Using Stock Sectors And Groups For Better Trading

This is for equity traders and stock option traders. There are two approaches
you can use to decide what stocks to trade. One is called a topdown
approach, and the other is called a down-up approach. Here are the
differences:
1. Top-down approach:
a. Sector
b. Group
c. Individual

In using this approach, you start the analysis at the sector level
and work your way downward to individual stocks. Traders using this
approach first look at the stock sector charts. Then they analyze the
groups, and then pick the best individual stocks to trade, thus the name
“top-down approach.”

You can use this approach by looking for sectors that have been
sleepy for awhile. Then look at the most sleepy stock groups within
that sector. Then, choose the best or longest-sleeping individual stock
in that group and use the Pyramid Trading Point to enter.

Another way to use this top-down approach would be to look for
the strongest trending sector, up or down. Then wait for an ART Reversal
to form and find the best group in the sector. Finally, identify
the best individual stock that has also formed the pattern you are
looking for.

Maybe you want to look for a strong trend and a pullback, and then
a reversal pattern back in the direction of the trend. Or you may want
to go short off the ART Reversal and trade the correction. There are
different patterns to look for, depending on how you want to trade and
what makes you comfortable.

2. Down-up approach:
a. Individual
b. Group
c. Sector


In this approach you will find the individual stock first and then
analyze the group and finally the sector to see how the stock is behaving
in relation to its peers. This can be helpful when you are getting a
signal to go long on an individual stock, but the volume is a bit low and
you are wondering why.

If you look at the group and it is in a downtrend, and your individual
stock is generating a long position on low volume with no positive
news out, then I might question going long. Again, if it is in play by
either momentum traders or position traders, you will see significant
volume on the time frame you are trading. The more volume, the more
players are participating.

This down-up approach has saved me many times from going into
the market when it is not ready to move. It will show you when the
market is being manipulated on low volume by market makers. Real
trends take “outside paper” coming from off the floor to move prices
significantly.

Many traders worldwide need to be participating for a significant
trend to develop. Significant trends occur when traders from many different
time frames are participating in the trend.

When using the ART top-down or down-up approach, you can get
an idea of who is involved in that stock you are about to trade. If
the sector is not performing well, chances are that long-term investors
are not buying now. They may be holding or waiting to buy, but they
are most likely not buying a downtrending sector or group. It is possible
that they have sold their positions already.

This is why bullish trading swings remain small until sectors turn
around. Without the investor group’s money to add buoyancy to a stock
in a poor sector, smaller short-term traders can then cause these stocks
to sell off more dramatically by shorting the stock, especially if the
significant money is not buying the stock at that time.

By keeping trading techniques and ideas as simple as possible,
you can quickly confirm a trade without getting bogged down with too
much information. When I look at groups or sectors, it does not take
me more than a few minutes and sometimes less to confirm a signal.
It needs to be that quick or you will never use it, especially if you
are trading intraday. You can use intraday charts for groups and sectors,
too, if you have intraday data for them.

If you are a scalper or trading under 10 minutes, it becomes impractical
to view groups and sectors and stay focused on that short
time frame. Activity in groups and sectors probably won’t be of much
help under a 15-minute time frame and is best used for 60-minute, daily,
and weekly charts.
Read More: Using Stock Sectors And Groups For Better Trading

Trading Without Stop

If you do not use stops, you are setting yourself up for failure. When trading
stocks, for example, if you do not use stops and hang on to losing trades to
a point where you emotionally feel you cannot exit the trade because the
loss is so large, you are doomed.

If this happens, you are “married” to that stock and it may not be a
stock you really want to own as an investment. Some stocks we trade are

good for short-term trades only because we are taking advantage of the
momentum in the stock. It may be a stock we would never invest in and
hold for a long time.

If you find yourself wishing for a stock to turn around, you’re not trading
well. Based on the reasons you entered the trade and the location of
your stop, you should always know in a second whether you should be in
or out of a trade.

WHAT HAPPENS WHEN YOU DON’T HAVE A
STOP-LOSS EXIT STRATEGY?
Never trade without knowing exactly where you will get out if the trade
goes against you. All large losses start as small, manageable losses. Let
me share with you an e-mail I received from a trader visiting the Traders
Coach.com web site. It illustrates the importance of using stops:
Dear Bennett,
I received your e-mail and I think your techniques along with your
software are fantastic. Unfortunately for me I am stuck in a bad
trade where I was caught without a stop/loss in the March “BP” several
weeks ago. I have lost so badly that I think I may have to fold
up my trading tent and seek a job! I have been waiting for a reversal
but I do not think one will materialize by expiration. I see a potential
triple top forming but I do not know how long the funds will press the
upside. I am looking for scalp trades in other markets with the little
margin I have left so as to try and recoup something by expiration.
If I am fortunate enough to survive, I will try to not make the same
mistake again.

I often receive calls from traders who either did not set a stop-loss or
failed to get out of their trade when their stop was hit. They tell me that
now they cannot get out because their loss would be too large to bear. If
this is happening to you, then you do not yet have the trader’s mind-set.
You have to realize that being stopped out is a natural part of trading. You
must accept this and not let it get you angry or upset.
Remember, it is better to cut your losses short. It is the only way you
will be in a position to let your winners ride.

SETTING MENTAL STOPS
For some markets it is better not to put the stop actually in the market
when you have the position on. Some market makers will see your stop,

and if there are enough other traders with similar stops, the market makers
may try and hit your stop. Then they make money and you do not. In
markets like this, you can set a mental stop and get out immediately if it is
hit. Be sure you have the psychological toughness to get out when you are
supposed to. If you don’t, then go ahead and enter the stop when you take
the trade.

MOVING STOPS
Never move your stop for emotional reasons, especially when it is your
initial stop. As new trailing stops are determined to lock in profit, you can
move your stops based on newly confirmed Pyramid Trading Points and/or
ART Reversals. If you add on to your winning trade (increase your trade
size), your stop must be adjusted to control your risk in relation to your
new trade size.

When adjusting your stop due to an increase in trade size, always adjust
the stop closer to your current position to lower the risk in relation to your
larger trade size. Once you do this, you should never roll back your stop,
since now your larger trade size will warrant the tighter stop to maintain
proper risk control.

Many students ask about moving stops based on different time frames.
This is an advanced technique. As a general rule, always set your stops on
the same time frame as you entered the trade. In other words, if you use a
daily chart to base your trade entry, use the daily chart to set your initial stop.

There are exceptions to this, but only after you have developed enough
experience. Become profitable using the same time frame first, then perhaps
venture into multiple time frames later.

With the ART system, stops are set based on the realities of the market
and should only be moved when the ART software designates new stoploss exits.
Read More: Trading Without Stop

Treat Trading As A Business

Understanding what your objectives are by first having an understanding
of what type of trader you are is critical to achieving success. Are you entering
a trade as a scalp, a day trade, or a swing trade; or will you look to
expand the trading opportunity as a position trade to ride a long-term
trend? Another reason that I shared with you in Chapter 1 on the various
forex investment vehicles besides the spot forex markets (such as the exchange
traded funds (ETFs) and the futures and options markets) is so
that you can decide which investment vehicle you may want to use to capture
a profit within your risk-to-reward parameters and in the time frame
you expect the market might take to reach those objectives based on decisions
regarding what your objectives and your expectations out of the
trade are or what the time horizon for the market might need to reach
those price objectives. Then you will be able to determine which time
frame to follow, and then you can monitor the shorter-term time frame as
well.

You may think of yourself as just a day trader; or maybe you are a
long-term trend follower. Eventually you will encounter market phases
that may dictate that you diversify your trading tactics. In periods or consolidation
phases, as a longer-term trader, you may need to use short-term
day-trading tactics to cover your operational business expenses. This is a
great time to bring this to your attention because if you are reading this
book to expand your knowledge to learn how to trade or if you are currently
trading for a living, remember that this is a business. You need to
treat it like a business.

Therefore, some considerations need to be made,
such as forming a corporation in order to deduct expenses such as your
computer equipment, your quote feed, your DSL line, travel to various investment
conferences, and continuing education seminars. You should
seek advice from a tax specialist so that you can take advantage of all regular
and necessary expenses as business deductions. This can help you
save thousands of dollars each year. What matters most to every trader
and investor is creating a positive cash flow. After all, it would be horrible
to finally start learning to make money consistently in the market and find
out that you cannot take any expense deductions that could literally save
you thousands of dollars each year.

As a forex trader, let’s see what your total expenses could be: Suppose
your quote feed is $200 per month and your DSL is $50 per month. Renting
a small one-room office could run $500 to $700 per month. Then there are
equipment expenses, such as your desktop computers, a laptop for travel,
monitors and printers and ink cartridges and general office supplies to purchase
and upgrade from time to time, say $2,000. Attending an investment

conference could mean $700 roundtrip airfare, plus $250 per night for hotel
and meals. If you have business entertaining expenses and went to at least
two conferences per year, you could be talking as little as $5,000 to as
much as $25,000 in actual business expenses that can be deducted if you
are running trading as a business.

If you are a first-time smaller investor and decide that trading for a living
is something you have the financial resources, time, and emotional
makeup to trade full time, what business plan do you have in place to protect
the money you make in the market? Where will you put your profits as
a short-term trader? As a longer-term trader, what will you do when market
conditions change according to your system or methods? Not only do you
need to cover your cost-of-living expenses, mortgage payments, or, for
some, dockage fees for the yacht, but you need to cover the business expenses.

The forex market offers an individual a bare-bones means to participate
in the markets on a pay-as-you-go method because there are no
commissions. Forex dealers do provide, as we covered, free charts, quotes,
and news. There are, however, the considerations to cover the bid and the
ask spread each time you trade. So if you are a day trader, consider that if
you trade a minimum of twice a day at 3 PIPs (percentage in points) per
transaction as your cost to enter a $100,000 contract value position, then if
you trade 10 lots each trade, that amount would equate to $600 per day. At
an average of 200 trading days per year (minus personal days, holidays, and
vacation time away from the markets), you need to cover over $120,000 a
year, not including covering the losses on bad trades. My point is that trading
is not free. Therefore, it is important—more like critical—that you explore
all your options and trading opportunities. Now with that said, let’s
see how to use various time frames in your analysis.

The first step is to identify the type of trade into which we will enter. Is
it a day trade, is it a swing trade (which lasts two to five days), or is it a
long-term position trade? Once we acknowledge what our objective is and
what our goals are, then we can narrow our expectations. Let’s assume I
am a day trader. I will generally be able to identify what the average range
for a day is and expect that if I miss 20 percent of the bottom and 20 percent
of the top, then I can expect to capture 60 percent of the average daily
range. My expectations are now for X amount of a given range. Now how
do I start? First, I need to structure my computer and charts to a format
that is conducive to day trading. As we went over in the previous chapter,
using a system that earmaked 40 PIPs profit on a day trade system, some
FX prop traders even set their goals on less that that, for instance, 30 PIPs,
or within a specific time period, such as eight or six bars from entry. You
need to determine whether you are day trading in order to use these parameters.
Let me show you what I use in day trading.
Source: Forex Conquered: High Probability Systems and Strategies for Active Traders

Trading Currency Stocks?

Foreign currency trading is not just for gamblers or hungover commodity traders. It really has become a respected asset classification and is extremely popular with professionally managed trading entities and hedge funds. Foreign currency is so hot that major players are taking it to the extreme. How so? Well, there is now what is called exchange traded funds (ETFs) on foreign currencies. The first to be introduced was the Euro Currency Trust (FXE). On the first day of trading, the Euro Currency Trust had over 600,000 shares trading hands.

Advantages and Disadvantages

As with any product, there are advantages and disadvantages to ETFs. One is that this vehicle has an annual expense of 0.4 percent of assets. If that amount is not enough (the interest rate is below the 0.4 percent expense ratio), then the sponsor can withdraw deposited euros as needed, which could diminish the amount of euros each ETF share represents. The currency ETFs are linked to the spot price versus the U.S. dollar. The obvious strategy to make money in these vehicles is to see the value move in the desired trade direction (you can buy and sell short) and to cover the interest charge less the trust expenses.

The benefactor or the depository for the ETF is JP Morgan Chase Bank. This product is structured as a grantor trust, and Bank of New York is the trustee. Here is how JP Morgan will make money: It will maintain two eurodenominated accounts in London, a primary account that will earn interest and a secondary account that will not earn interest. JP Morgan will not be paid a fee for its services to the ETF. It will instead generate an income or accept the risk of loss based on its ability to earn a spread on the interest it pays to the trust by using the trust’s euro position to make loans in other banking situations. To be sure, JP Morgan has an advantage of floating money, so I would not worry that it will put itself in a position of extreme risk.

Source: Trading Currency Stocks?

Definition Of Competency In Trading

I have a very simple definition of competence in trading and an equally simple definition of expertise.
• A competent trader is one who consistently covers his or her trading costs.
• An expert trader is one who makes a consistent and acceptable living from his or her trading.


It is impossible to limit one’s definition of trading competence and expertise to the possession of particular abilities, personality traits, and skills. This, as we saw in last article, is because there are many forms of trading requiring quite different strengths. I know many competent traders of stock index futures who are not competent in other markets, and I know many competent position traders who could never cover the costs of scalping. Defining competence and expertise by the consistent attainment of results provides the only yardstick by which we can gauge whether participants realize nonrandom edges in the marketplace.

The criterion of covering trading costs may seem like a modest definition of competence, but there is more to breaking even than meets the eye. The inexperienced trader looks at a trade as a 50/50 proposition: Either the market will move in one’s favor or it won’t. Even if we generously assume that traders will be equally good at harvesting profits and absorbing losses—something that does not come easily to human nature, as behavioral finance researchers have found—trading still is not an even bet. For traders to truly cover costs, they must recover the expenses of a real-time data feed, trading software, and other tools purchased to aid trading. Add to this hardware expenses for screen traders, the cost of an adequate connection to the markets, and the expenditures associated with maintaining redundant systems (in case of equipment or connection failure), and this overhead can add up quickly. Professional traders, who require very fast connectivity to exchanges, dedicated computer support, and state-of-theart software configurable to their needs, can easily spend thousands of dollars a month on such overhead. If they are high-volume traders, they probably also have expenses associated with exchange membership fees.

What retail traders may save in overhead by trading from their homes is eaten up in other ways. For a frequent trader, retail commissions accumulate insidiously. Five dollars per round turn does not sound like a lot of money to a five-lot trader of the ES futures who might trade three times a day. At $75 per day, however, this expense easily tops $15,000 in a trading year. If our five-lot trader is trading an account size of $100,000, he needs to achieve a 15 percent return just to break even relative to commissions. Add in those equipment and other overhead costs and it’s easy to see how the odds are loaded against the average trader.

In reality, the situation is much worse than I have just depicted. Suppose our five-lot retail trader enters and exits positions at the market. Doing so, he gives up a tick of execution with each round turn by buying the offer price and selling the bid. In other words, if he immediately exited every trade, he would lose one tick per trade simply as a function of losing the bid-ask spread. Trading three times a day with those five lots, this adds up to 15 ticks per day that must be overcome to break even. At $12.50 per tick, he is in the red $187.50 each day or more than $37,500 each trading year. Add that to the commissions and—incredibly—he has lost half of his trading capital in a year without a single blowup.

To cover costs, a trader actually must be at least modestly and consistently profitable. This requires appreciable skills at execution, risk management, and the reading of market patterns. While covering one’s overhead is not an exciting goal, it is a necessary one along the path to greater success.

When a restaurant opens, it can stay in business only by recouping its fixed overhead: the costs of equipment, real estate, personnel, food, taxes, and utilities. If it can do that in a reasonable period of time, it can then afford to wait for marketing and menu tweaking to build clientele. Your trading business will need to achieve competence long before it attains expertise. As with the restaurant, breaking even will buy you the time to survive your learning curve and reach that point where expertise can earn you a decent return on your capital.

What makes for trading competence, however? How does a talented novice become a competent performer? Can this process be accelerated? These are the questions to which we now turn. Fortunately, a sizable body of research lights our way.
Read More : Definition Of Competency In Trading

Trading, dealing and investment

The ‘dealing room’ is to many people what the financial markets
are all about. A noisy, pressure-filled place where only a ‘certain’
type of person can survive and, until comparatively recently, that
meant mean, confident, strong-willed, young, men mis-behaving!

This kind of image and generalization is, not surprisingly, far off the
mark. Yes, there are many young, arrogant and noisy dealers, but that
is hardly unique to financial markets, and the antics of certain
professional footballers and offspring of the famous spring to mind.

Certainly, some dealers are known to ‘relax’ by playing hard in the
clubs and bars but then the demands of their particular job requires
a release of the pressure to perform aggressively and successfully for
many hours. Equally, in the heat of the moment as the success of the
deal varies, an outpouring of emotion is hardly surprising. OK so the
language may be bad and the humour often tasteless to the ‘average’
person, but then if you cannot handle that you shouldn’t be on the
dealing floor or, for that matter in a job, which means you potentially
come into contact with that kind of environment. In any case, not all
dealers or dealing rooms possess these characteristics. Many are full
of decent hard-working and pleasant men and women doing their job
and having good and bad days at the office, exactly the same as the
operations teams in the middle and back offices!

Of course, to those who have to liaise with the dealers in this
supposedly raucous environment, it can be somewhat daunting,

particularly for new or junior personnel. A problem can exist in terms
of the relationship between the so-called front office and those
supporting that function in the middle and/or back offices. If the
relationship issue becomes too significant it impacts across the
business. What causes the relationship between dealers and operations
to be really good or bad or even in between?

There are many possibilities. Certainly a lack of understanding of the
role of each area, the processes, critical times and failure to
appreciate the importance of a request or piece of information will
not make for much mutual respect. Operations teams need to
understand the dealing environment, the important issues and the
pressure. By doing so they can communicate better and from a
position of confidence and that will be appreciated. The dealers are
essentially a client and a very important one at that. Of course, that
does not make them always right, nor does it require total
subservience, in fact exactly the opposite is needed. However, there
is no doubt that a firm with a front office and operations team that
have mutual respect for each other, has understood the working
environment and the requirements that each area has and can
genuinely work together, will be highly successful.

It is therefore important for an operations team to understand the
basics: for instance, in the dealing area there are differing roles and
ways of actually trading. There are principal traders dealing with the
firms’ own money, arbitrageurs trying to profit from price anomalies,
market-makers quoting bid and offer prices in amounts which they
are committed to trade and sales teams executing orders on behalf of
clients. The dealers in a fund management organization will be
operating very differently from a principal trader at a major
international bank, the latter being often referred to as traders.

Dealers or traders in different types of products have markets, which
can be more or less volatile than others and consequently are more or
less difficult to trade in. Dealers on the sales desk are operating for
clients trying to achieve the best price and get paid a commission
while traders have profit targets to hit if their bonus is to top up their

basic pay. There is pressure on both, but it is a different pressure.
Likewise, the skill sets are different and so, often, is the character of
the person.

It is essential for operations personnel and particularly managers and
supervisors to understand the trading and dealing they support. By
recognizing what is going on in the pre-trade and trading environments
they will be better able to provide the services that are needed
and also to cope with the occasional outbursts and stress on the
relationship between what is, after all, two integrally linked business
units which need each other. The front–back office relationship is
vital to the overall success of the company. Without a good
understanding of each other’s roles there is potential for significant
risk situations to develop and the likelihood of financial loss through
unnecessary errors and inefficiencies. Just as importantly, there is the
risk of breaching regulations, hidden dealing, incorrect positions and
compliance failures, all of which will have very significant consequences
for the firm should they occur. If we look at the issues that
arise in trading and dealing we can see where the potential for
problems lies.

Whatever is transacted in the marketplace has to be settled. This
fundamental premise illustrates that the operations function is
important to the front office otherwise any profit the dealer makes will
not be realized. The efficient recording of the transactions and their
reconciliation to the market are vital. The information on open
positions, status of trades and whether a purchased security has been
received and is therefore available to be sold and delivered on, will
enable the front office to avoid transactions that may incur costs as
well as to take advantage of opportunities safe in the knowledge that
their dealing position is confirmed and correct. Suffice to say that if
the information is late and/or error-strewn the dealer can lose
confidence and be reluctant to take new positions until the true
position is confirmed. Losses can occur on existing transactions
because of late settlement, incorrect instructions and sundry other
errors. Additional costs and expenses including possible fines levied

by the exchange and or regulators are a real possibility. These costs
reduce the profit or increase the loss on the trades, making the dealers’
job harder and will not endear the operations team to them.

The traders therefore rely on operations teams to check, verify and
record the trade details and to reconcile the positions held on the
book. Traders and dealers assume that the transactions they enter
into are OK, but only the matching process confirms this is the case.
Matching processes differ depending on the type of market. Openoutcry
markets generate potential unmatched or ‘out-trades’ because
of the face-to-face dealing process where there is scope for
misunderstanding and error. Electronic markets, on the other hand
have no mismatches as the system can only carry out trades where the
details match. There is a point here to remember, of course, and that
is that a trader or dealer can still carry out an incorrect transaction,
i.e. buying instead of selling in an electronic market and so from an
operations point of view the traders and dealers records need
verifying to the trades actually carried out.

Key points in the process are the order placing to the booth on the
trading floor and the transmitting of the order to the trader in the pit
or area designated for trading by the exchange. Once the trade is
completed, which can be a matter of a few seconds, the order is
confirmed as filled by the booth clerk. However, at this stage the
trade is not matched. That will be the case after the details of the
trade are compared to the details submitted by the counterpart to the
trade. If everything agrees then matching is complete and the
transaction passes to the clearing process for settlement. If it does not
agree then the two parties to the trade must resolve the disputed
details. On most markets there will be a strict deadline by which the
unmatched trades must be resolved.
Read More : Trading, dealing and investment

TRADING THEMES

Browne’s investment process is classic fundamental bottom-up stock selection. He
works hard on basic measures of performance like free cash flow generation to come
to an understanding of what he thinks a company isworth. Hewants, through research,
to identify stocks that are not being correctly valued and then assign them a target
price, buying and holding them until that price is achieved. He is happy to hold the
stock for a year or so if the price is rising. In fact core positions in his fund may
be held for two years with positions actively traded. He spends a lot of the research
time working on themes, like the German banking story, or new legislation where the
impact on stock prices has yet to be recognised by the market. He uses stop-losses on
both long and short holdings to minimise losses, which raises the level of trading the
fund does to protect assets.

No hedge fund manager can exist in a fundamental bubble, and Browne’s asset
allocation approach within the fund is based on a top-down model of the world. He
has very clear ideas about the direction in which the world economy is travelling and
those ideas shape his current positive outlook on the equity markets. In Browne’s
model Europe has some issues to face that will weaken interest in equities, but he
says there are sufficient new catalysts to enable an astute asset manager to uncover
undervalued stocks.

The $360 million long/short fund is diversified across industries, market caps and
countries and there is a bias against over-weighting in one industry or market. Browne
has managed the fund since the beginning of 2001, after operating a hedge fund at
Chase for three years. In the bear market of 2000–03 the fund made money in every
year. Measured against the Dow Jones Stoxx index of European companies it was up
11% in euros in 2001 against the Stoxx 50’s minus 18.7%. In 2002 it returned 6%
against minus 35% for the Stoxx 50. In 2003 the fund made 2.2% against the Stoxx
50’s 10.5%.

As with most hedge funds the investment philosophy is absolute return, with the
standard 20% performance fee; Browne’s in trouble if the fund losses money. The
focus on absolute return means that funds like Browne’s sacrifice performance for a
lower risk profile. The benefits of that are evident in a bear market where they still
make money, but during a bull market they can lag the index. His fund typically runs
between 50 to 60 positions, with each averaging about 1.4% of the total portfolio.
The fund closed to new investors in the middle of 2003 having reached its target size.
Read More : TRADING THEMES

Trading Long

A strong idea that worked for Browne between the years 2000 and 2003 involved
figuring out which companies would lead out of the bear market. He assumed that
investors who had lost money to technology stocks would seek out companies that
looked different. He reasoned that risk-averse investors would return to valuation firstprinciples,
wanting to own firms already generating cash with strong balance sheets.

There ought to be some companies he could buy and squirrel away for the market
recovery. Maybe even technology businesses that had been sold indiscriminately
because of their association with an unloved sector.

Browne began screening for companies with a good business model, plenty of
growth potential and plenty of money already on the balance sheet. An out-of-favour
technology company was exactly what was thrown up by the screening process.
Wanadoo is a French Internet Service Provider that is the gateway to the
internet for millions of computer users across Europe. It appeared to be making a lot
of money and yet had suffered in the bear market. The growth potential was apparent,
the company was rolling out a broadband service and had over 8 million users of its
internet connection. Browne decided he should pay the company a visit to confirm
that the business model looked as good on the inside as it appeared from the outside.

What he saw was a business that fulfilled his valuation requirements. It came with
the added benefit of a much improved valuation proposition, having been a casualty
of the tech fall-out. That put the current stock price well below what he thought the
company was worth: ‘It was unloved not because of how it operates but just because
it was an ISP.’ Browne bought at 6.5 euros and has seen his holding double in value.


Good investment ideas are too precious to be squandered. Browne realised that
if Wanadoo fitted the profile there might be other European ISPs that were also
generating good cash flow. He also bought shares in T-Online, Germany’s largest ISP
and a unit of the country’s telecom giant, Deutsche Telekom. Both companies were
starting to capitalise on a new business opportunity he thought would be extremely
lucrative. While carrying out research work on the telecom sector he had noticed
rising levels of broadband use among home computer users. An army of armchair
internet browsers fed up with slow connection speeds were prepared to pay extra
for faster downloads. The ISPs were in the prime position of already serving those
customers. They could therefore offer a premium broadband service at a premium
price with few start-up costs. This was all good news for company profit margins, and
Browne’s stock positions.

Another company that has made Browne’s long book is Anglo Irish Bank.
The Dublin headquartered company is listed on both the Irish and London
stock exchanges; it’s a niche business bank more interested in lending to other companies
than chasing the retail consumer market.

Small companies can struggle with financing. They are too small to tap the equity
market, they are often misunderstood by the high street retail banks, and private
equity money often demands an ownership stake. Browne had an idea at the start of
2003 that he should examine the players lending money to small companies. Banks
that understood small companies and their desire to borrow in a low interest rate
environment ought to be thriving. Browne says that Anglo Irish just leapt out of the
screen: ‘it had a 30% return on equity, an established management team and the
lending book looked to be of good quality.’


The early research work looked promising. Browne next sought out information
on any future plans the bank might have for raising cash. There are few things that
frustrate a fund manager more than buying a company’s stock only to see their holding
diluted by further shares being put into the market. There was nothing to indicate that
Anglo Irish intended to raise cash by issuing more shares to existing shareholders.

In fact Browne’s research highlighted the management team’s desire to develop the
business organically. Browne bought the company’s stock at the start of 2003 and has
watched the price double. ‘This was the right company with the right balance sheet
in the right segment of the market at the right time.’
Read More : Trading Long

TRADING SHORT

A consistent theme for Browne’s shorts is companies that are exhibiting signs of
balance sheet distress which the broader market has not yet picked up. The Swiss–
Swedish engineering company ABB (Figure 2.3) has been a very good short play for
the hedge fund. In the middle of 2000 Browne was looking at what he figured was a
15% premium to the market in the ABB share price. On the surface the company’s
balance sheet looked reasonable; cash had been flowing in from the sale of powergenerating
businesses and the market, says Browne, had difficulty seeing beyond the
money. On his calculation of what the company was earning, the share price looked as
though it ought to be 10-15% below the market. He decided to start shorting the stock.

Browne initially sold the stock at 26 euros and sat in the short position for several years.
The timing was fortuitous for him if not for ABB. He had decided to short the
stock just as the company was pitched into the kind of litigation that would keep any

CEO awake at night. ABB was sued by over 100 000 individuals claiming exposure
to asbestos from boilers produced by a unit of the company. ABB’s share price went
into free-fall as the litigation risk threatened to push the company close to bankruptcy.

After shorting at 26 euros, he closed the short when the price hit 4.50 euros.
At the time of writing, Browne was still actively shorting the Spanish retailer
Inditex: ‘It is the only retailer that still produces its own products. Vertical integration
is wrong for retailers.’ Browne’s beef with Inditex (Figure 2.4) is the group’s insistence
on producing its goods in Spain when there are lower cost centres of production for
clothing, such as China or India. At the time of the company’s IPO in May 2001
analysts hailed the vertical model praising the idea of ‘just in time’ delivery of new
fashions to the stores every two or three weeks. Browne says that the idea is no longer
new and the company’s rivals can achieve the same turnaround by using lower cost
manufacturers. Through the last six months of 2003 the Inditex share price fell from
24 euros to a little over its IPO price of 14.70 euros.
Read More : TRADING SHORT

A BEAR LESSON

The previous chart makes it all too clear that investing involves risk.
(We’ll look at this in more detail in Chapter 2, “Investing as a Contact
Sport.”) If you look at those nine modern bear markets beginning in 1956
and ending in 1990, you will notice that during this 34-year period, investors
have struggled with bear markets about 25 percent of the time.
Contrast that with the 10-year uninterrupted run of the last bull market,
and it’s easy to see how investors became overconfident.


This overconfidence, combined with little experience with bear
markets, left many investors wondering what hit them. The classic mistake
for inexperienced (and even experienced) investors is to watch prices
rise in a bull market and buy near the top. Then when the market heads
south, they follow the stock down and sell near the low. A “buy high and
sell low” strategy is no strategy at all.

Many folks writing about bear markets encourage investors to sit
tight and ride out the storm. This may make sense if the investor is 30
years from retiring, but the poor soul we mentioned earlier doesn’t have
the luxury of riding out a bear market—she can’t wait five years to recover
her loss. The only way she can meet her immediate needs is to cut
her losses as quickly as possible and retreat to safer investments, such as
cash and bonds.

The lesson of the modern bear markets is that what goes up can and
almost certainly will come down. Investors need to be prepared.

SLAYING BEAR MYTHS
Not all bear markets are the same. However, it is important to slay some
basic bear myths before we go any further;
■ Everyone loses in a bear market. We’ve defined a bear market as
including most of the market leaders, such as the bellwether S&P
500. Not every stock or even every stock sector loses money during
a bear market, and there are always stocks that do poorly during
bull markets. The cliché that a “rising tide lifts all boats” is not
true in the stock market.


■ You can see it coming. You can’t. Bear markets are notorious for
disguising themselves. Market corrections, which we discussed earlier,
are great decoys for bear markets: You never know when a market
correction is going to escalate into a full bear market. In our

earlier example of 1987, investors faced a sharp market decline.
Was it a market correction that would rebound shortly, or the beginning
of a continual decline into a bear market?

■ Bear traps are false signals sent by the market that suggest it isabout
to reverse course and head up. A bear trap occurs when a
stock drops sharply and panicked investors sell near the bottom,
only to watch the stock rebound. The broad market can execute
bear traps also. A straight-line drop in prices seldom marks a bear
market. Most often, prices will fall, then rebound to a level near
the original point, and repeat the pattern over and over. However,
the long-term trend is that the rebound never quite regains all the
lost ground.

Casinos use a version of the bear trap on their slot machines.
You put in three coins and pull the lever. A ringing sound means
you won. However, when you look in the tray, the machine has
only returned two coins. This incremental loss doesn’t seem as bad
as not getting anything back, so you’re encouraged to try again. In
the stock market, this type of incremental decline is a perfect disguise
for a bear market.

■ Bear markets can be averted. It’s preposterous to think we can
control the stock market. If we could control the stock market,
there would never be any bear markets. Actions can encourage or
discourage bear markets (such as interest rates and taxes), but there
are no controls. In Chapter 3, we’ll discuss the causes of bear markets
in more detail. We may even need bear markets to bring down
stock valuations to more reasonable levels, thus setting up future
bull markets.

The Persian Gulf War caused the bear market that began in
1990. Oil prices escalated along with interest rates. Rising energy
prices often lead to inflation. All these factors negatively affect the
stock market. Toward the end of the 1990s bull market, the Federal
Reserve Board (the Fed) raised interest rates six times and oil
prices escalated. Many feel the Fed went overboard in its attempt
to cool the economy and precipitated the bear market.


■ The Fed is responsible for the stock market. The Fed is not responsible
for the stock market, although it watches the market
closely. Fed pronouncements about the economy and interest rates
are widely followed by investors. The Fed views its primary responsibility
as controlling inflation. Inflation is a primary cause of bear markets, but the Fed is more
concerned with the whole economy. Inflation is deadly to any
economy and benefits virtually no sector. The Fed of course knows
that raising interest rates could eventually hurt the stock market,
but inflation hurts everyone.
Read More : A BEAR LESSON

Investing vs Trading

There are some important differences between investing and trading, even though
some people may use these terms interchangeably without giving it much thought
of what each entails. Advantages can be found in both ways of growing your
money, neither is better than the other – they have different roles.

But when it comes to growing your wealth in the forex market, trading is usually
the way to go due to the unique aspects of this market.

Value ownership
Investors are concerned with acquiring the ownership of the financial instrument;
they have the confidence that the instrument will continue to rise in value. They
tend to “buy low and sell high”. For example, when they see that the stock price is
going down, they may see it as a good opportunity to buy and own the stock
‘cheaply’ so that they may profit when the stock goes back higher in the future.

Traders, on the other hand, do not have much concern with the buying and owning
of the instrument. They exhibit the same ease with either longing (buying) or shortselling
the instrument. Unlike investors, traders are more willing to buy ‘high’ in
the hope of being able to sell even ‘higher’, or short-sell ‘low’ in the hope of being
able to buy back later at an even ‘lower’ price.

Time frame
Investing usually entails the “buy and hold” concept, whereby an investor’s goal is
to acquire a financial instrument and to hold it for medium to long term, in the hope
that the instrument will rise in significant value after a certain period of time.

Trading couldn’t be any more different. In trading, a trader’s main goal is to profit
whichever way the market goes, whether upward or downward, within a shorter
time frame. While there is short and long term trading, the holding period rarely
extends beyond more than a few months, or longer than a year.

Getting in
Serious investors tend to buy an instrument based on the underlying fundamental
reasons. For instance, savvy stock investors will analyze the background of a
company, pour over its quarterly earnings report, assess the company’s reputation
and strength in the particular industry sector, and assess the potential of its products
and the track record of the management team. Traders, however, tend to look for
high-probability trade setups using technical analysis as their favourite tool, and
many of them also incorporate market sentiment into their trading decisions. Short-

term traders are quick to recognise changing market trends, and take advantage of
price swings in the market, whether in range-bound or trending environments.

Getting out
The “buy and hold” mentality of investors tends not to deviate far from “buy and
forget”, as many investors almost have zilch idea of when to get out of their
investment when things do not go well. Many stock investors are left with
worthless stocks as they do not have stop-loss boundaries or know when to cut their
losses. While there are also many traders out there who do not have risk
management rules in place, traders overall are generally more aware of proper risk
management than most investors. Whether or not they translate these rules into
practice is another thing altogether.
Source: 7 Winning Strategies for Trading Forex: Real and Actionable Techniques for Profiting from the Currency Markets