Wed 11 Jun 2008
A new breed - Index Speculators
Posted by ray under Miscellaneous, Money Management
Index speculators, a new breed
from http://awanginvest.com/?p=415
It is educational for readers/traders to understand why commodity prices keep rising in spite of ample supply. Please read the testimony and you will be enlightened!
June 10, 2008 – 10:58 am
michael-masters-written-testimony
This excerpt of a Testimony by Michael W Masters before the US Senate has been submitted by NicT of HK which I reproduce hereunder:
What we are experiencing is a demand shock coming from a new category of participant in the commodities futures markets: Institutional Investors. Specifically, these are Corporate and Government Pension Funds, Sovereign Wealth Funds, University Endowments and other Institutional Investors. Collectively, these investors now account on average for a larger share of outstanding commodities futures contracts than any other market participant.
These parties, who I call Index Speculators, allocate a portion of their portfolios to “investments” in the commodities futures market, and behave very differently from the traditional speculators that have always existed in this marketplace. I refer to them as “Index” Speculators because of their investing strategy: they distribute their allocation of dollars across the 25 key commodities futures according to the popular indices – the Standard & Poors - Goldman Sachs Commodity Index and the Dow Jones - AIG Commodity Index.
Please read more at link at the top of page.
It is educational for readers/traders to understand why commodity prices keep rising in spite of ample supply.
Here is a bonus to go with the abovementioned article - NUGGET OF TRADING WISDOM: 2% Rule
The 2 % rule is a basic tenet of “risk management” or “capital preservation” as they are more descriptive than “money management”.
Larry Hite, in Jack Schwager’s Market Wizards (1989), mentions two lessons :
- Never bet your lifestyle ie never risk a large chunk of your capital on a single trade.
- Always know what the worst possible outcome is.
Hite goes on to describe his 1 % rule which he applies to a wide range of markets. This has since been adapted by short-term equity traders as the 2% rule:
|
The 2 Percent Rule: Never risk more than 2 percent of your capital on any one stock. |
This means that a drawdown of 10 consecutive losses would only consume 20% of your capital.
Ana aka IDkit
Ag. Moderator
June 11th, 2008 at 6:01 am
“The 2 Percent Rule: Never risk more than 2 percent of your capital on any one stock.
This means that a drawdown of 10 consecutive losses would only consume 20% of your capital.”
This is incorrect, if your 2% rule is taken from your current account balance at the time of the trade.
June 11th, 2008 at 7:07 am
Colin
When we do our annual books, we usually take the capital say at Jan 1 at the beginning of the account year, and in this context, I base the 2% rule.
By using say the Turtle formula, if we stick to 2% of capital, when we work out our RR, the final result should be 2% maximum loss per trade, which is what matters.
What was in the post about the consecutive losses was a quote.
However, you can prefer to do your rate of returns after each trade which is not the usual mode for most, as it would be too time-consuming.
If we stick to 2% rule, how you base your returns should be good risk management.
Thank you for your views.
Ana aka IDkit
Ag Moderator
June 12th, 2008 at 6:14 am
The whole idea behind a strategy like only risking 2% is your risk of ruin or risk of draw down is low enough that you can trade without worrying about being extremely unlucky. One of the drawbacks of avoiding risk of ruin is you also limit your potential gain. Obviously, staying in the game is more important than maximising returns, from a life perspective.
However, by not tailoring your risk strategy according to your current balance and not your start of year one, you have the potential of not adding enough risk to your particular situation or risking too much for the calculations you’ve made. Once you lose a percentage of your trading bankroll, the next percentage loss will be a smaller amount than the previous loss, but still as crucial as to deciding the variance and standard deviation that your trading will go through. In other words, you’re short changing either performance or increasing risk for no upside, because you’re not taking advantage of the math.
Sports betters have known about this for years. Many traders take the approach that close enough is good enough, or that its too much time calculating. Rest assured though, anyone with a good sample who back tests a more dynamic risk system against past trading would find more profits and less drawn downs than their current system. A simple 2% at the start of the year system may be easy to manage, but you can’t convince me you aren’t, if not slightly, short changing yourself.
June 12th, 2008 at 6:24 am
Colin
I concur with you.
My point is that novice traders can start with a simple formula of 2% of capital each time they take a trade to work out the RR.
As they progress, they can be more sophisticated like you.
Good post to add value here. Thank you.
ANA aka IDKIT
Ag Moderator