Unwinding isn’t always relaxed

Does there always have to be a reason? When it comes to financial markets, even if there isn’t a reason, folks will try and explain one. Ah, that move, that was Middle East buying. Oh no, perhaps, it was China. However, often there can be a good reason to explain a move, and slowly it percolates through the market. An example of this is what appeared to be distressed selling of some Chinese tech stocks and US media stocks on Friday, which were done as block trades (see the FT’s article on this and this very insightful Twitter thread from @bauhiniacapital on this).

 

Clearly, being able to pinpoint an unwind of large positions would obviously be great! That’s obvious. But how can we go about this in practice? First, of all for an unwind to occur, the positions need to be there. In FX, one way to try to determine this (and indeed for most futures), is to look at CFTC positioning data, which is broken down for various specific groups. Admittedly, this positioning data is not comprehensive, especially for FX, where futures makes up a relatively small section of the market and it’s also quite lagged. These can also sometimes be augmented with other information about positioning, such as market color and flow insights from market makers (provided it has been suitably aggregated and lagged).

 

Extended positioning in an asset itself does not necessarily signal an unwind. You might actually look at a chart of positioning data against spot, and actually you often observe that positioning can remain extended for a very long time. It is nevertheless an important prerequisite for an unwind that there is some positioning. No positions, nothing to trigger the unwind.

 

Let’s take a step back and thing of a reason for a flush of positions. One reason can be profit taking or new information which makes the reasons to hold a position less attractive. For example, it could be a decent earnings report in a heavily shorted name.  Another reason is the forced exiting of positions, where for obvious reasons, the speculator is going to have to be less price sensitive when it comes to the price at which they exit.

 

This forced exit can be as a result of losses on that asset (and hence the portfolio), as well as because risk limits have been breached, even if that position is underwater. If we have a rough idea of positioning, and how much spot has moved, we can get a ball park figure for whether those positions are doing well or below water. For understanding when risk limits are breached, we can use volatility spikes as an indicator. We might well end up getting contagion into unwinding of other assets, if losses are big enough, where potentially the positions weren’t extended.

 

Trying to model an unwind in positioning isn’t particularly easy, however, once we have a few variables, such the ones I’ve mentioned above, it at least gives us a start to understand when such an unwind could occur.