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Resident trader
Riding the bucking bull
Will Kraa, August 13, 2007
As I mentioned in the first trade I discussed on CompareShares, there are times when I like to trade Telstra (TLS) as it is a liquid stock where short term trades are possible without difficulty in opening and closing large volume trades.
Trades in the T3 installments (TLSCA) can also be profitable seeing it has similar price movements but for a smaller outlay. The trade I want to discuss this time was a TLSCA trade. On this occasion TLSCA had moved in a short term downtrend as it had retreated from resistance at $3.50 and by 27 June had dropped to as low as $3.07 and then over the next few days traded largely sideways (see the chart). I decided that there was a possibility of a rally in price which might be exploited for a short term trade.
On Monday 2 July prices opened at $3.12 for TLSCA and after the market settled down it was trading at around $3.11and I opened a CFD long trade for 50,000 TLSCA at $3.11. My stop was at 1 cent below the low for the last few days at $3.06.
I was aiming in this trade to make at least three times the amount risked which was within reach for a short term trade at $3.26. Over the next few days the price did rally as I had expected and got to $3.23. At that stage the trade had moved above the opening price for this trade by more than the amount risked and so I moved my stop to a breakeven price at $3.12, 1 cent above the opening price to account for interest and commission. But then prices suddenly retreated again.
On Friday 6 July the market gapped lower to open at $3.15 and slowly traded down to reach as low as my stop and so I closed the trade. I made a very small profit after accounting for the commissions and interest. Over the next few days there was only sideways movement, some of it below my adjusted stop, before another rally which took the price to well above the previous target. If I had not been stopped out it would have been a trade which could have made me over $6,000.
It is possible to argue that in this case it would have been better to leave my stop at the initial level of $3.06 and then I would not have been stopped out of the trade. But it must be remembered that the first task of a trader is to protect capital. The likelihood of the trade reversing to a loss was greater once the price had retreated to almost the opening price after going up decidedly and so it was prudent not to risk a loss a this stage.
Short term trades like this one are quite different to longer term trades where stops can be wider and trades are given room to move to catch the longer term profits expected. In the short term trade it is necessary to take profits quickly or protect them with a close trailing stop once targets are reached and at the same time to protect capital if the trade does not perform as expected.
Looking further along the chart there is a rally after the sharp drop in price when the market as a whole got the wobbles occasioned by the US problems. This might have been a good trade but I was not prepared to take it as the market at that stage was too volatile and all kinds of irrational price moves were possible. Also the TLS report loomed and I did not expect any joy from that. A trade going short would have been profitable but such occasions are too risky to trade. There is absolutely no way of figuring out what may happen.
In trading it is necessary to keep abreast of some fundamental facts and events that are due. Having a trade (especially a short term one) open when a report is due is risky. When a good stock announces a good result which nevertheless is slightly below optimistic expectations the price is likely to get hammered and when a stock of more dubious quality announces a bad result which is not quite as bad as expected there is likely to be a rally in price.
A good company can also release an excellent report above expectations but if the outlook for the future is not as rosy the price will still go down. The market does not price stocks on their history but on their outlook. This explains the strange price actions so often seen when reports are released.
Trading these events is not for me and I find it better to be aware of such things and be out of the stock at those times. The same is true being short when a dividend is due. You are required to pay the dividend and you have to be aware that some CFD providers even require you to pay any franking credits. At the same time they do not give you the franking credits if you are long so it pays to know these things to avoid nasty shocks.
I do not trade share CFDs with providers who do this and if you are about to open an account it is good to find out these little details. Take the time to carefully read the Product Disclosure Statements. This is tedious in the extreme but is important so you know exactly what you are agreeing to especially when trading CFDs. You might in fact be surprised at some of the things the providers are allowed to do with your trades or your money.
So let’s get back to trading during the present upheavals. It is a wild ride if you have open positions either long or short. Just before the current volatility started I had made so much profit that I thought, ‘This can’t last’ and the sensible thing would have been to turn almost everything into cash and have a holiday. I did not do that and now realise that would have been an excellent thing to do. But now selling good performers at times when prices are irrationally low does not appeal to me and I have not sold much. Some days my account is up, some it is down and I do have a lot in cash so when things start to get back to some semblance of normality I will be ready to move. At least I sleep well at night.
There are still some things worth buying even at the present time if you know what to look for. I bought one stock a week ago which has by now doubled in price and today (Friday) with the market a sea of red it has gone up 10% (sorry, correction, while writing this it has gone up another 10% making 20%). Which stock I can hear you say? I’m not telling you since I can’t give advice and I don’t want people to buy it simply because I have bought it. I’ll tell you about the trade when it is over. Another long CFD trade I opened a few days ago has also done particularly well so far, down just a bit today, so not all is doom and gloom.
But the problem with trying to outwit the market at the present, particularly with CFDs, is that it is all too easy to be on the wrong side of things, long when you should be short and short when you should be long. People who have done research over markets in all countries have found that over many years this time of the year is more likely to be volatile so if you want to take a holiday the time from May through September/October is a good time to do it. If you are a good trader you can afford an extended holiday and if you are just learning you are more likely to get hurt at the present. Not that that is necessarily a bad thing as you will learn lots. But the lessons will be expensive. Maybe better to learn from my mistakes when I tell you about them.
Calculations:
Buying price $3.11, initial stop $3.06, risk per share 5 cents.
This was my CityIndex account which at the time had just over $93,000 total value so to risk 3% of that I can risk $2790.
To buy 50,000 shares I will risk 50,000 x $0.05 = $2,500. Adding commission will make it just over the correct amount to risk. So that was the correct number to buy to keep to my risk management rules.
The margin for the trade was $7,775 and there was plenty of available free equity to cover that and leave plenty to spare so the trade was permissible. I like to leave close to 30% free equity to cover adverse moves.
Trade size: Buy 50,000 x $3.11 = $155,500 and Sell 50,000 x $3.12 = $156,000 giving a gross profit of $500.
Commission @ 0.1% is $155.50 + $156 = $311.50 Interest is about $180 so that leaves about $8.50 net profit. It is therefore a true breakeven trade once all costs are taken into account.
Breakeven stops are important. There is no sense in allowing a trade which has reached the point where it is profitable to turn into a losing trade unless it has not moved much above the opening price and there is no valid reason to move the stop up. In this case it would have been better profitwise to leave the stop at the initial level but that is something which cannot be foreseen. We can only trade the knowledge we have and at the time it looked likely that the rally was over and there was enough downside risk to make it better to close the trade.
Once a stop is exercised it is no use saying ‘what-if’, sticking to the rules is the only way to trade well, to protect capital and to ensure eventual profits.
More articles from this week's CompareShares newsletter:
Markets: Share correction insights
Smart Investing: The best of times, the worst of times
International: India on the move
Companies: Unloved offshore miners
Carbon exchange: A beginner's guide to carbon trading
Markets: Central banks pump in cash to calm fears
Investing: Wealth funds to overcome fears
Stock of the week: Regional Express Holdings
US: Uranium stocks bull run
Resident Trader: Riding the bucking bull
Forum of the Year: Battle heats up for top spot
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