everything you need to know about trading: preview
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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 Rules2 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 TradingAlgorithm TradingQuantitative Trading
Pair strategy
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 theSpread returned to 0%.
Sell Ford sharesBuy 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=digital-text&ie=UTF8&qid=1395280259&sr=1-1&keywords=everything+you+need+to+know+about+trading
Everything You Need to Know About Trading
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