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Couple of random thoughts: - Building things like this is always great. And its a fun site to poke around on. - I would not count on this approach or expect i
by HFguy 4y ago
Couple of random thoughts:
- Building things like this is always great. And its a fun site to poke around on.
- I would not count on this approach or expect it to be reliable in terms of actually hedging. Correlation, as a measure, has lots of issues. You are boiling down a lot of complex relationships into a single number. While it is convenient for many calculations, there are many problems. For example, many asset classes will go through periods with positive correlation and then later, negative correlation. This is due to a factor driving both securities price becoming more or less volatile compared to the other drivers. E.g., recent increased volatility around inflation expectations driving correlations between rates and equities. Whereas, few years ago, inflation was not driving anything.
- One alterative approach is to have a "risk model". Which essentially decomposes a security into drivers. Each security then represents a basket of these drivers. You can then use this model for range of purposes. While not perfect by any means, the model contains more information than a correlation. These too have a range of issues and creation and use is as much art as science.
- In general, you won't find many negative (or even very low) correlations across individual equities. Most stocks are driven by a common set shared risk factors that drive much of the risk. But if you can find negatively correlated securities (or lowly correlated), then that is certainly helpful.
- deltree7 4y agotl;dr -- All trading strategies work, until they don't. And most people blow up their account, because their trading strategies worked for a long time.
- vasco 4y agoThe amount of engineers that discover finance an the incredible, flawless, never-gonna-go-wrong-strategy of being short volatility and feel great about their results for a long time before blowing up their accounts never ceases to amaze me. Speaking for a friend, of course.
- riku_iki 4y agoDid friend forget to put loss stops when issuing orders..
- tdhz77 4y agoNot sure about the friend, but it happens to the best of us. Somebody on Wall Street has my money.
- riku_iki 4y agoI am trying to understand this part. Setting stop loss for qualified trader should be like looking around when you are crossing the street on intersection. There some people may have gambling problem, or software has bugs, but it is another story..
- tasuki 4y agoIf I think a thing should be worth 45, and I buy it for 40, and then it goes down to 30, I'd rather buy more than sell? I've never understood stop-loss, it seems to me that by using stop-loss, one is basically saying "I don't know what the fundamental value is and if it goes down I want to sell". Then, why buy the thing in the first place?
- somebodythere 4y agoYou long an asset because you expect to sell it at a higher price (or because it hedges against some other asset in your portfolio). You short an asset because you expect to buy it back at a lower price. Not every strategy has a strong opinion on the fundamental value of an asset (none of the strategies I run do), and even those that do, might place an offer higher than their fundamental value because they know that the other side of the market is willing to pay that higher price. Similarly, one might sell an asset below their fundamental value because they believe the price will continue to move against them in the short term. A strategy that indiscriminately buys more of an asset as the asset price goes down only works with an infinite bankroll. Such a strategy run with a finite bankroll will necessarily blow up eventually. Rigid stop losses mostly just increase the volatility of a strategy though (which also contributes to portfolio drag). A sustainable strategy harvests volatility of the underlying (mean reversion) and/or dynamically deleverages (momentum) as the price moves against the entry.
- huijzer 4y agoTL;DR: Correlations does not imply causation. Having said that, if you can find a negative correlation AND there is a strong reason to believe that the negative correlation will hold as long as X and Y hold, then the tool could be very useful.
- HFguy 4y agoYes, agree, correlations don't imply causation. The TLDR is more that correlations throw a lot of information away.
- all2 4y agoHow would one determine what X and Y are?
- macco 4y agoThe idea is that you search for negative correlations and then you look into the two asset, if there is some relationship. For example if the price of oil goes down the stock price of Ford should go up. The correlation is only a first indicator.
- bumby 4y ago>But if you can find negatively correlated securities (or lowly correlated), then that is certainly helpful. Is it more likely to find negatively correlated securities across industries, like the SPDR ETFs, rather than individual stocks?