≈ Don’t you cry tonight. ≈

Nature can teach us anything we want. Billions of years can’t be wrong, so, let’s drink from such an encyclopedia of wisdom.

Think about an onion. A bulb in the center, as the base of the vegetable, and many outer layers. These outer layers become dry and brittle the farther they go from the center.

So how do onions relate to hedging?

Hedging like an onion doesn’t mean you’re going to cry while hedging positions in your portfolio. Quite the opposite, it will prevent you from crying. Going from the center to the outer layers we have:

– Hedge one position;
– Hedge a group of positions (a system);
– Hedge a group of systems (the entire portfolio).

Let’s use a recent example: the Natural Gas futures contract, a.k.a. The Widow Maker.

Your system sells calls against /NG. However, you are a Tackle Trading Member, a smart trader, and you won’t touch them naked. So how do you go about hedging them like an onion?

– Hedge one position – Position size appropriately (max loss on each position) and buy OTM Calls (creating a Credit Spread—built-in hedge).
– Hedge a group of positions – Position size appropriately (max number of simultaneous trades, a synonym for max capital allocation on the system). You can also trigger opposite trades or trade assets that are inversely correlated to /NG.
– Hedge a group of systems – Portfolio design with appropriate position sizing.

Stay tuned traders. We are about to release a new 101 series, focused on the basics of system development so you won’t be the Thanksgiving turkey.

Chart of the Day

The Widow Maker

If you grab the chart above (Natural Gas futures, 6 months) and flip it upside down, you will see a great resemblance with Taleb’s chart “1000 and 1 days in the life of a Thanksgiving turkey”, published his famous book Black Swan. He wrote:

“Consider a turkey that is fed every day. Every single feeding will firm up the bird’s belief that it is the general rule of life to be fed every day by friendly members of the human race […]. On the afternoon of the Wednesday before Thanksgiving, something unexpected will happen to the turkey. It will incur a revision of belief.”

Replace every instance of the word “turkey” in the sentence above by “trader”, “hedge fund manager” or “investor”. These guys (obviously not Tackle Traders) have been selling naked calls on Natural Gas futures and then something unexpected happened: check the video of the day.

Video of the Day

Bring Out Your Dead!

Look what happens when people trade naked calls on /NG.