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Controlling Risk: A Hamzei Analytics-Minyanville Chat, Part 2



This is a transcript of the Controlling Risk chat hosted by Fari and Hamzei Analytics on Aug 31, featuring Minyanville professors Greg Collins, Kevin Depew, Jeff "Showtime" Macke, Greg Weldon and Jason Goepfert. The discussion covered a wide scope of topics including retail / consumer, the macro environment and general trading.

Click here for Part 1

Greg Collins: At this point why don't we open it up for Q&A.

Adam Barkeloo: good day gentlemen. I have a question... don't sell into oversold conditions, yet that's what I was groomed to do as a trader. When stocks fall, they tend to get oversold quickly. Seems you must begin to sell into up moves, no?

Jason Goepfert: I'll take a quick shot at that question. For me, "selling into oversold" is more a question of time frame than methodology. In the short-term, it rarely pays to sell into a market that is oversold (depending on your definition of oversold). But longer-term, say out a couple of months, it can be a different story. If a market gets oversold and stays there, despite readings that normally indicate a rebound, then you have a good idea that it's safer to sell longer-term. But if your time frame is 5-10 days or less, I would not look to buy overbought or sell oversold conditions

Eric Willer: what kind of effect do you think Katrina will have on prices of commodities/commodity stocks other than oil, especially since many commodity imports come up the Mississippi?

JB: FWIW, on a sentiment (not technical) basis, worst declines have historically come when AAII bullish percent is oversold.

Kevin Depew: The same is true of other OB/OS readings as well. Louise Yamada's group (when she was at SSB) published a study of these types of events a couple of years ago.

JB: Does anyone even care about Fannie Mae (FNM) anymore?

James Ellis: Schaeffer was pointing out to me, at MIM2, nobody likes the obvious ugly slow death shorts, bad charts, slowing fundies and not much risk of a buying frenzy but no SEXY down 30 pts in a day, slow bleed, so not a trade per se maybe one theme, choosing entry and exists on extremes- FNM possibly WMT, BA etc...

Greg Weldon: another macro land-mine ...

Jeff Macke: I can't speak for him, but I believe ToddO still cares about FNM, regardless of his positioning

Lynn Becker: Did anyone ever care? (just kidding)... I see the commentary on that at and think... hmmmm I should be aware of what all the fuss is about... ;)

Kevin Depew: ultimately, I'm not so sure that anyone who pays taxes shouldn't be very concerned about FNM

Greg Weldon: I think a tangent theme, applicable in this forum in particular ... is to be LONG Volatility, as a theme

Conor Sen: As a trader, it so tough to wrap your arms around the risk in FNM that it's tough to play

JB: Fannie just bleeds down to 50 without hardly any press at all.

Greg Collins: for certain - but the real problem as Conor points to is that we don't know how bad FNM, JPM really are...we are talking huge numbers without a lot of oversight, or any real disclosure.

Greg Weldon: indeed, undefined derivative risk centers ...

Lynn Becker: A question I have for the crowd is how can the "home gamer" trader make use of Succo's comments... he is always commenting on cheap option sellers, but I don't know how to *USE* that information in my trading.

Chris Kapilla: Jason, how do you feel about being long volatility? I recall a chart you posted that indicated we could be in for years of 'compressed' volatility?

James Ellis: I think after FNM bounces it could be a good long term short and buying the vols in that and some of the less followed closet financials GM, F etc. might pay some bills.

Greg Weldon: good question Chris ...

Jason Goepfert: Good point, Chris. Basically what I did was look at the past 100 years of historical vol on the djia

Jeff Macke: Lynn, simply knowing the existence of that order flow in options land, at real time, is valuable to any equity trader

Jason Goepfert: and about once a decade, we saw a period of 1,500 days or so where it never got above 20%

Jason Goepfert: right now we're at around day 600 or so

Jeff Macke: On July 7th, very near the sharp bottom lows, Succo noted that there was a virtual "selling panic" in options. That was your rally cue.

JB: Overlay long-term charts of Enron and Fannie Mae as I sent to Toddo last December. They are spooky to me, especially as Fannie convincingly busted its neckline, has retested the underside, and broke down anew. If 10 yr note breaks down further and we get Brian Reynolds historic surge in refis again, who will finance it? The ABS market instead of the GSE's?

Jason Goepfert: Traders have a tendency to get hung up on the VIX but it's only been around for 20 years, not enough time to see enough volatility cycles.

James Ellis: buy cheap vols -go out and pay for leaps on the stocks that seem destined to slow death, but not buying enough time is death, and then not actively managing the position is death, also only doing a proper amount, not excess of 2% of account size

Greg Collins: Lynn - I think the real issue for the "home gamer" is about understanding the macro dynamic and the structural issues in the market place. You can't, nor should you try to directly apply John's process to your own. The implications of compressed volatility, the existence of debt induced / liquidity driven markets are all critically important for any trader.

Jonathan Liu: I understood that the theme of this discussion was controlling risk. Can you guys talk a little more about that?

Greg Collins: At the end of the day it is critical to understand that while risks in the marketplace have not yet surfaced - that does not by any means imply that they don't exist.

James Ellis: go to cash , sell your house , buy LEAP Puts, buy gold silver and a bomb shelter, just kidding - maybe not lol

Greg Collins: the risk equation is largely a function of analyzing probabilities - most folks don't do that. They should.

Jason Goepfert: Jonathan, as far as what I look at, the greatest risk comes when marginal trades are over-leveraged. I'm not talking about home equity and the like, I'm talking about margin in brokerage accts, heavy options positions, leveraged at the rydex funds, heavy long positions in the futures. Right now, I'm not seeing them overly leveraged in most of those areas.

James Ellis: I agree probabilities of an outside event and constantly paying up a small amount so if that outside event happened you wouldn't be capsized

Jason Goepfert: James, I'm not so sure about that...

JB: controlling risk may be as simple as Jeff Saut presented at MIM2 keynote - don't let anything move against you by more than 20%. But it all depends on unique factors such as time horizon, trading/investment objectives. For instance, I could care less if PAAS goes down 20% from here, I would use it as an opportunity to scale incremental exposure.

Jeff Macke: echoing Jason's point, look for areas where "laypeople" are making outsized profits. JB:, one of the great underlying themes in terms of controlling risk was having your own personal paradigm for "downside protection". 20% is Saut's. It works for him. He sticks to it and, by doing that, takes his emotion out of the game.

Kevin Depew: The problem with "fixed" risk management systems is that cycles change and have a way of reaching into your fixed system and moving against it at the wrong times.

Greg Weldon: okay then, what is an acceptable 'per idea-theme' risk many times might you execute a strategy, if it fails once ...

JB: Macke - exactly.

Greg Weldon: how does it incorporate into the sector risk? And then the portfolio risk from various angles: VAR, % of NAV etc

Jeff Macke: One of the more insidious risks that I don't think people discuss enough is the risk that you start ignoring your mistakes.

Greg Weldon: micro bottom-up for risk

James Ellis: 20% is great but on a trading position it might be tighter on an option it might be bigger and on a little micro cap of a small portfolio position it might be bigger.

JB: Kevin Depew's work at Dorsey with the sector bell curve is a great way to monitor sector risk

Greg Weldon: man, that's a ton of risk ...

Jeff Macke: not learning from them and/or not even taking the positions off. Avoiding either panic and/or shocked apathy controls your risk.

Greg Collins: One of the major takeaways relating to the concept of controlling risk really centered on the importance of time horizon and ensuring your goals are realistic and in synch with your objectives. Succo mentioned recently that he could withstand a move in gold to $200....could you? I know I couldn't.

Jonathan Liu: I always understood pre-defining your risk on a trade to be important.

Greg Weldon: Critical. Pre-determined risk and death discipline. On that singular point, Succo has predefined his risk profile on that idea

JB: withstand gold $200? Sure, a diversified portfolio should allow for that probability.

Greg Collins: How many folks out there have a truly diversified portfolio?

James Ellis: I'd be gone

JB: I'd back up the truck

Greg Collins: That really underscores the point about time horizon pretty well.

Greg Weldon: personal comfort came out of MIM2 as a key point

Greg Collins: It's a question to consider when you read John or anybody's else's work. Steve Shobin said it best I think Greg - it all begins with an understanding of self first and from there developing an approach that YOU can follow consistently.

James Ellis: maybe after it got there

Greg Weldon: in defining a methodology, and risk profile and then sticking with it Shobin was excellent on that point.

Jeff Macke: My not being long gold (pausing to duck incoming flak from fellow profs), I could handle 200 quite easily. In fact, I'd be a buyer!
Jonathan Liu: On a single trade it's easy, you just pick a stop that makes sense and trail it up. What sometimes gets me is sector risk, for example I have a fairly high exposure to energy right now, when it's already had a huge run. Yet there is still a lot of potential in that sector, IMO. How to do you manage that kind of risk?

James Ellis: but on the way you would be puking

JB: I've allowed for that probability with dry powder to buy more, and use no leverage (read: margin)

Greg Weldon: toughest question Mr Liu

Jeff Macke: If it's making you puke, you have too much risk.

Greg Weldon: how to play with the house's money

JB: weldon: EXACTLY!

Greg Weldon: secular still stellar, but the risk is blown out now

James Ellis: take a third off - leave the rest on

Greg Weldon: my experience has been that a de-leveraging basis volatility works to smooth the ride. When it reverses, the vol will explode near-term, and slippage could be significant. A point not usually ... pre-determined

Jonathan Liu: I seldom use much leverage. Can you explain that in somewhat more lay terms, Greg?

Sally Limantour: As volatility increases or decreases in a market, do you adjust your risk accordingly? Do you have a fluid approach to risk management or do you stick with x % all the time?

JB: split-adjusted, INTC went from like $5 to $3 back in 1995ish on its way to $80 in 2000. I view the HUI the same way. My risk profile is in sync with my time horizon and my micro/macro view. That is how I manage risk in metals.

Greg Weldon: trading around a core position, adding on strength in a bull trend, then liquidating the peripheral position as vol expands. Great question, Sally. When it decreases, you can usually get a bigger position on but, then chances are greater, that you are early in the trade. It makes it riskier at the beginning of a trend but, that is when I like to be aggressive

Jonathan Liu: Okay, I think I understand now, thanks J

JB: Jim Sinclair sells 1/3 of his metals positions near interim peaks (sells strength) and buys weakness. if the trend runs after his sales, all the better for his core. If the market comes back in, he is able to buy weakness when most people are flipping out about COT raids on the metals

Greg Collins: any other questions out there? please feel free.

Jason Goepfert: regarding energy specifically, it recently made up over 1/3 of all assets in the Rydex sector funds. The only other times one sector has generated that much interest was in tech and biotech four years ago. Looking at some of the patterns around these spikes in interest, I don't think it necessarily pinpoints a top, but it does pretty good at identifying times volatility is about to pick up, and I think we're seeing that now with energy too.

Jason Goepfert: so that's one way to monitor when risk is likely to increase

Greg Weldon: what was the time lag ??

Jason Goepfert: pretty much instantaneous

Greg Weldon: to the top, from the 1/3 line ??

Greg Weldon: interesting. For sure, the swaps in Energy do NOT show signs of an impending peak. Usually the 1Q winter gasoline spreads are in 'contango', into STEEP backwardation.

JB: I agree about Energy, and took some off the table recently (XLE, OIH, etc.). Not all, just partial sales. I am nervous about all the newly-minted Energy bulls running around but I also know that T Boone Pickens said this will be the most interesting 4th quarter in his 50 years in the oil business, and he said that well before Katrina.

Kevin Depew: nor do any of the charts across the complex I follow, though that is certainly one of the more popular themes out there (that energy has peaked)

Greg Weldon: implies the price increases will stick, thru the holidays and beyond

Sally Limantour: Jason, have you done any studies on wild volatility and market tops? This is something I am used to in the commodity markets, but have never grounded with statistics.

James Ellis: Greg so you think energy has more room?

Greg Weldon: the innards suggest so, yes. Possible iceberg mentality, seen only the tip.

Jason Goepfert: Sally, I have not done so with commodities, which I think, are different than equities in terms of how they respond to volatility

Greg Collins: That's kind of what I was getting at with the comment I threw out on the buzz asking if energy is currently at a similar juncture to where the homebuilders were two years ago.

James Ellis: wow that would be amazing, if this is the tip

Greg Weldon: Sally, we did some at Commodity Corp as applied to Natural Gas in the nineties. Some of the historic peaks in energy were just exceeded this week, accompanied by accelerating momentum.

James Ellis: I am looking to add to coswf and others if we get a dip but we don't seem to be getting one

Greg Weldon: by the way, use the spreads between different time frames, ROC wise

James Ellis: interesting

Kevin Depew: yet another risk few focus on. Being unable to add to positions.

JB: see how much of this chat is dedicated to energy. Sentiment tell?

Greg Weldon: Kevin, a huge point

Kevin Depew: if, as some believe, gold is really poised to exceed 500-600, then, that is really just the tip of the iceberg. Such a small asset class compared to what most market participants are used to

James Ellis: any new thoughts on silver since Laurie brought up the physical markets having short supply?

Greg Collins: what we should be talking about in terms of risk is the enormous HnS in the BKX. And what the yield curve is saying.

Greg Weldon: land mine - BKX...yield curve to inversion

James Ellis: well that is why I was thinking long term puts in BAC, FNM etc...

Greg Collins: look at Citi on a 5 year chart

Lynn Becker: Isn't an enormous, obvious HnS in BKX just begging to be faded?

Greg Weldon: like other Anglo-home wealth reflated curves, UK, NZ, and AUD

JB: but when most people see obvious HnS (like the one forming in the Dow), don't they rarely play out as traders anticipate them?

Lynn Becker: JB: and I are on the same page. :)

James Ellis: ugly charts bounce like kangaroo's then when you are "exhausted" short

Greg Weldon: key for the BKX will be the end of declining Volatility, on the long-term charts. The momentum of the decline has slowed dramatically

Jason Goepfert: JB:, that is something Mike Santoli touched on...causation versus coincidence. Do h&s work because there is something inherent in the pattern, or do they work because other traders see them (or don't they work at all?). There was a Fed study done on h&s and if I remember correctly, those patterns were not successful on indexes, but were with individual stocks.

Greg Weldon: if that turns, when a pattern like this is reconciled, obvious or not, it will play.

Kevin Depew: on point & figure basis volatility charts are poised for very interesting upside breakouts. Not anticipating them yet, but just to be aware that the potential is there right now.

JB: J Goepfert - exactly.

Greg Weldon: dang, love those P+F charts

Kevin Depew: Greg's point should not be taken lightly. Many of these HnS patterns are taking place on long-term weekly charts. The greater the timeframe of the pattern, the larger the importance and potential magnitude of the move

Greg Weldon: send me the vol series man !!!

Greg Weldon: NOT to mention, the severe momentum divergence in BKX

Greg Collins: we are talking about going back to Nov '04. With the yield curve as it stands and the macro imbalances that's not my type of trade. As Toddo says though "you can do anything you want as long as you're disciplined"

Kevin Depew: indeed

Greg Weldon: in the post-2000 higher high

JB: I hate the banks as much as everyone else, just playing devil's advocate. We all "see" it so and the market rarely is that easy.

Greg Collins: Steve Shobin said it often "clues abound" - I'm not telling anybody to go out and short the banks here (although full disclosure I am short Citigroup) - I'm just saying that's a signal that shouldn't be taken lightly in the context of the overall risk environment / macro backdrop.

Greg Weldon: A lot of potential technical juice to grease the downside, when the macro-timing is right. Well, exactly the flattening in the ED strip is supportive to the banks. Is the Fed offering a 'tell" in terms of a bias change by conducting a derivatives meeting in NY? Sniff sniff.

Kevin Depew: I'll post the vol series tomorrow a.m.

JB: McCulley's piece suggested Fed is gonna keep going. Seems they are going to overshoot as they have every other time. Question is what happens when something snaps harder. Snoop thinks we are mid-cycle and such a pause will send us to S&P 1440.

Sally Limantour: I have been buying futures on the VIX the past month. This market is thin! What other ways would you outright buy volatility?

Greg Collins: I unfortunately have to jump into a meeting with our friend Toddo but please feel free to continue the discussion. I think it's clear that these folks are tremendously talented. Thank you for your time today - I hope you found this helpful.

Luigi Fabio: I get the feeling I'm a trifle late.

Sally Limantour: Thanks Greg

JB: Lata Collins

Jason Goepfert: Sally, something I've done in the past, and it is very basic, is simply buying straddles or strangles

Greg Collins: Thank you Fari and thank you to all of you for your time. For those of you who aren't MV subscribers feel free to shoot an email and we'll gladly set you up with a gratis month trial to check out the 'Ville. We've got a lot in the works on the heels of Ojai including a site re-design and a number of new contributors. Stay tuned! For everyone else - we'll see you on the buzz and banter.

Greg Weldon: ask some of the option guys here, about creating synthetic vol in just about anything ...maybe in something housing related.

Greg Collins: Luigi - are you related to Meehan? Anyway - take care...find those opportunities.

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