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There is an expression in trading about risk management which essentially says
: set a threshold of pain (mental stop) and a threshold of panic (real stop).
There is a systemic problem with hedge funds. If you trade two instruments
which are assumed to be negatively correlated to one another...the Prime
Brokers will allow you to carry almost an infinite amount of leverage.
If I can carry almost a trillion dollars in notional value with less than 1% in
capital in a traditional long/short then a loss of correlation can be
devastating. LTCM short was in bonds against a long in a number of
areas...some in emerging markets and some simply in U.S. Blue Chips which were
held synthetically long (long calls/short puts). When leverage like that is
allowed...the doubled edged sword of leverage...swings back the other way.
The good news is that in the future the OTC derivative market will probably get
regulatory treatment similar to the listed market(In all fairness I work for a
listed market CBOE and I have what might be viewed as a biased view)in terms
of margins and position limits.
Scot Billington wrote:
> The recent failings of Long Term Capital illustrate the first and most
> important concept for a new trader, exit strategies and bail out points. I
> don't care about AMI, Elliott Wave, astrology, systems, fundamental
> analysis or Moses speaking from up on high, if you don't have a point at
> which you will exit every position, you will eventually go broke. You are
> not different or special. No exit, no money. This group had Salomon
> Brother's ex-bond chair, 2 Nobel Prize winners, and an ex-Federal Reserve
> vice chairman, yet they forgot the number one rule of trading, cut losses
> short. I don't care what you think, what your model says, or that the
> market can't go down because of XYZ, you must have a level at which you
> will not lose anymore money. There, literally, is no other way. Most
> things in trading can be done multiple ways. This is not one of them. If
> you are trading without a stop or exit level, stop before you lose all your
> money. You will. V. Niederhoffer (?), the other large fund to recently go
> belly up, was famous for trading without stops, too. (Isn't it odd that
> these two groups had one thing in common and they both lost all their
> money.) No stops may work for a decade, but the historically off the
> standard deviation charts move is coming at some point, and if you have no
> exit, you will go broke.
>
> If you disagree with these premises, I encourage you to respond with your
> points. The ensuing discussion may save you quite a bit of money because
> you are faulty in your reasoning.
>
> sb
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