- 10 Rules of Trading Better on Spreadbets (alpeshblog.com)
I spend about 140 hours a month looking at the markets. My analysis is in a monthly newsletter which I then use for the month ahead as my trading and investment bible. If you’d like a complimentary copy of this month’s 40 page+ issue – email me at firstname.lastname@example.org
When I wrote my first book, The Mind of a Trader, I interviewed some of the world’s leading traders. Over the past 13 years since then I have met thousands of traders including spreadbetters from around the world – from my talks in Beijing and Guatemala to San Francisco and India.
If I had to write down what professional traders do that retail investors should do then they would be these:
If you know how much money to put into each trade you will make more money than those focussed on just making profits.
Spread trading is about making money of course. But to make money, you need to know how much money to put into each trade. That will, as much as calling the market right or wrong, determine how much money you make and keep.
One such rule is that if you know the stock could drop by an amount X before you exit, then that amount you could lose should be 2% of your total capital. I keep it that simple. In fact all professionals keep it that simple! The reason is if I have a string of five losing trades, then I am down 10%. Not too bad. Most people after 5 losing trades are down 50%!
Look at the table below. If your portfolio loses 20%, then you need to achieve a 25% gain to break-even. 25% is more than even Warren Buffett’s long-term average. The point is, make sure you do not even make a paltry 20% loss. It is easily lost.
So the point is look at the figures. It is why the world’s best traders cut their losses short and quickly. Phone in to any TV programme and ask any stock-picking analyst who appears on TV ‘if my portfolio drops 30% as a result of your stock-pick, how much does it need to rise to break-even?’
I guarantee they will not know.
|Loss of capital (%)||Gain to recover (%)|
An experiment was conducted involving forty people with Doctorate Degrees. The doctorates were asked to trade on a computer. They started with $10,000 and were given 100 trials playing a game in which they would win 60% of the time. When they won, they won the amount of money they risked in that trial. When they lost, they lost the amount of money they risked in that trial.
How many Ph.D.s made money at the end of the experiment?
Two! The other 38 lost money. 95% of these very academically smart people lost money playing a game in which the odds of winning were better than any odds in Las Vegas. Why did they lose?
My own analysis has found winning spread betters mimicked successful professional traders in their win/loss profiles. Of course professional traders would be trading with much more money, but spreadbetting winners returns distributions looked the same.
The point to note with winners was that they had a few big winning months, very few big losing months. And most of their trades won a little and lost a little. Whereas losers had a few big losing months, very few big winning months and most of their trades also lost a little and won a little. So what is the difference between winners and losers? Winners had a way of ensuring no big losing months. They also had a way of ensuring big winning months. Losers didn’t.
How did winners do this? For some, they added to winning positions. Others never let a winning trade become a losing trade once it was up 10% for instance. Others had tight stop-losses at which they exited. They would not wait on a loser. They would never add to losing trades. Some winners had the attitude that each trade at the start is a 50-50 gamble and so you bet small. Once you know it is moving in your direction, you add more money. If it is not, you exit quick. Losers did the opposite. They exited their winning trades to pay for their losing trades, to which they added even more money in an attempt to lower their average break-even point.
We are recommending a long position in EM equities, implemented via the EEM ETF with a target of 55 (+15%).
Our overall view of the global cycle and asset environment for the remainder of the year remains constructive. Since November, we have argued to avoid EM equity exposures given tightening and inflation pressures. But we think the balance of risks is shifting as we have highlighted in recent publications, and markets have yet to acknowledge this still nascent development. The tightening headwind has seen many large EM markets underperform substantially in recent months, and we think the forward profile looks much better than a few months ago.
We expect EM tightening to continue. But several large EM economies have already seen a significant slowing in activity. For example Brazil and India have seen industrial production slowing from close to 20% yoy to the low single digits. Perhaps most importantly, as our China economics team recently outlined, we believe that Chinese policy tightening and slowing activity have come through somewhat faster than expected. So we expect lower growth in 1Q, but expect economic momentum to reaccelerate for the rest of the year as policy authorities ease the pressure on the brake pedal, and equity markets typically benefit in this type of macro environment. Our Asia Pacific Portfolio Strategy team has upgraded Chinese equities to overweight today.
In addition, agricultural prices, a significant part of the EM inflation problem, have plateaued in recent weeks, and while there is still plenty of risk of higher prices, normal weather would see the impact of this factor in the headline inflation measures start to fade gradually over the summer. Broadly speaking, we believe there is a good chance that the most intense phase of tightening in EMs is behind us. While we do not yet see policy easing anywhere, the pace of incremental tightening is set to slow and we want to position ourselves for this shift earlier rather than later.
The most obvious risk to this trade is that we are too early. Inflation could run ahead of our current forecasts and the actual fact of ongoing rate tightening – even if anticipated by the market and at a slower pace than before – could continue to be a market headwind. And we expect tightening to continue in EM markets and in some places to intensify. But on our central outlook we expect inflation to moderate and growth to settle at healthy levels.
There are other risks as well, including higher oil prices, continuing headline risks out of the MENA region and a broader soft patch in global markets as leading indicators moderate and some of the G4 central banks begin to inch back from their exceptional easing stance. But given the poor performance of EM equities hitherto, they are arguably somewhat better protected. The dollar denominated EEM ETF has underperformed developed market equities very sharply since November 2010 despite its historically positive beta to these markets, and the local currency indices have actually sold off significantly in absolute terms too. So the risks seem more asymmetric here, with limited further downside, but the possibility of significant returns as fundamentals and sentiment on EM equities turn.
While the pattern of tightening and the balance of other risks varies across the main markets, we think the diversification offered by a broad group of EMs is probably helpful.
Exchange Traded Funds (ETFs) are redeemable only in specified units and only through a broker that is an authorized participant in that ETF program; redemptions are for the underlying securities. The public trading price of a redeemable unit of an ETF may be different from its net asset value; an ETF can trade at a discount or premium to the net asset value. There is always a fundamental risk of declining stock prices, which can cause investment losses.
Investors should consider the investment objectives, risks, and charges and expenses of an ETF carefully before investing. Each ETF prospectus contains such information about the ETF, and it is recommended that investors review carefully such prospectus before investing. A copy of the prospectus for all ETFs mentioned in this material can be obtained by investors from their Goldman Sachs sales representative, or from the offices of Goldman, Sachs & Co., 200 West Street, New York, NY, Attn: Prospectus Dept. (1-212-902-1394). Prospectuses are also available from ETF distributors.
Goldman Sachs is an authorized participant in each ETF mentioned in this material and participates in the creation and redemption of shares of each ETF mentioned in this material. Goldman Sachs, as an authorized participant or otherwise, acquires securities from the issuers of the ETFs mentioned in this material for the purposes of resale. As of March 30, 2011, Goldman Sachs has the following positions: EEM-long. Professionals who authored this material have no financial interest in any ETF mentioned in this material. One or more affiliates of Goldman Sachs is a specialist, market maker or designated liquidity provider for the following ETFs: EEM.