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Long post -- TRADING FAST MARKETS, excerpt from Alpha Trader. Super relevant right now.
1. Correct position size is the difference between winning and losing in a crisis. Too big is not OK; you might blow up or get fired. Too small is not OK either; you need to seize the moment.
Trading in fast markets is when the most money gets made and Alpha Traders emerge. I remember as volatility went to the moon in 2008, I changed my normal trade size in USDMXN from 20 million to 3 million and I was still amazed (scared) by the volatility of my P&L. If you can size dynamically using forward-looking estimates of volatility, that is ideal. Look at what options markets are pricing for 1-week volatility. If you can’t do that, look at the average daily range over
the past five days.
2. Keep an open mind and use your imagination. When COVID-19 hit, the market took oil from $65 to $50 as concerns about consumer demand knocked a market that was already bulled up on “cheap” energy stocks. Then the OPEC meeting in early March crumbled and crude plummeted from $50 to $27 in a week. The pressure from COVID-19 started the ball rolling then the Saudi pledge to pump like crazy broke the back of the oil market. Anyone watching oil go from $65 to $50 might have thought that was enough of a move. “It’s a big move! I’m going the other way!” Not a good plan. Which leads to the next point about crisis markets.
3. In crisis markets, there is no such thing as overbought and oversold. Don’t be the person that fades the whole bear market all the way down. In a crisis, stocks can stay oversold for ages and then get wildly overbought days later. You need to differentiate between run-of-the-mill sentiment driven risk aversion and crisis risk aversion.
Most risky asset sell-offs are routine affairs that should be traded using sentiment and overbought and oversold signals. When you see put/call ratios or the Greed & Fear Index or DSI or whatever positioning indicators flashing a reversal signal, it is normally time to pounce. But in a real economic or financial crisis, these signals are useless.
4. Have courage. Insane markets are the reason you got into this business. Don’t hide under your desk and hope for the tornado to pass. Get involved and trade like you know you can. Don’t put yourself in a position where you look back years later with regret. It is better to try and fail than to forever wonder what might have been.
By the time the 2008/2009 Global Financial Crisis was over, careers were made and lost. Some of those lost were not people that blew themselves up but just traders that sat there doing nothing while their peers extracted insane P&L out of thin air. Most of my best trading memories are from crisis periods because these periods deliver fast, volatile and exciting markets.
Like any high stress profession (pro sports, jet fighter pilot, professional poker...), trading success comes down to how you respond in the periods of extreme stress. Don’t be shy, get involved.
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