Looking for Pro firm
- Thread starter Chuck Krug
- Start date
No way. I'll bet you right now a dime to a dollar that the OP's head is spinning. He doesn't have a f*cking clue now what you are offering. Take my word on this. It's a strong as oak.
Portfolio margin adds no merits to this discussion because portfolio margin itself is highly complicated in terms of what it is and how the margin is calculated. Now adding 10 to 1 leverage to something that is ambiguous at best is going to end in disaster. Here's how we solve this dark horse. You don't have to pay for this. It's on the house. Don't ask this guy about his strategy. Don't ask this guy what he is having for dinner tonight. Simply explain to him the math. What he puts up and what he can lose. We can save our existential conversations for another thread. What we need here is simple and concise math. Trust me on this.
Most people don't understand leverage, including the U.S. government.
The grossest leverage abuses of all came in an area that has little to do with trading, real estate. Joe Blow receives the message from friends, family, Uncle Sam, and his favorite A.M. radio show that owning a home is as American as apple pie, that real estate prices are going to keep going up forever, and that he is an idiot if he doesn't own a home.
So he goes out and gets a mortgage at 90% LTV, and possibly borrows the money for that (because he also has credit card bills he should have been paying off), thus leveraging his entire fucking net worth by an order of magnitude, and then 18 months later the house has dropped in value by 40% and he is laid off from his job. And the whole process as just described is the housing bubble in a nutshell.
The answer isn't ignorance, or restricting opportunity for those who know what they are doing. No matter how fool-proof you make something, along will come a bigger fool. The answer is education. Giving people the knowledge and the tools to make a responsible choice, and then letting them decide for themselves.
Traders of all people should not be making appeals to the nanny state. Not saying that you're doing that... it's just a peeve of mine in general. There are asshole politicians who would outlaw margin completely, or, hell, even outlaw trading completely, for the good of the masses who supposedly need coddling and protecting. We shouldn't encourage that attitude, even indirectly. We should encourage transparency and clarity and responsible adult choices.
Dark horse, all I'm asking is we remove the words portfolio margin from the discussion. It's simply not applicable anywhere in this discussion. I knew the second that guy mentioned those two words that this trade was going to go south.
Fools will be fools, Mav. I don't think you're giving the guy enough credit. But to the degree there are true fools out there, you and I can't protect them. And I don't think we should make quixotic attempts to do so by denying smart, responsible traders access to good tools and good conversations regarding those tools.
Like mountain climbing or professional race car driving, trading in and of itself, for the unwise and uneducated, is a dangerous endeavor to undertake. (And you don't hear Charles Schwab telling anyone that.) If the bar was set by the fuckwit who can barely stir soup without wearing a helmet, there would be no cause to talk about trading at all. For those who are slow to understand, let's help them through clear communication and good conversation, not trying to restrict what's talked about.
I appreciate the nuanced response Darkhorse and I do understand what you are saying. However, your comments miss some small subtleties about the nature of leverage and its impact on the risk/return profile in the context of a market neutral strategy.
So, while I agree with your general statement regarding leverage as simply an "amplifier" of what is already there, it's not entirely the case. There is more to it than that.
I should clarify that when I'm talking about "utilizing more leverage", I do not mean simply taking existing positions and scaling them up. I'm talking about adding new positions. (That said, even scaling up existing positions could potentially increase the Sharpe ratio due to non-linear trading costs.)
The key point to understand is that market neutral strategies can change in their risk/return profile as leverage changes. Said more precisely, the expected sharpe ratio increases as leverage increases.
This can happen for a whole host of different reasons. There is sampling error, non-linear trading costs, non-linear shorting costs, more precise portfolio hedging that is only available at higher leverage levels, among other things. If you want to think of it graphically as an efficient frontier, the slope of the efficient frontier simply continues to increase as risk and return increase. Of course, at some point, the marginal increase in sharpe ratio slows down. But my point here is that the sharpe ratio can keep going up as leverage is increased (At some point it might hit an inflection point, but that point might be 50-to-1 or higher).
You did make an important distinction that, for some strategies, there may be some threshold leverage required simply to implement the strategy in the first place, and thereafter it's simply an amplification process at work. This is correct as a generalization, but it's not correct as a rule. If the efficient frontier is increasing with leverage, then one would want more leverage - at least to a threshold that one would consider reasonable given the capital base.
Anyhoo, the main point I want to make here is that - in the market neutral world at least - leverage is a much more complicated dynamic than it is in other trading strategies.
Generalizations, generally speaking, are no longer generally applicable.
Quote from Jay_Ap:
I appreciate the nuanced response Darkhorse and I do understand what you are saying. However, your comments miss some small subtleties about the nature of leverage and its impact on the risk/return profile in the context of a market neutral strategy.
So, while I agree with your general statement regarding leverage as simply an "amplifier" of what is already there, it's not entirely the case. There is more to it than that.
...
Anyhoo, the main point I want to make here is that - in the market neutral world at least - leverage is a much more complicated dynamic than it is in other trading strategies.
Generalizations, generally speaking, are no longer generally applicable.
Thanks Jay and I am sure you are correct. As you figured out, I was speaking in very general terms for the sake of communicating a point.
I think the generalization has merit, though you are also quite right that certain complex strategies derive part of their edge from strategic leverage availability under certain circumstances.
In fact I can see a business model comparison: Some businesses have lower risk via access to a line of credit (a form of leverage), depending on how intelligently they use it and when.
So, yep. Point taken. We are feeling out the elephant and meeting in the middle here. And you are probably correct too in your general realization that first loss programs are not going to be the ideal for strategies that have highly unique leverage utilization aspects to implement properly.
Did you just read his follow up post? LOL. Pay me. I won this bet.
Look, I'm trying to help you. I'm not even talking about leverage that is how confused you are. I'm not trying to save anyone. What I'm asking you to do is simply provide the math. Not get involved in a deep meaningful conversation about the nature of risk. Read this guy's response and tell me he understands. Do it with a straight face if you can.