Friday, April 22, 2011

Lesson No 2 - What Instrument to Trade?

My focus on these lessons will be for aspiring new traders with limited capital of less than S$30k and how they can take small steps in trading and shorten their learning curve.

I will also showcase a trader with a small capital trading from home using the Pats system platform and monitoring his progress without any pressure for him to perform. His result will be posted on my other blog on Trading Performance. He has many years of experience in trading and now experimenting with different strategies in Forex Trading which he felt have better growth prospect. I'm surprised!

I have longer term investments in properties and shares but for short term trading, I have chosen to trade in futures for my bread and butter. The major reason is that the transaction cost is the cheapest, please let me know if there are any other instruments that are more competitive and secure, I will definitely look into it.

By joining as a member of SGX costing S$1,200 a year, I enjoyed preferential comm rate for all Exchanges given by my broker over a retail customer. But of course I have to pay taxes on my profit after cost while most retail customer even some full time, treat their profit as capital gain which they felt is tax free. (Grey Area)

The difference in comm is quite substantial, from the statement you will notice that the comm for trading Simsci is S$1.70 and US$0.65 for the Taiwan contract. While retail customer might be paying anything from S$8 to S$12 for the Simsci and for those who trade higher volume, they can bargain the comm down to maybe S$5 which is still more than double. Comm for trading the Nikkei is US$0.70, with a tick value of roughly US$30, making it one of the best contract to trade in term of costing.

I have chosen to specialise in the Simsci because of the scratch trade rebates given to members even though the comm is among the highest. For any trade at the same price in a given half hour time bracket (ex. 8 am to 8.30 am or 8.30 am to 9 am), SGX will refund me the clearing fees of S$1.50 per contract. Thus I only need to pay S$0.40 to my broker for a round turn of Simsci contract.

Another reason for choosing Simsci is that most of my funds are in Sing Dollars which I can use as margin to trade without incurring any interest for holding the Simsci position overnight. If I will to trade the Taiwan contract I will need US$ and I need Yen for Nikkei as margin for my overnight positions. Interest is charge by my broker for extending these foreign currency loans to be put up at the Exchange as margin while I receive a very small amount of interest for my credit balances.

For those who are non members, one of the most competitive broker is Interactive Brokers, check out their website, they offer very good rates for trading overseas contracts, free trading platform and some Exchange fees for charting services.

Many felt that trading futures is risky compared to other instrument because of the leverage. They are just ignorant. What can you do with S$30k in your account and wanted to trade for a living?

Any Fund Manager who can consistently return 10% nett per annum to their client is a damn bloody good manager because 90% of them failed to do so. A return of 10% for $30k is only $3k a year which is only $250 a month. Can you survive on it doing full time trading? So your goal will be to make at least $3k (10%)a month or 120% a year.

Those who are thinking of quitting their job for full time trading career need to consider it very carefully before taking the plunge because you will need to be a super trader making 10% a month less all cost in order to survive. Of course, there are many who made it, the journey is long and tough.

I will use Simsci as an example in my illustration, a basket of 27 blue chip stocks listed on SGX at the current price of 3770 x 20 per tick which has a value of S$75,400.00 for 1 contract.

Futures trading requires margin because of the high leverage of up to 20 times depending on the volatility and this margin will be adjusted accordingly by the Exchanges periodically, it's not fixed.

Paying a comm of only S$1.70 to trade a value of S$75,400 worth of blue chip stocks is extremely cheap and you need to put up a margin of less than $4k. Nikkei at the price of 9670 x 500 gives us a value of Yen 4,835,000 or around US$59,000 worth of 225 blue chip Japanese stocks. Buying 1 contract cost only US$.70 for the professional traders, this is the reason why I traded futures.

A retail trader paying S$10 for 1 contract of Simsci worth S$75,400 is still cheap compared to buying stocks, probably he need to pay around S$200 comm for that value of stocks. The only difference is that retail traders can choose individual stock to trade and pick those that he feels have better potential of upward price movement.

One big advantage of futures over stock trading is that you can go short the futures naked and hold that position until expiry. Another is you are investing in a diversified portfolio of blue chip stocks, no headache in stock picking.

Another fact that most are ignorant is that interest cost and dividends are being factored into futures pricing. Dividends are paid for those buying into futures when there are dividends to be paid out by some of the stocks in the basket. For example the price of the April Simsci contract is now trading at 3770 while the May contract is trading at a discount of about 28 ticks at 3742, implying a S$560 dividend to be paid out. Historically, investors holding and rolling over their long term positions are assured of returns over time due to inflation and dividends.

The April Simsci contract was also at a discount of 28 ticks over the previous March contract making a payout of S$1,120 over a 2 month period. So for the long term investors, when they roll over their position forward, their pricing will get cheaper and cheaper over time due to the dividends and low interest rate now. One exception is if one were to buy the Nikkei at the peak in 1990 at 39000, he will be losing his pants and still rolling his position at a loss after 20 years. Thus the importance of cutting losses.

So for a investor who used S$4k as margin to buy one contract in March and roll over to May contract, a period of 2 months, can reap a dividend of S$1,120 as long the the futures price remain the same till expiry. He will have additional capital gain if the price move further up while suffer losses if the price depreciate. For 1 Simsci contract value of $75k that yield 3% dividend, one would expect to get S$2,250 worth over a 1 year period with a margin investment of S$4k. That's 50% return if the price remain the same a year later.

Rolling over position from April to May is call calender spread which will be active towards the end of the expiry date for any futures contract. There is a spread quote which is heavily traded too by those who specialise in spread trading. April contract now is known as the near month while May, June, July the far month.

With a $30k account, a trader can easily day trade up to 20 Simsci contracts at one go, that is where the risk comes from. The leverage of up to S$1.5 million worth of stocks with just S$30k. If make use properly, that is where you can reach your million dollar dream.

For those who are not currently members of any Exchanges, find a good and cheap broker. There are many futures contracts that are very liquid with good volatility, it's one's preference, to name a few, mini S&P, Nasdaq, Dow, FTSE, DAX, Gold, Oil, Currency futures, etc. Traders now have plenty of choice. Understand the contract and monitor it closely for some time before you attempt to trade.

8 comments:

coconut said...

great staff fat. thanks and no arguement on that.

thats why for retail traders (like myself), i really feel we can't make money doing day trading, let alone scraping.

0.4 for round turn if made within half an hour at the same price? wow thats a real advantage there! any minimum trading volume one must maintain?

Fat88Trader said...

As long as you are a member of SGX, scratch trade rebates of clearing fees are refunded to the trader the following month without any trading volume requirement for the Simsci contract.

coconut said...

thanks. when i first saw your statement i thought it was some kind of volume rebate.

ignorant i am, but i can't turn back the clock. i have to carry on from here where most of my trading forcast on stocks. you don't see a 50 year old golfer just turn professional do you? haha.

but for the inspire traders, you should know who and where to get started.

Jianwen said...

This is one of the best detailed post.. thanks Mr Fat88 :D

Fat88Trader said...

Friends, thanks for the kind words of appreciation.

S.Ong said...

Hi Fat88,

Could you advise how to roll over Simsci contracts? Does it mean closing one contract (mark to market) of the expiring month & initiating another for the next month? If mark-to-market, then it may involve profit/loss? Can I roll over in order to avoid having to close it at a loss; in other words, I don't want to close a loss-making position but to hold it till market conditions turn & close it for a profit?

Thank you.

alitergalen said...

Money Managers are responsible for managing the securities portfolio of multiple clients on a daily basis.

Nina Athena said...

I am really inspired by your article. You have given countless of information and knowledge that people in the trading world would need. Thank you for sharing. Would love to see more updates from you.

Shares to Buy