- 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.
The 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.
If 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?
You 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.
Just because you think it's worth 45, doesn't mean everyone else agrees. You'd ideally want to stop out somewhat close to your open and reassess your trade, and maybe even reverse on a break under. I'd rather get out at 38 and look at buying in again at 30 than holding and hoping.
because your strategy/estimation looks like not perfect in this case, and you may consider to cut your losses at 38, and not become broken if it goes down to 20.
I’ve never used the stop loss. Not once. It’s the dumbest concept I’ve ever heard. [If a stock goes down 15%] I’m automatically out. But I’ve also never hung onto a security if the reason I bought it has changed. That’s when you need to sell.
He is long term investor, and probably invests without strategy but by researching "the reasons".
Trading strategies is more for shorter term investors, when circumstances can change very fast while you are visiting bathroom, and induce significant losses, that's why you need stop loss to limit your risks in such cases.
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.
The 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.
- 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.