Long/Short RiskTrading Plans
To calculate your stop losses, find the historical worst returns for each individual spread. To pull this off, you have to calculate the historical returns of the spread and then weight them. This requires using the spread’s all time returns. Calculate the return for the long side’s days historically, calculate the return for the short side’s days historically, and then created a weighted average of those returns. These should go all the way back until either the long side or the short side ceases to exist.
Then sort them from highest positive return to lowest negative return and use excel to count the returns. Multiply the count of returns by 10%, 5%, and 1%. That will give the row number for the spread’s 10th percentile worst return, 5th percentile worst return, and 1st percentile worst return. When the spread has fallen below the 5th percentile worst return, exit both the long and short position to close the spread. This assumes the 5th percentile return is not a ridiculously high loss, like 30%. A 10% loss should be a good benchmark for exiting a spread.
The last issue is tracking the spread’s returns. If fortunate, your brokerage platform has a “Pair Ratio” indicator into which you can type in a Long Asset and a Short Asset. It then divides the long asset price by the short asset price and charts the path of gains and losses for the spread. You want upward lines. You can emulate it in excel by taking the long closing price and dividing it by the short closing price all the way back until one series of closing days’ cease to exist. By graphing that chart you can keep track on the individual position, and if its increasing or decreasing over time.
In the case things go really wrong, you should always close out your portfolio, the entire portfolio at a loss of roughly 20% total invested capital. If you lose the entirety of this portfolio value, exiting your trades and revisit your investment process. Stepping aside to analyze your system is more important than sitting in the market and absorbing this loss.
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International Economic Analysis:
- Major Currency Economic Summaries
- Performance of Major Imports and Exports
- Mandates of Central Banks versus Expectations
- Performance Indexes of Major Economies
- Economically Correlated Currency Projections
- Large Funds Currency Sentiment Readings
- List of Technical Indicators to Look For
- Occasional: Foregin Exchange Technicals Markups
American Markets Analysis:
- Summaries of American Economic Structure
- Performance of Major
- Federal Reserve Mandate versus Expectations
- Performance Indexes of U.S Economy
- Economically Correlated U.S Dollar Projections
- Large Trading Fund Index Sentiment Readings
- Market Wide Earnings Versus Valuations
- Fundamental Ranking of U.S Business Sectors
- Best and Worst Future Consensus Estimates
- Occasional: Firm Fundamental Strength Report
- List of Technicals to Look for While Trading
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