My Macro Trading StyleMy Macro Trading StyleA combination of fundamental analysis and quantitative optimizationA combination of fundamental analysis and quantitative optimization

by Simon Liu Xinyi (Ph.D. in Economics)by Simon Liu Xinyi (Ph.D. in Economics)

My study, experience and My study, experience and thoughts on Macro Tradingthoughts on Macro Trading

ContentsContents

I        The Basics of Macro Trading

II       Why do I trade FX, Interest Rate and Stock Indices

III      How I Trade

IV      How I Do My Trading Research

V       How I Manage the Trading Risk

 

I. I. The Basics of Macro TradingThe Basics of Macro Trading

• Macro trading is based on the movements in global financial markets. The strategies are typically based on forecasts and analysis about interest rates trends, movements in the general flow of funds, political changes, government policies, inter-government relations, and other broad systemic factors.

• I trade mostly plain vanilla FX, US Interest Rate Futures, and Major Stock Indices, most of which are extremely liquid and traded around the clock.

• Those plain vanilla instrument are usually traded on margin. A lot of people lose money because of excessive leverage and poor risk management, although they might have very solid analysis.

II. II. Why do I trade FX, Interest Rate and Stock Why do I trade FX, Interest Rate and Stock IndicesIndices

• Great LiquidityMost of the instruments I traded have great liquidity for 24 hours. This is critical because the expected profitability is related to the range of price movement, which in term is related to the trading hours.

• Great TransparencyThose Macro instruments are the most transparent among all asset classes.

• Reasonable Volatility and Diversity The volatilities of those instruments are reasonable for good profitability without much leverage, for example, JPY/AUD, 30-year treasury bond futures, and Russell 2000 futures.

• Personal ExperienceI have been studying those Macro-factors for my Ph.D. thesis and have been trading those instruments for two years with nice profit.

III.III. HOW I TRADE (1)HOW I TRADE (1)

• Fundamental trade with quantitative optimizationMy trading decisions includes two components. The first component is based on fundamental economic analysis with logical reasoning, and monitoring of economic, political and financial events. I would rank order the confidence of each scenario for decision making.The second component is the quantitative optimization to maximize profit and minimize risk. A set of parameters will be determined, including minimum position, maximum position, entry, stop loss and exist positions.

• Rule based, disciplined Once I decided to trade on one of the ideas, the trading orders are completely rule based. This minimizes emotional interferences which may not have strong logical background.

• Minimal usage of leverage Unlike a number of FX traders, I am not a fan of high leverage and have great emphasis on risk management. It also helps to minimize emotional interferences.

III.III. HOW I TRADE (2)HOW I TRADE (2)

• Focus on volatility rather than market timingMy quantitative optimization aiming to profit from market volatility, instead of market timing. And based on my personal experience, I am not good at market timing.

• Electronic TraderI trade through internet and I can trade anywhere as long as there is internet connection. I only call my brokers personally when internet is down.

IV. IV. How I Do My Trading Research (1)How I Do My Trading Research (1)

• Proposals with logic reasoning First, based on continuous study of Macroeconomic trend, I would draft proposals of trading ideas. Although some subjective judgment and bias is unavoidable, I will try my best to be objective, and establish ideas based on logics.

• Opening minded researchMarkets are often efficient. There are arguments that support the thesis, and also arguments that support the antithesis. I keep an open mind to assess the logic of both arguments.

• Rank order of trading ideasEventually, I will rank order those ideas and choose those that I feel most confident about.

IV. IV. How I Do My Trading Research (2)How I Do My Trading Research (2)

• Two-Step Quantitative modeling My Ph.D. thesis in Economics is on financial time series modeling with periodic structural breaks. For my trading plan, quantitative time series modeling is used to maximize return and also minimize risk. The quantitative modeling has two steps.

• Quantitative modeling step 1Step 1 of the quantitative modeling is on the time series itself. For example, I may model an FX rate (e.g. JPY/CAD) as an mean-reverting process, whose mean-reverting speed is associated with asymmetric credit boom and bust cycle. I would also like to impose a fat tailed distribution to reflect reality.

• Quantitative modeling step 2Step 2 is to compute a trading rule and a set of parameters to optimize the tradeoff between return and risk. I often impose a few parameters for such optimization: a minimum position, a maximum position, a few profit taking and re-entering points.

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IV. IV. How I Do My Trading Research (3)How I Do My Trading Research (3)

• Quantitative modeling step 2 (continued)Similar to the concept of maximum likelihood estimator in statistics, I believe there is a dynamic “maximum return/risk weight” in trading. For example, a set of parameter would look like this:

Min_position: short at least 200K of JPY/CAD

Max_position: Long 700K of JPY/CAD at the very most

Initial_position: I would enter the trade with initial short position of 300K

Exit_point: conditions to square the position and cut loss.

Iterative process:

Profit_taking: I would take profit, and reduce the position by 100K if the price favors me by X%.

Re_entering: I would re-enter if price goes against me by Y%.

 

V. V. How I Manage the Trading Risk (1)How I Manage the Trading Risk (1)

• No excessive leverageI am very disciplined not to take excessive leverage, even for extremely liquid product like FX.

• Conservative scenario analysis I would carry out very conservative scenario analysis to stress test the robustness of the trade.

• No Over TradingI usually only place maximum few trades a day that strictly follow the rule.

• Stop LossI have exit condition for every trading strategy that would be strictly followed.

V. V. How I Manage the Trading Risk (2)How I Manage the Trading Risk (2)

• Probability Trading

Most importantly, I don’t gamble with the market. I think in terms of probability and trade what the market can give me in terms of probability