In Excel: Having discipline for long short with beta across the entire trade to hedge out risk

Part of https://quantlabs.net/blog/2014/09/having-discipline-in-your-risk-management-for-long-term-trading-for-profit/

You can have single asset position limits based on a percent of the total portfolio i.e. 10% of total. Your single positional notional value can go up by doing nothing.

You can add a portfolio stop loss. If you put a 10% stop loss on each S&P 500 position, you could put 5-10% on the portfolio stop loss. These could cost your portfolio at 1% if apply the position stop loss.

In Excel

A theme could be defined as a typical long short view.

A cross constituent sector trade could be a high risk compared to other trades. The long could be defensive as in oil (cyclical)which means it could be more sensitive to the business cycle of the economy. If you are bullish, you could do a cyclical long vs a defensive short. It would be opposite if you saw the economy being bearish. If you use beta of each, so calculate the ratio. For every unit of move in the market, the long may move a certain percentage based on the beta ratio. In terms of deploying capital, for every dollar in the long, you short the beta ratio times to hedge out market risk. The short will move a lot less than the long as compared to the betas.

If you apply a self imposed spread trade restriction, so to deploy x dollars on the long, you will need to commit y dollars on the short according to the beta spread radio. This could break your limit. You may need to reduce the amount on the long to fall within your position trading exposure restriction. If the market drop n %, the long and short should drop the amount based on our betas. You could apply more capital to reduce the risk you would deploy more money on the short since the long will move more according to the long beta. It may prevent you from losing money the trade if more is applied to the short. It will be assumed the long will always outperform the short over the long term of the trade. You can hedge out the risk based on the kind of exposure you want.

If you beta ratio goes up to a high level (i.e. 3), your gross position exposure can go beyond the limit you allow. You would need to asjust your short and long position. You then question if the actual trade is worth hanging onto. For every long dollar, you would need to allocate 3x on the short side which makes the trade extremely capital hungry. Always find trades that have a lower beta capital ratio meaning it should be less than 2. There should always be a more efficient long short trade.

You could alsouse a theme of multi spread trades (2 long and 2 shorts) to diversified way. If you view is bullish and your longs and shorts are inthe same sector, you should hedge out sector risk with an intrasector trade spread. If you have a gross exposure limit of 100k with a 20k theme limit. Remember to apply beta to each long and short. You need to add all betas. for a total and a total of each long and short combos. If you have 2 cyclical long vs 2 defensive short, you would expect more long beta total since they are sensitive to business cycles. You need to ensure that you portion more money on the short side vs long. You need to figure out each beta’s contribution as compared to the total beta. Adjust the total for both long total and short total. TO figure weightings, you need to invert these percentages when allocating capital. Because the short side moves less, you need to portion more capital to the short side. For the long total, you need to portion each long stock out of the total long weighting of capital allocation. You need to invert again to get the correction portion capital allocation within the longer short side. You will be able to calculate the weight portion of the total trade capital, calculating the number of shares needed, based on each cost per share. You should present the % of each long and short position of the total portfolio as well. This type of trade of multiple stocks in a long with a short further diversifies the trade to reduce further risk.

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