Becoming Who You Want To Be

Global macro traders thrive off of risk. In fact most traders do as without risk there is no reward. That being said one of the most important things that a trader can do is to incorporate several levels of risk management into their trading process. Lucky for us there are about a gazillion different ways to try and mitigate and at times virtually eliminate risk.

One of the first and most important risk management tools available to the macro trader is the practice of positions sizing. Position sizing is when you determine an optimal amount to risk on a trade. Obviously several factors can go into your position sizing algorithm. You can look at the probability of the trade working out. You can look at the over all risk versus reward ratio. And you can look at how much of your portfolio you want to risk. Obviously there are hundreds of potential variables that you can input into your position sizing model.

Now that you have your position sizing algorithm it is time to focus on eliminating or at least minimizing tail risk events. Tail risks are for very improbable events that most investors never even look at or consider. Any stock can go to zero. Your CEO might be committing fraud. Your town could experience a huge earthquake. These and countless other events are considered tail risk events.

One of the easiest ways to cut off tail risk is by building your position using options. When you are a net buyer of volatility, which is to say that you are long options whether they be calls or puts, you are only risking the amount that you have put into the trade. For instance if the option position costs you one thousand dollars then you can not lose more then that.

Options are very useful to cut off tail risk because they totally limit your risk while allowing for plenty of upside. In fact sometimes they provide a lot more bang for the buck then an outright stock position as they can have a lot of inherent leverage.

As with any trading strategy however there is still some risks that you must be aware of. Two of the most common are one that you may be overpaying for the options. Just like when you buy a stock you don’t want to pay too much.

The other major risk is that your time horizon does not fit the trade. If you want to hold the position for years then move on and probably pass on using options. However if you want to hold it for weeks to months then go in and check them out as you can do a lot of risk reduction using options.

Ensure that when you are trading that you look at al the available ways to express your market view. By doing this you will often use options and in so doing improve your global macro trading results.