Back to Basics: What are the Best Principles for a Beginner to Know?

When I began my trading journey I remember feeling almost overwhelmed by the sheer volumes of information widely available on the internet but not being able to grasp where this information would prove to be vital further on.  All I was looking for was some basic do’s and don’ts when trading, a basic set of rules or goals I could work towards.

#86808450 / gettyimages.com

 This week I stumbled upon an article written by Brian Lund titled; The 10 Commandments of Trading.  In his article Brian shares some important aspects traders should keep in mind when they start trading. Here’s Brian’s 10 Commandments: 

1. Know yourself
2. Educate yourself
3. Find a mentor
4. Develop a methodology 
5. Use the right tools
6. Turn off CNBC 
7. Remove your emotions
8. Cut your losses 
9. Trade less make more
10. Only trade liquidity 

What sticks out in this list that is absent from so many? They are basic principles which lay down the elementary foundation of a traders future and it’s the same principles which guard the hierarchy of professional traders.  Simple to recite, simple to remember.

There are a few aspects of the article I want to deal with that made sense to me when I read through it, something that stuck out when thinking about my first experiences as a trader.

How often do you hear emphasis being place on the individuality of the trader?  As rewarding as trading can be we need to bear in mind that taking responsibility for ourselves is critical in our growth as traders. In the list above the words yourself and your ring the right tune.  New traders often lack the confidence to confide in themselves to be able to trade that’s why it’s important to take ownership of your trading, it liberates your inner self and helps you find your path to successful trading. 

“Trade what you plan and plan what you trade” is one of the many trading axiom’s most commonly heard but here’s the dilemma; how does a trader plan for something his never participated in?  It does created a sense of indefinite goals.  That being said there should be one plan which remains priority no matter the circumstance, Risk Management.  Lund’s list mentions cutting your losses and knowing how much you’re willing to lose but does also state the need to develop a methodology. 

What this suggests is that you should understand your risks you are taking but in the same light accept that in the beginning your trading process is going to be rudimentary. You have to accept that in order for you to place the building blocks to your trading plan you have to be able to absorb losses you incur over that period of construction.  Ensuring your losses are kept to the minimum will increase your chances of building a solid trading methodology.

#78457373 / gettyimages.com

Although Lund’s list is concise it’s simplistic; something which helps to achieve certainty in the goals we wish to reach.  By organising the stepping stones to our success we are able to focus on each aspect independently but at the same time know that the combined effort of each yields an overall goal we wish to achieve.  

#2667694 / gettyimages.com

The primary goal we want to achieve with the 10 aspects is to expand on them further, allow ourselves to discover the trading process as a whole and be able to draw our own blueprint of how we see the market and its mechanisms. We are the architects of our own trading success, become creative with your mind but always remember the pillars of strength which make it robust and hold the structure in place for enduring times so that we may be resilient when most needed.  

If you would like to contact me you can through my email at cadetrader@gmail.com or if you wish to follow me on twitter and get the latest updates of news, interesting commentary and general trends in the market, my twitter handle is @CadeTradeR if you follow this link it’ll take you directly to my twitter timeline: https://twitter.com/CadeTradeR 

Derivatives: Weapons of Mass Destruction or Absolute Necessities

When I was first introduced to the concept of derivatives a few years ago the idea excited me. I got to work immediately on finding out more about these financial creatures of wealth creation. It felt as if I was in speculators heaven. I could take a position on the market both ways and not have to tie up all my money doing it.  What could ever go wrong?

 Type in the words “derivative trading” and you'll be mesmerized at the amount of brokers offering to open an account for you. But one thing still evades me; do novice traders truly understand how derivatives work?  

To answer that question I’m going to share with you my first experience with derivatives. I was in my final year of varsity when I stumbled upon an investor’s newsletter advertising a “secret” very few knew about.  Still fresh in the game I was instantly interested and read on further. All I had to do was subscribe to a monthly service where a professional trader would send me a buy or a sell signal, what could be more difficult? But wait…there’s more. Not only was I going to receive monthly stock tips but I would receive a free guide, that’s right, a guide that if I spent reading for a few hours was going to solve all my financial problems.

Being the inquisitive person I am I had taken to search engines to see how true these claims were and clearly they weren't far from the truth.  I had broker after broker telling me how I could cash in on this new phenomenon. “Make $2000 from $500 in just 3 weeks” or “It’s so easy and painless, one click away from your financial freedom” and my personal favourite “I had never been involved in financial markets but today I’m earning a living from it”.

I thought I better try this out and see for myself and signed up for a free 14 day trial. My demo trading began within a few minutes of registration. Wow! Life was fast when it came to trading. Buying and selling at galactic speeds with some winning and others dead losers.  I had no idea what the contract specifications represented, all I knew is that large sums of money were going in and out at rapid pace. Something still puzzled me at the time, yes money was coming in but could this be sustainable?

My interest tapered down after my trial period had ended. I had seen a module in my varsity course which offered an introduction to derivatives. I immediately thought it would be a great idea to unpack the concepts and was almost certain that it would unlock the “secret” that had escaped me thus far.  This is when it hit me in the face like a ton of bricks.

Going through the work wasn't easy at all; it involved financial mathematics and complex equations.  It went into detail about the type of contracts you get, how they are used, who uses them mostly, why they were created, on which securities you can use them on and so on. It was recommended by the university to spend at least 120 notional hours on the module, I ended doing 200 hours.  But I can confidently say that those 200 hours were the best amount of time I have ever spent on really understanding how things work.

If I hadn't taken that module I would be none the wiser to the complexities involved in derivatives. It heightened my awareness to the possibilities derivatives held both positive and negative.  It also made me sit up and think about the people who don’t have any financial literacy or expertise; how lucky I was to have been afforded the opportunity to learn about these mechanisms which so few know about.

To answer the question I posed earlier on I would say no, I don't believe all traders fully understand how derivatives works which is why I have set out on raising awareness to as many traders as possible so that their fate does not end up the same as the fate of traders gone bust.  The reality of trading is that for a trader to ensure his long term success they need to fully understand every aspect of their trading process and that includes the tools and products they work with.

Derivatives are essential tools in trading. They effectively lower the barrier to entry into trading by borrowing exposure at a fraction of its full value which makes it a very attractive proposition to many.  Although the capital required has been lowered, we should not forget that the time and experience needed to succeed far outstrips any amount of money contributed to the trading journey.

The real risk with derivatives comes from the trader who is unaware of its potentially destructive ability to erode his account to zero in a short span of time.  The leverage which is offered is most often misunderstood which leaves the trader in an overexposed position and vulnerable to the turbulent market conditions often experienced.

 

This is why it is imperative that when you wish to start trading you equip your mind with enough knowledge and conceptual understanding of the nature of derivatives, paying particular attention to the leverage.  Accept that although your broker is able to provide you gearing of up to 20 times in some instances, it does not necessarily mean you need to fully subscribe your capital to it. It’s important to remember that derivatives will always be around, they have been for many years but your trading capital won’t if you don’t employ responsible risk management principles.

    

 Finally, no trade is worth the money if it makes you lie awake at night. Trading can be a very stressful task which is exacerbated when a trader tries to test his courage with a higher than usual position. It doesn't make you a better trader competing against the market, rather respect it and leave the bravado at the front door.  

If you would like to contact me you can through my email at cadetrader@gmail.com or if you wish to follow me on twitter and get the latest updates of news, interesting commentary and general trends in the market, my twitter handle is @CadeTradeR if you follow this link it’ll take you directly to my twitter timeline: https://twitter.com/CadeTradeR 

What does Putin’s Conciliatory Tone on Crimea say about the State of the Russian Economy?

The great tragedy happening in Europe presently has to be the tensions between Russia and Ukraine following the annexation of Crimea by the Russian government.  Ukraine, a former Soviet state of the U.S.S.R has been plagued with civil unrest from rebel forces opposing the ruling government creating chaos on the street of Kiev.

Antagonist in Chief, Vladmir Putin has been assertive of his stance and until recently refused to compromise. This has resulted in the West, comprising of the United States and European Union imposing sanctions on his government, much of which has been brushed aside or countered with tit-for-tat measures against his opponents such as a ban on airlines in Russian airspace.

#454226160 / gettyimages.com

However financial markets around the world reacted positively to the news coming out of Crimea late in the week where Putin and various lawmakers met to discuss continuing tensions. Putin’s comments were understood to be conciliatory in nature. Why the sudden about turn?

Unpacking key economic indicators can help us understand why Putin may have taken this stance. I would like to share with you some of the charts I thought could be useful in explaining this.

Since the sanctions imposed by the West is related to trade with Russia, I’d like to start off with trade indicators because any impacts that will be seen first will come from this part of the economy. 

Some interesting trends do emerge when we look at the chart of the Russian Ruble:

This is a chart of the US Dollar against the Russian Ruble for the last 2 years. Going back to the beginning of 2013 an uptrend has emerged which seems quite strong.  Emerging market currencies have been hit hard and Russia is no exception.  Although a weak currency does make Russian goods cheaper and does stimulate local manufacturing, it hasn't helped them over the last 3 months since they haven’t exported any goods to EU region as a result of the ban.  Russia’s biggest exported goods are oil and natural gas which make up roughly 60% of total exports. Most of these go to Europe.

We should note that the above chart does not represent the previous 3 months but rather 2 years, however what is does indicate to us is that there is a strong upward trend which can remain in place for as long as a solution can be found.

The next chart is Balance of Trade, but before I continue let me explain what is the balance of trade and why is it so important.

The balance of trade is the difference between exports and imports of goods and services and should not be confused with balance of payments; however it does form a large part of it.  When a country exports more than it imports we say there is a trade surplus and when it imports more than exports there is a trade deficit.

It’s a fallacy to think that it is good to always have a trade surplus and bad when you have a trade deficit. It is more dependent on the state of the economy which will ultimately decide if it’s good or bad.  Trade surplus are good when an economy is contracting, by exporting more than importing it helps stop an economy from declining and reverse upwards so it is able to once again grow.

Trade deficit works well when an economy has expanded rapidly and might be over exerting itself with a need to slow down. One way to do this is to tap into the surpluses made so as to slow down the expansionary process.  

The chart above shows the Russian balance of trade from 2000 till present.  Russia has been known to run trade surpluses due to their supply of oil and gas to European region. Over the last 6 years there has been a steady uptrend in the balance of trade. This would suggest that a Russian export has been expanding faster than its demand for imported goods and services.

But as said before a surplus is only useful when an economy has expanded rapidly and needs to cool down. Let’s see what the Russian economic growth looks like and compare the two. 

What we see is a very different picture to what we've seen on the balance of trade.  The Russian economy peaked in 2008 and has been in a steady downtrend since then.  Let’s use some data points to assess the correlation.

Notice the peak in the economy in 2008 in both the trade surplus and the GDP growth. Observe how the follow through happens almost immediately afterwards as Russian policymakers run down the surplus. Again when the economy builds momentum from the bottom of the Financial Crisis and reaches a high in 2010. The same procedure follows, both charts turn down and the same with 2012.

But look at the charts nicely and you’ll see the Russian economy flirted with recession in 2013 and has since turned negative in 2014. What can we conclude from these observations?

Although Russian has a trade surplus and if the government wanted to run it down the Russian economy is in a very poor conditions to do so.  However we know the government is not running it down, that’s being done by the EU and US with trade bans.

Russia is at a critical breaking point here, if the current situation were to be prolonged it has the ability to plough the Russian economy into the depths of recession, the worst since the fall of communism.  What does it mean for Putin’s political aspirations?

The people of Russia are beginning to get frustrated with the lack of traction in the economy.  Once the economy paths its way downwards jobs are lost and manufacturing is slowed down that can’t be good for consumer sentiment. 

Here’s another graph of Russian Inflation: 

Russian policymakers have been able to normalise inflation over the past 6 years but notice the band the inflation rate has been in since late 2012 early 2013. Sideway band suggesting everything is in check until recently where it popped above the upper band and has broken past the previous lower high. This could suggest that inflation in Russia could increase dramatically in the next few months which would make sense taking in consideration the weak Russian Ruble.

It’s clear from the above analysis that there is economic distress in the Russian economy both in the long and short term.  What Russian policymakers need to realize is that supporting or creating wars with other nations is not going to solve these problems and will only attract condemnation from the rest of the world.  

If you would like to contact me you can through my email at cadetrader@gmail.com or if you wish to follow me on twitter and get the latest updates of news, interesting commentary and general trends in the market, my twitter handle is @CadeTradeR if you follow this link it’ll take you directly to my twitter timeline: https://twitter.com/CadeTradeR

Market Commentary: Flowing Volatility from News Events have Created a Dangerous Space to Trade.

My article at the end of June went into detail about the lack of volatility and how it had left many traders frustrated.  I also explained how no volatility had created a condition in the market which wasn't allowing price action to form technical formations to which traders could act upon.

Since that article we have seen an uptick in volatility in financial markets worldwide with major indices reaching all-time highs; however over the past month complacent bulls have been shaken awake from the bombardment of negative news flow from around the world.  Financial woes at Banco Espirito Santo, Malaysia Airline MH17 shot down with innocent civilians on board, tension between Israel and Palestine and recently Argentina defaulting on debt…again.

#466751651 / gettyimages.com

 

Although volatility, like oxygen is required to create combustion, it is the source and level of control over the volatility that concerns traders most.  The volatility which has been created in the last month has emerged from news events which most traders would agree is out of their control.  These violent bouts of headwinds produce erratic movements with little sense to make of them.

   

Conversely, when it comes to dealing with technical signals such as price action, support and resistance, whether it is lateral or trending, they do generate a point of anticipation in direction.  The volatility which follows through will either validate or nullify a trader’s position. The benefit with using technical analysis is the fact that it simplifies the trading process into one standardized methodology and it is a forecasting tool in the sense that the trader sees what is likely to happen on the chart before he executes the trade.

In saying that we can concluded that the reason why most professional traders shy away from events such as earnings reports is because they have no control over it, its pure speculation and a dent in their edge.  

When it comes to new traders, they often left licking their wounds and trying to figure out what went wrong with all the turbulence.  I can recall moments in my own trading when I was still fresh in the game trying to profit out of news flow and coming off second best. When it comes to working with volatility you need to use it in conjunction with direction. 

If we were to use the two together we are able to work out the different markets that can be present.

1.       High Volatility with Trendiness; these are the markets traders enjoy, trades work out quickly.

2.       Low Volatility with Trendiness; are slow to work but price is a lot more stable, patience required.

3.       High Volatility with No Trendiness; extremely dangerous markets to trade, erratic movements.

4.       Low Volatility with No Trendiness; very frustrating markets to trade, often no follow through.

Now let’s put this to practice with the JSE Top 40 and see what the price action has done in the last 3 months.

In the month of June the market jumps higher and begins to path its way out to fresh all-time highs. Notice how the breakout occurs and the subsequent retest at 45 500. From that point the market continues its ascent until it is met with resistance at 47 000. Also note the size of the candles in May, very small relative to the candles we saw in June, this was the first sign that volatility was perking up.

The first time the index reaches 47 000 we see a sharp selloff and the index almost comes back touch support at 45 500. It turnarounds and has another go at breaking the resistance but fails once again. Notice the trading action from that point, it as if the price is bouncing around but not in any distinctive direction. Finally the index finds the momentum to touch the resistance and once again we see a sharp selloff back down to 45 500.

We can conclude that the trading action in the last month has seen a marked increase in volatility and no trendiness.  It has been statistically proven that traders make less money in a sideway market than they do when the market is trending.  Adding to the fact increased volatility from news flow creates turbulent price action which is hard to execute from, we can see why July was a very tough month for most traders.

But what can we learn from of the analysis above. Quite simply wait for the technical signals to lead the volatility, trying to trade a market that is dependent on news flow is comparable to driving a car without a steering wheel.   We know the key support and resistance levels are going to be 45 500 and 47 000 respectively, should anything happen in and around those levels take cognisance.

Finally, if you're not seeing anything happening on a short term chart take a step back and pull the chart out to a longer time frame.  The chart below is the same chart as above the only difference is it represents 6 months. 

Suddenly it all makes sense now. The Top 40 has been trending in a very neat medium term uptrend but the uptrend has now come to an end with the break which happened last week. What would this suggest, bias to the downside, if the Top 40 were to pullback from where we are now my guess would be we could come down to the blue line which represents the 200 day moving average, that’s a level of 43 000, roughly 6.5%.

Again the key level is going to be 45 500, we have to see that break and begin descending with a degree of trendiness before we can be sure that a pullback is in place. Until then it’s best to watch from the side lines. 

If you would like to contact me you can through my email at cadetrader@gmail.com or if you wish to follow me on twitter and get the latest updates of news, interesting commentary and general trends in the market, my twitter handle is @CadeTradeR if you follow this link it’ll take you directly to my twitter timeline: https://twitter.com/CadeTradeR