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Trading Plans

Long Short Equity & Foreign Exchange

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Trading Plans Summary

In order to trade successfully, you must have a battle tested plan. Giving our users great starting points for their trading and investing is important to us. Over time, WealthCE will develop trading plans to be hosted on the site. For now, our future plans include Basic Sector ETF investing, Long/Short Equity investing, Macro-Based Foreign Exchange, and Options. Over time, we will expand our offered trading plans to include many other formats of investment. Check this section often.

Long/Short equity plans take advantage of the benefits and the risks of both buying and short selling equity. When buying equity, you also buy the benefit of any factor that can increase price, and the risk of any negative factor that can decrease price. When short selling equity, you acquire the risk that prices increase due to any potentially beneficial factor, and will benefit from any factor that decreases prices. In Long/Short trading the factors from both should cancel each other out if the shares are highly similar (with the exception of expected price direction).

Any foreign exchange currency’s value is ultimately based on the economic strength of the economy backing the currency. A weak economy with a currency that is massively over circulated will have a very low value, especially if the central bank associated print’s large volumes of new currency. A strong economy with a currency that is under circulated will have a very high value, especially if the central bank prints very little new currency.

Trading Plans

Major Economic Analysis

Economic Summaries
Statistical Currency Projections
Large Speculator Sentiment
Technical Signals Lists

American Equity Markets

Economic Performance Index
US Dollar Projections
Market Sentiment Tracking
Sector Strength Tracking
Consensus Estimate Rankings
Fundamental Firm Analysis

Basic Trading Advice

Most people, including you, have serious misconceptions about trading. This lesson will attempt to reduce more complex trading lessons into some very basic trading advice that you can easily follow. Be sure to read this section before you continue into later sections. In this section we’ll give you thirteen tips to ensure your long term trading success.

The Basics of Trading and Probability

This is the simplest thing you need to know about Trading/Investment: You can’t guarantee a trade. You can only increase the probability of being correct. Your goal is to maximize the probability you are right (via analysis) and minimize the probability you are wrong. You use risk management to control the size of loss to the maximum extent possible to avoid losing too much capital. This ensures that if you land on the wrong side of probability, you can still play the game. You eventually will and always can lose trades, since the probability of loss is never zero.

Long/Short Equity

Long/Short equity plans take advantage of the benefits and the risks of both buying and short selling equity. When buying equity, you also buy the benefit of any factor that can increase the price and the risk of any negative factor that can decrease price. When short selling equity, you acquire the risk that prices increase due to any potentially beneficial factor, and will benefit from any factor that decreases prices. In Long/Short trading the factors from both should cancel each other out if the shares are highly similar (with the exception of expected price direction).

Sometimes, these risks are not asset specific. There are multiple kinds of risk: Market risk, Sector Risk, Industry Risk, and Asset specific risk. Long/Short equity is based on building portfolios that eliminate market, sector, and potentially industry risk. This allows investors to potentially leave only asset specific risk, and focus mostly on ensuring the company is well selected in the context of fundamentals.

Long/Short Equity Introduction

Long/Short Equity Introduction

There are three kinds of risk in the market. There is Market Risk incurred by all instruments in a market, Sector Risk incurred by all instruments in a sector, and Asset risk specific to the asset. Asset risk is especially derived from the way the underlying company is managed. The goal of a successful long/short equity portfolio is reducing all three to some or a major degree while simultaneously beating the market. If you can repeatedly do this, you will be a successful investor.

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Macro-Economic

Macro-Economic

The goal of the economic level is identifying the position in the macro-economic business cycle for the next 12 to 24 months. This is essentially an estimate of future Gross Domestic Product levels (the output of an economy). In an expanding GDP environment, certain sectors do well, while others do relatively poorly, even though they will still see expansions in value. The sectors which usually do well are industries where people can splurge, called “discretionary”. In contracting business cycles, the discretionary sectors do badly while requirements for living retain their value. Even in an economic depression you still need electricity, water, food, heat, gas, etc. Things you don’t need are excessive.

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Sentiment Level

Sentiment Level

The sentiment of the market is essentially a “how do you feel today?” test. A market is essentially just a large group of people who want money, and everything is designed solely to earn and avoid losing money. It (they) can feel confident. It (they) can feel scared. You can take advantage of both.

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Fundamental Level Part 1

Fundamental Level Part 1

The Fundamental level consists of two phases. The first is projected performance, and the second is past fundamental trends. The first stage requires building on the work of others. Use analysts and investment bank projections for the future by looking at Price to Earnings and Price Earnings Growth in “Forward (future) Years”. The second phase requires looking at the firm’s quarterly fundamental trend over the past year, and the year over year fundamental change over the last 3 years. Both phases reveal firms with good fundamentals while eliminating companies with poor fundamentals.

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Fundamental Level Part 2

Fundamental Level Part 2

The second fundamental level contains the deeper dive into company fundamentals. In this level you review the finances of your long and short candidates. For long candidates, you’re seeking improving year over year fundamentals. For short candidates, you’re seeking deteriorating year over year situations. Look back over 3 to 4 years, since a longer term fundamental trend being driven by economic factors discussed earlier is best. There are specific aspects to review. Most of these are easily available on MorningStar.com, so you don’t have to calculate them yourself, just look them up.

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Equity Technical Level

Equity Technical Level

The technical level also divides into two phases. The first is used to filter equities based on trend, and the second is used to actually enter trends in your direction bias. You want to be sure the list of companies you have labeled bullish are in an uptrend or bullish reversal pattern. You want to be sure the list of companies you have labeled bearish in a downtrend or bearish reversal pattern. This requires studying technical analysis. If they’re not, either wait or scrap the idea.

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Risk and Hedging Level

Risk and Hedging Level

When complete, you should have screened out poor candidates using economic, fundamental, and technical trends. Your remaining “candidates” are no longer candidates, but tradable investment positions. The last things you need to do is match long/short equities into spreads and build your Long/Short equity portfolio.

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Position Watching & Position Management

Position Watching & Position Management

To calculate your stop losses, find the historical worst returns for each individual spread. To pull this off, you have to calculate the historical returns of the spread and then weight them. This requires using the spread’s all time returns. Calculate the return for the long side’s days historically, calculate the return for the short side’s days historically, and then created a weighted average of those returns. These should go all the way back until either the long side or the short side ceases to exist.

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Foreign Exchange

People will buy strengthening currencies, buy rising markets, and buy rising yields. All of these are driven by factors associated with economic demand. Ultimately, foreign exchange trading comes down to reading economics. Start by using economics to find improving or deteriorating factors for currency demand and supply. Use sentiment readings to see if others see the same factors in the market for the currency that you do. Look at technicals regularly, and wait to see if the trend in the currency pair begins move in that direction. If it does, use risk management to control losses and restrict damages in the case you are wrong on any given trade.

Economics Analysis

Economics Analysis

The most important thing to remember when trading currencies is that capital desires returns. Capital will flow into equity and bond markets that give profitable returns and out of markets which do not. Buying an investment in a specific financial market requires transacting in that market’s main currency. If bond yields are rising and stock market values are strong, the currency must be purchased to investment. This raises the value of the currency. If bond yields are falling and stock market returns are weak, investors will leave the market. Retrieving their returns from the market requires selling the currency for their own domestic currency, or the currency of another nation whose investments they want to buy.

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Sentiment Analysis

Sentiment Analysis

An economic bias alone is not enough to place a trade. There is a delay in correlations between economic trends and currency trends, which means even the best economically developed ideas need to be timed. You must still accurately time your entry. We use sentiment and technicals for that purpose.

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Technical Analysis

Technical Analysis

The technical stage is the final analysis stage before you take a position. Technical analysis is not used to generate trading ideas, but merely to time your entries into trading ideas generated by economics and confirmed by sentiment. If you have an aligned economic and sentiment bias, the technical level must align with that bias and give you an entry signal to take a position. If alignment occurs, you know that your trade idea is probably correct and you should trade now.

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Risk Management

Risk Management

Risk management exists because you can always be wrong. These systems attempt to predict the future and will have a higher accuracy rate than wild guessing, but there is no 100% system. If you have a 9 wins per 1 loss win rate, your wins mean nothing if you lose your whole account when you are wrong. Risk management controls how much you can lose.

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Trading Plans

International Economic Analysis:

  • Major Currency Economic Summaries
  • Performance of Major Imports and Exports
  • Mandates of Central Banks versus Expectations
  • Performance Indexes of Major Economies
  • Economically Correlated Currency Projections
  • Large Funds Currency Sentiment Readings
  • List of Technical Indicators to Look For
  • Occasional: Foregin Exchange Technicals Markups
Trading Plans

American Markets Analysis:

  • Summaries of American Economic Structure
  • Performance of Major
  • Imports/Exports
  • Federal Reserve Mandate versus Expectations
  • Performance Indexes of U.S Economy
  • Economically Correlated U.S Dollar Projections
  • Large Trading Fund Index Sentiment Readings
  • Market Wide Earnings Versus Valuations
  • Fundamental Ranking of U.S Business Sectors
  • Best and Worst Future Consensus Estimates
  • Occasional: Firm Fundamental Strength Report
  • List of Technicals to Look for While Trading
Trading Plans

Brokerages, Insurance Firms,
Financial & Trading Software.

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