I’ve noticed quite a lot of volume going through MEO Australia this morning as it broke from a wedge formation – often a precursor for a quick move in the direction of the break – traditionally a day trading stock.
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Stock breaking from a wedge
Thursday, August 27th, 2009Breakout trading
Wednesday, August 26th, 2009Stocks breaking from consolidation – what can it mean?
Consolidation refers to a state of relative equilibrium between buyers and sellers where the area know as “support” is viewed as a “cheap” entry point while the upside is limited to the point known as “resistance” we’re traders view the security as over valued. When this key level of support or resistance gives way on a change in perception by market participants, this can create profitable trading opportunities. The upside target is often calculated by the depth of the channel the stock has broken from. It is also important to see that the underlying volume in the stock has increased significantly. A high level of volume can indicate the start of a strong move. One example on the market today could be; Jabiru Metals (JML).
What is a CFD?
Tuesday, August 25th, 2009What is a CFD?
A CFD (Contract for Difference) is an agreement to exchange the difference between the entry price and exit price of an underlying share. For example if you buy a CFD at $10 and sell at $12 then you will receive the $2 difference. If you buy a CFD at $10 and sell at $8 then they pay the $2 difference.
When you enter a CFD contract this does not involve buying the underlying instrument, even though the movement of the CFD is directly linked to the share price. Because you do not own the share you are only required to provide a deposit which could be as low as 5% for Australian shares. This means you can trade up to 20 times your initial capital.
Why Trade CFDs
Leverage: CFDs enable you to obtain full exposure to a share for a fraction of the price of buying the underlying instrument. CFDs require only a small initial margin as a trading deposit.
The ability to go ‘short’: CFDs allow you to sell shares you don’t own. This enables you to benefit from falling share prices.
Simplicity: CFDs mirror the price and liquidity of the underlying market
Hedging: CFDs allow you to employ more advanced strategies such as hedging your existing share portfolio.
Dividends and Corporate actions: CFDs allow you to benefit from dividends or bonus issues which may occur in the underlying instrument on which the CFD is based.
Cost: Trader Dealer provides the most competitive brokerage structure on the Australian market. Trade $100,000 of stock for just $66. But that’s not all, trade unlimited times in the one stock on the one and well book it as one trade at the end of the day.
Gold – two scenarios for bullion
Tuesday, August 25th, 2009
Gold has been quite subdued since June with some conflicting economic pressures containing it to a relatively tight range. The main aspect impacting the price of Gold undoubtedly is the US dollar. Gold and the US dollar have had an inverse relationship for the past six months or so with weakness in the greenback pushing bullion higher and vice versa. Looking at the US dollar Index, which measures the value of the US dollar against a basket of six other major currencies, we see that it’s trading at critical levels. Two broader patters are obvious in the chart below.
Now looking at the gold chart independently of the Dollar index, we see a wedge formation with a series of higher lows and lower highs constricting the relative price movement in Gold. Although the marginal bias in a pattern like this is to break in the direction of the prevailing trend it’s by no means a forgone conclusion. The only real conclusion that can be made is that Gold is likely to break one way or the other with quite a degree of velocity.
Two trains of thought are evident at this juncture;
- The rise in equity markets have come too far too soon with underlying earnings unable to support the inflated share prices that we’re currently seeing. Equity markets roll over and the US dollar benefits from a flight to safety. This is a bearish scenario for gold which is likely to break below key support of $930 an ounce with a move to $880 likely.
- Equity markets continue to be bullish with the signs of economic recovery filtering through to company earnings supporting higher equity prices. At this stage, traders look towards the fundamentals of the US dollar and view the large quantitative easing strategy (printing money to buy debt) as a negative for the greenback. The US dollar breaks support increasing the appeal of gold as a store of value. Gold is then likely to trade above $1000 an ounce before year end.
Option one is supported by the majority of market commentators – Option two would therefore be going against the crowd – sometimes its better the tread your own path!
Pairs Trading
Tuesday, August 25th, 2009Because it is easy to short sell with CFDs this opens up an opportunity known as pairs trading. Pairs trading can allow you to play the difference in performance between two securities and is market independent or market neutral. Pairs trading is accomplished by taking two positions simultaneously, one long and one short. If you had the view that Commonwealth Bank (CBA) was likely to outperform National Australia Bank (NAB) then you would buy CBA and sell a similar quantity of NAB. Often the difference between the two prices is expressed as a ratio.
In the example below if you bought $50,000 CBA at the beginning of the year at $32.10 and sold $50,000 NAB at $28.80 then the ratio at the start of the year is 1.11. It does not matter now whether CBA move up or down, it is important that the ratio improves for you to make money. This means CBA must rise faster than NAB or CBA falls slower than NAB.
At the peak in mid February CBA is at $37.00 and NAB is at $30.40, the ratio has become 1.22. The trade is now in a profit position. At the beginning of April CBA is at $35.00 and NAB is at $28.60, the ratio is still 1.22 meaning there has been no change in the position since February and your profit will be the same as it was in mid February.
Pairs trading is market neutral as you are trading the relationship between the two prices, not the rises or the falls in the shares. You will be paid interest on the short position and you will have to pay interest on the long positions. The difference in interest payments will be the interest rate spread the CFD provider takes.
How do corporate actions relate to CFDs?
Tuesday, August 25th, 2009If you are trading Direxct Market Access (CFDs), holders of are able to participate in corporate actions, including share splits, dividends and rights issues. Dividends are received when a long CFD position is held overnight over the ex-dividend date, conversely if a short CFD position is held over this period the holder of the CFD must pay the dividend. The dividend is credited the day the share goes ex-dividend. Holders of physical shares may be required to wait for up to 3 months before receiving a dividend.
A similar situation occurs if the stock announces a rights issue. If you hold a long CFD position over the ex-rights date, you have the opportunity to participate in the rights issue which can often be done at a deep discount. It’s important to advise your CFD broker if you want to take up the rights. If you are short a CFD over the ex-rights date, you will become short the rights to buy stock. That is, you will need to deliver the stock at the issue price. This can often be a negative given you will need to purchase the stock at the prevailing market price in order to deliver it at the issue price.
CFD Trading Models
Tuesday, August 25th, 2009
There are three types of CFDs available on the Australian market.
1. Market Made CFDs
2. ASX CFDs
3. Direct Market Access (DMA) CFDs
Market made CFDs first hit the Australian market back in 2002. When you deal with a market maker you trade on their market, with their prices and liquidity. Transparency is an issue when dealing with such providers as the prices are not guaranteed to replicate the underlying exchange. Providers have the ability to increase the spread between the bid and offer therefore costing you money. Re-Quotes are a common occurance when dealing with market makers – each time costing you money.
ASX CFDs are relatively new. They are exchange traded with the ASX novating the transaction between the buyers and sellers. Although a good idea in principal, the life blood of any market is liquidity and unfortunately, ASX CFDs lack this critical ingredient. From a statistical point of view, ASX CFDs account for less than 1% of the Australian CFD market according to Investment Trends.
With Direct Market Access CFDs, you are guaranteed to be trading on the price and liquidity of the underlying exchange. Your order will be visible in the market depth and will be subject to the conditions set out by the particular exchange. From the example below, if you placed an order to buy BHP at $36.59 (level 7), your order would be behind two existing orders at that price level.
DMA CFDs ensure transparency during execution and reduced trading costs.
Managing the downside
Tuesday, August 25th, 2009
Risk management
Once you find the answer to the question ‘How to get in’ you now have an open position in the market. Two things can happen with the open position. You can make money or you can lose money. You need a plan to deal with both scenarios.
If the market goes against you, you need to have a predetermined point where you will exit the trade with a loss. This is commonly known as the stop loss. A stop loss is a protective order placed at the same time as the position is opened that will automatically close your position should it trade at a certain level against your initial view. For a long position the stop loss is placed below the market. For a short position the stop loss is placed above the market. It can be quite stressful watching a trade go against you however by employing a stop loss order, you have already considered the downside and concluded that the potential reward warrants the risk.
It’s simple to create a protective order. Once your position is open you can create a conditional order that will automatically close the position at a predetermined level. In this case, we want to sell 2000 BHP if the stock trades at or less than $36.00.
Short selling explained
Tuesday, August 25th, 2009
Unfortunately, markets and prices don’t always go up. There are periods of time where prices fall and where going long or buying doesn’t work. With CFDs you have the opportunity to profit from a fall in prices as well as a rise in prices. To profit from a fall in prices is said to be going short or short selling.
If a CFD trader believes prices are falling they can sell a CFD first at a high price in order to buy it back later at a lower price. In order to do this they may borrow the CFD from their CFD provider and sell it before buying it back at a later date. The CFD trader would then benefit from the difference in the price they bought and the price they sold the CFD.
This may seem a little complex at first however the concept is that you sell first and buy second, hopefully selling at higher price and buying at a lower price. Some examples may help.
CFD Example – Going short and making a profit
Going short’ is simply opening a short “sell” CFD position to profit from a fall in prices
Steve saw that Lihir Gold (LGL) had broken key support and looked set for a pullback. Steve places a sell order for 35000
LGL shares at the current market price of $2.78. The face value of the trade is $97,300 and the margin rate on STO is 10%. Therefore $9730 ($97,300 x 10%) is required as margin to open the position. The trade is placed and Steve holds a short LGL CFD position with a face value of $97,300
When opening a short position you have received a cash payment for the full value of your short position and receive interest on this amount at the RBA target rate minus 2.25% pa. The overnight interest rate is calculated by dividing the per annum applicable interest rate payable by 365 (days per year).
Assuming that the price of LGL drops by 10c the following day to $2.68 the trading profit will be $3500 which represents a 36% return on Investment including transaction costs.
The Trade in detail
Opening the trade – ‘Going Short’- Selling 35,000 Lihir Gold (LGL)
|
Trader Dealer |
|
|
Price of Lihir (LGL) |
$2.78 |
|
CFDs sold |
35,000 |
|
Commission |
$66 |
|
Total Exposure |
$97.300 |
|
Margin Requirement (5%) |
$9,730 |
|
Total outlay |
$9796 |
Closing the trade – Buying 35,000 Lihir Gold (LGL)
|
Trader Dealer |
|
|
Price of Lihir (LGL) |
$2.54 |
|
CFDs bought to close position |
35,000 |
|
Commission |
$66 |
|
Net Profit from trade |
$8400 |
|
Total outlay |
$9796 |
|
Financing received |
$18 |
|
Net profit |
$8286 |
|
Return on total outlay |
98.64% |
However if the trade had gone against your initial view and you decided to close the position when LGL was trading at $2.82, you would have lost $1514 inclusive of costs.
Dividends – when dealing in CFDs
Tuesday, August 25th, 2009Dividends are treated differently with CFDs than shares.
For shares there are a number of key dates to understand. Once the dividend has been declared by the company, usually in their annual or half yearly report, the share is said to be cum dividend (which is translated to with dividend). Anyone purchasing the share while the share is cum dividend is entitled to receive the dividend.
The share then goes ex dividend (which is translated to excluding dividend) and anyone purchasing the share on the ex dividend date or after is not entitled to receive the dividend. The ex dividend date is the day the share price usually drops by the dividend amount or close to it.
The record date is 3 days after the ex dividend date which allows for the share transactions that occurred on or before the ex dividend date to be recorded. This is due to the ASX rules that require settlement within 3 days of the purchase, known as T+3. On the record date the share holder must own the share and have ownership recorded with the share registry to receive the dividend.
And finally there is the payment date which is the date the dividend is actually paid to the investors. This could be anywhere from weeks to months after the record date depending on the company’s dividend policy.
Dividends with CFDs are far more streamlined with the ex dividend date being the important date. Any CFD trader entering a long position on a CFD before the ex dividend date will receive the dividend in cash on the ex dividend date. Buying a CFD on the ex dividend date will not entitle you to receive the dividend.
On the other side of the equation any CFD trader entering a short position on a CFD before the ex dividend date will have the cash amount of the dividend deducted from his or her account on the ex dividend date.
Franking credits are tax credits that a shareholder receives when they receive a dividend payment. This tax credit is available in recognition that the company has already paid tax on the dividend before it is paid to the shareholder. Franking credits are not available to CFD traders.
