Managing Trades In The Guillotine

Here is a update of how I’ve managed the Telecom multi-way spread.  I will walk you through the various ratios I’ve traded, and decisions I’ve made along the way.

Chart 1:  I constructed this spread to act as my anchor chart.  I use this chart to make decisions about how the relationship is holding up, as a whole.  Weighting decisions are made based on where and how the SP500 and the individual stocks in the spread are trading.

Chart 2: This is the ratio I started trading the spread.  Coming into December I was generally bullish for a number of reasons.  When I initiated the position the SP had pulled back to what I considered support.  My original weighting was skewed to the long side quite aggressively.  I was a an aggressive buyer first and a passive seller second.  The green arrow marks the bar where I initiated the position.  I remember two things surprised me when I initiated the position: one, how strong the market was, and two, how strong FTR was.

Chart 3: Now that I’m in the trade I have to manage the risk.  What do I know about the relationship besides the fundamental and seasonal edge?  I know the volatility, and the TFE.  I lighten up when the trade outperforms its normal volatility, and I lighten up when the trade is getting “old”.  The TFE tells me that I’ve got 25 trading days in the trade total (medium term) and 10 days short term.  Count the bars from the previous swing low in the chart above, bar number 11 intersects the blue line to the upside, which is late in the game, on a short-term basis.  My volatility models tell me to expect $1.60 per day movement.  You can probably eyeball the price movement in the chart and see that it had greater than a $1.60 move. The trade did what I hoped it would.  The line is where I adjusted the ratio and lightened up on the trade.  Keep in mind, the market is ripping here so I’m a net seller into strength.

Chart 4:  Now we are getting both late in the game based on the timeline for the trade and combined with a very overbought market.  I’m not looking to get out of the trade, but to readjust my hedges so that I can stay in the trade and not get shaken out.  By the end of the day, I’ve stopped out of my extra long positions, and I’m back near my anchor chart spread ratio.  As the market is selling I’m taking risk off the long side and my shorts are offsetting the losses to the remaining long positions.  Get it?  The blue line marks roughly where I adjusted back to the current ratio.

The trade is for December, and I’m waiting to see what the next couple trading sessions bring.  A pullback to 1216 or lower and I will be taking off some of the hedges and adding back some additional long exposure.  Dynamically adjusting the position as we go.

Overall the trade has been positive, but not as good a performer as I would have liked.  The longs have underperformed, somewhat.  It’s still early in the month so I can’t complain.

I hope this wasn’t too confusing.  I’m sure it created more questions than it answered.  With any luck you should have some insight into how I trade around a position and adjust based on what the market is doing.

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