VALUE
Entry Value – This is the value (share price, Futures contract value, forex pair value) at which the transaction is entered
Reference Value – this is commonly used as the starting point for all entry and exits values to be calculated. The reference value is normally associated with resistance and support levels – e.g. for a falling resistance line, it is the projected value of the line at any time in the future. For a horizontal support or resistance line it is an absolute value of the resistance or support point
INSTRUMENTS
Shares: A share is a portion of a company and entitles the holder of that portion of the company to a share of the value and profits of that company
CFD: CFD is an abbreviation of “Contract for Difference”. A CFD is an agreement / contract over the value of the share, when entering a CFD transaction.The purchaser doesn’t own the share, they have entered an arrangement with a private company over the inherent value of that share, and they then profit or lose from share value depending on whether the share price goes up or down after the contract wasentered. CFD’s are a convenient instrument for a private trader to be able to profit from falling share prices (shorting the market), as you are merely selling the contract, and then buying it back to square the transaction.
CFD’s are often used over a range of instruments – shares, indicies, futures contracts
When Trading shares, CFD’s, Options etc, there are 2 transactions, a buy and a sell, and it does not matter which order these transactions occur in, as long as the sell is at a higher price than the buy, you will profit.
If you believe the share price is going up, you buy the contract and then sell later, if you believe the share price is going down, you sell the contract and then buy it back later.
A major advantage of CFD’s is that you need only commit a portion of the overall position value, normally around 10% (much like a margin loan or a mortgage on a house). The commitment however is that you are responsible for the total amount, not just the 10% deposit you have put down.
An index CFD can also be used to Hedge (insure) the value of a held portfolio, especially an illiquid portfolio such as Superannuation / Pension Fund / 401k (whatever name is give to your retirement funds) in order to preserve the higher values of the funds during a retracement or “crash” such as we have seen in 2008 / 2009 and 2011. It is possible to insure the value of your funds using CFD’s.
Forex Foreign Exchange (Forex): examines how 1 currency relates to another currency and is measured in pairs the first currency in the pair is the base currency of the comparison and the second is currency is the local currency compared to the first. USDAUD tells us how many Australian Dollars it will take to buy USD$1. Therefore a rate of $0.9666 is telling us that it will take $0.96.66 Australian to buy USD$1 where as the reverse AUDUSD at the same time is $1.035 – telling us that it will take USD $1.03.5 to buy AUD$1.
These forex pairs enable us to monitor how each currency compares to the other currencies around the World.
Futures: A Futures Contract is a contract over the future value of the instrument over which the contract stands. Most Futures Contracts are over individual Commodities such as Coffee, Sugar, Gold, Wheat, Stock ( cattle, pigs etc). These contracts originally started as a way for the producer to lock in a minimum amount they will receive for their product and for the buyer to lock in a maximum amount they can expect to pay for the product. This was necessary because of the sometimes huge pricing fluctuations brought about by climate, natural disaster (flood or drought etc) and to give some level of consistency and certainty for both parties in the transaction.
While most Futures contracts are over commodities, they are attached to Indicies, Currencies, Bonds, Treasury Notes, Bank Bills, Interbank lending rates etc.. CFD’s are merely a contract over the share price in much the same way that a Futures contract is a contract over the future supply price of a commodity
ORDER TYPES
Market Order: This is where the order executes immediately it is placed onto the platform, this is because the order is deemed to be “at the current market price” of the instrument. This is an order which is placed in the system, in order to get the participant into the instrument immediately, with no delay.
On Stop: This is where a predetermined price must be reached for the order to execute, e.g. Buy BHP – On Stop – $45.50. This means that regardless of where the current price is, the order will not execute until the price gets to and trades at $45.50. This is a handy order type as it enables the technical trader to place the order, but not have it executed until the price gets past an existing resistance / support level.
Stop Limit: This is where the trader places an order to exit a position at a predetermined profit level. Relating this to the above order for BHP, the trader may place the stop limit order as follows Buy BHP – On Stop – $45.50 stop limit $48.50. This means the order doesn’t execute until the price reaches $45.50, but when the price rises to $48.50 the position is immediately sold.
If Done: This type of order is most frequently used to attached an Initials Stop order to the main order being placed, i.e. and On Stop order to enter a transaction, where the “If Done” order only comes into action after the transaction is executed. If we had a Buy On Stop for BHP at $45.50 and we determine that if this order is executed we want our Initial Stop to be a Sell at $43.25, but we don’t want this order to become active until after the $45.50 entry order has been triggered, we would then enter this as an “If Done” order which is attached to the Buy order.
In this case, the Sell at $43.25 is totally ignored if the price doesn’t trigger our entry price of $45.50 and then falls away to $43.00 or below.
OCO: This order is “One Cancels Other”. This order is commonly used where the price could break either way, up or down, and the trader would like to catch it no matter which way the price moves. What happens here is that the trader determines an entry value for each direction, and then places both orders, linking them with OCO, then whichever order is triggered, the other order is immediately cancelled.
This is particularly useful when traders are using technical analysis and can identify a Symmetrical Triangle, which can break either way and will reach a predetermined point, but the trader does not want to miss out on the profit, should they not correctly determine the direction the price will take.
Indicies: In index represents the combined value of the group of shares which makes up the index – i.e. S&P/ASX200 is the combined value ot the top 200 shares on the Australian Stock Exchange – S&P500 is the top 500 companies in the United States and comprises companies from 2 exchanges New York Stock Exchange and NASDAQ – FTSE 350 is the top 350 companies listed on the Financial Times Stock Exchange in London.
Because an index is a combined value of different companies at different prices per share, the index is expressed as a numerical points value rather than a dollar value
RISK MANAGEMENT
Position Size: This is the overall value of the position taken, rather than the amount of money lodged for the transaction. For shares you must lodge the full amount for the transaction and $30,000 worth of shares is a $30,000 position size. Whereas, if you entered a CFD over the same number of shares you need only lodge $3,000 for $30,000 worth of shares BUT, the position size is still $30,000.
2% Trade Risk: The 2% Trade Risk rule is a risk management tool to enable the trader to minimse their risk exposure on any given tansaction. There is a lot of misconception regarding this rule and its application. This rule applies to the trade risk for the individual transaction and declares that a traders should not risk any more than 2% of the Trading Account Balance on any single transaction – this is not to say they should only spend 2% of the account balance on the transaction, but that they should not risk more than 2%. This then helps determine the maximum number of shares which can be purchased in this transaction.
The trade risk is the cumulative value of the trade risk per share, which is calculated as the difference between the entry price and the initial stop.
If the Entry Price is $10.50, and the initial stop is $9.75, the trade risk per share is $0.75. If the Account Balance is $50,000, 2% is $1,000, so here we divide the 2% ($1,000) by the trade risk per share to give us the number of shares to buy. $1,000/$0.75 = 1,333 shares is the maximum which may be purchased under this guideline.
Capital Exposure: This is another risk management guideline designed with diversification in mind for trading and is designed to limit your risk exposure to an individual company or group of companies in the same industry. For example having all your investments spread across 10 major banks gives you 100% risk exposure to the Banking Sector, whereas limiting your exposure to a maximum of 20% of your capital to the banking sector encourages diversification across a range of sectors.
This guideline generally suggests that a maximum of 20% of your Account balance to be exposed to a single company or group of companies. A complication arises however when applying this guide to sectors – under the Global Industry Classification Standard (GICS) for sectors, there are unrelated groups of companies within the same sector, e.g. within the materials sector are contained companies in the following groups, Building materials, Chemicals (including explosives – Military and Commercial, Fertilisers, Industrial chemicals), Gold Mining, Other Metals, Coal Mining, Containers & Packaging, Paper (which includes paper manufacturers) & Forest Products (which includes agricultural investment schemes and managed funds). There are many unrelated groups of companies in this sector.
As you can see it can get very confusing, I think if we just look at diversifying our investments across a range of unrelated Industry groups, we come back to the heart of this guideline. It would be possible to have 60 – 80% of your portfolio in the materials sector without compromising the intent of the Capital Exposure guideline, as a result of the unrelated groups within the sector.
Capital Allocation: Again a risk management tool for helping us limit our exposure to riskier transaction types by getting us to deliberately allocate maximum percentages of our portfolio to Blue Chip, Mid Cap & Speculative companies. A conservative approach would be to break our Account Balance into 7ths and allocate 4/7ths to Blue Chip companies, 2/7ths to Mid Cap companies and 1/7th to Speculative (riskier) companies.
Initial Stop Loss: This is the initial Stop Loss which is calculated as part of risk management, in order to limit the effects of any losing transactions
Trailing Stop: This is the stop which is used once its value is between the rpice action and the initial stop, the trailing stop is rather like a safety net, as the price moves in the desired direction, the trailing stop follows the price action. In this function the trailing stop acts as a profit trap, locking more and more profit, until it is triggered and the position exited.