How to make Money in the Stock Market.This blog looks at how you can make money trading and investing in Forex, Stocks Options and Futures.


Saturday, 6 January 2007

A short Guide to Hedging

As promised here is some background and insight around hedging-incidentally as I surmised the markets took a turn down yesterday and the QQQQ Puts I bought have already increased by just under 20% in one day.I cannot say if this is the beginning of a correction but I am glad I have some downside protection.Hedging is a little discussed but very important tool for investors.It may sound like an outdoor activity involving shears and ladders but it can be the difference between poor and great returns

What Is Hedging?
The best way to understand hedging is to think of it as insurance. When people decide to hedge, they are insuring themselves against a negative event. This doesn't prevent a negative event from happening, but if it does happen and you're properly hedged, the impact of the event is reduced. So, hedging occurs almost everywhere, and we see it everyday. For example, if you buy house insurance, you are hedging yourself against fires, break-ins or other unforeseen disasters.

Portfolio managers, individual investors and corporations use hedging techniques to reduce their exposure to various risks. In financial markets, however, hedging becomes more complicated than simply paying an insurance company a fee every year. Hedging against investment risk means strategically using instruments in the market to offset the risk of any adverse price movements. In other words, investors hedge one investment by making another.

Technically, to hedge you would invest in two securities with negative correlations. Of course, nothing in this world is free, so you still have to pay for this type of insurance in one form or another.

Although some of us may fantasize about a world where profit potentials are limitless but also risk free, hedging can't help us escape that hard reality of the risk-return tradeoff. A reduction in risk will always mean a reduction in potential profits. So, hedging, for the most part, is a technique not by which you will make money but by which you can reduce potential loss. If the investment you are hedging against makes money, you will have typically reduced the profit that you could have made, and if the investment loses money, your hedge, if successful, will reduce that loss.

How Do Investors Hedge?
For the most part, hedging techniques involve using complicated financial instruments known as derivatives, the two most common of which are options and futures. We're not going to get into the nitty-gritty of describing how these instruments work, but for now just keep in mind that with these instruments you can develop trading strategies where a loss in one investment is offset by a gain in a derivative.

How does this work in Practice
Say you have bought shares in Google(Goog) you believe that they are a good long term bet but you want to protect yourself from any potential downside in the short term.You would buy a number of PUT options in Google to protect you should they fall below a certain price-say $450.
Every put option is worth 100 shares so if you owned 200 shares you would need to buy 2 PUT options.If the share price fell below the $450 then your PUT options would increase in value to protect and minimise the losses.(This is a reasonably simplistic explanation as there are a no of other factors at play here but this is the general principle behind using Options to Hedge)
Keep in mind that because there are so many different types of options and futures contracts an investor can hedge against nearly anything, whether a stock, commodity price, interest rate, or currency.

The Downside
Every hedge has a cost, so before you decide to use hedging, you must ask yourself if the benefits received from it justify the expense. Remember, the goal of hedging isn't to make money but to protect from losses. The cost of the hedge - whether it is the cost of an option or lost profits from being on the wrong side of a futures contract - cannot be avoided. This is the price you have to pay to avoid uncertainty.

We've been comparing hedging versus insurance, but we should emphasize that insurance is far more precise than hedging. With insurance, you are completely compensated for your loss (usually minus a deductible). Hedging a portfolio isn't a perfect science and things can go wrong. Although risk managers are always aiming for the perfect hedge, it is difficult to achieve in practice.

What Hedging Means to You
The majority of investors will never trade a derivative contract in their life. In fact most buy-and-hold investors ignore short-term fluctuation altogether. For these investors there is little point in engaging in hedging because they let their investments grow with the overall market.

So why learn about hedging?

Even if you never hedge for your own portfolio you should understand how it works because many big companies and investment funds will hedge in some form. Oil companies, for example, might hedge against the price of oil while an international mutual fund might hedge against fluctuations in foreign exchange rates. An understanding of hedging will help you to comprehend and analyze these investments.

Because risk is an essential yet precarious element of investing, you should, regardless of what kind of investor you are, gain a fairly good awareness of how investors and companies work to protect themselves. Whether or not you decide to start practicing these intricate uses of derivatives, learning about how hedging works will help advance your understanding the market, which will always help you be a better investor.

Best Wishes


Friday, 5 January 2007

Market Update and QQQQ Hedge

The Dow Jones Industrial Average (DJIA – 12,480.7) added 0.05 percent on the day, edging into positive territory.The S&P 500 Index (SPX – 1,418.34) tacked on 0.12 percent, but was capped by its 10-day moving average. Finally, the Nasdaq Composite (COMP – 2,453.4) saw the largest percentage gain on the day, logging an increase of 1.25 percent.
In terms of news today orders for U.S.-made factory goods increased by 0.9 percent during November. The strongest demand was for computers, transportation equipment, and defense goods. Excluding transportation, orders for U.S. goods dropped by 0.5 percent for the month, which suggests an overall weakening of the manufacturing sector.

The Markets are making me slightly nervous at the moment I feel something is in the offing.There does seem to be a bit of a struggle going on with the last couple of days swinging to and fro.It is always difficult at this time of year to ascertain whether we are seeing the results of thin markets and people window dressing, but I bought some QQQQ Feb 43 Puts today to give some downside protection to my Portfolio.
They will not be enough to completely hedge my positions but will cushion the blow a bit if we lurch downwards over the next month.

Increasingly I am using Options as a Hedge in my Portfolio to protect the downside.I am firm in my beliefs for the mid Term and the Macro Economic picture supports this, however we cannot force the market and we have to be patient, using options to hedge your portfolio and allow you to stay in the game longer to give your strategies time to unfold is good sense.It is extremely difficult (if not impossible) to pick Market tops and bottoms-but learning to use options as a hedge is a great way to allow you to ride out the daily and intra day noise that can be emotionally difficult to trade through when you are investing for the longer term.

I will post some insight into hedging tomorrow for those of you who are interested in a bit more detail-meanwhile if anyone has any questions on this or any other topic then please feel free to ask.

Best Wishes


Thursday, 4 January 2007

The China Syndrome-Part 2

Following on from my previous post where we looked at Taiwan as a good potential mid term investment I want to touch on China.China is still one of the fastest growing economies in the World and although growth is not as high as it has been there is no real sign yet of it slowing dramatically.I believe that we will see good growth in China at least till post the 2008 Olympics and possibly beyond.The sheer size of China makes it a formidable market and one where if you pick the right stocks could generate some excellent returns over the next few years.It can be volatile so if investing I would be looking to hold the shares for 2+years with a 25% stop loss.

Some of the shares I like to capitalise on China are below :

China Medical Technologies (CMED)
Hong Kong Shanghai Bank (HBC 4% Yield)
Templeton Dragon Fund (TDF 4.5% Yield)

I also like iShares FTSE/Xinhua China 25 Index Fund (NYSE: FXI) it is up 102% in the last 18 months and 65% since June.

However you look at it China is going to become an increasingly large player on the Global Economic Stage and we really need to have some exposure to these markets.The fund route is a good option as it allows some measure of diversification-but may not deliver the opportunity for some stellar gains with indiviudal stocks such as CMED.

All for now I will report back later today hopefully on the US markets.

Best Wishes


Wednesday, 3 January 2007

Trade Confirmation

B half position at 14.80 in Taiwan Fund EWT-will wait to see what happens and whether I will buy more-if it moves up quickly will not likely and will just sit with what I have.If it moves down towards 14 in next couple fo weeks will buy second half.

Best Wishes


Trade at Open-iShares MSCI Taiwan Fund EWT-NYSE

Hi just a quick note to confirm that I am going to open a position in the Taiwan Fund at the Mkt open, as this is a long term position I will probably scale in to it buying half my desired no of shares and then waiting to see if there is any pullback and I will buy the rest.So just to confirm I will be buying at the open the iShares MSCI Taiwan Fund EWT-NYSE at the open for my Pension fund.I will be back later on with the second part of the post from yesterday.

Best Wishes


Tuesday, 2 January 2007

Go East Young Man-Made in Taiwan and the China Syndrome Part 1

The US Markets are closed today so I thought this might be an opportunity to look beyond the US shores to another favourite market of mine-the Far East.For many years the Asian Markets have lagged far behind the US and Europe.I think we may be seeing the tentative shoots of recovery in certain markets.Japan is still a wildcard but I believe that 2007 may prove to be a good year for Taiwan. In 2006 a number of emerging mkts including some in Asia have hit all time highs but Taiwan still lags and is over 43% below its high from Feb 1990.Taiwan is home to some of the largest Tech and Electronics companies in the World. Companies that produce I-Pods and the Mini Mac as well as supply major IT companies such as Dell and Hewlett Packard-the link therefore to PC and Semi-conductors is inextricable-when these markets boom so does the Taiwanese economy.If you believe that these sectors are likely to start to move in 2007-(think Vista and PC's) then Taiwan is a good place to invest.For me the best way to play this is via the iShares MSCI Taiwan Index Fund(EWT-NYSE).This fund is broadly based and diversified but heavily weighted to Technology Companies. Another boost for Taiwan is that it is one of the major trading partners of China. The Chinese economy is still one of the fastest growing economies in the world and as the mass Chinese become more affluent then they will increase their expenditure on goods such as PC's and Technology-this can only be good for the Taiwanese economy and for the iShares MSCI Taiwan Index Fund(EWT-NYSE).I will be opening a position in this fund at the mkt tomorrow.I will also post Part 2 of this communication looking in a bit more detail at opportunities to gain some exposure to China such as Hong Kong Shanghai Bank (HBC) , Templeton Dragon Fund (TDF-NYSE) and China Medical Technologies (CMED-NYSE).

Best wishes for the New Year and Good Trading