Published on March 20, 2014
eBook Preview: Everything You Need to Know About Trading
Trading versus Investing • Investing involves longer holding periods of investment vehicles (stocks, bonds, futures, currencies) • Trading involves shorter holding periods of trading vehicles (stocks, bonds, futures, currencies)
Trading versus Investing • Investing involves fundamental analysis using financial statements that are reported on a quarterly basis. • Trading involves supply and demand analysis using news and technical analysis on very short time frames.
Trading versus Investing • % of managers outperforming their benchmarks? Studies show 75% of managers DO NOT beat their benchmarks. • % of traders that make money? Surveys estimate that 95% of traders DO NOT make money trading in the long run.
What trading used to look like? • Paper, Paper, Paper • Ticket orders • Runners
What does trading look like? • Screens, Screens, Screens • Information on screens • Price quotes, charts, trading platform
Types of Trading • Institutional Trading • Brokerage Trading (discount, full service) • Proprietary Trading • Quantitative Trading
Products to Trade • Currencies • Equities (stocks, ETFs) • Bonds • Options • Commodity Futures (Crude oil, Gold...) • Financial Futures (S&P 500, Ten Year Note)
How to create a strategy
What is a trading a strategy? • A strategy is a set of defined rules that are applied to a trading product (stocks, bonds, currencies, futures product) with the goal of generating a profit. 2 Sets of Rules • Entry Rules • Exit Rules
Tools for entry rules • News: Bloomberg, Reuters... • Technical Analysis (Covered in depth in the trading seminar)
News strategy • Entry Rule: Company AAA announces that it will acquire company BBB for 20% more than the current market price. Buy BBB on the announcement of the news.
Technical strategy • Entry Rule: Company AAA has lost 20% of its value in the past 10 trading days and it is now currently oversold. Buy AAA when it becomes oversold.
Technical Analysis • Overbought and Oversold
Risk Management/ Exit Rules 2 Types of Exit Rules • Profit Taking Exit Example: Sell 100 shares of BBB at $100 profit. • Stop Loss Exit Example: Sell 100 shares of BBB when I hit unrealized loss of $100.
Backtesting a trading strategy Backtesting means analyzing the trading results of how your system would have performed in the past. Example: If I bought BBB every time X happened and sold BBB every time Y happened, how would much money would I have made or lost from 2009 to 2012?
Automating a strategy Automation of a trading strategy is when you program the buy and sell rules in a program on its on. Automating a strategy is often called: Black Box Trading Algorithm Trading Quantitative Trading
What is a Pair Strategy? • Market Neutral Strategy. • Theoretically supposed to make money in up, down and sideways markets. • Developed in the 1980s at Morgan Stanley • Involves taking 2 products that are historically correlated.
Correlation • Find two stocks that are highly positively correlated. Correlation of 0.90 = Strong positive correlation Correlation of -0.90 = Strong negative correlation
Finding stock pairs for trading • Coke and Pepsi • Wynn Casinos and Las Vegas Sands • GM and Ford What about other less obvious? • Spurious Correlations
How to make money with pairs? • When the two stocks diverge in price: Buy the oversold stock in the pair. Sell short the overbought stock in the pair.
How to make money with pairs? • GM Ford % Diff Jan 5% 6% -1% Feb 2% 4% -3% Mar 20% 11% 6% Apr -7% -1% 0% May 2% 1% 1%
How to make money with pairs? Step 1: Find a correlated pair. Spread= GM/F GM Ford Spread Jan 5% 6% -1% Feb 2% 4% -3% Mar 20% 11% 6% Apr -7% -1% 0% May 2% 1% 1%
How to make money with pairs? Step 2: Determine your entry rule based on the spread. If Spread => 6%, Buy oversold stock. Sell the overbought stock. GM Ford Spread Jan 5% 6% -1% Feb 2% 4% -3% Mar 20% 11% 6% Apr -7% -1% 0% May 2% 1% 1%
How to make money with pairs? Step 3: Execute the pair trade. Buy Ford shares. Sell short GM shares. GM Ford Spread Jan 5% 6% -1% Feb 2% 4% -3% Mar 20% 11% 6% Apr -7% -1% 0% May 2% 1% 1%
How to make money with pairs? Step 4: Determine your exit rules. Close the trade if: Spread returns to 0% Or if I lose $1000. GM Ford Spread Jan 5% 6% -1% Feb 2% 4% -3% Mar 20% 11% 6% Apr -7% -1% 0% May 2% 1% 1%
How to make money with pairs? Step 5: Close the trade since the Spread returned to 0%. Sell Ford shares Buy to cover GM shares. Profit= 6% GM Ford Spread Jan 5% 6% -1% Feb 2% 4% -3% Mar 20% 11% 6% Apr -7% -1% 0% May 2% 1% 1%
Summary • Pair trading is very popular because its concept is simple and logical. • Pair trading is more complicated than it looks. • When applied properly, pair trading can be extremely profitable.
Thank you http://www.amazon.com/Everything- Need-Know-About-Trading- ebook/dp/B00G4QZPCM/ref=sr_1_1?s=d igital- text&ie=UTF8&qid=1395280259&sr=1- 1&keywords=everything+you+need+to+kn ow+about+trading Everything You Need to Know About Trading
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