How do I reduce risk in this situation?

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hlpsg
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How do I reduce risk in this situation?

Post by hlpsg » Sat Jul 10, 2004 9:14 am

What would you do to reduce risk in the following situation?

Let's say your not a day trader, and you're trading futures (wheat) where a 1 cent move is $50. You go long at $250.00 and you buy one contract of wheat. You place a stop loss simultaneously at 249.90 hoping to reduce your risk to (0.10 * 5000) = $500.

The very next day, wheat opens and starts trading at $242.00! This triggers your stop loss and you sell, making a loss of (250 - 242 = 8 * 5000) = $40,000!

This situation wipes out most of your capital. How will you reduce your risk in this situation, to whatever risk you decide to take (giving some leeway for slippage of 3 - 4 cents?)

I could think of 2, but both did not appeal to me at this time.

1) Day trade, liquidate all holdings at close and buy back the next day.
2) Trade options (I don't really know too much about this currently)

Thanks, I'd like to hear your thoughts, and also any other such dangerous risks someone might easily overlook during system testing.

richard
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Post by richard » Sat Jul 10, 2004 9:57 am

I don't think your numbers are right. At this time September wheat is trading for about $3.40 per bushel. 5000 bushels to a contract. A penny move is worth $50. There is a limit of $0.30 per day that applies to everything except the spot month.

If wheat opens Monday and gaps down to, say $3.20, you have a loss of 20 cents X $50 = $1000. Your stoploss, if you had one, would presumably fill at this level.

A stoploss will fill on a gap-up or gap-down but it will not fill where you intended it to. That is a risk you assume in commodity futures, especially pit-traded commodity futures.

You could have the following situation: you go long on wheat, with a stoploss, but wheat opens limit-down for day after day. There is no trading at limit-down and you lose thousands and thousands of dollars.

That meltdown risk is a risk of futures. If you do not want to face this risk, you can as you say trade options or some other market (Forex for instance).

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Re: How do I reduce risk in this situation?

Post by verec » Sat Jul 10, 2004 2:17 pm

hlpsg wrote:This situation wipes out most of your capital.
If by "most" you mean, say, more than 75%, doing the math backwards tells me that you started with about $50,000.

Now, excluding slippage, the loss you were willing to accept ($500) was about 1%. So far, so good.

The problem is that your stop was well within the "noise" level, assuming that your figures were realistic, and I guess that some simple measure, like the ATR, would have told you to place your stop way below the mark you did.

In turn this would have meant that your risk was far more than the 1% you described, which really means there is really no way you should have taken that trade, given your starting capital.

If you are in this kind of set-up, where your system tells you to enter, but your capital tells you that you can't, forcing the issue is just a call for luck, good or bad. Which is most likely? :roll:

Demon

Post by Demon » Sun Jul 11, 2004 3:31 am

Hi Hlpsg, you're math is incorrect. You correctly state that a 1c move is $50, you go long one contract, but you then multiply the 8 cent move by $5000 not $50. The price of wheat is in cents per Bu not dollars.

Hope this helps.

hlpsg
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Post by hlpsg » Mon Jul 12, 2004 6:45 am

richard wrote: That meltdown risk is a risk of futures. If you do not want to face this risk, you can as you say trade options or some other market (Forex for instance).
Richard, thanks for your continuing patience, I really appreciate learning here than learning out in the market, so thanks!

If I may ask, how is forex different from futures? Is there some kind of rule that protects the speculator?

hlpsg
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Post by hlpsg » Mon Jul 12, 2004 7:03 am

Darran wrote:Hi Hlpsg, you're math is incorrect. You correctly state that a 1c move is $50, you go long one contract, but you then multiply the 8 cent move by $5000 not $50. The price of wheat is in cents per Bu not dollars.

Hope this helps.
Darren, you are absolutely correct, it should have been 0.08 * 5000 instead of 8 * 5000.

richard
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Post by richard » Mon Jul 12, 2004 8:21 am

hlpsg wrote:
richard wrote: That meltdown risk is a risk of futures. If you do not want to face this risk, you can as you say trade options or some other market (Forex for instance).

If I may ask, how is forex different from futures? Is there some kind of rule that protects the speculator?
Forex is basically a cash market, so your losses are limited to your cash invested. If you are blown out, you won't owe your broker any money.

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FX

Post by Bollinger » Mon Jul 12, 2004 5:36 pm

Richard,

Your comment that "your losses are limited to your cash invested. If you are blown out, you won't owe your broker any money." is not correct with most brokers. FX positions are forward contracts for the delivery of a certain amount of foreign currency, and if your account doesn't have sufficient cash to make that delivery (or the loss resulting from adverse price movements) then you'll still be liable to make up the difference.

I think RefcoFX had some sort of guarantee that you wouldn't be liable for losses in excess of account value, but that's certainly not the norm in the interbank market.

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Post by richard » Mon Jul 12, 2004 6:00 pm

Thanks, Bollinger, for correcting my mistake.

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Post by Forum Mgmnt » Mon Jul 12, 2004 6:15 pm

Many brokers offer guaranteed fills at your stop however. I'm pretty sure Oanda and RefcoFX do this.

This means your risk can be limited to what you decide. The price for this is increased execution costs in form of a greater spread.

You'll also find that your stops get filled the moment the other side of the trade hits your stop. So if you have a stop to buy at 105.10 and the ask gets that high your stop will be filled there even if the highest actual trade previous to that had been 105.05.

- Forum Mgmnt

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Post by richard » Mon Jul 12, 2004 8:36 pm

the point is then that FX is lower risk in terms of potential liability in event of a meltdown or meltup -- is that not correct?

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Re: How do I reduce risk in this situation?

Post by NOIZE » Fri Jul 16, 2004 12:09 am

to reduce risk, trade with a bigger account. for this scenario, one way to better your esteem is to rationalize it as "at least it wasn't an exchange limit and i wasn't overtrading at all......"



hlpsg wrote:What would you do to reduce risk in the following situation?

Let's say your not a day trader, and you're trading futures (wheat) where a 1 cent move is $50. You go long at $250.00 and you buy one contract of wheat. You place a stop loss simultaneously at 249.90 hoping to reduce your risk to (0.10 * 5000) = $500.

The very next day, wheat opens and starts trading at $242.00! This triggers your stop loss and you sell, making a loss of (250 - 242 = 8 * 5000) = $40,000!

This situation wipes out most of your capital. How will you reduce your risk in this situation, to whatever risk you decide to take (giving some leeway for slippage of 3 - 4 cents?)

I could think of 2, but both did not appeal to me at this time.

1) Day trade, liquidate all holdings at close and buy back the next day.
2) Trade options (I don't really know too much about this currently)

Thanks, I'd like to hear your thoughts, and also any other such dangerous risks someone might easily overlook during system testing.

Nathan
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risk.

Post by Nathan » Fri Jul 16, 2004 2:30 am

the basic idea is one I have spend a good deal of time considering. For me it means ballancing the desire to be aggressive based on intended risk (stop levels) against the potential loss on blow out trades.

In your particular example, the cbot wheat contract's face value is not even 40k, so if u are long just one contract u could not possibly lose that much unless something seriously crazy happens.

I factor an atr volitility measure, underlying contract value, and my conseptual view of what a realistic potential risk is. Basically getting numbers from two different criteria and using the smaller of the two.

Perhaps the best way to get a handle on the problem, is to run some simulations, over a ton of markets, and go look at the price action and losses on the worst trades. alternatively, perhaps go back over historical data, and measure worst case situations like large gaps and limmit days.

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Post by hlpsg » Fri Jul 16, 2004 8:35 am

Thank you for the reply.

Yes I made a mistake in my interpretation of the prices of futures, as they were in ASCII format and they came something like 232.50 and instead of taking that as $2.32-1/2 I took it to mean $232.50. Sorry about that.

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Post by Honeycomb » Mon Sep 10, 2007 2:28 pm

This kind of thing happens in mini contracts pretty often. Big selloff in the illiquid overnight session, then opens way down, takes out a ton of stops and bounces back to normal within a half hour. As was mentioned, not such a big deal for people trading daily bars as opening gaps figure into ATR, and you just wouldn't be trading with a stop that tight. If you're trading hourlies or 2-hr bars though, you can exceed your predefined risk by a whole heck of a lot.

Some ideas:

Use limit orders as protective stops. That way if opening price gaps through your level you don't take your loss until price bounces back near equillibrium.

Maybe see if your broker can do stops that don't get placed until X minutes after the open, that way you don't get shook out during opening volatility.

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Post by RedRock » Mon Sep 10, 2007 3:14 pm

Honeycomb wrote: Some ideas:

Use limit orders as protective stops. That way if opening price gaps through your level you don't take your loss until price bounces back near equillibrium.

Maybe see if your broker can do stops that don't get placed until X minutes after the open, that way you don't get shook out during opening volatility.
1. What if it doesent bounce back or fill at your lmt?

2. IB, and perhaps others have this option. you can specify a start and terminate time for your order.

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Post by Honeycomb » Tue Sep 11, 2007 12:12 pm

RedRock wrote:What if it doesent bounce back or fill at your lmt?
Then you Lose. :twisted:

Seriously though, if you look at traders like Chick Goslin, he often doesn't have a stop on overnight for this very reason. What we're trying to avoid is getting stopped out because of overnight-session shenanigans that are reversed once liquidity comes back. For fundamental-caused gaps it's either trade with a bigger account so you can wait it out, or use options as insurance.

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Post by RedRock » Tue Sep 11, 2007 1:39 pm

I use time based orders which simulate pit hours or "most liquid" sessions when possible. But then, I'm old fashioned that way...

Making daily bars which match these liquid only periods for testing / generation,is another story... :?

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