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    • Hedging you Portfolio through CFDs

    Friday, October 1st, 2010

    Hedging your Portfolio through CFDs

    Markets have surged this month, recovering from one of the worst August performances for a decade, however they are now trading at key resistance levels with the ASX backing off the top of the trading range that has been in place for the past six months. Because of this market activity, prudent investors may like to take this opportunity to take out some insurance on their portfolio using a hedging strategy.

    What is Hedging?

    Hedging is a risk management strategy that traders and investors use to limit and/or offset their position from the probability of loss from fluctuations in the prices of their current holdings, this involves taking an equal and opposite position.

    Investors may wish to hedge their existing portfolio so that they can still be eligible for the dividends due for the individual parcel(s) of stock, or so that you do not realize the underlying capital gains of the stock portfolio.

    The Case for Hedging Your Portfolio

    The ASX market has struggled to make a new high this week, for the first time in a month investors are facing some headwinds including: Asian markets being focused on Japan’s expensive currency and China’s commitment to tighten money supply; Europeans refocusing on their sovereign debt problems; the end of the Aussie dividend season; the RBA signaling an interest rate hike, and mixed investor sentiment and economic data from overseas markets.

    Overseas data is also pointing to a faltering economic recovery with the US Fed and the Bank of England (BoE) hinting at further quantitative easing, and European investors are spooked again over the sovereign debt concerns which are resurfacing for the PIIGS economies.

    Markets look set to avoid the dreaded “double-dip” near-term, but we do expect some weakness into October. We expect the 4650 to 4700 levels to remain at key resistance near-term and because of this suggest that investors should take this opportunity to protect their portfolios as we move close to the seasonally weak month of October.

    In this article we will illustrate how you can insure your portfolio by using CFDs to hedge your portfolio position.

    Hedge Position Using Index CFD

    Hedging involves taking an equal and opposite position to your current portfolio position. Hedging your position using index CFDs means that you can hedge against a fall in the value of your portfolio, if the market does retrace. Please also note that because your portfolio is made up of a limited number of individual share parcels, the change in the value of your share portfolio will not exactly match the movement if the Index CFD. The Australian AU200 Index CFD mirrors the performance of the S&P200 stocks.

    Please find below an example:

    If you have a $50,000 portfolio of shares and you believe that the Australian share market is set to fall, especially since we are now trading into the seasonally weak October period, you can hedge your portfolio using the Australian AU200 Index CFD, which is currently bid at 4600.0.

    This can be achieved by Selling 11 AU200 Index CFDs at 4600.0, which is approximately equivalent to the $50,000 portfolio of stocks, requiring an Initial Margin of 5%, as detailed below.

    Trade Calculations:

    Trade Calculations

    There are no commissions charged on Index CFDs and as this CFD is trading over an underlying futures contract, there is no funding interest to be applied to the CFD position, as it is already priced in the futures contract.

    Possible Outcomes

    There are two possible outcomes that can arise from the above example:

    1) The market falls:
    If the market falls to be offered at 4500.0 by mid-October, then the AU200 Index CFD can be repurchased, to record a profit of $1,100 on the CFD position, even though your portfolio of shares will have devalued by a similar amount.

    2) The market rises:
    If the market rises by say 100 points to be offered at 4700.0 by the end-of-October, and you feel that the market will continue to rise, then the AU200 Index CFD can be repurchased, to record a loss of $1,100 on the CFD position. However your portfolio of shares will have likely increased in value by a similar amount.

    Conclusion

    Hedging is all about risk management and traders and investors should consider this strategy if they feel the market is due for a pullback, so as to limit the possibility of loss from the fluctuation in the value of their current holdings.

    For more information on CFDs you can contact our CFD trading desk on 1800 853 856 or you can visit our website.

    By Michael Hevern
    Head of Research

    The information provided within this blog is general advice only and you should consult the services of a financial professional in order to ascertain whether the information is applicable to your investment strategies and risk profile.

    Risk Disclaimer
    Be aware that CFDs are leveraged products which carry a high level of risk to your capital, as it is possible to incur losses that exceed your initial investment. Therefore CFDs may not be suitable for your level of acceptable investment risk. Before proceeding with CFD trading, ensure you fully understand the risks involved, otherwise seek independent financial advice.

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    CFD Trading: Pairs Trading With CFDs

    Friday, July 16th, 2010

    If you have been struggling with the volatility in your trading accounts lately then perhaps it is time to take a look at pairs trading using CFDs. Pairs trading can dramatically reduce the impact of daily market swings on your account, is market neutral and can deliver profits in both a rising and falling markets.

    What is Pairs Trading?

    Pairs trading involves buying one share (trading long) and selling a second share (trading short). The long position in one share is matched with a similar sized short position in another share. If you believe BHP will outperform RIO, then you could buy $50,000 BHP and sell $50,000 of RIO. You then profit from the difference in performance between the two shares.

    Buy the share/s that you believe are stronger and sell the share/s that you believe are weaker. If the market rises, all shares are likely to rise but the strong share should rise more than the weak share. This reverses when the market falls because the weak share is likely to fall faster than the strong share. This strategy will usually under perform a straight long position when the market is rising but will minimise losses when the market falls.

    Trading currency is one form of pairs trading because a currency is always traded in relationship to another currency. Traders can trade the relationship between the Australian dollar and the United States dollar. If your view was that the US dollar was going to outperform the Australian dollar, then you would buy the US dollar and sell the Australian dollar to the same dollar value. Your profit or loss is then dependent on the relative performance of the two currencies and is unrelated to the performance of either currency to another currency, for example, the Euro.

    When pairs trading using CFDs you will receive interest on the share that you have sold short and you will have to pay interest on the share that you have bought for the long position. For example if the interest charged is the RBA base rate + 2 per cent on long positions and RBA base rate – 2 per cent on short positions, your net interest charge will be the difference of 4 per cent when using this strategy.

    The Market Analyser software has two very useful charting features that can assist with your pairs trading. The obvious “Pair chart” displays the red line below the graph showing the relationship of the two shares. The “Overlay chart” draws the chart of the second share as a line on the original share. In the example below the base chart is BHP and the overlay is RIO.

    Market Analyser Chart: BHP and RIO

    From studying this chart it becomes clear that BHP and RIO follow each other fairly closely, most of the time, but there are times when the two charts diverge. At the very right of the chart BHP has been underperforming RIO, which can be seen by the pairs chart in the lower screen falling away during June. At the same time the overlay chart of RIO is moving higher more rapidly than BHP. This is reversing the out performance of BHP through May, where BHP fell less than RIO did. If you were long BHP and short RIO you would have made money in May, but lost money in June. It is important that the pairs chart in the lower window is rising or falling for you to make money, it is unimportant what the price is actually doing.

    Pairs Chart: BHP and RIO

    Pairs trading can provide you with the opportunity to profit from differences in the performance of two shares when trading with CFDs. Market Analyser has two tools that can assist you to find opportunities to pairs trade, by plotting the relative performance of the shares you are interested in. CFDs are the ideal instrument to use for pairs trading as CFDs can be easily short sold. In addition to this pairs trading with CFDs reduces the volatility and can smooth out your overall returns.

    By Jeff Cartridge
    Education Manager

    Sign up for a free trial of Market Analyser!

    Risk Disclaimer
    Be aware that CFDs are leveraged products which carry a high level of risk to your capital, as it is possible to incur losses that exceed your initial investment. Therefore CFDs may not be suitable for your level of acceptable investment risk. Before proceeding with CFD trading, ensure you fully understand the risks involved, otherwise seek independent financial advice

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    CFD Trading: Seasonal Weakness and Contracts for Difference (CFDS)

    Friday, July 2nd, 2010

    CFD Trading: Seasonal Weakness and Contracts for Difference (CFDs)

    Seasonal Weakness – Historical Patterns

    The markets have certainly been weak lately, falling to new lows day after day into the end of the financial year. This drop is not unusual, with seasonal weakness showing up during June each year. Maybe it is investors realising losses before the year end or raising funds to prepay interest on investment loans that has this downward effect on the market. If we take a look at the history of seasonal tendencies then this year is right on track with previous years and the pattern they play out. Look at the chart below which shows the regular pattern of the markets that have occurred historically. Weakness through May and June is normal and not something unusual at all. Even the bounce in mid June played out as expected from studying these historical patterns.

    S&P ASX 200 Seasonal Chart

    On the bright side however, July and August look much stronger from a seasonal perspective. Newly invested funds and superannuation are often put to work in early July, giving the stock market a lift at this time. But is it different this year?

    Currently global growth is suffering and governments world wide are loaded with debt. Are we going to see a strong rally through July as we have in the past?

    The best clues to this will be the price action going forward. Seasonal patterns are what “typically happen”, but are not a guarantee of future performance. If there is a significant deviation from this road map then that is sign of a bigger cycle in play and that the challenges facing the world’s economy may be more serious than first thought.

    Consider 2008 (brown line on the chart below) when the July – August rally failed to materialise, and falls continued into early July, before moving sideways through August and gathering downside momentum in September and October 2008.

    S&P ASX 200 Seasonal Chart2

    While hindsight is a wonderful thing, the seasonal patterns here were known well in advance, in fact since January this year. So what can you do when the seasonal patterns turn negative or, more importantly, if the expected rally fails to materialise? This is when you could consider using Contracts for Difference (CFDs) to protect your portfolio or profit during these periods of market weakness.

    Contracts for Difference (CFDs)

    One of the key advantages of Contracts for Difference is the ability to short sell easily and efficiently. If you currently own shares you can short sell a CFD on the index to protect the value of your shares. Even though your shares go down in value, the value of the CFD increases. A portfolio of $100,000 worth of shares could have been hedged by selling 20 contracts of the XJO index.

    During the recent fall the Aussie market peaked just above the 5000 point level on the ASX 200 and fell to 4300, for a drop of 14%. Assuming your portfolio lost 14% then it is now worth $86,000. By selling 20 contracts short on the index at 5000 and if you were to cover them at 4300 you would make a profit of $700 per contract or $14,000 on the CFD position. This completely offsets any loss in value on your share portfolio and while the gain on the CFDs is taxable, there are no capital gains tax implications that would be incurred if you sold your shares.

    Alternatively you can short sell individual shares using CFDs to profit from falling prices. While the seasonal patterns may be looking up for July, if the expected rally fails to materialise now might be a good time to sharpen up your skills and add CFDs to your portfolio as protection against any future drops.

    By Jeff Cartridge
    Education Manager

    Risk Disclaimer
    Be aware that CFDs are leveraged products which carry a high level of risk to your capital, as it is possible to incur losses that exceed your initial investment. Therefore CFDs may not be suitable for your level of acceptable investment risk. Before proceeding with CFD trading, ensure you fully understand the risks involved, otherwise seek independent financial advice.

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    CFD Trading: Using CFDs to Short Sell on Short Notice

    Friday, June 25th, 2010

    We have reviewed our market this week with a view to trading it using Contracts for Difference (CFDs).

    What’s a CFD?

    A CFD is an agreement to exchange the price difference of an instrument between the time a contract is opened and the time it is closed. CFDs are highly leveraged derivative products that allow traders to trade using margins from 3% to 25%, depending on the liquidity of the underlying instrument. In this section we refer to instruments in CFD trading which can be shares / indices.

    Benefits of trading CFDS

    One of the key benefits of trading using CFDs, particularly when trading the market short, is that the process is not complicated, it is simply just the reverse of trading long. There are other instruments for trading the market short which include options and solutions offered by margin lending providers, however there can be issues with the liquidity in the options market and problems in finding the stock to short with margin providers.

    CFD Models

    There are a number of CFD provider models such as the market maker model and the direct access model. As the names suggest, the marker maker model (MMM) is where the CFD derives a CFD price based on the price of the underlying instrument (it need not exactly match the price). The direct access model (DMA) uses prices which exactly match the price of the underlying instrument.

    Things to consider when trading CFDs

    The other key consideration when CFD trading is the liquidity of the underlying instrument. Traders should only trade instruments that are liquid, because their profit/loss account can be significantly impacted due to slippage when entering/exiting trades. With this in mind we have reviewed the S&P ASX top 20 stocks. Learn more about CFD Trading.

    Major markets around the world are hovering around their key levels as defined by their 50 and 200 day moving average. In our previous article about Market Momentum we highlighted that the positive momentum that markets had enjoyed from March 2009 has now subsided. All the key markets are still below their 52 week highs and with the exception of Hong Kong and Germany, overseas markets are still below their 200 day moving average.

    The S&P ASX 200 appears to also be losing momentum and is finding resistance at the key levels of the 50 and 200 day moving average. We have evaluated the top 20 stocks and summarised the results in the table and chart below.

    Table: Performance of the S&P ASX Top 20 Stocks

    Performace of the S&P ASX Top 20 stocks

    The table above shows that generally the bias is to the downside in the medium term. In the ASX top 20 stocks, there are 12 stocks in a medium term downtrend and only 6 in a medium term uptrend. Of these 6, only 3 stocks are trading over 4 percent above their 50 day moving average. Half of the top 20 stocks are trading below their 50 day moving average and of these stocks, 6 are trading over 7 % below their 200 day moving averages, which confirms the underlying weakness in these stock prices.

    Chart: Price Performance of the S&P ASX20 relative to key level of 50 and 200 day moving averages.

    Price performace of the S&P ASX200

    The chart above clearly indicates that the weakest stocks in the S&P ASX20 are: AMP, Brambles (BXB), Macquarie (MQG), QBE, and Westpac (WBC).

    Conversely in the S&P ASX20 the outperformers are: Newcrest (NCM), Telstra (TLS) and Wesfarmers (WES).

    As outlined above you can utilise CFDs to trade the market short on short notice, by trading on margins of 3% to 25%, and benefiting from downward movements in the underlying stock price. Your open positions will be valued every day at the close of business price, with your profits or losses, credited or debited to your account each day.

    By Michael Hevern
    Head of Research

    Risk Disclaimer

    Be aware that CFDs are leveraged products which carry a high level of risk to your capital, as it is possible to incur losses that exceed your initial investment. Therefore CFDs may not be suitable for your level of acceptable investment risk. Before proceeding with CFD trading, ensure you fully understand the risks involved, otherwise seek independent financial advice.

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    Update – MEO

    Monday, September 21st, 2009

    Back on the 27th August we took a look at MEO flagging its wedge formation. Trading the wedge formation can be profitable in a short space of time  if volume supports the move as was the case in MEO. The stock is currently trading at 72c

    20090921_MEO 

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    Update – JML

    Monday, September 21st, 2009

    A quick update on a couple of stocks we have spoken about in the CFD posts;

    Jabiru Metals – we used as an example of a breakout strategy back on the 26th August. The stock was trading in a range between 30c and 36c. It broke from that range implying a target price of 42c. Its now exceeded this and continues to look strong.

    20090921_JML

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    Read the tape – it can tell an interesting story.

    Monday, September 21st, 2009

    One of the most famous stock market books ever written, the Reminiscence of a Stock Operator, presents some key principals that are as relevant today as they were back in 1923 when the book was written. Edwin Lefevre describes the exploits of Larry Livingston, a career trader who cuts his teeth in the bucket shops of the late 1800’s. An uncanny ability to ‘read to tape’ and pick the prevailing trends in the market was learnt as a quotation board boy in a stock-brokerage office. It tracks the wins and the losses, the wealth and the hardship in the life of a trader. One common theme throughout the book is the tape – which tracks the buyers and sellers in the market and the prices they are willing to deal. The tape tells a story about a stock more important and influential that anything the media could construct. In today’s world of sophisticated trading platforms, the tape takes on a slightly different form and is referred to as the market depth. The open interest of buyers and sellers, and the volume of shares changing hands can offer a key insight into what’s really happening in a stock.

    You need not look further than Telstra and its recent price action. On the 21/8/09 the Futures Fund sold more than 600 million shares in the Telco in an off market trade with institutions at $3.47. The trade showed up in market volume the following day and stuck out like Alf Stewart on a Mardi Gras float. A big red bar on anyone’s chart should ring some alarm bells. It was not until yesterday when reports surfaced that the Government had made Telstra an offer it just can’t refuse. The offer will see Telstra either voluntarily separate its retail and wholesale arms, or face government intervention in the form of forced functional separation and a ban from acquiring additional wireless spectrum necessary to evolve its NextG mobile network. ‘Google’ Telstra news and you’ll get the full story however ‘the tape’ gave an insight into the issues at the telco before any news had leaked (at least not the public).

    20090921BLOG_TLS

    An argument could be made that the market is at the start of a new major bull run. I don’t know one way or the other, but we are seeing a greater number of stocks breaking to new highs. On a scan yesterday afternoon, 70 stocks came up as closing to new 100 day highs. This number will grow as the market continues to strengthen. Trading ‘breakouts’ or stocks making new highs over a certain number of days is a valid strategy and one that was made famous by the “Turtle Traders”. Volume is an important characteristic when looking at stocks that are breaking out to new highs. Before entering on a breakout, ask your self – is there significantly high volume pushing the stock to new highs. I like to see twice the daily average volume over the past 15 trading day. I also like to see that buyers are in control of the stock into the close. This means that the close minus the open is greater than the high minus the close.  Plus, the trend must be in the direction of the breakout.

    Soldiering on with the assumption that we’re at the start of a major bull run, and understanding that their will be bumps in the road along the way, we need to understand when selling pressure is bearish or bullish. If a stock pulls back, we look for the pull back to occur on declining volume to be comfortable the stock is trading inline with the general flow of the market. If the volume intensifies, look more closely at the second day of declines. In a lot of instances, stocks that have been trading in an uptrend for quite some time, can have a ‘blow off’ day where traders will panic to lock in profits. Although its very hard to do, it can be beneficial to wait for a second day before making a definitive decision on the best way forward. This can be seen in Extract Resources (EXT) during its recent run higher. It has paid to take a step back and monitor the volume on any pullback that has occurred.   

    Although volume is only one part of the puzzle when it comes to analyzing stocks, it’s often an under utilized indicator that can give real insight into the flow of smart money.

    Key Principals;

    1. Volume should increase as a stock makes new highs. I like to see 2 times the average volume over 15 trading days
    2. A pullback on light volume can often be bullish
    3. A pullback on high volume is bearish however it’s often beneficial to see how the stock settles on day two of the pull back. – note this does increase the risk
    4. Volume spikes (days of super high volume) are worth scanning the market for. 10 times average volume should suffice.
    5. Steady volume when a stock is trading in a channel equates to accumulation. A break to the upside is likely.

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    Longer term look at the Dow

    Tuesday, September 15th, 2009

    Some months ago we plotted a number of longer term patterns in the US market. Looking at the Dow Jones Industrial Average below, we noted an inverse head and shoulders pattern with the neckline around 9120. This pattern suggested a break of the neckline would be bullish in the medium to longer term. This has occurred and the pattern is now firmly in play. We also noted the existence of an Ascending Triangle which is quite common as part of a broader head and shoulders pattern. Essentially both chart patterns are traded using the same set up. Buying a break of resistance and setting a target equal to the depth of the pattern. In this case, the depth equals 2600 implying a pattern target of 11700. 

    This is certainly a longer term target however we’ll look for a number of factors to monitor progress. The higher low structure is our primary concern. Each dip in the market should remain higher than the last. If this occur as it has been, the trend remains strong. The biggest immediate test of this occurs around 9700 which is historical resistance. The next key level becomes 10,000, a psychologically important number the market will focus on. We’ll revisit this longer term pattern regularly to update you on the broader market structure.  

    20090915_DJI

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    BOW – Pattern Target

    Monday, September 7th, 2009

    When you look to trade an ascending triangle, one of the key benefits to this pattern is its defined price target on the upside. The target is taken from the depth of the pattern and added to the breakout – from our example last week in Bow Energy (BOW), the break out level was $1.35 with the depth of the pattern of 20c implying a price taregt of $1.55. BOW is trading around this level today.

     

    20090907_bow

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    Ascending Triangle – Bow Energy

    Friday, August 28th, 2009

    Looking at Bow Energy Intra Day today I noticed a clear break of a short term ascending triangle – the breakout level was $1.35 for intra-day trading. Also below – find  an article on the chart pattern I wrote some time ago.

    20090828_bow1

    Written 29/6/09

    The psychology of markets can be identified by looking at specific patterns in price. The theme is not new and technical analyst’s have been trading the markets successfully for decades picking reoccurring patterns that identify what the crowd is doing. Early examples include the ballroom dancer Nicholas Darvas who was made famous for his development of the Darvas Box used to trade stocks breaking from a consolidation zone, and Ralph Elliot who is renowned for developing Elliot Wave Theory that aims to identify the stages of market cycles. These are true market theorists who developed ground breaking principles that we all now have the benefit of applying.

    Over the coming weeks, we’ll discuss price patterns, technical indicators and the predictive advantages they can have. We’ll kick off this week with a look at Ascending Triangles which aim to pick stocks in an uptrend that have taken a breather or paused for some reflection. It’s important that we understand the psychology behind a pattern to get in tune with the markets. An Ascending triangle is quite simple to understand but first let’s look at an example; Extract Resources (EXT).

    ext1
     From December 2008 we saw a significant run up in EXT from below $1 to a peak of $5.40. A couple of points on the rally. Volume was building throughout the run with a significant spike towards the end of the rally. Had you held a position in this stock, watching the fall in volume over the last three days of the move would have given you a clear indication that the rally was about to falter.

    As the rally faltered, we saw a volume spike on a large down day as traders scrambled to get out at any price after seeing their open profit erode. One analogy that is often used in the markets is penguins following each other off the ice shelf. In this example however the volume and aggressive nature of the sell off didn’t last long as new buyers (who may have missed the rally entirely or could of possibly sold out earlier predicting a pull back) found value in EXT at $3.50 (just after hitting $5.40), this supported prices pushing it back up to the high around $5.40.

    Those trader’s who failed to get out last time, took this opportunity to get out second time around. This occurred twice before a break occurred on the third time.  A break occurs when there are more buyers in the market than sellers, with the buyers prepared to pay more for the stock. There was a couple of days of indecision before momentum really kicked in and volume intensified. Note; Its important to look towards volume to underpin the move higher. Like other patterns in the market, we’re not looking for perfection, but rather a pattern that has the likely hood of occurring time and time again.

    See below some additional examples of the ascending triangle in action.

    Stock; Karoon Gas (KAR)
    Buy; Triggered on a break of $8.00
    Stop; Two or three day low – below the breakout level. Alternatove stop could be 2 X ATR
    Target; determined by the depth of the pattern. In this case, $2.50. Implied target of $10.50

    kar1

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