Questions relating to Markets that have been asked by some of our members:
I try to allow the market to dictate the timing of trades, as well as the timings when I do not trade. Price action, volume and hype are the important components in deciding this:
Price Action: obviously you want the instrument you are trading to move as if you are trading on margin it costs money even if the position doesn't move. You also want the indicators that help you make trading decisions to be moving; in my case the SOX, the Dollar and sometimes the bond market and commodities. This indicates to me that the "hot money" is trading and this is the money I am interested in.
Volume: Low volume moves have less relevence than high volume ones. They often result in choppy difficult markets.
Hype: I especially like hype filled markets. If the majority of commentators and analysts and calling for a move one way then it is often likely that the opposite will happen. I have certain commentators and analysts I follow as they have proved, over a period of time, to be consistently wrong. Also if the volume and the price action moves contrary to the the prevailing market view (Muppet hype) then that contrary move can be explosive. A good example of this is the post September 11 2001 rally.
Taking all of this together the important thing is to have a plan but to be flexible enough for that plan to be altered. Never assert your views onto the market.
H
I get so many questions about my trading strategy with regards to methodology and why I do certain things. I am going to try and put it down in writing though I will find it hard becuase it is a methodology that has evolved over many years and is something I do naturally.
Firstly, I work on the basis that the markets are inefficient. An individual commodity is either under-valued or over-valued most of the time and only acheives its nominal fair value for a minute period of time. This is basically due to human nature but if you want a more thorough explanation then read Soros' The Alchemy of Finance. If one starts from the premise than it is easier to have a flexible trading style as one does not tend to "marry" positions. Though I have fundamental ideas I NEVER lose sight of the fact that the market is always right hence the need for stop losses regardless of how sure one is about a certain position. A number of people tried to short tech stocks in the late nineties but lost a fortune going against a trend even though they were eventually proved correct.
To give you a practical example I will use the positions I have on my book at the moment and my reasonings for them. ( December 4th 2002 ) Long Cable and Wireless at 81pence with a 79p stop , Long Tesco at 195.25 pence with a 193p stop, Short of the S&P at 921.9 with a stop at 931.25 and short Dollars against the Swiss Franc at 1.4770 with a 1.4725 stop.
As members know though I am a long term bear for the market in general I nevertheless try to buy equities that I believe are undervalued when the technical levels prove attractive. Fot them to be attractive I want to see some good buying volume and an easily established stop loss level nearby. Initially with CW our stop loss was at 75p but as it rose to 88p we moved it up, ditto with Tesco. However though we favour an equity market rise in the short term we still look to go short of the S&P and the Dollar if they go through important levels and when we can put an easily definable stop loss in place. Our short S&P and Dollar positions act as a part hedge against the long equity positions yet as we have stop losses on all of the positions if there is a large move one way or the other we would expect to profit greatly. If the equity markets crash we will get stopped out of our share positions and run the S&P and dollar trades. If they rise strongly vice versa.
Sounds easy doesn't it? Well it isn't. Our biggest enemy is a choppy market. We live for trends and that is why it is important to know when not too trade. Volume and price action is a big determinant here. Many people are surprised at my seminars when I inform them that on average 6 or 7 out of ten of my trades lose money but it is true. I make money because my losses get cut out far far quicker than my profits.
Getting a nicely balanced book in the right market is sometimes difficult but once we have it the profits can come very quickly and the job becomes very easy. Anyone who has not yet read Reminiscences Of A Stock Operator yet the please please go and read it. It expounds many of the themes I have discussed here, but far more eloquently.
Anyway I hope this helps.
Harry
I have lost count of the number of times that I have been asked why we don't trade the Dow Jones. I am also surprised that some professionals do not even understand what do Dow is. Right here goes:
The Dow Jones Insustrial Average is 30 stocks chosen by the editors of the Wall St journal. It is NOT a weighted index but rather an average. If Eastman Kodak with a market value of $10 billion moves up $1 it moves the average the same as if Microsoft, with a market cap of $282 billion, moves up a dollar. This therefore means it can be wildly effected by moves in one company, especially as each $1 move accounts for roughly 20 points in the Dow.
Almost all mutual and hedge funds therefore use the S&P 500. It is therefore more liquid and the technical analysis is more true due to this greater liquidity and the fact that it is unlikely to be effected by a move in one share no matter how large.
So there you have it. We could play to the crowd and cover the Dow but it is not how we do things. We don't trade it with our money and its as simple as that.
harry
Most hedge fund use the closing prices on the daily chart to decide when to enter or exit medium term positions.This is because we don't wish to get messed around with stupid market maker or rumour driven spoofs. Take HSBC for instance. We know that 717 is the level and it traded just below there as the marketmakers used the illiquid markets to take out some stops. It is however now back at 722p.
It is correct though that you could lose alot of money if it traded straight through to 695p and closed there. I have a method that I use to get around this which I call "stepping". In this example I would and have split my trade size into 3 equal amounts. In my trading platform I have entered 3 stop losses at 716, 715.50 and 715. In this instance the first one got triggered but I thought this was a "false break" as it was on low volume during the AGM. i then bought these back when it went back through 718. Though I pay a little bit of spread away it protects me from an impulsive move through the main levels but also means that I am not going to lose my whole position on a false break. If i had been triggered on all of them I would have put a stop entry back in at 718.
harry
Just as US equities tend to dominate world stock markets, US Treasury bonds tend to lead global interest rate markets.
A decent proxy for the US government bond market as a whole is the 10 yr note and its fortunes can be followed on most trading or technical systems by looking at the 10 yr note futures contract. Some spreadbet firms don't have this, but a reasonable proxy is the 10 yr Bund contract, which tracks 10 yr Euro bond yields. Be aware that although Bunds will tend to trade up/down with USTs there is a yield spread/difference which does change, so they are not an exact replacement, but generally good enough to give you an indication of what is happening in bond markets generally!
Cyclicals are basically any stocks which are heavily dependent on the state of the economy for profits, for example, engineering/manufacturing firms, tech companies and the like.
Companies such as food retailers are defensive, since people need to eat regardless of the state of the economy !
Cyclicals do well when the economy shows signs of an upturn as people revise their views of these companies' future profitability. You will see fund managers rotating out of defensive stocks into cyclicals as they become more confident of the outlook for the economy.
A fat finger is a term used to descibe an input error when entering trades on an electronic trading platform. Occasionally, a trader/broker will hit the wrong key, for example, mistaking Buy for Sell (!) or, more commonly, hitting '000' instead of '00' and selling/buying more stock/contracts than he intended. This type of error can also occur when entering 'limit' buy/sell orders and the incorrect limit price gets entered.
This kind of error can cause violent moves in stock/futures prices, but generally sees the market recover its original level pretty quickly.
Well, there are various ways of looking at this !
So, sterling lower after the cut - probably because traders fear that the BoE knows something the market doesn't and sees further rate cuts down the line. Well, maybe, but the UK still has the best economy in the world and growth is only 2nd to Japan so far this year ! Sentiment is poor right now, but should the market come round to thinking that the BoE will stand ready to cut to keep the economy on track 1.5-2 yrs down the line then the growth argument will take over and £ should regain its poise (as it subsequently has ! ... 29/7/03)
Hope this helps - it's not easy to work out, but I for one don't think our economy is too bad at the moment compared to the rest of the world !
The futures price is literally the spot price, plus/minus the interst rate differential to the expiration of the futures contract, such that there is no arbitrage possible between the spot and futures market. I'm not sure what system you are using to trade currencies, but if you are using one of the spreadbet firms eg CMC/Deal4free.com you can trade something called 'rolling cash' which is akin to trading spot, but you get either a credit/debit on your account at the end of the day to account for the interest differential You can therefore continue to run positions if you don't want to cut them out at the end of everyday. The total charge for such a facility is very low in real money terms and is what we use when trading currencies. I imagine most firms use some derivative of this when allowing customers to trade fx. Most of the daily transactions in the forex market are done in the spot market and rolled over in a similar way - if it's good enough for the pros it should be ok for us mere mortals ! We don't trade fx futures - can't really see the necessity given the liquidity we are afforded using spreadbet methods and over here profits on this type of activity is currently tax free - always an advantage !
Stops are always a personal judgement - what we're trying to achieve is a balance between protecting either profits or capital and not getting a stop triggered because of some erroneous price spike ! The choice of stop level will also be dependant on your time frame for trading - i.e. shorter-term traders will tend to have a tighter stop than a longer term player, who is looking for larger and longer term moves.
With the S+P you know the technical levels reasonably accurately. The 'wiggle' room attempts to protect you from getting stopped out by spikes, but as to where they go is very subjective. Personally, if I'm long what I'll do is look below the market's current level for a support level (either a major support for longer term positions or an intermediate/less important support for shorter term trades) and put the stop a 'couple' of ticks below this level. Whatever stop level I decide upon, I'll always move it 1 tick further away (or 5 ticks with currencies) since experience has taught me that Sod's Law dictates that the original stop will get triggered, followed by a rebound !
With regards to trailing stops - these will be moved based upon various criteria e.g. if the position is a longer term position I'd look to reset the stop every day, but, if the market has been range trading for that day I might just leave the trailed stop alone and wait until the market has a 'decent' move away from the current level. E.g. if the market has a big move, then I'd move the trailing stop up to protect those profits. Again, the decision on the exact level is not an exact science, but were I long and the market had spiked up through a resistance level, I'd move the stop to just below this level, with some 'wiggle' room, to 1) protect the postion and 2) to avoid getting stopped out on any 'false' retracement (i.e. a pullback to the level before a further push higher, which often occurs). If youremember back to the AZN trade a few weeks back, we moved the stop up every so often - ie there was no hard and fast rule - we moved it up as and when then stock price allowed us to !
So, for trailed stops, you need to keep your eye on the market and adjust the stop based upon your time horizon/how the market price evolves over the time of the trade. I know it can appear a bit difficult in practice, but if in doubt, just move the stop a couple of ticks away from your original level.
By doing this, if you have got the market wrong you don't give away much more money than you would have done in the first instance, but the flip-side is that by moving the stop slightly (because we can all wrongly miscalculate the stop level !) you allow yourself the opportunity to take advantage of a winning position if the market doesindeed go your way !
Unlike the Dow the FTSE is weighted, which is a good thing, however it is extremely lop sided. BP alone accounts for almost 10% of the FTSE and the top seven companies account for 46% of the whole index. Here is a rough indicator of the top ten weightings :
BP 9.95%
VOD 8.8%
GSK 7.8%
HSBA 7%
RBS 4.6%
AZN 4.1%
SHEL 4%
BARC 2.7%
LLOY 2.5%
HBOS 2.5%
If you are playing the FTSE index it is important to keep an eye on these stocks and the important constituent sectors: Oil, Banking, Pharmaceuticals and little old Vodafone by itself.
We've tried to break the recent range, both to the upside and to the downside and the net result is that we're still stuck in it ! On the surface, range-bound markets should be the easiest thing in the world to trade - all you do is sell at the top, or near it, and buy when down towards the bottom. However, there is one human trait, which generally precludes profitable trading in such environments and is often the cause of such 'choppy' trading conditions - anticipation. When the market approaches the top of a range there will be a decent number of short-term speculative traders looking for it to break higher. When this doesn't materialise, they chuck in the towel, adding to the acceleration down towards the bottom of the range. The speed with which the market retraces convinces other short-term traders that this time the range will break to the downside. What happens ? It doesn't, so the short-term shorts end up chasing it back up higher. All that happens is that those traders trying to anticipate the break end up playing into the hands of the more savvy traders, who use the lower end of the range as support and the upper end as resistance and position accordingly. Remember that, for a large proportion of traders, the market will always look good at the top and look appalling at the bottom. Resist the temptation to try and anticipate the break. Be patient. When the break comes, use stop entry levels to get into a trade - you know if it's a false break if the market spikes and retraces back into the original range - just look at price action at the October low in the S+P ! If the market does go with the break you are into the new trend, which is a damned sight easier to trade than getting chopped about in ranges ! Patience is the name of the game and is one of the hardest things in the world to practice !!
Placing stops too close to a level can be a problem - in this case, try moving the stops by a few points and see how you fare then. One thing's for certain - one cannot trade without having stops in place - otherwise there's no discipline and I've seen more traders than I care to mention getting caught with a worsening position just because they didn't have stops in a market, which had just broken important levels !
The other point to mention is that one can always get the stop level wrong by a few points and then see the market reverse e.g. if one gets stopped out on a spike either higher or lower. In this instance be ready to re-enter the original position once the spike is unfolding and then enter a stop level a few points above the spike, which caused the stop to get triggered in the first place. This is something that will become more apparent the closer one follows the market - it is necessary to be watching it closely to follow this strategy.
Stops may annoy you, but I would suggest that it's common to remember the 'badly' placed stops and forget the good ones, which saved your skin !
Spread trades are trades, which take a view on the relative performance of one asset vs another. For example, you can trade say the CAC40 Index vs the DAX or the FTSE vs the DAX etc. To exploit relative differences you would buy the undervalued asset and sell the overvalued asset, with the hope that the two come back into line.
Equities traders also enter into relative value trades looking to exploit price divergences between individual stocks e.g. HSBC vs Lloyds/TSB or Tesco vs Sainsbury or BP vs Shell. These are known as 'pair' trades.
Spread trades are also often seen in fixed income or bond markets, which, by their very nature tend to be a lot more 'scientific' than equity markets. Bond traders spend a lot of their time exploiting anomalies in bond yields or entering into yield curve spread trades, such as buying 2yr notes to sell 10 yr notes. They also enter into other 'relative value' trades via the futures markets e.g. trading March Euribor contracts vs June Euribor contracts to trade their views in the money market.