Obligatory Brexit post
I've had a few questions along the lines of "what are you going to be doing to prepare your trading system for Brexit?" (and I'll admit there is a strong element of bandwagon jumping here). The short answer is nothing. The slightly longer answer forms the rest of this post.
(This is not a post about whether we should be in or out. If you're interested, I'm voting to remain. Rather than retread all the arguments about this I can't do any better than recommend you read chapters 8 and 9 ofthis excellent book. If you're too lazy to do that then I will point out that nearly every respected economist or grouping thereof has suggested that leaving will have significant negative economic costs. I could also point out that you probably shouldn't be voting unless you've done some proper research first.
Any weblog remarks trying to interact me on the political facet of this debate could be deleted. That's what twitter is for men.)
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| Nigel Farage was a commodities broker. Draw your very own conclusions. Source: reflect.Co.Uk (image shopped of route, but too exact no longer to apply) |
Change of route
Firstly should I change the direction of any of my trades? For example, put on a short GBPUSD position in anticipation?
Lest you've forgotten I run a systematic trading machine, trading nearly forty futures markets the world over. A couple of critical factors there. The first is the "across the world" bit. Quite plenty of the portfolio will be in general unaffected by using Brexit.
The second, more important, point is the word systematic. I didn't put "systematic mostly, except when I feel like putting on a different position". If you want to trade in a discretionary way, be my guest (though you'd still benefit from using a systematic position management framework like the one described in my book). But if you're going to trade systematically, then do it properly. We can't backtest these kinds of interventions, yet we made money in our backtests.
Actually I'd seriously question why anyone would bet on Brexit. It's a very close run almost binary event and there is no insider knowledge available (though this might work and even then the exit polls on a very close vote might come out wrong). But it's your money.
Change in chance
This is a more interesting point. I scale my positions according to expected risk. But for expected risk I actually use historic volatility. What I do not use is option prices, i.e. implied volatility. Now if you have a terrifying binary event approaching then historic volatility may well not reflect the true uncertainty in the market.
It's no longer the equal time scale but going into payroll numbers the market frequently turns into eerily quiet however if you wanted to sell one week vol you'd get a miles bigger top class (that is some thing the author did at the same time as nevertheless trading options at an funding bank. Never once more).
It does appear reasonable then that we have to growth our expectation of volatility, and for this reason reduce our positions, to mirror the upcoming Brexit event.
(If this is a topic you're interested by it would be remiss of me now not to plugthis super paper)
In practice however I am no longer going to reduce my positions. This is for some motives.
Firstly I do not have a GBPUSD role, or indeed EURUSD, although I think I may want to prevent myself taking any on before polling day. My positions in other markets are much less manifestly uncovered to Brexit.
Secondly historic cable vol is clearly quite high already, reflecting the swings inside the polling numbers. Using realised rather wouldn't make that a great deal difference.
Thirdly, and most importantly, this is not some thing I've finished systematically earlier than or properly backtested. I do not have the generation or the time to put in force this properly, and frankly the benefits would be very small compared to different projects I need to paintings on so I in all likelihood in no way will. It's now not really worth doing in a half assed manner.
Note that huge hedge price range like my former employers AHL do use implied vol as an input into function scaling, but then they have got the time and the sources to do it well.
Just out of curiosity...
Out of interest I concept I'd see if my portfolio looks to have a sturdy sensitivity to an in or out.
I don't trade FTSE, but even if I did it would only be a few percent of my portfolio. I trade both GBP and EUR against the dollar, but as it happens I'm flat in both right now. I trade European equities, which I guess could suffer a bit, and also short European equity vol. I'm long german bonds, which I guess might go up, and French bonds which might do anything (probably go on strike).
My biggest positions right now are: long soybeans, Eurodollar, French bonds, short VIX, long US 20 year bonds, bunds, short copper, long Korean bonds and long the S&P 500. Apart from the French bonds and Bunds there is nothing there that is exposed to Brexit, and even these will be second order effects. It doesn't even look like a strong "risk on" or "risk off" theme, though I look to be a little bit more "risk off". Overall my risk is around 3/4 of the long run average, reflecting relatively weak signals.
I trade pretty slowly, so it's unlikely this will change before polling day. As always diversification is the best weapon against instrument specific risk.
Equities, currencies and hedging
In fact my biggest sensitivity to Brexit is in the non-futures part of my portfolio. I have some UK equities that I trade purely systematically (though not automatically), and a buy and hold diversified portfolio of ETF's covering various asset classes and countries. Again it's "buy and hold" not "buy and then sell if I get a bit scared with some tactical trading when I feel like it". There will be no trading here.
The ETF's are not currency hedged, so a GBP devaluation following brexit would benefit them (I measure everything in GBP value), ceritus paribus. The effect on stocks is a little tricker to predict, but I would imagine my UK stocks would hurt - perhaps 5% at worse? A huge one day drop which will probably be partly reversed, but not the end of the world.
As I've said before my futures trading account is funded by a long stock position, which is in a mixture of UK stocks and a European ETF IDVY; hedged by a Eurostoxx futures short. This is a more interesting little portfolio; ignoring the effects on stocks if the pound gets hammered then in GBP terms this portfolio will go up in value - there will be a gain in the value of the ETF but the futures hedge won't move since it's unaffected by currency movements.
I try and keep my currency balances spread fairly evenly, so I do have some Euros for margin purposes and a bit extra which again could gain in value.
Conclusion
It's my policy (read this) to rarely intervene in my portfolio (this was the last time when 2 year german interest rates went below zero - 10 year rates have now done the same but I'm still trading bobl and bunds since their volatility has remained high enough). So it shouldn't be a huge surprise that I'm not intervening now.
Handily it doesn't look as if Brexit will affect my portfolio too much, since otherwise it would be more difficult than ever to sit on my hands - something that is usually the best course of action.
