Three of a Perfect Pair

A great question came in today via email, and I like to answer these publicly while maintaining the Reader’s anonymity. The old adage from the classroom is, “If you have a question, chances are there are many other people with the same question, so ask away.” Question is in RED, and my answer follows.

For risk / market correlation purposes, how many total currency pairs at any given time is allowed before a trend trader becomes too risky?

My approach would be to study the correlations and cut position sizes down to the sleeping point. In other words, it’s the trader’s behavior that is risky, not necessarily the instrument/vehicle traded. IMHO, I trade commodity futures more conservatively than most investors handle their mutual funds: they have no sense of risk management at all. It only STARTS with diversification…

I would also note, if you’re trading the interbank, you pay special attention to the exotics as the spreads can be wide, and they can also be illiquid – which is horrible for risk management when you’re trying to exit the losing trade in particular. Test your model with an obscene skid/slippage figure for those.

Please note: I reserve the right to delete comments that are offensive or off-topic.