Case Study, Diego: Four Quiet Months and One Loud One

[Fairman]

Case Study, Diego: Four Quiet Months and One Loud One

Diego is a composite character. He runs a carry trade, long a high-yielding currency against a low-yielding one, with a 10,000-dollar position size relative to a 20,000-dollar account. The pair paid positive swap, and his account grew 0.6 percent a month for four months. In the fifth month, a risk-off shock cut the pair by 9 percent in a week.

Compute the effect. Four months at plus 0.6 percent: 1.006 to the 4th power is 1.0242, so the account reached about 20,484 dollars. A 9 percent fall on a 10,000-dollar position is 900 dollars, a 4.4 percent loss on the account at that point. The account fell to about 19,584.

Net after five months: 19,584 against 20,000, minus 2.1 percent. Four months of carry were erased by one week.

How should he have thought about it? The carry earned 120 dollars a month on 20,000, while the position's monthly volatility was perhaps 3 percent of 10,000, which is 300 dollars. He was collecting a small, steady premium for bearing a risk several times larger.

What if the position had been 20,000 dollars, matching the account, with the same percentage drop? The loss would be 1,800 dollars, 9 percent. Carry would be 240 a month.

What protects you? Smaller size, a stop loss, a volatility filter that exits when risk-off signals appear, and diversification across pairs. The first of these matters most.

Lesson: the smoother the income, the more carefully you should study the tail.

Exercise: compute the ratio of monthly carry to a one-standard-deviation monthly move for any carry position you consider.

[Shadow Trader]

A requote and slippage get lumped together as bad fills, but they hand the decision to different people. With a requote the broker comes back and says the price asked for is gone, here is a new one, take it or leave it. The choice stays with the trader, so the cost is time and sometimes the trade itself. With slippage the order was already committed, and the market decides the price on arrival.

For a scalper that difference matters more than the labels suggest. A declined requote costs nothing except the entry, which makes it a missed trade, not a lost one. Slippage on a ten pip target is paid in full whether anyone wanted it or not, and on a tight scalp it can erase a meaningful chunk of the expected edge in a single fill.

The funny part is that accounts which remove requotes usually do it by switching to market execution, which is exactly where slippage lives. The cost did not disappear. It moved from a visible prompt to a quiet number in the fill price.

Calling one of them better misses the point. What matters is which one a strategy can tolerate, since a trade that depends on a precise entry fares differently from one that rides a wider move.

Do you prefer a setup that can requote, or one that always fills and lets the price land where it lands?