There are 2 topics I wish to address today - Hedging with the FTSE100 and Cash for Panic Stricken markets.
When the markets in general have had a good run up and are looking very toppy (overbought - easiest way to measure this is Relative Strength Index (RSI) up around 65 to 70 on the FTSE100 Daily Charts - any half decent Charting Tool can give you this for free), I try to look for opportunities to sell some of my Stocks or to at least Trim some positions and bank some profits. Alongside this, the ideal approach is to ‘Hedge’ my Portfolio using Spreadbet Shorts on the FTSE100 - you can also achieve similar effect by buying an Exchange Traded Fund (ETF) called XUKS (there is also a beast called XUKS2 which gives you 2 times the movement in the FTSE100 - very risky and should only be used for a few days at the most).
The idea is simple really - as the overall markets fall, the value of my Portfolio holdings will fall and the FTSE100 short should gain as the market falls - obviously if the FTSE100 continues to rise, then I will lose on the Short - for this reason, it is often good practice to have a Stop Loss price level above where you open the Short to close the Position and lock in a small loss - BUT AVOID A BIG LOSS. I intend to revisit the whole subject of Stop Losses in a future Blog Post…….
Anyway, the subject of Hedging is very pertinent right now as I have really screwed up. As you know, the Markets have been dropping like a brick lately - the problem is that I do not have a Short Hedge in place. I am absolutely kicking myself and trying to understand where I have gone wrong. Prior to the Scottish Referendum Vote on Thursday 18th Sept 2014, I had put on several Short FTSE100 spreadbets at about 6850 worth about the equivalent of £55k - this should have Hedged my position to an extent but not fully by a long shot. I tend to find having a sensible small Short works best - if your short is too big, it kicks you hard if the markets continue rising and you end up getting Stopped Out for a big loss. I set a Manual Stop Loss at 7000 where I would close the Shorts and take a small hit.
I was obviously concerned that a Scottish ‘Yes’ vote for Independence would mean rapid falls in the markets on the Friday after the vote. As it happens, I was watching the Special Programme on BBC2 after the Polling Stations had closed and Peter Kellner from YouGov said that their most up to the minute Poll had an easy win for the ‘No’ side. As soon as I heard this, I logged into igIndex and closed my Spreadbets for a tiny profit - Index spreadbets trade outside of Normal Market hours so I could do this.
So, this then meant I had no shorts - I was fully exposed if markets dropped but it they went up then I would gain nicely. On Friday, the markets shot up but as the day progressed they started to fall back and by the close of the day they made a Daily Candle Pattern of a sort of Upside Down Hammer - after a good run up this usually indicates that the market will turn down, so this was the first clear signal I missed - don’t worry too much about Candles at this point - again, this is something I intend to address in time.
Sure enough, on the following Monday, the markets fell heavily and they also fell heavily on Tuesday - maybe this was a signal as well that the markets wanted to fall a lot - although it was ambiguous because on the Wednesday we had a bit of an Up Day and it looked like things were stabilising.
Another key signal I failed to respect was that the 50 day Moving Average was crossing the 200 day Moving Average from above and this was forming a ‘Death Cross’ (yep, it sounds nasty and it obviously is). I tried to be rational about this and looked at previous recent examples where this had occurred and I felt it was inconclusive - on the last occasion the market rallied soon afterwards, and I felt this would happen again.
A big Fundamental Factor that I totally underestimated was the Seasonal Effect of Autumn and Sept / Oct often being difficult months. Anyway, I felt that Sept had been ropey so we might have a reasonable Oct - in fact, October has been up about 75% of the time in recent years. The caveat to this is that some Huge Falls from Stockmarket Folklore like the Wall Street Crash in 1929 and Black Monday in 1987 happened in October…………
Right, where does this get me? I am beating myself up about this because I don’t think I have played it well - but Hindsight is also perfect and the reality is would I have been able to do it any differently? There is a famous Trading Adage which says, “Trade what you SEE, not what you THINK” - this means you should look at clear chart signals and act on them in an unemotional way - maybe I am guilty of letting my Emotions about the Scottish Vote and Wishful Thinking that the rally will continue rule my decisions…………hmmmm
It is clear that when markets have taken a huge beating like they have just this last week, many stocks get extremely oversold and true bargains can be snapped up. The problem for me this time is that I failed to move into Cash at the top and so I don’t have much Firepower for the bargains. I could take on some Leveraged Long Spreadbets but to be honest, I am already extremely exposed to the Long Side on these and it is probably not sensible to increase my risk.
One thought that hit me was that maybe I should institute a policy of always trying to keep maybe 5% to 10% of Portfolio in Cash so I can snap up bargains in the big market falls - ok, probably 5% would be about right. It would mean getting 100% of my resources into the markets at the bottom and then having the good discipline to trim positions as the markets moved up so that I had perhaps 5% in cash at the top. Sounds easy, in practice it won’t be - just something to think about.