions rather than speculating so their activity is far less revealing and far more noisy.
You can find the data online for free and download it directly here.
Raw format is kinda hard to work with
However, many websites will chart this for you free of charge and you may find it more convenient to look at it that way. Just google “CFTC positioning charts”.
But you can easily get visualisations
You can visually spot extreme positioning. It is extremely powerful.
Bear in mind the reports come out Friday afternoon US time and the report is a snapshot up to the prior Tuesday. That means it is a lagged report - by the time it is released it is a few days out of date. For longer term trades where you hold positions for weeks this is of course still pretty helpful information.
As well as the absolute level (is the speculative market net long or short) you can also use this to pick up on changes in positioning.
For example if bad news comes out how much does the net short increase? If good news comes out, the market may remain net short but how much did they buy back?
A lot of traders ask themselves “Does the market have this trade on?” The positioning data is a good method for answering this. It provides a good finger on the pulse of the wider market sentiment and activity.
For example you might say: “There was lots of noise about the good employment numbers in the US. However, there wasn’t actually a lot of position change on the back of it. Maybe everyone who wants to buy already has. What would happen now if bad news came out?”
In general traders will be wary of entering a crowded position because it will be hard to attract additional buyers or sellers and there could be an aggressive exit.
If you want to enter a trade that is showing extreme levels of positioning you must think carefully about this dynamic.
Bet correlationRetail traders often drastically underestimate how correlated their bets are.
Through bitter experience, I have learned that a mistake in position correlation is the root of some of the most serious problems in trading. If you have eight highly correlated positions, then you are really trading one position that is eight times as large.
Bruce Kovner of hedge fund, Caxton Associates
For example, if you are trading a bunch of pairs against the USD you will end up with a simply huge USD exposure. A single USD-trigger can ruin all your bets. Your ideal scenario — and it isn’t always possible — would be to have a highly diversified portfolio of bets that do not move in tandem.
Look at this chart. Inverted USD index (DXY) is green. AUDUSD is orange. EURUSD is blue.
Chart from TradingView
So the whole thing is just one big USD trade! If you are long AUDUSD, long EURUSD, and short DXY you have three anti USD bets that are all likely to work or fail together.
The more diversified your portfolio of bets are, the more risk you can take on each.
There’s a really good video, explaining the benefits of diversification from Ray Dalio.
A systematic fund with access to an investable universe of 10,000 instruments has more opportunity to make a better risk-adjusted return than a trader who only focuses on three symbols. Diversification really is the closest thing to a free lunch in finance.
But let’s be pragmatic and realistic. Human retail traders don’t have capacity to run even one hundred bets at a time. More realistic would be an average of 2-3 trades on simultaneously. So what can be done?
The key thing is to start thinking about a portfolio of bets and what each new trade offers to your existing portfolio of risk. Will it diversify or amplify a current exposure?
Crap trades, timeouts and monthly limitsOne common mistake is to get bored and restless and put on crap trades. This just means trades in which you have low conviction.
It is perfectly fine not to trade. If you feel like you do not understand the market at a particular point, simply choose not to trade.
Flat is a position.
Do not waste your bullets on rubbish trades. Only enter a trade when you have carefully considered it from all angles and feel good about the risk. This will make it far easier to hold onto the trade if it moves against you at any point. You actually believe in it.
Equally, you need to set monthly limits. A standard limit might be a 10% account balance stop per month. At that point you close all your positions immediately and stop trading till next month.
Be strict with yourself and walk away
Let’s assume you started the year with $100k and made 5% in January so enter Feb with $105k balance. Your stop is therefore 10% of $105k or $10.5k . If your account balance dips to $94.5k ($105k-$10.5k) then you stop yourself out and don’t resume trading till March the first.
Having monthly calendar breaks is nice for another reason. Say you made a load of money in January. You don’t want to start February feeling you are up 5% or it is too tempting to avoid trading all month and protect the existing win. Each month and each year should feel like a clean slate and an independent period.
Everyone has trading slumps. It is perfectly normal. It will definitely happen to you at some stage. The trick is to take a break and refocus. Conserve your capital by not trading a lot whilst you are on a losing streak. This period will be much harder for you emotionally and you’ll end up making suboptimal decisions. An enforced break will help you see the bigger picture.
Put in place a process before you start trading and then it’ll be easy to follow and will feel much less emotional. Remember: the market doesn’t care if you win or lose, it is nothing personal.
When your head has cooled and you feel calm you return the next month and begin the task of building back your account balance.
That's a wrap on risk managementThanks for taking time to read this three-part chapter on risk management. I hope you enjoyed it. Do comment in the replies if you have any questions or feedback.
Remember: the most important part of trading is not making money. It is not losing money. Always start with that principle. I hope these three notes have provided some food for thought on how you might approach risk management and are of practical use to you when trading. Avoiding mistakes is not a sexy tagline but it is an effective and reliable way to improve results.
Next up I will be writing about an exciting topic I think many traders should look at rather differently: news trading. Please follow on here to receive notifications and the broad outline is below.
News Trading Part I
Disclaimer:This content is not investment advice and you should not place any reliance on it. The views expressed are the author's own and should not be attributed to any other person, including their employer.
|8:30:00 AM||Personal Income||Jan||-||0.40%||0.30%|
|8:30:00 AM||Personal Spending||Jan||-||0.30%||0.20%|
|8:30:00 AM||PCE Prices||Jan||-||0.40%||0.40%|
|8:30:00 AM||PCE Prices - Core||Jan||-||0.30%||0.30%|
|8:30:00 AM||Initial Claims||24-Feb||-||230K||227K|
|8:30:00 AM||Continuing Claims||17-Feb-18||-||NA||NA|
|10:00:00 AM||ISM Index||Feb||-||59.00||58.40|
|10:00:00 AM||Construction Spending||Jan||-||0.30%||0.30%|
|10:30:00 AM||Natural Gas Inventories||24-Feb-18||-||NA||NA|
|2:00:00 PM||Auto Sales||Feb||-||NA||NA|
|2:00:00 PM||Truck Sales||Feb||-||NA||NA|
|ALGT||Allegiant Travel Rg||0.70||0.02|
|AMNB||American Nat Bnk Rg||0.25||0.03|
|APLE||Apple Hosp REIT Rg||0.10||0.07|
|BAC||Bank of America Rg||0.12||0.01|
|BAX||Baxter Intl Rg||0.16||0.01|
|BRKS||Brooks Automatio Rg||0.10||0.02|
|CBOE||Cboe Glbl Mkt Rg||0.27||0.01|
|CHFC||Chemical Financi Rg||0.28||0.02|
|CHRW||C.H.Robinson Wld Rg||0.46||0.02|
|D||Dominion Energy Rg||1.67||0.04|
|FLO||Flowers Foods Rg||0.17||0.03|
|FRME||First Merchants - Registered||0.18||0.02|
|HLI||Houlihan Lokey Rg-A||0.20||0.02|
|HLT||Hiltn Wrld Hldgs Rg||0.15||0.01|
|MLHR||Herman Miller Rg||0.18||0.02|
|NAVG||Navigators Group Rg||0.07||0.00|
|ODP||Office Depot Rg||0.03||0.04|
|SEE||Sealed Air Rg||0.16||0.02|
|SPKE||Spark Ener Rg-A||0.18||0.35|
|TRST||Trustco Bank Rg||0.07||0.00|
|WSR||Whitestone REIT Rg||0.10||0.09|
|WTS||Watts Water Tech-A||0.19||0.01|
|WY||Weyerhaeuser Co - Registered||0.32||0.04|
|Company||Release||Est. EPS||Company||Release||Est. EPS|
|51job (JOBS)||Afternoon||0.64||Liberty Interactive Co. - Series B Liberty Ventures (LVNTB)||Morning||N/A|
|Algonquin Power & Utilities (AQN)||Afternoon||0.12||Liberty Interactive (QVCA)||Morning||0.49|
|Altisource Residential (RESI)||Morning||-0.56||Liberty Interactive QVC Group (QVCB)||Morning||N/A|
|AMC Networks (AMCX)||Morning||1.50||Liberty Media Co. - Series A Liberty Formula One (FWONA)||Morning||-0.22|
|America First Multifamily Investors (ATAX)||Afternoon||0.06||Liberty Media Co. - Series C Liberty Formula One (FWONK)||Morning||-0.38|
|American Outdoor Brands (AOBC)||Afternoon||0.08||Liberty Sirius XM Group (LSXMA)||Morning||0.41|
|Anheuser Busch Inbev (BUD)||Morning||1.10||Liberty Sirius XM Group (LSXMB)||Morning||N/A|
|Apricus Biosciences (APRI)||N/A||-0.15||Liberty Sirius XM Group (LSXMK)||Morning||0.40|
|AquaVenture (WAAS)||Morning||-0.24||Loxo Oncology (LOXO)||Morning||-1.14|
|Ares Commercial Real Estate (ACRE)||Morning||0.23||LTC Properties (LTC)||Afternoon||0.50|
|Ashford Hospitality Trust (AHT)||Afternoon||0.21||MBIA (MBI)||Afternoon||0.09|
|Atlantic Power (AT)||Afternoon||-0.04||Methode Electronics (MEI)||Morning||0.66|
|Avaya (AVYA)||N/A||-0.14||MGP Ingredients (MGPI)||Morning||0.47|
|Babcock & Wilcox Enterprises (BW)||Afternoon||-0.06||Middlesex Water (MSEX)||N/A||0.33|
|Barnes & Noble Education (BNED)||Morning||0.07||Nationstar Mortgage (NSM)||Morning||0.43|
|Barnes & Noble (BKS)||Morning||1.05||Natural Resource Partners (NRP)||Morning||0.95|
|Best Buy (BBY)||Morning||1.99||Nektar Therapeutics (NKTR)||Afternoon||-0.33|
|Big Lots (BIG)||Morning||N/A||NeoPhotonics (NPTN)||Afternoon||-0.22|
|BioScrip (BIOS)||Morning||-0.08||Nordstrom (JWN)||Afternoon||1.22|
|BlueLinx (BXC)||Morning||N/A||Nutanix (NTNX)||Afternoon||-0.25|
|Cable One (CABO)||Morning||5.86||Omeros (OMER)||Afternoon||-0.16|
|California Water Service Group (CWT)||Afternoon||0.22||ORBCOMM (ORBC)||Morning||-0.09|
|Canadian Natural Resource (CNQ)||Morning||0.30||Paratek Pharmaceuticals (PRTK)||Morning||-0.75|
|Capella Education (CPLA)||Afternoon||0.99||Park Hotels & Resorts (PK)||Afternoon||0.22|
|City Office REIT (CIO)||Morning||-0.09||Pattern Energy Group (PEGI)||Morning||0.05|
|Colony NorthStar (CLNS)||Morning||0.35||Patterson Companies (PDCO)||Morning||0.52|
|Concert Pharmaceuticals (CNCE)||Morning||-0.43||Pico (PICO)||Morning||N/A|
|Consolidated Communications (CNSL)||Morning||0.02||Pinnacle Foods (PF)||Morning||0.95|
|Cott (COT)||Morning||0.02||PRGX Global (PRGX)||N/A||0.14|
|CPS Technologies (CPSH)||N/A||N/A||Quarterhill (QTRH)||Morning||0.04|
|Crescent Point Energy (CPG)||Morning||0.06||Regal Entertainment Group (RGC)||Afternoon||0.33|
|Dawson Geophysical (DWSN)||Morning||-0.28||Revlon (REV)||Morning||0.08|
|DENTSPLY SIRONA (XRAY)||Afternoon||0.81||Ribbon Communications (RBBN)||Morning||0.17|
|Dixie Group (DXYN)||Morning||0.01||RTI Surgical (RTIX)||Morning||0.03|
|DURECT (DRRX)||Afternoon||-0.05||Safeguard Scientifics (SFE)||Morning||-0.68|
|Easterly Government Properties (DEA)||Morning||0.32||Sothebys (BID)||Morning||1.40|
|Farmland Partners (FPI)||Afternoon||0.13||Southwestern Energy (SWN)||Afternoon||0.10|
|Fidus Investment (FDUS)||Afternoon||0.37||Spartan Motors (SPAR)||Morning||0.09|
|Floor & Decor (FND)||Morning||0.68||Splunk (SPLK)||Afternoon||0.33|
|FS Investment (FSIC)||Afternoon||0.19||StoneCastle Financial (BANX)||Afternoon||0.40|
|FTS International (FTSI)||Afternoon||N/A||Strayer Education (STRA)||Afternoon||1.29|
|GAP (GPS)||N/A||0.58||Tegna (TGNA)||Morning||0.30|
|GP Strategies (GPX)||Morning||0.26||Toronto-Dominion Bank (TD)||Morning||1.13|
|Hemisphere Media Group (HMTV)||Morning||-0.06||TransAlta (TAC)||Afternoon||N/A|
|Horizon Global (HZN)||Morning||-0.14||Tribune Media (TRCO)||Afternoon||0.50|
|Hospitality Properties Trust (HPT)||Morning||0.52||Triple-S Management (GTS)||Morning||0.27|
|Icahn Enterprises (IEP)||Morning||0.56||Tronox (TROX)||Morning||0.06|
|Impax Laboratories (IPXL)||Morning||0.12||Uniti Group (UNIT)||Afternoon||0.02|
|Intra-Cellular Therapies (ITCI)||Morning||-0.51||US Concrete (USCR)||Morning||0.90|
|Intrexon (XON)||Afternoon||-0.32||Vector Group (VGR)||Morning||0.12|
|Keysight Technologies (KEYS)||Afternoon||0.39||Veritiv (VRTV)||Morning||0.79|
|Kohl's (KSS)||Morning||1.47||Vermilion Energy (VET)||Morning||0.20|
|Leaf Group (LFGR)||Afternoon||-0.27||VMware (VMW)||Afternoon||1.61|
|Liberty Braves Group (BATRA)||Morning||-0.25||Whitestone REIT (WSR)||Afternoon||0.08|
|Liberty Braves Group (BATRK)||Morning||0.04||WMIH (WMIH)||Morning||N/A|
|Liberty Interactive Co. - Series A Liberty Ventures (LVNTA)||Morning||0.02||XO Group (XOXO)||Morning||0.11|
|ZIOPHARM Oncology (ZIOP)||Afternoon||-0.13|
Since the COT report comes out weekly, its usefulness as a market sentiment indicator would be more suitable for longer-term trades. The question you may be asking now is this: How the heck do you turn all that “big giant gobbled-up block of text” into a sentiment-based indicator that will help you grab some pips?! One way to use the COT report in your trading is to find extreme net long ... English I'm often asked to provide an alternate view on the CoT data. For example, the indicator "Commercial index" is an oscillator from 0 to 100, but oftentimes it can be helpful to look at the absolute position. So, here the absolute position of certain parts of the CoT report are given, alongside with the percentage of a given time frame to ... The COT Index indicator is based on a popular formula taught by Larry Williams and Steve Briese in their Commitment Of Traders books. A reading of 100 indicates a new high for the indicator period, while a reading of 0 indicators a new low. The COT Index is useful for locating price extremes, and can be used to indicate possible reversals. COT Index Inputs. COT Pair Index. The COT Pair Index ... What you want to do is create an index that will help you gauge whether the markets are at extreme levels. How to Create an Index That Measures Market Extremes . Below is a step-by-step process on how to create this index. Decide how long of a period we want to cover. The more values we input into the index, the less sentiment extreme signals we will receive, but the more reliable it will be ... COT index = 100 x (current Net – Minimum Net) / (maximum Net – Minimum Net) Es ergibt sich somit ein Oszillator, welcher um die Nulllinie zwischen zwei Extrembereichen schwankt. In der unten stehenden Grafik erkennt man gut, wie der CoT-Index an dem Beispiel vom Kakao-Future gute Kauf- und Verkaufssignale geliefert hätte. Notiert dieser im ... Wir berechnen den COT Index ... Forex und CFD ́s birgt ein hohes Risiko und ist nicht für jeden Investor geeignet. Ein Investor kann möglicherweise mehr als das eingezahlte Kapital verlieren. Für den Handel sollte nur Risikokapital verwendet werden, bzw. Teile des Risikokapitals. Risikokapital ist Geld, bei dessen Verlust sich keine Änderung der Finanzsituation ergibt bzw. keinen Einfluss ... Commitment of Traders (COT) charts are updated each Friday at 3pm CST. Forex commitment of traders reports are based on the corresponding futures contracts traded on the Chicago Mercantile Exchange. View Futures Commitment of Traders charts here.
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This is the best use of the Commitment of traders COT report when trading forex for retail traders. The tutorial goes in depth on what to look out for in the... http://www.learncurrencytradingonline.com In terms of Forex sentiment analysis the best indicator you can use in your Forex trading strategy is the COT commi... The cot report is used in various forex strategies and is a tool which many traders don't utilize properly. It's great for beginner traders to understand as this tutorial covers the main use when ... Forex cot report analysis How to use & Trade with COT The Commitments of Traders (COT) is a report issued by the Commodity Futures Trading Commission (CFTC... This is a free webinar presented by Larry Williams of iReallyTrade.com, and hosted by eSignal Learning will show how understating the interrelationship betwe... Why did it take so long for the Forex Q&A Podcast to talk about the CoT report? Is it a hidden gem? Is it trash we don't use? Are there other ways to go abou... Price action and COT in Forex - Duration: 38:31. Oraib UK 21,099 views. 38:31 . Learn to read and use the COT Report by the Commodity Futures Trading Commission - Duration: 40:17. DeCarley Trading ... GET YOUR COT TEMPLATE HERE: https://www.logikfx.com/product-page/cot-template USE COUPON CODE: "COT99" Up to 99% discount while it lasts! -----... In this video you will learn how to read Order flow, specifically the COT report which is the commitment of Traders, to find the best forex trading and swing... How to read & use COT report in Forex trading. 13th Aug, 2016 - Duration: 50:43. MYFOREXMAGICWAVE 14,675 views. 50:43 . US Dollar Index Weekly Chart Setup Update. 12-30-19 - Duration: 9:09 ...