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