Tuesday, 16 July 2019

TRADE OF THE WEEK #16 : HOMERITZ CORP BHD (WARRANT B)

Outcome
Gross Profits : RM9,143
Return on Investment (ROI) : 36%
Duration : 24 hours


What do we know about the furniture industry? Not much. 

Did we plan to trade furniture stocks two months ago? Definitely not. 

Were we aware of HOMERIZ as a value proposition? Sure, it's good - relative to other furniture companies on Bursa Malaysia.

Were we aware of the inherent value of HOMERIZ's two newly issued warrants when they were listed on 9 July 2019? Not really.

Did we get into one of the HOMERIZ warrants at a good price and made great profits? Absolutely.

So can you trade something without knowing much at all about the company? The safe answer is : sure, but your reasoning has to be damn solid. 

As traders, we have to be able to look outward and inward. For HOMERIZ, we had an inverted view of how the warrant behaves. Rather than looking at fair value (this is public knowledge, as far as we can tell) or even the fundamental prospects of the company (which we also do, but with a different trading approach), this time our primary focus is on our bread-and-butter skillset : price and volume analysis. 

This is what you get when you pair an abnormal range for a stock price to move with abnormal volume activity (shares/warrants bought and sold) : volatility.

Here's a tip : always look for 'good' volatility. This is where you can feasibly enter a warrant at an enormously appealing price point. 'Good' means that the volatility that brought the warrant price down can just as easily drive it upwards. You think you understand volatility? Good.

What you do with that understanding is this : find a price point where you are convinced that the profit opportunities from that 'good volatility' far exceeds your downside. In theory, your downside risk is lessened when the stock has already fallen steeply, providing you with a trade that has a very good reward-to-risk ratio. 

We are adept at doing this; we are in fact quite OK at it. This meant that we can identify a good opportunity and commit to it by looking at the warrant and how it is moving. It sounds simple, but it's not. 

It may be the case that HOMERIZ warrants (one of them) are undervalued if the company's fundamentals and the warrant's conversion price are taken into account. But these factors do not always move markets. Good warrants can stay down, and terribly overpriced warrants can suddenly gain more.

You may find these concepts quite dry. Perhaps our real life application of them is more entertaining. This skill is very valuable to learn; it yielded us close to RM10,000 within 24 hours, after all.

THE TRADE

On 9 July, we noticed that HOMERIZ-WB opened at a steep premium of 20.5 sen. This rally did not seem to have legs. The warrant did nothing much but decline steadily for the rest of the morning.

You may ask: "OK, so how now?". Believe us, we were like that as well. We kept watching the warrant as it goes through the motions. It was clear from our observation of price and volume that the equilibrium is not there.

This EQUILIBRIUM is the point where buying demand equals selling demand. This is important as when it comes to newly listed company warrants, you have to understand the buyer's and seller's motivations.

Buyer's motivation is simple : the warrant does in fact seem inherently undervalued compared to where the stock is trading. You probably know this or at least know where to look for details on this. We're not going to elaborate on this here.

Seller's motivation is even simpler : the quick bump and warrant opening at that steep price (above 20 sen) is a strong incentive to take quick profits. For existing HOMERIZ shareholders, these free warrants are expendable; selling them means easy money. Hard to argue with that from a short term perspective.

We know about these motivations, but they aren't our motivations. No sir.

We are only motivated to trade this when our criteria are met. One of them is the aforementioned equilibrium.

How to see it? That is the point where the previously volatile warrant stabilises - it did fall from 20.5 sen to 12.5 sen in half a day, after all - and where it finds solid buying volume. It is essentially the bottom, where you might say there is nowhere for the warrant to go but up.

The better you are at identifying equilibrium, the better your price point is, assuming you're not the fat whale / millionaire uncle who created the bottom by buying an tens of millions of HOMERIZ warrants (Editor's Note : if you are in fact the whale, please drop us a line. We have a few projects you might be interested in...).

We are further comforted by other favourable factors. Remember that these have nothing to do with the company fundamentals. It is purely the characteristics of the trading instrument, in this case the warrant.

1) The inherent undervaluation of warrant B, based on its conversion price and HOMERIZ stock price presently.

2) The relatively low amount of warrants issued : 75 million. Total turnover from the first day easily exceeds total warrants issued. Which means somebody is churning.

Apart from this, our final confirmation that the warrant can reach the skies (just like our all time favourite stock pick) is our special sauce. It's not easy to explain; in fact, we dare say that it's an intuitive trait that comes with both practice and experience.

The sauce is this : the liquidity in the warrant must be exactly appropriate for it to go up. Not too high (which means the sheer selling volume will dampen the upside prospects) and not too low (which makes the warrant illiquid, making it more volatile and making it difficult to sell our positions).

What defines 'exactly appropriate' can differ. We're generally OK if the stock has a buy and sell orders of nearly equal amounts (let's say :2,000 lots buy VS 2,000 lots sell).

In HOMERIZ-WB's case, the level turned out to be closer to 10,000 lots for buy and sell orders. The appropriate-ness was proven by the warrant's trading activity prior to us entering.

Yes, we are also careful, not to mention typical worrywarts. We don't care about catching absolute bottom prices; it is preferable to confirm the momentum first.

That upwards momentum is confirmed when you have discovered the equilibrium (A) and the appropriate liquidity (B).

As (A) and (B) make themselves apparent, you should have (C) : upwards momentum. In other words, a price rise.

So this is how we approached HOMERIZ-WB exactly:

  Notice the "WE BOUGHT HERE!!!" part.

We even had a little tweet a bit later to commemorate that entry point. This was when we were convinced there is upwards momentum.
For the record, the intraday low on that day was 12.5 sen. We bought into HOMERIZ-WB starting at the 14-14.5 sen range, a premium of 12 % off the lows, but still at a discount of 30% from the warrant's opening price.

Between 12.5 sen and 14 sen - less than an hour - a few things became apparent to us:

1) Equilibrium was achieved at the 12.5 to 13 sen range, it seemed. Total turnover at this level was massive: more than 12 million warrants transacted. The selling looks to be exhausted faster than the available buy orders.

2) We witnessed 10,000 lots (a million warrants) cleared easily at 13 and 13.5 sen - that kind of liquidity was we deemed to be appropriate.

3) Of course, upside momentum is already confirmed.

Now for the fun part: we bought into the warrant with maximum conviction. There is no more deliberation or worrywartness to deal with. After buying an okay-ish position of 1,700 lots, all that's left to do is to manage the downside and look forward to the upside.

Based from experience, we knew that the potential for a large move upwards is likely to happen within the day. Newly listed warrants tend to do this (Editor's Note : we target them the way we target IPOs).

As you can see in the chart, by 3:45PM it's a moot point already. We can sit back and relax abit. This is because we are aware of this next bit about investor psychology.

Aaaahhhhh....

Recall that the warrant opened the day at 20.5 sen. It collapsed to 12.5 sen right after, no doubt bringing down a lot of early punters with it. The dumping accelerated, then stopped.

This being a cyclical move, by 3:45PM it became apparent that a strong rebound is happening. From 12.5 sen, the warrant quite quickly hit 16 sen. That's a 28% gain.

You don't have to take our word for it, but we knew that the goalposts have shifted. The real money is made within that range from 16 sen to 20.5 sen. In other words, your punter uncles and their cohorts would now be fully confident of this warrant hitting 20.5 sen again. The circle of life.

Thematically, you can look at it as the 'greedy phase', which came right after the 'fear phase' was fully consummated.

We are of course on this same boat towards the upside, but we highlighted this phase as it helps set our exit points. We decided to hold on for the ride and hold on until 20 sen, by which time we would sell.

There are some basic set of expectations that would (usually) confirm our theory on the warrant rally continuing:

1) That same greed will bring an influx of new buying volumes from 16 sen onwards.

2) There may be crazy volatility, but if the warrant closes at a point that is far higher than 16 sen by the end of the day, a brief rally the next day is a strong possibility. Yes, we target these brief rallies as a selling point. Notice that we sold at the top on 10 July? (Editor's Note : the rally resumed on 11 July but that's a different story...)

Why basic? Because if what we anticipate comes true, it will happen exactly the way it think it would. And it did!

Anyway:


What you see here is the potency of the idea. As a trading strategy, it's worth exactly this much.










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