What about trading in the event of sudden volatility in commodity prices? What about risk-taking with a “risk parity” trading platform?
These are the questions that I will not address in this article. Those who wish to can read the technical analysis in the article that I wrote in June about the volatility and possible downside of Bitcoin.
My only goal is to give an example of how a “risk parity” platform, where all the currency trading is conducted by margin, can be used to trade futures trades that are more profitable than most traditional exchanges and hedge funds, but not necessarily as profitable to buy, sell, and trade crude oil.
This is a very technical discussion of a very technical topic.
The risk parity approach
The idea that one can operate a “risk parity” trading platform should be explained in more detail, as it is likely to raise eyebrows among traditional investors.
In order to “trade” in a commodity or derivative product, one has to make a trade by sending a small capital in the form of a margin order to the exchange, who will sell the derivative or commodity at the market price and buy it back at the margin.
The price of each commodity or derivative is represented by the total spot market value at the time of the trade, plus or minus one “margin” placed onto the contract. If total market value at the time of the trade is less than certain thresholds, the order is rejected.
These “margin requirements” are sometimes referred to as transaction fees; I shall use them to refer to them throughout this article. They are paid by both “participants” (the customers who place the order) and “traders” (the traders who can place the order).
In order to trade commodity derivatives, “dealers” on the risk parity side of such platforms often have to make big cash trades to get a high percentage of their net profits; for example, selling Brent crude oil futures in October 2016 and buying oil at the spot market price in November 2016 earned the trader $1,750,000—a 50% profit—but netted the trader just $350,000 in profit. (The trader can get $5 on each futures contract and a 35% profit if the price of the futures contract goes up. A trader can get a 60% profit if $90,000 is the spot price at which he makes a high profit.)
The most common way of implementing a margin-based trading strategy is the option-sett
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