Imagine your system trades a lot of positions on a typical day. Then a rare “black swan” event happens. You realize the system has accumulated too many positions in the same direction, and your total capital is severely affected. How can you prevent such events in the future? This article will help you through these situations.

Prerequisites

The system must be able to generate alpha for beta optimization to be beneficial.

These parameters can be legally done through all major brokers in Vietnam.

Beta Optimization

A professional trader in Vietnam usually has an absolute beta between 1.5 and 3. We recommend an optimal beta range from 0.8 to 1.2, with an acceptable beta range is 0.5 to 1.5. This metric, though not mathematically proven, can be estimated on the following basis.

First, the market always grows in the long run due to economic growth. At a conceptual level, a long position is more profitable in the long run than a short position. We favor the algorithm with more chances of opening a long position to take advantage of the general market beta. While big losses do happen in times of crisis or catastrophic macro events, it’s the risk that a system must accept. The beta strategy achieves about a 7% annual return in the Vietnamese stock market. The return rate is similar to a savings account, while there are more risks in the stock market. However, the assumption of a 7% annual return supports the concept of a positive beta system.

Second, keeping beta between 0.8 to 1.2 makes the system more resilient to unexpected black swan events. The system can withstand any market crash unless all assets become worthless.

Third, the optimal beta helps reduce margin costs. In the long term, borrowing is not a good strategy. As of 2022, the margin rates in Vietnam range from 9% to 14% per annum.

Finally, with a beta of 1 (and a portfolio split evenly between stocks and derivatives), there’s still 40% of the capital left for other strategies such as the market-neutral strategy. The alpha from these strategies from this 40% capital can boost the performance in tough times and diversify the system further.

Suggestions When the Beta Is Outside the Optimal Range

• Below lower limit: prioritize algorithms that favor long positions and avoid opening more short positions.

• Above upper limit: prioritize algorithms that favor short positions and avoid opening more long positions.

In simple terms, when the system overbuys, it will ignore any coming buy signals and only accept neutral or the opposite signal. It will miss out on profits from a long position and lose everything from a black swan event.

When the system has many long positions or short positions, with the same winning probability, opening a position in the opposite direction will be much more profitable in the long run.