Sunday, January 30, 2011

Managing ZB Position

The events in the Middle East are potentially a game changer for trading ZB. For the last six weeks I've been methodically shorting at resistance and doing quite well. But this 119-122 consolidation range we've been in is the result of a sell off after bonds entered a short-term bubble. That bubble was predicated on fears of a double dip recession and financial institution instability in Europe which turned out to be short lived. Though I've been expecting to stay range bound with an eventual leg down, it is possible that new outside macro inputs will trump the technical picture. I have stayed true to my plan and scaled in to a maximum short position of 5 contracts Below is the risk profile associated with what I previously believed was my worse case scenario. However, that was based on a continued consolidation range and slowly recovering world economies. If this Middle East thing turns in to a game changer then all bets are off.

As we learned many times in recent history from Long Term Capital Managment in 98', 9/11, and the 2008 Financial Crisis, all correlations go to 1.0 in the short-term. Take a look at Friday's 1-minute daily chart below of the ES and ZB on Friday. They are almost mirror images which is what you would expect. This is drastically different from their correlations over the last six weeks as the ES was slowly rising and ZB was tightly range bound. Here is why this is important to me, I might not wait until confirmation of a broken technical pattern to exit my ZB shorts for a loss. If we get a retracement of the equity market losses on Friday which also translates in to a reversal of ZB to the downside, I might exit my trades no matter where they are and head to the sidelines until further notice. Remember the May 6 Flash Crash was the harbinger of a much broader equity sell off over the next few months. I have zero idea what will happen going forward and won't even bother trying to predict, I'm simply going to be cautious and manage my risk as being short US Treasury futures and having unlimited risk is not where I want to be in a time of 1.0 correlations and Middle East instability. If the macro environment changes, then I need to be prepared to change as well.

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