Saturday, 12 January 2019

TRADE OFTHE WEEK #4 : DAMANSARA REALTY BHD


Five seconds of observation, plus 10 seconds to decide : do we want to go into this trade? We did, and the reward was some fat profits.

This case is an example of using pure intuition, an important skill for any aspiring trader. It's a skill that has to be honed and fine-tuned. Not only would you be operating with imperfect information, you may also end up making hugely consequential decisions with no supporting information.

That consequential decision is to trade, and committing significant amounts of money into it. This is not a random throw of the dice; acquiring this skill comes from mundane observation work, incessant note taking, and of course, our personal favorite - trades that have lost money in the past.

So how to develop intuition? Simply put, our view is that you have to be able to draw historical parallels. You have to notice the following in the stock, for starters:

1) price and volume activity
2) velocity (how fast it moves)
3) volatility (the rate of fluctuation in the price)
4) the broader market conditions (especially important for momentum-type trades)

Got that? Now do it about 100 times, in 100 different trades. It will likely take you years. We didn't say it was easy, but it can be done.

While many may think we can coast and live large for the rest of our lives trading, the reality is totally different. We still have our respective day jobs, and there are as many tough days as good ones. But every loss endured, and every profit gained, must be seen as a learning process.

There are no two ways about it. Lose money, take notes, repeat, and get better at it. And you will start getting gains.

And when you become good enough, you start thinking intuitively. You see similar situations where a stock can deliver massive profits from a large move - because you've seen it in the past and learnt from it - so you decided to go in.

In a nutshell, this is the explanation behind our successful trade in Damansara Realty (DBHD). We didn't need to do fundamental analysis (there was no time). A cursory Google search revealed no new bit of news; not that we expected any. The stock simply popped up on our screen in the 'top gainers' section (huge price movement on low trading volume) and we intuitively decided to go in.

As you probably know, many stocks that go up massively on low liquidity can fall back  to Earth hard. We assure you, with enough learning and intuition, you can tell apart the good opportunities from the bad ones. But you have to recognise the signs quickly, because in this case, time was literally money (to be won or lost).


THE TRADE

A five-minute chart in DBHD on 4 January 2018. As you can see, we sold near the peak for that day.

The key movement here is the move from 24 sen to 30 sen on very low volume. Our initial thinking was to risk a small amount at the 30-32 sen range and see if the stock continues to rise. If it stops, we would be exiting with a small acceptable loss.

Again, when it comes to thinking about loss limits, remember the golden rule; you must be willing to accept a 5% loss for the opportunity to make 10% in profits. (Editor's Note: you can change the numbers, but stick to a risk-to-reward ratio of 2:1 or more).

By doing this, you'll have a clear idea of what's at stake. It will prevent you from being lazy, or not properly observing your loss limits.

So we bought into the stock at 32 sen at first. We know there will be fluctuations, and perhaps some real selling pressure at 30 sen. The 'breakout' was not assured yet.

The key for us to go all in was the price activity between 9:10 and 9:15, represented in the 't' you see here.




The five minute chart, zoomed in. 9:00-9:20AM

We hope you have a basic understanding of these charts. the 't' basically means that the stock ended the five minute period where it started - at 31.5 sen. The bottom end represents a low of 30 sen and the upper part represents a high of 32 sen.
During this five-minute period, there was substantial buying activity in the stock. This recognition, for us, mostly came from our intuition. Remember that this all happened in five minutes.

Then in the next five minute phase, the stock comfortably broke a new high for the day. We thought it can realistically hover in the mid-30s range or further. Having received the confirmation of our thinking in the movement of the stock, we went in and bought more shares.

And it went up as we expected. We have seen this before. Our intuition guided us in this whole trade.

And less than 30 minutes later, by 9:38AM, we exited. The monetary reward of developing this intuition? In this case, it's a 16% gain in 27 minutes. Gains of RM6,000 plus. (Editor's Note : we try not to compute such gains on a per-minute basis as the figures can be truly crazy sometimes, but we do hope to demonstrate the very real and tangible rewards of being a trader who can recognise opportunities like this one). 

Those first fifteen seconds truly mattered in the end.





OUTCOME
Gross profit : RM6,295
Average Return on Investment (ROI) : 16%
Duration :Intraday (27 minutes), first hour of trading








Monday, 7 January 2019

YEAR IN REVIEW : IMPORTANT TRADING LESSONS LEARNT IN 2018

2018 was both a great and humbling year for us. It marked the first year that the Fund is fully operational, and consequently the documenting of its performance via this very blog. It is a result from four solid years of planning, painstaking research, unsuccessful experimentation, and various other failures.
 

 Keep the pain inside. Source.

Through this blog, we have also encountered (actual) people who (actually) enjoy reading about our journey. We have received a lot of encouragement over this project, even from random strangers on the Internet. We are grateful for the support and look forward to publishing more meaningful content for our readers this year.

Our modus operandi is simple : if we run the Fund well, and conduct excellent trades, we will have something good to write about. We are real believers in giving away information and lessons for free. We do hope that our writing helps you in some way in your own investment journey, whether as a value investor or a contra trader. Whatever you want to be, take charge of your finances. Be bold and take risks, because YOLO.

Obviously last year was a challenging one for the markets. There was a lot of volatility and as a result, investment performance was undoubtedly impacted; it doesn't matter if you're a hotshot multibillion dollar protfolio fund manager or small fry like us.

Our own returns, while good, have been very lumpy. This was a consequence of experimenting with different tactical approaches. We explored many, many strategies with mixed results. But only by doing this - and by incurring the occasional five-figure losses - can we fine-tune our philosophy.

To be a proper fund manager that can consistently outperform the broader market, we needed a competitive advantage. We had to find what we're best at and filter out our worst impulses; indeed, we do partake in emotion-driven trading and suffer from indiscipline when it comes to setting our thresholds.

We are not rockstars; this has been a slow and steady and sometimes painful process. But we are passionate about trading, which has been a major part of our lives.

We don't mind waking up in the middle of the night to check gold prices. Ask us about the history of Bursa Malaysia and we will bore you for hours with dull facts. We have no choice but to become morning people as our biological clock is attuned to market hours.

To us, figuring out the markets is the most interesting puzzle in the world.

What we aim to look like by the end of 2019. Source.



MAJOR LESSONS LEARNT LAST YEAR - IN NO PARTICULAR ORDER

 
1) We are Traders, and That's OK 

We have used the words 'trading' and 'investing' interchangeably in the past. This is because we do not care for the distinction; both practices are intended to chase profits. One is supposedly long term and the other short, but in essence they are both wagers on a positive future outcome.

Of course, value investing (and the dividend yield approach) is seen as more respectable compared to trading. Rightly or wrongly, traders are viewed as scalpers, vultures, short termists, and other undesirable terms.

But tell you what: George Soros was a short term trader (among other things). Warren Buffett is a long term value investor. They both became billionaires in their own approaches. Our point is: there is really no right or wrong. We value diversity of thought, not absolutism.

Without short term traders, there would be no liquidity in the market. And without liquidity, stock markets would be even more volatile than they already are. Even major funds like the EPF engage in opportunistic short term trading. We are all out there to try and deliver the best results, no matter the approach.

When we started the Fund, we admittedly were somewhat confused about this distinction. We have aspirations of being a long term value investor, but that's not really part of our skillset. Like everyone else, we do enjoy the benefits of short term trading and large gains, but we did not see ourselves primarily as traders.

Now it is very clear : we are traders, because that's what we are best at. This means that the Fund's mandate should only be to capture short term opportunities. Our track record speaks for itself. 

So choose an approach that works for you. It's your money; be responsible for it.


2) Being 100% in Cash is Almost Always the Right Move (In a Volatile Market)

The wealth funds that manage billions of ringgit of your money are big fish in a small pond. It's a double edged sword; the EPFs and PNBs of this world own enough shares to support the entire stock market, but this essentially means that their overall performance is directly correlated with the FBM KLCI. The market goes down, they go down (Editor's Note : we mean their ability to deliver fat dividends).

Just like us, sometimes they end up making stupid decisions. But they have to stay invested, because of their mandate, and because their stakes are so big they have no choice. In worst case scenarios, you'll encounter something like Tabung Haji's ridiculous markdowns on their disastrous stock investments.

Objectively speaking, we think this is a senseless portfolio.

As an individual retail investor, your advantage lies in your nimbleness. You can actually get out of the market and remain in cash. Are you a dividend chasing investor? You can still get out and wait to buy your favorite shares at a discount (Editor's Note : to us, averaging down is simply throwing good money after bad, and it's totally unknown if your future dividend yields can actually offset this reckless behaviour).

Our mindset is that of someone preparing for a market crash scenario; the volatility we have seen in the markets so far tends to be a precursor to much darker things to come. During a crash, your favorite dividend-rich stocks will not save your portfolio; their long term value may be assured, but you may be underwater longer than you can hold your breath.

If you're young (20s to mid-30s), you probably haven't lived through a real bear market as an investor. If you're older, and have lived through a real economics slowdown driven bear market (97-98), you're either totally scared or have become wise enough to know when to take your profits.

We always pick safety over complacency. And being in cash has saved us many times in recent months from the worst of the market turmoil. Ready cash is a potent weapon; keep some to buy into the market when everybody else is panicking.


3) The Simpler the Strategy & Mandate, the Higher Probability of Profits

Just like you, we think we know everything there is to know about buying stocks. We have made tons of money by using Strategies A, B, and C. Therefore we are experts in all three, and immediate success awaits.

We used to think this way, and we were completely wrong. There is a better way which can deliver even better returns.

Let's say you're especially good at three strategies. For example, let's say:

A = technical trading
B = trading volatile stocks during earnings season
C = trading KLCI component stocks (big caps).

The best way to optimise your performance and trading profits is not to keep pursuing all three strategies. You actually need to find the one strategy you're best at, and keep at it. Even if it means losing out on potential profits from the other strategy.

Still doesn't make sense? Then compare it to a surgeon with a specialisation, or a lawyer who only practices in one segment of his field. Our point : in trading, don't be a jack of all trades and don't be too smart for your own good, because eventually the losses will catch up with you.

We value clarity of thought above other things. By concentrating on one thing, we're able to steadily hone our competitive advantage, or that all-important 'edge'. Our mind is not muddled by three different approaches at the same time. If you have three things you think you're good at but you can't figure out which one it is you're best at, then you might be in a bit of trouble there.

We're not saying it's bad to be good at different things. But for trading, concentrate on one thing at a time. Learn to compartmentalise and prioritise your work.

What we have learnt was that the easier it is to explain our competitive advantage - to other people, and especially to ourselves - the easier it is for us to find the best trading opportunities.

Make it worth the pain. Source.


4) Psychology & Intuition Matters

Speaking of competitive advantages, one of ours is that we're adept at analysing 'fearful' market phases.

There have been countless times where we have gone into a stock or warrant and made good profits because of the temporary, artificial mispricing. Understanding this segment of market psychology is the foundation for our trading activity. Without it, we would be toast.

But at the same time, we have developed a better understanding of trading intuition. To us, it's not about choosing between being a 'gut trader' (purely intuition) and a 'systematic trader' (purely systems or signals-based).

Obviously doing our homework on the stock is just as vital. But intuition helps us make that trading decision just a little bit faster, and in certain situations, this can make all the difference.

We firmly believe that intuition can be developed from repeat experience. You've seen the same situations before; you may not recall exactly what but as a collective whole, you understand that this trade has important similarities to a previously profitable trade.


5) Detach Feelings or Emotion from Trades Quickly

A lot of people, when they're just starting out, tend to take trading losses very personally. It can lead to indecision, regret, and feelings of stupidity. It's basically the failure to detach the self from the trade.

Our advice: if you really want to be a trader, never take losses personally and emotionally. Some people take a day to get over it, some can move on after 10 minutes of crying your eyes out, and some can move on after not trading for an entire week. Do what works for you; even more importantly, don't rush back into trading until you're regained that clarity of thought.

This is important because every trade must be analysed critically and unemotionally. We don't rush out to get new spouses right after a divorce (Editor's Note: those who do probably have no place in the trading biz).

So for your own sake, do learn how to overcome painful trading losses. They will inevitably happen, but don't let them kill you. Let them make you stronger.


6) The Key to Active Trading Is... to NOT Trade So Often

We get it. Trading sounds like fun, rewarding work. That's probably why you've read this far into the post. Easy money? Sure; we understand that short term trading elicits the same feelings you'd get after a big win at the casino.

Sorry to burst your bubble, but to stay alive, you must NOT be trading most of the time. Trade smart, not trade often. Even if we're doing this trading business full time, we accept the likelihood that there may not be any trading at all to be done for days, or even weeks. That means zero cash flow, and a stint driving fro Grab to make ends meet for your spouse and children.

A freelancer, needing to fine tune this business model. Source.

The real lesson is to only trade when the opportunity arises. And the next one will dispel any notion of 'fun' you may have towards trading: it takes considerable mental strength to do absolutely nothing most of the time. But there is no better filter against losses.

A simple analogy: Military strategists have now discredited carpet bombing (indiscriminate trading) as an effective method of defeating the enemy. They cause a lot of collateral damage (your small losses adding up, plus your brokerage fees), and do not meaningfully contribute to the end outcome of winning the war (making substantial, sustainable profits in the long term).

Instead, we favour precision drone strikes (Trading only when the situation allows it). The military now only attacks specific strategic targets to erode the enemy's capabilities (trade smarter, not more often). And this is done very rarely, and is backed by thorough planning and analysis (duh). The intention is to minimise collateral damage (decrease overall losses) while optimising the intended end outcome.

You win the war by conserving your resources and deploying them effectively, not via brute force. This is trading smart in a nutshell.


7) The Biggest Losses Come From a Series of Crucial Mistakes

The really big losses - and we've had several - come from a series of lapses. They tend to be a succession of serious misjudgments that snowball into into a major one.

A simple example is what tends to happen when you don't stick to your loss thresholds. Maybe you planned to exit that stock at 35 sen. It just hit 34.5? Hmm.. perhaps you should wait a bit for a rebound. By the time you're done with this thinking the stock probably would have collapsed to 30 sen, thus rewarding you with an extra 5 sen per share loss.We've gone through this scenario countless times - we're still learning.

The only way to prevent this from happening, or at least minimise its frequency, is to be self-aware of the mistakes quickly. We set very rigid, unbendable rules nowadays. Self-discipline has to be mastered; it does not come naturally for most of us, especially in a high pressure trading context.

So always write down your trading parameters and stick to them. Any breaches should be punishable by death (metaphorically). Even when you falter, always take notes to mark down your mistakes.

The next time you exited a bad trade at a huge loss, look at the catalogue of mistakes you've written down. You will find that the losses could have been minimised at every step of the way.

If you're not self-aware, you're bound to self-destruct.


8) The Biggest Gains Come From Playing It Safe & Boring


Consistent profits only happen when you execute your trading plan properly. When you have a winning trade, the temptation is always to try and maximise your gains. Even worse, you may be tempted to double down on your position, thinking that you're playing with the paper profits.

This is a fatal approach; doubling down simply means your profits can evaporate twice as fast. And if doubling down was never part of your trading plan at the beginning, you've also committed the lethal mistake of letting your greed take over your brain.

As an example, let's say you committed RM10,000 to a stock. It just gained 10% - fantastic. If getting out at 10% was part of your plan, you should exit and call it a day. Even if the stock immediately went up another 20%.

Because when this happens, we are naturally tempted to go back into the stock and chase the gains we didn't get. It's human nature to try and roll the dice. But if you're aware of this - the fact that your decision making is grounded in greed and foolishness, not logic - perhaps you will avoid doing this the next time.

Understand what parameters are for. For loss limits, we should never let them be breached. For profit targets, it's hard to exit and forego your extra gains, but trust us, it's the right thing to do. If you don't want to gamble with the losses, don't gamble with the profits. Value them for what they are; profits derived from a well-executed trade, not from rolling the dice.

IN OTHER WORDS...

Learning is a slow process. Like trading, you should never feel rushed. The process is incremental and can be painful at times. But stick to it and you may end up with some good stories to tell.




Wednesday, 2 January 2019

TRADE OF THE WEEK #3 - GLOBALTEC FORMATION BERHAD


 
We'll be honest - we didn't really pay attention to the company's fundamentals. But for a penny stock (it has since consolidated its shares), the company not only is somewhat profitable, it also has a snazzy website.

This was a trade idea that originated in about 5 minutes, and culminated in great gains. All within the first hour of the market's opening.


On 26 December, the company's newly issued warrant - GLOBALTEC-WA - caught our attention. Originally priced at 0.5 sen, it opened at 5 sen and immediately sped up to 9.5 sen within 10 minutes. A 90% gain.


We went in after that. Bloody hell! You may say - how can we buy a warrant after it has already doubled in value?


On a side note, we didn't have a predetermined attack plan or whatever. We just saw the price activity in Bursa Malaysia's top gainers. We thought the warrant looked interesting.


Now we'll let you in on a very important secret. Our potential success in this trade boiled down to three very simple questions:


1) Can it stay above 10 sen and for how long?


2) How far can it go beyond 10 sen?


3) Does the warrant look good enough to attract buying interest?


First, we decided to go in because there was sustained buying interest at the 10 sen level. By this we mean that somebody's buying small lots, and at the same time liquidity remained low. This is characterised by typical buy-sell queue at the time:


Buy - 0.105 - 0.12 - Sell

It was that kind of warrant - very intriguing really. Low-ish volumes but it kept going up. Low liquidity but no real collapse. Now for the fun part - disregard the fact that GLOTEC-WA is already trading at 110% its opening value. By 9:15AM.

We were confident that there is still upside, although it definitely would be temporary. We define that window of opportunity as our 'time stop' - this trade has a limit of 3 hours to work. If it doesn't, we exit.

The second parameter : we will buy in at 10 sen and above. Our immediate exit point is at 10 sen. with each half hour, we raise that exit point by 0.5 sen - assuming a sudden decline hasn't already triggered a hasty exit for us.

THE TRADE 

A minute-by minute chart in GLOTEC-WA, 26 December 2018. As you will see, we sold near the peak.
 
So we ended up buying small increments. We entered at 10, 10.5, 12, 12.5, and 13 sen, ultimately ending up with 90,000 shares. It's a fairly risky position, given that the average buy-sell queue was around 15,000 shares at the time.

To simplify, we were risking about RM2,000 in losses for the opportunity to gain RM4,000 in profits. Our average price for the 90-lots position turned out to be 12.5 sen; we were looking to exit at 15 sen per warrant. Anything more would be a bonus, of course.

We acquired that stake between 9:18Am and 9:36AM. Fluctuations were good (think of a normally beating human heart). We took up some warrants at 13 sen and prices fell to 11 sen; it didn't faze us. Though to be honest, we were ready to bolt if it became clear that a collapse was imminent.

What boosted our confidence was pretty simple. During a 10-minute period of downward pressure, there were substantial queues at higher prices. We can't recall the exact amount, but it's something like 1,000 lots each at 12.5 and 13 sen; at this period the warrant was trading at around 11.5 sen. Those sell queues were cleared rather quickly, meaning that the warrant was poised for a breakout.

We remained calm and stayed on standby to sell. The main question at this point was how far the warrant can go.

It went far enough, as it turned out. Low liquidity, coupled with solid buying interest, propelled GLOTEC-WA upwards very quickly. We reached our 15 sen selling threshold, but there was more buying, still.

Prices momentarily remained strong, with heavy volume, at the 16-16.5 sen level by 9:44AM. This gave us enough time to dispose the entire 90,000 warrants position in one shot. 

As you can see from the chart right above, that was the best that it got for GLOTEC-WA on this day.

The key to our success was as follows:

1) We anticipated a rally and assigned sensible loss-stop and time-stop parameters quickly.

2) We timed the exit properly based on our analysis. It was partly intuition, but we sensed that the buying interest will peak at above the 15 sen range. (Editor's Note : warrants traditionally follow the movement of their underlying share. But in this instance, GLOTEC shares didn't really go anywhere. This meant (for us) that the upside is capped).

3) We also knew that because of the finite liquidity, this sort of rally won't be sustained. And yes, we have been in these kinds of situations/trades before; we knew what we were doing.

The outcome of this trade was amazing. Again, we have to mention that this trade lasted all of 26 minutes.




OUTCOME
Gross profit : RM3,600
Average Return on Investment (ROI) : 32%
Duration :Intraday (26 minutes), first hour of trading




Tuesday, 25 December 2018

TRADE OF THE WEEK #2 - HSI-H4O (PUT WARRANT)

Note : The 'Trade of the Week' series showcases an interesting recent trade to highlight winning strategies in a basic, short form format. Not all trades deserve a long form writing treatment; some readers may also prefer a quick read. 

There will be no external links in these posts; we also hope you can read candlestick charts to get a better sense of our market timing. 


The Hang Seng Index (HSI) is a perfect proxy for all that is happening in the world's markets right now.

Like Japan's Nikkei, most of the time it takes its cue from movements in the US markets (S&P 500 and the Dow Jones). There are tangible reasons for this - many HK-listed companies have direct business interests relating to the US, like Apple's parts suppliers. It is also proxy to the ongoing trade war, given that the largest HK-listed companies tend to have sprawling businesses in mainland China; Tencent and the biog property developers, for instance.

We are not experts on Hong Kong or China's markets. But we do study the index movements closely. We especially like the correlation between how US markets perform and how the HSI would be impacted as a result.

We are of course aware of all the headlines generated out of the US, and the current fears in the market. We read the same papers and check the same Twitter accounts as you do.

To overly simplify our approach - and without giving our secret sauce away - this is what we tend to check before deciding whether to trade (Editor's Note : the timezone is Malaysia, +8 GMT) :

1) Last night's US markets performance (any decline of above 1.5% will trigger alarms for us).

2) The top headlines over the past 24 hours globally - we get everything we need from Twitter.

3) US markets futures after closing - the crucial hours between (1) and Hong Kong's market open.

4) 'Pre-market' prices for HSI warrants, both calls and puts - the crucial 30 minutes when Bursa Malaysia opens (9AM) prior to Hong Kong's market open (9:30 AM).

Because of the direction of the global markets right now - you know which way that is - we are more interested in trading put warrants. The reasons:

1) Liquidity and volatility is assured (unlike Malaysian stocks/warrants during this current market phase)

2) Real momentum exists (unlike Malaysian stocks/warrants, whose upward trajectory tends to be interrupted in a bad market).

3) Nothing else is gaining (when everything is declining, only put warrants look attractive. Hence, other people would be inclined to trade them too, resulting in situation (1)).

In December 2018, the put warrant that we usually trade, HSI-H4O, tends to be heavily and actively traded. It is incredibly sensitive to movements in the underlying - the actual Hang Seng Index - while liquidity is virtually assured. It is a good product; we take our hat off to Macquarie Capital Securities for producing such a reliable, tradeable warrant.

You may be wondering: why choose this warrant? To us, it's simply because it has good liquidity and constantly reflects actual movements in the underlying index. Many call and put warrants out there tend to have one or the other but not both. Through painstaking research and observation, we chose this particular put warrant.

And one last thing : we trade put warrants on an intraday basis. Hence, we don't have to look at the technical characteristics of the instrument (things like exercise price, theoretical breakeven point, implied volatility etc). Our time frame for trading this is very, very short.

One last, last thing : trading HSI put and call warrants is very risky. You need to be certain you know what you're doing, otherwise your P&L may be down to sheer luck. The approach that we're describing here is just one way of trading them safely and profitably. Your risk appetite may differ to ours, but we hope this trade can generate some ideas for you and lead you in your own research.

Here we will describe two separate trades for the same put warrant, HSI-H4O.


The Hang Seng Index, daily price movement in December.

TRADE #1 : 20 DECEMBER, 2018


5-minute candlestick chart, 9:00AM to 11:25AM.

We wanted to be in a trade on this date because the night before, the Dow closed at a new low for the year. At 9AM, HSI-H4O opened at 36 sen to reflect this, an increase of 9% from the previous day's close.

While wary of the potential fallback, we were keen to take a position. Hence by 9:21AM we bought in at 35.5 sen and 36 sen for a total exposure of 60,000 shares.

But in the next hour we were swept into a wave of unwanted downside volatility. The actual index rallied for a short period, driving down put warrants to an intraday low. Our put warrant position was suddenly staring at a 7.5% paper loss.

Actual Hang Seng Index price movement, 30-minute chart. The downwards movement means profits for us.


In moments like this, we don't panic (although the inclination is there).  We took emotion out of the equation and made a logic-driven decision: if prices do not recover by 11AM, we will exit this position. The movement in the put warrant already threatens to invalidate our expectation for going into HSI-H4O in the first place - we had expected it to hit a peak of 38 - 38.5 sen.

By 10AM, it was clear that the upsurge was shortlived; the put warrants went back to 35.5 sen. Seeing this, we were willing to stay a bit longer in the trade.

Then the moment came : at 11AM the Hang Seng dropped 1% (see the big red candlestick right above). On this day, the correlation exists: the Dow Jones fell 1.5% the night before, after all.

HSI-H4O also rocketed upwards to 37.5 sen; a 5.6% gain in 10 minutes.We decided to exit at this price.

The reasons for exiting are simple: we were indeed fortunate to have derived profits at all. The downward volatility showed that we didn't enter at an optimal price point, thus undercutting our potential profits. And because of that volatility, we didn't have the luxury of waiting until the put warrant hits 40 sen (our best case scenario). Short term upward bursts are the perfect selling opportunity; indeed, it is when everyone else is buying.

HSI-H4O closed at 38 sen that day. We were happy to exit from this trade, lasting all of 2 hours and 20 minutes. Thematically, we would be looking at the put warrant with a fresh perspective the next time we decide to jump in.

As we explain here:



TRADE #2 : 21 DECEMBER, 2018

5-minute chart, 9:00AM to 4PM. Notice the huge range and volatility!

US markets went through another bad day, losing around 2% in value overnight. This spelled trouble for Asian markets.

As expected, HSI-H4O opened higher at 40.5 sen, or a 6.5% gain from the previous day's close. It actually went further to 42.5 sen by 9:10AM.

But this time we weren't too eager to go in. For obvious reasons - if you're into technical analysis - 40 sen and above is not a good price point to enter; there may be selling pressure to drive it below this resistance point. It would be ideal for us to get a position in below that, so we nibbled a bit.

When the put warrant headed downwards, it presented a buying opportunity. We bought small positions at 38 sen and above based on simple parameters; either it goes back to 40.5 sen or it doesn't. For reference, we would be happy to cut our losses at 36 sen, coincidentally our entry point from yesterday's trade.

Based on experience, we were acutely aware of two things:

1) If the warrant quickly went back from an intraday low to a position of strength (in this instance, from 38 sen to 40.5 sen), there is a real possibility of further strengthening. This is the characteristic of the underlying index, of course, not just the put warrant itself. Fear is a key driver for the market during times like these, so this kind of volatility is to be expected.

2) But if the move happens, and happens quickly, it is time to sell. It is the only moment to know for certain that we are selling when everyone is buying - it is a limited window of opportunity.

So HSI-H4O subsequently went back up to 40.5 sen. We managed to buy some more at 40 and 41 sen, expecting the put warrant to at least reach the prior intraday high of 42.5 sen (this principle is based on our description of (1)).

Being aware of (2), we decided to count our blessings and run. We sold at 42 sen for a profitable trade lasting just over an hour.

Remember that volatility is not the same as momentum. We have learned from bitter experience that holding on for longer translates to much more risk assumed (Editor's Note : on this note, we also believe that you should NEVER hold on to any overnight position in HSI warrants, no matter how strong the momentum is. What happens the next day will be a 50:50 option between profits and destruction; there's just too much risk involved).

It was the right decision to exit. For the rest of the day (after we sold at 10:08AM) the put warrant practically collapsed. It fell to a low of 33.5 sen by 4PM. Had we stayed, we would've risked a 14% loss.

At the end of the day, in each of these trades we took the safest route possible. There is no point waiting for bigger gains if you're risking even bigger losses.

We didn't say it was easy, but if you have the opportunity to make RM1,000 in an hour from trading, would you take it?




OUTCOME

Gross profit : RM2,880 from two trades
Average Return on Investment (ROI) : Above 4.5%
Duration : Intraday







Thursday, 20 December 2018

TRADE OF THE WEEK # 1 - V.S. INDUSTRY BHD

Note : This is our first installment of the 'Trade of the Week' series, where we showcase an interesting recent trade to highlight winning strategies in a basic, short form format. Not all trades deserve a long form writing treatment; some readers may also prefer a quick read over lunchtime (the same time it took us to write this post). 

There will be no external links in these posts; we also hope you can read candlestick charts to get a better sense of our market timing.  






Why VS? Basically it's due to the fact that the stock has been under immense pressure lately. Its recent earnings report suggest future weakness in terms of overall growth. The company itself warned investors about this, swiftly followed by downgrades by the research houses.

Why growth weakness? It's due to the company highlighting that a 'key customer' is expected to place lower orders in the coming quarters. We suspect that this is Dyson, the UK appliances company and a huge source of contracts for VS (and its smaller peer, SKP Resources) in recent years. VS's stock was on a high earlier this year, but has since plummeted from RM2.40 to below 70 sen.

It got a lot worse on 17 December as VS hit its limit down price immediately following the earnings disclosure. The stock stopped trading at 82 sen on that day.

THE TRADE 

5-minute charts for VS, from 18 December to 11AM on 19 December (our trading period)


18 December, 2018

This was when it got our attention. We immediately sensed an opportunity to make good contra trading profits. But to go into this stock required a calculated approach, and the entry point must be well timed. Otherwise the volatility will cause our position to swing into a loss.

We contemplated a few possibilities on how the stock would trade the next day after it hit limit down. Obviously the stock is expected to trade lower than 82 sen, but how low?

We would have been quite excited to pick up the shares if it got close to the next day's limit down threshold, which is 52 sen. At 8:59AM on 18 December, it looked like it was going to open at 66 sen - 16 sen below the previous day's price.

We decided against going into the trade immediately at the opening, as we were concerned that the stock could go lower. But VS showed serious buying strength and immediately hit the 70 sen mark, or a 6% increase from the open.

Our first move is to go into the stock at 70.5 sen, as buyers cleared the 70 sen selling queue easily (thousands of lots). We anticipated a rally to 75-78 sen, a best case scenario and a good exit point for us to make significant profits.

However, 70 sen is typically expected to be the resistance point. The risk is that the trading could just stay there for the rest of the day. After VS hit 72 sen, the momentum shifted. Now there was a lot of selling pressure concentrated at the 69.5-70.5 sen mark.

Sensing this, we exited our position at 69.5 sen by 10:30AM for a small loss - by this point we understood that it is more likely that the stock will decline as opposed to going up. We put a time limit on this trade to work; when it was reached, it was clear that the stock will not move up quickly.

We stayed on the sidelines to watch the stock; our original theory was already disproved. VS weakened steadily thereafter and hit a new intraday low of 63 sen at 3:50PM; as you can see, we saved ourselves from a further 9% loss (and a lot of grief). The stock closed at 65.5 sen on that day.

19 December, 2018

The key to trading is finding the right windows of opportunity to trade. If there isn't one, just don't go in. Sounds simple enough, but it's easier said than done - speaking from experience, we know that people have a tendency of seeing signals that simply aren't there. Some people trade for the sake of trading, or worse, for the 'fun' of it.

We consciously try to avoid such bad behaviour. We were wrong yesterday, so we reassessed the potential outcomes. It was plausible that VS could continue to fall further or stage a rally; this is obvious, so we had to refine our thinking to formulate a scenario where we can reasonably go in.

It's a bit like a computer program command: execute if, and only if. To simplify our next approach for trading VS (yes, we still saw trading opportunities here despite the previous day's activity), here's a distilled version of our analysis:

1) If VS opens below 65.5 sen : don't trade.
2) If VS opens at 65.5 sen : don't trade.

Both 1 & 2 are signs of weakness, not momentum. But if there was upwards momentum, we expect to see volatility quickly. In this trading scenario (volatility trading), this is what really mattered.

But there's also Scenario 3:

3) If VS opens much higher than 65.5 sen : put on a moderate size trade.

We were hoping for Scenario 3 because of this : On 18 December, a lot of investors would have attempted to buy VS at the lows. Because the stock didn't move, they may also have thrown in the towel (like us), and some may have been forced to sell at the lowest prices (not us).

But if the stock rallies immediately on 19 December, it is highly suggestive of real buying interest. In numerical terms, we could capture a profit opportunity at any point between 65.5 sen and 72 sen (yesterday's intraday high). And if the buying interest is sustained beyond 70sen, there's a chance of the stock breaching the 72 sen mark; this would be a bonus for us.

With this in mind, we waited to see how the market would open. Basically Scenario 3 unfolded, and having noticed that quickly, we put on a position at 68.5 sen (our order was keyed in at 9:01AM). The stock rallied further as we expected, quickly hitting yesterday's 70 sen resistance point.

At this juncture, we could have got out with a 1.5 sen per share gain. That would be a reasonable thing to do. But we sensed further upside for the stock based on our observation of the buy and sell activity.

We were committed to two zero-sum outcome possibilities.

1) Exiting at 68.5 sen (our entry point) if the stock weakens. Basically break even, but a small loss due to the brokerage fees.

2) Wait and see if the stock can test the 72 sen mark.

Basically, we were willing to give up 1.5 sen in gains for the chance to achieve a 3.5 sen per share gain. Our thinking was clear; there was literally a price for the consequences of our actions.

Again, the time stop is important. To avoid the recurrence of yesterday's trading activity, where the stock lost momentum at the 70 sen mark, we decided to set a two-hour limit to our angle. If VS doesn't rally further by that time, we would happily exit.

Fortunately we didn't have to wait long. By 9:55AM the stock hit the 70.5 sen mark on heavy buying volume. Our best case scenario expectation was unfolding.

By 10:30AM, the stock hit a high of 74 sen. Anywhere above 72 sen is a bonus for us, of course. We got out at 73.5 sen, a point which we thought was the highlight of the buying frenzy. To us, it was likelier that the stock will not continue its rally. We were also close to our mandatory 10% profits per trade target, so getting out was the sensible option.








So good returns all around. Nothing better than a well executed trade, and profits that came as a direct result of proper planning.

Outcome

Gross profit : RM2,500
Return on Investment (ROI) : 7.3%
Duration : Intraday, 1.5 hours








Wednesday, 19 December 2018

WE'RE ALREADY IN A BEAR MARKET - WE JUST CAN'T ADMIT IT YET

 They will maul you, kill you, and worst of all: force you to liquidate your margin share financing account.


2018 will be known as the year that we, the Malaysian investor, decided to get rid of the 'stupid premium' accorded to stocks once and for all.

Having been an article of faith since practically forever, we have finally awoken from our delusions and have started assigning proper valuations to these companies.

The stupid premium is simply this ; rich valuation given to stocks with simplistic business models and previously held monopolies. We loved tech counters which dominates government contracts via murky direct tenders, assuring them of fat profits at the expense of the government's coffers i.e. taxpayers (MYEG, SCICOM, PRESBHD, DSONIC). On average, these four counters have fallen by 60%.


Tech - screwed

Or how about the upstream oil and gas service providers that we used to love so much? While oil prices staged a brief recovery this year, these companies' debt loads threaten to swallow them whole. Remember that BARAKAH used to be worth RM1.50 barely four years ago (now trading at 5 sen, or a 96% loss). And the lovely SAPNRG, which is now worth about 33 sen from its peak of RM4.50 five years ago (92% loss). We have already told you about the dangers of investing in oil and gas counters.

Very smart people (institutional funds, pension funds, bankers, etc) are fully invested in these stocks and have committed to holding them until near-worthlessness, it would seem. These companies have lost roughly half their value this year on average.

Oil and Gas - running on fumes

Spare a thought for the parcel delivery companies who were counting on e-commerce (greater parcel volumes) to save them. Turns out they couldn't catch up with rising expenses, a shift in the operating environment, and Jack Ma's declining enthusiasm - we should know, we traded these stocks at their absolute peaks.

Parcel companies - 'bungkus' already

And last but not least, the construction companies that were the toast of the town as recently as a year ago. By virtue of their own abilities and/or connections, they could count on getting the biggest share of major infrastructure projects. That angle has been thoroughly extinguished post-May 9; everything is being reassessed and those heady days are over. Just look at the big players in the KVMRT project and where they are now.

Construction? Go fly a kite.

Collectively, we have put stupid premiums - or, to put it more delicately, rich valuations - to these stocks in the past. We never needed a truly credible angle; any big contract announcement will do. Any link to the latest high concept thematics is OK. We forget that contracts won and contracts executed are two different things. We also forget that a contract is an agreement between the client and contractor - if the client is the Government of Malaysia, it can choose not to continue the contract, because (1) it can and (2) it can't spare any money.

 Sweet dreams (are made of this). Source.

For similar reasons, this is why we don't take seriously companies that have billions of ringgit worth of contracts but questionable abilities to execute them. Upstream oil and gas companies do this all the time - big, fancy contracts used to prop up their stock prices, until suddenly they don't anymore.

Notice the four sectors we highlighted - each used to have a protective moat around them:

1) Oil and gas - Petronas throwing around lucrative contracts, an enthusiastic public market supporting any fundraising efforts.

2) Mail and logistics - friendly government regulation to promote e-commerce activity.

3) Construction - margins managed by the PDP contract structure, companies favoured purely due to historical ability to execute instead of best pricing.

4) Tech - government fully supporting new IT solutions and integrated software systems regardless of pricing, only favouring certain companies.

These moats/protectionist measures are all similar in one way. You guessed it:

Money pump. Source.



Will these protections come back? Who knows; for now it is really every company for itself. There are no longer any handouts and no easy ways out. Not because we have faith in political willpower, but simply because the money is gone.

We believe that the market and the market's participants (that's all of us us) have changed for good. We will no longer put premiums on companies that don't deserve them. For those companies, they are the ones who have to contend with trouble ahead; less contracts, overcapacity but underutilisation, weak sector prospects, and so forth.

We also believe that 2019 will be a serious bear market for stocks. A decline of 10% from present levels is expected... to be just the beginning.

When Google image searches turn into accidental lifelong enlightenment. Source


A SHIFT IN PERSPECTIVE

We specifically highlighted the companies above as their stocks are the first victims of a bear market's vicious self-perpetuating cycle.

Here we outline a progression of events that may already be happening.

Scenario A : Lower investors' expectation ----> stocks lose premiums over net tangible assets (NTA) ---> lousy sector prospects ---- > lower investors' expectation ---> stocks trade below their NTAs 

Scenario B : Global economic growth slowdown ----> Lower demand for key commodities (palm oil and crude oil) ----> Malaysia's economic growth slows down ----> corporate earnings (banks, construction, property companies etc) slows down ----> added pressure from even weaker ringgit (due to our weak fiscal position) ----> [Scenario A] for Bursa Malaysia stocks

And, to cap it all off:

Scenario B ----> Scenario A ----> steadily weaker quarterly GDP growth ----> negative GDP ----> recession scenario.

Blue = Events that are already happening as you read this
Yellow =  Events that are at risk of happening soon (give it six months)
Red = Apocalyptic worst case scenario that will probably cut the KLCI's value by half


How to time the crash tho?? Source.


We may have called the overvaluations a stupid premium, but the market catches up very fast. The collective wisdom of the market has already priced in the weakening growth expectations of companies. 

The ones we highlighted above are just the first stage - they are the previous market champions whose stock prices (justified or otherwise) used to outpace the broader market. Many of them are growth companies with an appetite for expansion (vying for contracts, M&A). But their misfortunes are a sign of worse things ahead for the entire market, and for the economy. 

This bear market is different from the most recent global recessions. It is not triggered by the collapse of some far flung investment bank. There are no toxic assets, loans, or securitised loans threatening the global banking order (we have plugged that gap). Trade wars are noisy and make for good newspaper reading, but even they are not enough to trigger this oncoming economic slowdown.

We are simply reverting to the mean. Global capital markets have been fueled by cheap money over the past 9-10 years (no more of that). This time, a slowdown means exactly that.

During the same period, emerging markets have also been reaping the rewards of ever greater FDIs, championed by China (no more of that, or at least much less).

We have had it so easy that governments and entire countries can cut lousy long term, debt fueled deals. Banks have loosened their standards faster than you can pronounce 'Lloyd Blankfein'. Even the most pious of us have committed sins to cover gaping holes.

Pump priming, something Malaysia are truly world champions at, has occurred at a global scale, fueling industries, global trade, and global consumption.

But in the end, everything comes with a price. A slowdown means that it's time to count the costs of 10 years of nearly unimpeded growth fueled by easy lending and cheap capital. 

Malaysia's Government now has no cash to spare. Neither does the US. China? They won't give a shit about your country; any and every form of protectionism will be for its own people. 

We are heading into uncharted territory as an economy. Without fiscal prodding, how will Malaysia truly fare? With a horrendously low taxpayer base, and still mounting debts, where and how can we finance growth? Don't take our word for it; our Finance Minister has already warned us of at a few years of severe pain.  

Are you hoping to see a fiscal balance eventually? Fat chance of that - pump priming created the gap between the Government's revenues and expenses in the best of years. In the worst of years (like right now)? The deficit is driven simply by ever increasing expenses to service debts et cetera (Editor's Note : as an alternative, we can also use 'ad infinitum').

If you think a balance budget is nothing but a pipe dream, the following is from 15 years ago.




THINK ABOUT YOUR FUNDS
We're trying not to be scaremongers or doom merchants, but we do implore you to look at the facts and think rational thoughts. 

Lembaga Tabung Haji can no longer afford to pay dividends to its depositors. So how about the rest of our GLC funds? Their pool of unrealised income (paper profits from investments) will dwindle the more the market falls. In many cases, their positions have become so large that they have chosen to go all in with their investment in losing companies. 


One simple example - Malaysia Airlines had RM12 billion in unsustainable debt until it was finally absorbed by Khazanah. At the moment, we have certain public listed companies (*wink*) with total debts of between RM8 to RM14 billion each. Do you really think they will make it out of this bottomless pit? (Editor's Note : PLCs with institutional funds support don't really go through bankruptcy; they tend to get privatised / 'restructured' at fractions of their original value instead)



                                  MAS's last financial statement before its privatisation in 2014.

When the market no longer supports stocks of past champions, their major shareholders will suffer. They are stuck in a liquidity trap with no way to dispose their shareholdings. It is likely that the EPF, KWAP, or what-have-yous, will 'do a Khazanah' or simply hold on to their investments. Aside from real investment savvy, their strength also lies in two things: their infinite holding power in stocks and the faith that Malaysians have accorded to them as custodian of our money.

Our main point is this: don't expect similar dividend yields from EPF and its cohorts. If it used to be 7%, prepare for 3.5% or below in a real bear market scenario. (Editor's Note : at least their market exposure would be hedged by their bond positions, though as the largest holder of Malaysian Government Securities, a rising yield environment will not help with overall investment performance). If the FBM KLCI drops 30-40% in this bear market, any dividend will wholly reflect market performance. Whether that will be acceptable politically, we're not sure.

We may be completely wrong, but right now we are following the smart money; there is little reason to suspect that the current market troubles are over. When corporate earnings justify lower stock prices, there are no premiums to be afforded; expectations would be inverted (lower income due to external factors), thus possibly driving stocks lower. Of course, we may be completely wrong, but ask yourself: would you consider buying TM stock now? How about ECOWORLD? How about GENTING?

And those are just the blue chip companies that make billions of ringgit in revenues. How about the lesser lights and the loss-makers? You know what we think about those, we assume.

WHAT CAN YOU BUY?

The short answer is - no one really knows. Even professional investors are confounded by the worst year for hedge funds in  a decade. How about low-cost, passive index funds? Possible ticking time bomb there too.

The truth is, this current generation has never truly lived through a global recession. We can't play outside the rulebook that has been prescribed to us over the past 10-15 years; buy the dips, stay the course. We think this is misplaced faith - during a crisis scenario, there will be such a severe disconnect between actual value and existing stock prices that most people will end up cutting their losses and give up (Editor's Note : good thing you're not managing billions. Otherwise you'll end up throwing good money after bad via a rights issue ;) ).

We have said time and again that long term forecasting on stocks is no better than guesswork. Even the smartest analysts and quants resort to what is essentially a calculated guess backed by historical data. Not crisis period data or economic slowdown data - perhaps these simply do not exist - but simply past performance of stocks over the past 10 years, a period with the biggest bull market the world has ever seen. But of course, they will tell you that past returns do not correlate to future performance. So is there a point?

It's becoming so comical that one respected research house and another can come to wildly different forecasts for the FBM KLCI at the end of 2019 - on the same day, no less. The deviation between the forecast is 192 points, or about 10%. We don't find these kinds of forecast or information as useful at all. Do you?

Wuh?

 
It can be 1,900 points or 600 points by end-2019 for all we know. Our advice: don't be primed into thinking that all is well in the economy, or the stock market, right now. The companies that you have seen earlier all have a money problem; less money to service debt, less money to ensure a healthy cash flow, less money coming in as revenue and profits as demand slows down, and definitely less money to make M&A moves to generate more money.

Malaysia's stocks are beginning to fall in tandem, regardless of their catalysts. This is the truly scary part.

Sure, there are good companies to invest in but you will have to take the pain with the gains. Expect dividends but negative capital growth on the stock price. Expect to hold stakes in companies for longer than you thought you ever would. Adopt a five-to-ten-year perspective on investments. Don't leverage yourself to the point of ruin, like these people
 
Bottom line - the well has dried. The easy money is gone. The crooks are going to jail.

But get your cash pile sorted out. We are patiently waiting for a real shock to the global markets to occur, which is the best opportunity to not just trade, but to build a real long term position in shares.

What you have seen in the markets this year is nothing - it's just a dress rehearsal.


Sunday, 2 December 2018

HOW-TO GUIDE : THE ONLY WAY TO TRADE INDEX CALL WARRANTS PROFITABLY


The last quarter of the year has been pretty lousy for the market, and for traders - we're sure you agree with us on this.  Some say the bear market has already begun. For us this is clear, at least for certain stocks that were market leaders as recently as two years ago. Global economic growth is losing steam - there's no better indicator of pain in the stock market than that.

 Not sure if Trump is talking about the GDP or his own brain capacity OH SNAP (Source)



See stocks like ARMADA, ASTRO, STAR, and FGV - all have been making new all time lows, and for good reason - fundamentally their business model no longer deserve premium valuations.


So much value destruction in barely a year. 


So what is there to do? We've touched on this topic before - what can you buy or trade in a bear market? Sure, you can express your bearish views by trading put warrants or sell short index futures - the KLCI certainly seems to be heading south. 


You can certainly make money by building up a large put warrant position or by short selling index futures, but it's equally likely that you will get hit by volatility. You shorted when global markets dropped 10%? Congratulations on losing most of your money as they rebounded very, very strongly.


30 November 2018 : the face you make when you recover 1% of your 30% loss. Source


Without over complicating things, these are the usual strategies employed during a bear market:


1) Buy index linked put warrants (you profit as the market falls) - Momentum trade


2) Sell short index futures contracts (you profit as the market falls) - Momentum trade


3) Buy index linked call warrants (you profit as the market rises) in the hope of being at the bottom of a market recovery - Mean reversion trade 


Our thoughts on these? Based on our collective experiences lasting five years and three serious bear market phases (where the KLCI dropped at least 100 points or more), we think the chances of profiting from these approaches are minimal. In fact, it is highly likely that you will lose money, and a lot of it. 


The issue with momentum is that people tend to assume that index linked warrants perfectly follow the direction of the market; but this is not the case at all. Aside from the usual time decay factor (there is less correlation between an index warrant and the market as the warrant approaches expiry), the market volatility will also throw such expectations further off course.


If you felt nauseous after reading that dense sentence, here's a simple comparison of gains/losses between the underlying (the Hang Seng Index) and the linked warrants - one call and one put.





 30 Oct, 2018
30 Nov, 2018
 Price Change (%)
 Price of HSI
 24,585
 26,506
 7.8
 Price of HSI-H40
 0.83
0.33
 -60
 Price of HSI-C3W
0.225
0.385
 71



If on 30 October you had bet on the market recovery (buy HSI-C3W), you'd have made a lot of money. But there was no credible justification for you to do such a trade. It is highly probable that yours was just a lucky guess.


If on 30 October you had bet on the market continuing to fall (buy HSI-H4O), you'd have lost 60% of your capital. There was every reason (and many credible justifications) to bet on the market falling further, but the market can be wrong for a lot longer that you can remain solvent.
 

We are students of fundamental analysis, and we agree that the market, be it S&P 500, KLCI, or Hang Seng, have a lot of room to fall further in the coming months/years. But you can be right about an angle but wrong about the trade.


The idea is sound but there was no good tool to express that idea (or you're not using the tool properly), so you end up buying put warrants that move like the heartbeat of someone having a cardiac arrest.


Our advice : DON'T BUY INDEX LINKED WARRANTS.



Unless....


There's actually a way to trade these fickle call warrants profitably. But there's a catch: you will have to literally be a contrarian. All the time. But is there a fair likelihood of profitability? Absolutely.


We have looked into our trading records for index linked call warrants, spanning about 45 separate trades in four years, and found that only one method is effective enough to not only make us meaningful profits, but also insulate us from losing massive amounts of money. (Editor's Note : On a long enough timeline, and when your luck runs out, there is a very high likelihood that you WILL lose money from employing strategies 1,2 or 3 as described above).


To make money, you have to show up when the market is in a state of absolute panic. It's an extension of our 'peak fear' philosophy, as you can read about in this post.


We only trade index linked warrants when the market gaps down. Here's a visual example of that phenomenon with a recent daily chart movement in the HSI:


Notice the two long green candles? The bottom is the opening price relative to the previous day's close (the gap down). They represent a decline of at least 1% immediately when the market opens


If you had bought call warrants when the market immediately opens at these gap downs, you would have made some serious profits not only within a day, but also in subsequent days. And it's not down to luck.


We strongly believe that prices are the ultimate manifestation of investors' current fears and hopes. Such sentiments determine the movement of prices, and when the sentiment peaks, you have a 'gap' situation.


When the index warrant gaps down, investors are fully pricing in those fears. There is massive selling activity driven by panic, and this may go overboard. As in a typical contrarian trade, we go in when we believe that an artificial mispricing has happened, as we would when a stock goes to limit down levels (Editor's Note : only in specific cases - not all limit down stocks present a good trading opportunity, obviously).


Or, to put it simply : investors' price in those fears by selling at price points that are excessive. We buy into those fears/excessive selling because the short term profit opportunity is appealing. Peak fear is when everything has been fully priced in; from there it can only go up, at least in the short term.


THE TRADE


Here's a real life example of us having this strategy put in practice. This is a trade on HSI-C3W on 21 November 2018.



So we look at several things before committing to a trade. Obviously the risk is that not only is the fall significant, but that it will fall further. We prefer exceptionally large declines to provide us with a bit of a margin of safety.


Looking at the situation from several angles, here was the score on the morning of 21 November.


1) HSI (the index) opened down 2.9%, an monstrous decline triggered by the previous night's tech-driven rout in the US markets.


From this we already know that while Hong Kong takes its cue from the US markets, the decline is more a reaction towards price movements rather than anything with fundamental justification. There are some huge tech players listed in Hong Kong, primarily Apple parts suppliers and behemoths like Tencent - a company so big relative to the Hang Seng's components that its stock practically moves the index around - but we checked; the price reaction is sentiment based.


2) HSI-C3W opened down almost 30%, obviously a huge decline in itself. It's an immediate reaction to the HSI's opening, as well as the HSI's futures prices.


We have a separate rule on trading index warrants : we don't trade them unless they have declined at least 20% on an intraday basis. We never buy at strength as we've stopped using any momentum strategies; we've found that they don't work.


WHAT WE DID


In the first half hour of trading on 21 November, we bought into HSI-C3W with a substantial position (100,000 warrants) at 27.5 sen. Note that the Hong Kong markets open at 9:30AM, so there's a 30 minute window where you won't find much liquidity; the panic selling usually occurs around this time.


Given the large losses in the US markets, we had an idea of how the HSI would open - we expected a decline of around 1.5-2% in the index, based on previous observation on how it correlates with the S&P500.


We thought there was a minimal possibility that the HSI would fall by 4% or even 5% - this has only happened once this year, and twice in the past three years. But just in case, we even set a time limit : if the HSI falls to 4% by 10AM, we would immediately cut our losses and exit.


Our trading parameters were somewhat simple. We set our stop loss thresholds on a case-by-case basis, but our risk-reward ratio tends to be at least 2:1 (we're willing to exit with a 1 sen per share loss for the opportunity to gain 2 sen per share or more).


For HSI-C3W, we were willing to cap our losses by exiting at 26 sen. Our profit target? 30.5 sen. Aside from meeting the 2:1 profit criteria, we also have our usual 10% capital gains target, as we do in every trade. If this trade doesn't bring our expected outcome (10% in profits or more) by 12:30PM, we are out of the trade. (Editor's Note: we are insulated from further losses by the loss thresholds and time limit)


THE OUTCOME


On 21 November, not only did the HSI recovered ALL its losses (from -2.9% to zero), it closed the day with a 0.5% gain. Our expectation was not just met, it was exceeded. We met our targets and were happy to exit.





RM4,000 in 5 hours? We can't complain. But HSI-C3W actually closed the day at 33 sen. The trade worked because we put ourselves in a situation where not only can losses be managed properly, the downside risk was limited - simply because the downside has been priced in.


And best of all, it doesn't matter if what you're trading is linked to the HSI. Can you do the same with KLCI warrants? Yes, and we have already proved it.