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Monday, 16 July 2018

CRAZY, ABSURD NUMBERS FROM LAST WEEK : REFLECTIONS ON TOP GLOVE, PASDEC & GKENT


We'll kick off this post with some mind-boggling statistics from last week (for us, anyway). What basically happened was we executed several profitable trades which went a long way towards boosting our capital position - already, almost half of our current capital pool is made up of this year's profits.


Details of our year-to-date performance can be found here (as of 2H18; it does not include P&L from the trades below). You can also track our latest activity on Twitter.


Ranked in no particular order of absurdity:


1) We made exactly RM50,351.44 in four trades (excluding commissions) over three days - July 9, 11, and 13.


2) The first trade - TOPGLOV-C34 on July 9 - delivered a 38% return on invested capital. That's RM11,300 in profits in twenty minutes.




Green = buy order. Red = sell.

3) The second trade - TOPGLOV-C33 on July 9 - delivered a 22% return on invested capital. That's RM8,050 in profits. In eleven minutes.


Ignore the middle part - we mistakenly tried to sell a nonexistent position in C34 (which were already sold) when it should've been C33.



4) Our third trade - PASDEC-WA on July 11 - delivered a 43% return on invested capital. That's RM19,501 in profits.. in just under three hours. Actually, excluding the two-hour midday market break, it would be just under an hour. Or more than RM325 in profits per minute.


*pulled.

4) Our fourth trade came from GKENT-CG which we disposed on July 13. The position was held overnight. This was our favorite one - we recorded the following return on invested capital within 24 hours for a total gain of RM11,500.



The main theme of this week's post is to show you the good and ugly sides of trading. This isn't an easy business, and it's especially easy to lose perspective. Behind these large profits are stories of massive doubt and uncertainty. Nothing here is a piece of cake.




To illustrate our point, let's have a closer look at the first trade. Did you notice this the first time?
Look closer.

We're sure you're generally aware of the events at TOP GLOVE right now. Similar to the KRETAM trade, we were fully anticipating a limit down situation and a subsequent recovery (stocks of large, reputable, profitable, dividend-paying companies are more susceptible to a successful rebound than... well, KRETAM). The limit down angle makes this a very high volatility trade.


Note that our first position buildup was 170,000 warrants at 13 sen by 9:05AM. But in just under two minutes, that position lost a staggering 42% in value - that's another absurd number for you. In other words, we briefly endured a RM9,350 paper loss within two minutes of entering this trade (yes, we were down by 42% on this trade).


How would you have handled this situation? Would you freeze and panic? Dump everything? Cry? (in the past, we personally have done all three and more)

 This is also known as the 'I bought Bitcoin in January' face.


What we did was simple : we maintained our composure and stuck to our trading plan. This is the most important key in high volatility situations like this. Freezing means you're caught unprepared - always have a plan, even when you're practically losing half your capital.


We can give you tips on maintaining composure, but in practice you will find it to be useless. It's not something we can teach - it simply comes with endless hours of practice and enduring large, real, horrible losses (we have been to hell and back many times, figuratively speaking). We suppose it might help greatly if you have a stable personal and professional life, as well as a strong bladder.

(Editor's note : most people usually have just one of these three - I personally prefer the last one over all else)


The following is our thought process for this trade and why it turned out to be successful. We're also going to demonstrate that these trades were completely thematically different. But these decisions, as always, are based on past observance of similar circumstances - we collect research and we trade on them under the premise that history never repeats itself, but it does rhyme sometimes.


The Trading Scenario for TOPGLOV-C34


Our viewpoint was fairly straightforward. TOP GLOVE's mother share hits limit down, thus the selldown will destroy the value of its call warrants - we anticipated this and have selected our preferred call warrants to trade. The loss of liquidity in the call warrants means that the selling will be even more desperate than in the mother share. For context, C34 closed at 22.5 sen the previous Friday.


On Monday (July 9) it fell all the way to 13 sen and we bought into it at that price. But we were in too soon - C34 quickly fell further to 7.5 sen. At this moment, the mother share was slightly off its limit down threshold of RM8.47 and was trading at around RM8.70.



We did not panic because the angle remains the same - the previously anticipated desperate selling caused the call warrant to plummet further (at its lowest point C34 was down by 72% from its previous close). We calculated the risks and decided it was one worth taking, hence we bought an additional 100,000 warrants at 7.5 sen. It turned out to be near the intraday low.


The beauty (and curse) of high-volatility trading is you're going to be proved right or wrong really quickly. By 9:20AM C34 gained more than 100% - absurd number alert! - as the artificial mispricing was quickly rectified. We felt that we showed some restraint by selling at between 14.5 to 16 sen as soon as the warrant's price rallied. C34 actually closed at 21 sen that day (!)


Another very important factor for us was that we demonstrated further restraint by not building up the position at that 7.5 sen level. We could've easily bought a million warrants if we had wanted to but we didn't and couldn't - such an act would have been a foolish gamble, and it was never part of our trading plan for C34.


To be clear, our decision was not a case of 'averaging down' - we thought carefully and thoroughly about an acceptable trade size and our expectations of the warrant's movement. We were emphatically NOT trying to trade our way out of a loss. Even with a huge paper loss our expectation did not change one bit. We are familiar enough with short term volatility to not be frightened by temporary setbacks.


Fortunately the price movement validated our assumptions very quickly - and for further context, that 7.5 sen per warrant position ended up making more than half our eventual profits from this trade.


For us, the most important element of this trade was having that restraint. Not trading can be the hardest part of trading, but it's the most effective risk management tool. We always think of the risk and the worst case scenario as priorities. For example, TOP GLOVE could have stayed at limit down levels instead of rebounding, causing a complete collapse in call warrant prices (we are cavalier traders but we will lose our shirts if our positions fall by 90%).


(Editor's note : I always say that we trade very conservatively but nobody believes us)


The Trading Scenario for C33


By this time (around 9:40AM) TOP GLOVE's share was closing in on RM9; there was a strong rebound from the limit down levels and the call warrants have also recovered. The mother share was exhibiting signs of accumulation activity at the RM8.90 level. If it breaks RM9 and beyond, C33 was likely to follow and blow past the 20 sen mark. We felt comfortable enough to acquire 200,000 warrants at 18 sen.


Why didn't we continue to trade C34? This is because we rarely re-enter a profitable trade (for that specific warrant) because its parameters have totally shifted - remember that the trading angle has been fully realised. C33 was an alternative and was available at a good price point. It also exhibited the kind of liquidity characteristics that we like.


We anticipated the breakout - of course, if it didn't happen, we would have taken the losses at a level we deem to be acceptable. But the breakout happened, and the mother share hit RM9.20 quickly. We sold C33 at 22 sen per warrant for a hefty profit. It actually closed at 23.5 sen that day, or a 135% gain from  its intraday low - sounds absurd, doesn't it? But it happened.


We must stress that this all happened in such a short time span - just around 11 minutes. Thinking on your feet is a necessity as a discretionary trader who's trying to execute a high-volatility play. As always, we followed our own rules instead of having the market dictate them for us. We set the scenario, the expectations, the profit targets, entry points, and exit points.




The Trading Scenario for PASDEC-WA


PASDEC-WA was a new issuance - we initiated a position on its first day of trading. We have observed that less than 30% of the time, a new company warrant issue can receive significant buying interest against all logical reason. This essentially means a complete detachment from the underlying value of the warrant itself.


A recent share takeover offer may have sparked some interest to ramp up the share and warrant price, though we personally believe it was not a serious offer (for example, warrant holders were offered to dispose their warrant at a mere one sen per share - obviously nobody will go for that).


The warrant's terms also had no bearing on its fair value relative to the mother share. It carries an exercise price of RM1, making the warrant essentially worthless as the mother share was only trading near the 50 sen range. (Editor's note : this pricing is normal for warrant issuances. The warrant offers shareholders an opportunity to build a bigger position and express a long term viewpoint. The expectation is that PASDEC's long term trajectory is good enough to attain a share price above RM1).


We suppose you may be wondering - how do we trade beyond reason?


This is not a fundamentals-based trade; it's purely based on price and volume activity. Simply put, what we did was set a target price to confirm a continuation of momentum. This target price is at a premium to what the warrant was trading at during the first few hours. If the warrant easily hits that target price, and if it supported by clear buying demand, we would build a position without hesitation. Or as Soros would put it, the trigger has occurred, so the only thing left to do is to pile in.


The most important factor : our price/volume expectations had to happen within a predetermined time period. This was key to our trading style - price, volume, and time converge to signal a high-return opportunity.



We waited until it was near the midday market close to build the position. It was just about two hours of waiting to see if the warrant will start exhibiting interesting characteristics - we weren't entirely convinced that it would, but we did put in on our watchlist.


The convergence occurred in a way we have seen numerous times before. This rally is happening, and it's not fundamentally justified or easily understandable, but there was real money to be made.


Note that our first position was at 8.5 sen - naturally our first target would be 10 sen, or a potential 17% yield. With a big enough position, we stood to make significant profits if this did happen. The warrant broke past 10 sen as soon as the market resumed at 2:30PM, and we bought some more at that price in anticipation for another wave of buying.


To trade big lots, you have to maintain composure. It's good to know and understand market psychology, but we feel a lot of traders lack the capacity for self-awareness. Your own psychology matters as much when dealing with these stressful factors all at once - managing a big position, dealing with a potentially gigantic paper loss, real time risk management, and executing buy and sell orders at the optimum price.


We don't become excitable when our trades become profitable - this has led to complacency in the past, resulting in serious losses as we became too greedy to exit. What we did was constantly trying to maintain a clear mind and ensuring that our decision making process was linear - we never change our trading plan midway.


For our hefty position of 500,000 PASDEC-WAs, we looked at this trade in the simplest terms. Any exit price beyond 10 sen is already a bonus for us (we've already locked in that 17% profit). The next phase is to gauge the trading sentiment; how fast the warrant is moving, looking for signs of weakness, and our favorite - looking for signs that latecomers are finally buying the warrant in heavy volume.


Note the underlined - this is how we determine our exit point. We try to dispose our holdings at the height of euphoria/market mania. Being early in such a trade is always important - this trade's profit potential diminishes once the entire market got wind of the warrant's big move. PASDEC-WA gained 100% in a day; that's a BIG move.


We sold our positions between 12.5-13 sen for a nice profit. It also happened to be near the intraday peak of 14 sen. The mother share didn't really move that much; all things considered, we probably would not enter PASDEC-WA again; the play has disappeared for good.


The Trading Scenario for GKENT-CG


And now for something completely different. We have successfully traded down and beaten construction companies before. There are some parallels between GKENT and our previous trade in GBGAQRS, and this was the perfect opportunity to test our theory.


We firmly believe that the market oversells bad news and underestimate the power of good news. This was somewhat evident in GKENT and its brethren in the much maligned LRT3 project.


We first flagged this piece of news on the morning of July 12. This was the day when we bought into GKENT's call warrant.



This was at 9:39AM; at the time, there was some modest movement in GKENT and MRCB's shares (they are the PDPs). At this point we were figuring out a play and have begun observing both stocks. We were more confident that GKENT, as a stock, will move faster than MRCB due to MRCB's unfavourable liquidity characteristics (overly liquid stocks face heavier resistance in any rally).


We also considered a number of MRCB and GKENT call warrants and ultimately settled with the only tradable warrant that GKENT had presently. We figured that the rest of the market would trade GKENT-CG as a proxy given that nothing else was available.


GKENT (and MRCB) only really moved in a big way when the market resumed following the afternoon break. The smart investor would've acquired the shares as soon as the news on LRT3 was out earlier that day. We did not.


But here's what we ended up doing. We made a fairly risky but calculated move to acquire the call warrant when the mother share was already trading at RM1.23, or 22.5 sen above the previous day's close. We were anticipating a limit up scenario to frame our trading angle. Here's what our thinking boiled down to:


a) Backed by historical observations, we foresaw a higher than average likelihood of GKENT hitting limit up (RM1.29) on this day due to the overflow in good sentiment and apparent strong buying interest.

b) If this was to happen, we expect to see volatile but clear buying activity in the RM1.20 to RM1.25 range. This means it was important to build a position in GKENT-CG while this was going on. The time window was expected to be very short - we had to move fast.

c) We ended up with 600,000 warrants at 2.5 sen apiece before GKENT's stock began its move to limit up levels. At this point we anticipated that investors who missed out on the mother share might just put on a speculative trading position in GKENT-CG.

d) GKENT ended the day at RM1.29 while GKENT-CG closed at 3.5 sen. Our position was already up by 40%.

e) We understood, also from historical observation, that a limit up closing will typically bring some strong buying interest as soon as the stock resumes trading the next day. We were looking to sell into strength to get the best price. Anything more than 3.5 sen is considered a bonus, and a hefty one at that.

f) We sold at around 4-4.5 sen on July 13. Almost all our expectations were proven to be correct.


But....

Unfortunately the numbers don't tell the full story. We also endured significant losses from a few grossly misinformed trades last week, namely in DSONIC-WA (a new issuance that proved too volatile for us to cope with) and TNLOGIS-WC (we had internal rules to not go into these types of speculative trades; we broke them and paid a dear price). In effect, these losses meant we had to pay a steep tax on overall gains to the tune of RM13K.


 Proof that sometimes we're too dumb to take our own advice.


Warrant trading is risky, puzzling, and fascinating at the same time. The rewards are tangible, and studying these instruments is worth the trouble. We mainly worry about the downside and the legitimacy of our trading plan; the profits will take care of themselves eventually.


Note : Do share with us your own trading experiences, crazy profits (or losses), and questions. We'll compile the best ones and share our thoughts here.