Hi guys, some words about “worst case scenario”.
So “worst case scenario” is that situation that is the most dramatic we could expect in a strategy.
It could be evaluated as the stop-loss or the maximum historical loss of a strategy we put in place, the maximum drawdown, some parameters we consider and consider it’s worst condition to decide how big we should be in the market, so to decide how many contracts, how much capital to put in the next trade.
So this is fine, the point is that it happens from time to time that this worst-case scenario is under evaluated or it is willingly put to a more reasonable parameter.
The recent happenings of optionsellers.com, for those who don’t know, these people they were a website, they were because now they are in big trouble, who were managing money with naked option sells and there was a whole theory behind that, a lot of educational material and studies have been prepared to show that this could be done and how it could be done to get maximum benefit, how to take advantage of all the inefficiencies, let’s call them like that, in the market.
Everything was fine, but for the recent moves in the energy futures and in particular on natural gas, that wiped out all the money that was managed and also created debts to the investors. So I’m not here to judge anything about what they did because I don’t know exactly how things happened in the accounts, so obviously I can’t give any opinion on the way that the money was managed, of course, all these things are dramatic themselves, so all the wise advices that come after don’t lead anywhere, but what I want to say is that this is a case where the worst case scenario was not evaluated, or it was not expected.
This worst case scenario obviously was not considered before it happened. Now, looking at the moves that took place on natural gas future the day of the disaster and seeing how they took place, I would have said that it could be possible to react somehow, perhaps.
Again, I was not there in those positions, I cannot give any judgment about what those people did because I believe they did everything they could to avoid what happened, but apart from the fact that if somebody trades options on natural gas future, you know that the order book is not always highly populated during the day, so it’s also difficult actually to open or close positions in some moments of the day, but apart from that, there are two possibilities.
I don’t see that move to be so strong sudden and dramatic to keep from taking any position to protect what happened.
There could be a case that, that move was not considered, so there was no real plan before it took place and without a plan, it is obviously very difficult to make any decision, especially when the moment is so dramatic.
Also, it could have been considered such an extreme move that it would stop at a certain level and so no real action was considered necessary because the expectation was for that move to come back, which it did not happen, it happened but at the very latest stage… too late!
So without saying that obviously, I could have made it, no! Obviously, the situation is what it is and probably nobody could avoid that.
What I’m telling you here is that we should always be pessimistic when we evaluate our strategies and our worst case scenario and in one side we should consider the worst case scenario worse than what we get as an evidence on past data, second we should never neglect those extreme conditions that we know sometimes happen but we believe will never happen again.
Things like: “Oh yes I know but this will never happen again come on!”.
This is a big, big mistake! Because when it happens, it’s no longer a strong hit on your account, a bad loss, it might be the loss that kills your career as a trader, because when you wipe out your account and you have debts with the broker obviously it’s very hard to start again and get back to be profitable, just because not only economically, financially also psychologically it is too strong of a hit normally.
So when you evaluate what could happen never ever cancel those things that you don’t consider possible again or possible.
If somebody says: “Yes but what if it drops 5%? Come on it never dropped 5%, maximum it did 2% how can it drop 5%?” No! If that could be considered, consider it!
Consider what you would do in the case that happened, only so you can prepare a plan that could, not will, could save you in case the worst case scenario shows its face to you and it’s an ugly face like mine.
So, guys, this was it, I hope it helps, I hope that you duly protect your money, because your money is important to you, and trading is actually dangerous especially if you don’t properly evaluate all the problem that could happen.
Ciao from Andrea Unger see you next time ciao.