Black Swans

Discussions about Money Management and Risk Control.
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Sam
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Black Swans

Post by Sam » Wed May 21, 2003 2:39 pm

Dear All,

I was wondering what type of protection, if any, do traders have against the 'black swan' type event in their daily trading activities.

For those those who don't know to what I am referring to, I am talking about 'rare' events such as sudden market crashes, currency devaluations, market suspension e.g. 9/11 type events and so forth. (The term 'black swan' is from Taleb's Fooled by Randomness book).

I have considered out of the money options for protection but they may or may not protect an existing position and can be expensive. Does anyone else have another answer? Does anyone else feel that this is an issue?

Forum Mgmnt, I am particularly interested in your views in this since you mentioned in the Original Turtle Trading Rules of how some of the turtles were hit badly by the overnight decrease in interest rates by the Fed after the crash of '87 by being short in the interest rate markets. Presumably the markets opened way beyond their intended stop loss exits. From observing this experience, did you make any changes with regard to your trading?

Thanks

Sam

Forum Mgmnt
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Post by Forum Mgmnt » Tue May 27, 2003 7:50 am

Good question, there are many people who blow out because they don't pay attention to this kind of thing.

The Turtle Rules already incorporated safeguards to protect against Black Swan events. The 4 unit limits, unit size, correlated unit maximums and overall directional maximums were all designed to protect against these kinds of events.

Testing using 20 years or more of historical data will show up a few such events so make sure you test using as much data as you have.

If you are really concerned, don't trade futures, trade stocks without leverage, there's no chance of completely blowing out doing that. You won't make the same level of returns however.

Risk and reward are related. The trick is to take a non-lethal dose of risk. Some people like to play closer to the lethal level, others farther away. The ones who take more risk will make more money, unless they blow up.
You have to find your own comfort zone.

Loitering Without Intent
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Post by Loitering Without Intent » Sun Jan 11, 2004 12:27 am

If you are really concerned, don't trade futures, trade stocks without leverage, there's no chance of completely blowing out doing that. You won't make the same level of returns however.
I agree with this, but even without leverage, stock trading has it's catastrophic events that can do serious damage to an account in seconds.

For example, listed companies occassionally (regularly?) go under for all sorts of reasons (bad management, fraud, natural and unnatural disasters, industry issues, etc.).

Enron always seems to come to mind about now (but I should add that blue-chip companies aren't as likely to go crawling into spider's holes as often as say dot com start-ups seem to).

So if I put on a stock trade for $50,000 with my stop at say $47,500, it's possible (although not probable) that I could end up loosing the whole $50,000. That's a 20R loss which could take a long time to recoup.

verec
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Post by verec » Sun Jan 11, 2004 8:49 am

Some brokers offer guaranteed stop-losses.

Most spread-betting houses in the UK do.

Of course this will increase your commission level, but that's an insurance policy against the "Black Swans" (But be sure to read twice their exclusion list, though :shock: ).

Sam
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Post by Sam » Sun Jan 11, 2004 2:42 pm

Exclusion list? By this do you mean particular instruments are excluded or is there a list of incidents where they will not guarantee the stop?

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Post by verec » Sun Jan 11, 2004 3:01 pm

I'm currently abroad, so I can't check straight away that of the broker I use, but yes I do mean "events" that are or are not covered by the guarantee.

Sam
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Post by Sam » Sun Jan 11, 2004 4:03 pm

Thanks for mentioning it - I will check it out....

Ghostrider
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Post by Ghostrider » Sun Jan 11, 2004 11:16 pm

trade cash against the future.


Taleb...He was my math prof at NYU, big ego, and IMHO he talks a lot.
Has issues with Wall Street salesmen making tons more than PhD professors.

GR

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Post by Loitering Without Intent » Mon Jan 12, 2004 12:21 am

Hedging with options is another alternative form of protection.

There are no specific event exclusions with options, but then options aren't available on all stocks, and even where they are available, not all of them are liquid enough to get "reasonable" prices consistently.

Overall, I'm yet to see an unleveraged stock trading system where the returns far exceed the expense of the insurance (options or guaranteed stop losses). It's usually the other way round; the cost of buying protective options on every trade almost always results in significant losses.

Of course, I'm happy to be educated otherwise. :)

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Post by Kiwi » Mon Jan 12, 2004 1:25 am

Personally the protection I take against black swans and amusingly arrogant professors (great popular writer though) is:

- diversify so that falling swans dont kill me
- be aware of report times when day trading to avoid holding positions at these times
- similarly I would be reluctant to enter certain positions the day before a major announcement.

Hedging with options has always seemed too expensive to me. Better to be aware and diversified. Remember also that half of the black swan events are likely to move the market in your favour.

John

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Black Swan

Post by shakyamuni » Sat Feb 07, 2004 3:44 pm

One good way to avoid Black Swan events is to see them coming ahead of time and get out of the market.
Last edited by shakyamuni on Sat Jan 08, 2005 4:46 pm, edited 1 time in total.

Ghostrider
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Re: Black Swan

Post by Ghostrider » Wed Sep 15, 2004 12:01 pm

shakyamuni wrote:On a jovial note...

One good way to avoid Black Swan events is to see them coming ahead of time and get out of the market.

Would you explain how you see Black Swan events ahead of time?

:P

richard
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Re: Black Swan

Post by richard » Wed Sep 15, 2004 1:19 pm

Ghostrider wrote:
shakyamuni wrote:On a jovial note...

One good way to avoid Black Swan events is to see them coming ahead of time and get out of the market.
Would you explain how you see Black Swan events ahead of time?

:P
The page 16 articles that are on their way to migrating to page 1 ;)

Ghostrider
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Re: Black Swan

Post by Ghostrider » Fri Sep 17, 2004 1:48 pm

richard wrote:
Ghostrider wrote:
shakyamuni wrote:On a jovial note...

One good way to avoid Black Swan events is to see them coming ahead of time and get out of the market.
Would you explain how you see Black Swan events ahead of time?

:P
The page 16 articles that are on their way to migrating to page 1 ;)

I have no idea what you just wrote.

richard
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Post by richard » Fri Sep 17, 2004 10:30 pm

someone recently wrote that it's the articles on page 16 in the paper that migrate to page 1 that can make you money...speaking fundamentally of course :) I was pointing out that there is truth to that wrt black swans.

The small story on page 16 becomes the Big Story on page 1.

Today, if I were to guess, I would say the impending bankruptcy of San Diego, California is a potential...but that is pure guesswork.

Speaking mechanically, there have been systems in the past based upon rating news stories appearances with a points-based system, depending on their page location, length, and the periodical they were published in. You keep records and observe the reaction in the market, and depending on the short term reaction you trade mechanically.

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