SCOTT WELSH TRADING BLOG

The Brilliant Trick Of Big Fund Managers

The Brilliant Trick Of Big Fund Managers

May 6, 2020

Ever get the feeling that millionaires have secret tricks?

I do.

And with good reason.

They do have tricks.

If you spend dozens of hours listening to big managers and reading interviews, you find that most of them end of mentioning the same thing. It’s the trick they use on their massive funds, and it has a cool-sounding name.

“Vol sizing.”

And with that advanced tool,  they sometimes do “vol targeting”. We’ll get to that.

“Vol sizing” is volatility sizing. And it’s ingenious.

Here’s the gist. Every instrument moves differently. And even the same instrument moves differently in different market conditions.

On May 4th, 2020, the SPY (S&P ETF) had a range of $4.77. That’s how much it moved that day.

On February 4th 2020, the SPY had a range of $2.29. The same instrument moved over twice as much as it did a few months ago.

The implications? What if we had a $3.00 stop on an SPY trade in February? Theoretically, it wouldn’t get hit and we’d have a winning trade. The entire range of the bar didn’t move our stop loss length.

What if we had a $3.00 stop on an SPY trade in May? Theoretically, it would get stopped out because the range moved more than $3.00.

Same system, totally different results. And the difference was the “vol” (volatility).

How do big managers get around this? They set their parameters by volatility, not concrete numbers. For example, a big manager would set that stoploss from above at, maybe, 1.5 times the average true range. That way, we’re always comparing apples to apples.

The NUMERICAL SIZE of the stoploss would always be different but the RATIO of stoploss to current action would always stay the same.

As the market goes crazy, “vol sizing” would adjust dynamically right along with it. If SPY is moving $4 a day, the stop would be set at $6 ($4 x 1.5), safely out of harm’s way.

If the SPY is only moving $2 a day, then the stop would be set at $3 ($2 x 1.5), again safely out of reach of the current market’s movement.

That’s why the big fund managers make big bucks.

They also do “vol targeting”. This subject can get so dense it can make your head spin, but the crux is: “vol targeting” looks at the volatility of the entire portfolio as it relates to each other and compares the current volatility of each instrument and then adjusts the trade sizes of each portfolio member daily in order to stay within the predetermined risk profile and return goals.

See what I mean? That is for the geniuses. We may never be able to have that weapon at our fingertips.

But we can use the sizing.

Instead of ignorantly using the same, ill-conceived targets and stops for every trade, we can use average true range (ATR) to give us this tool.

Using this idea, we can always have our system in tune with the current market.

Pretty fancy.

In our next email, we’ll use the fund managers’ brilliant vol sizing methods on a basic system.

I can’t wait to see how much more money we can make with this advanced method.

Talk to you soon.

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Disclaimer:
It should not be assumed that the methods, techniques, or indicators presented in these products will be profitable or that they will not result in losses. Past results are not necessarily indicative of future results. Examples presented on these sites are for educational purposes only. These set-ups are not solicitations of any order to buy or sell. The authors, the publisher, and all affiliates assume no responsibility for your trading results. There is a high degree of risk in trading.

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