Sunday, August 28, 2011

Day Trading The FTSE

A common approach to day trading is 'scalping' in this approach the trader aims to trim a small profit off the top of the market each day. An advantage of this approach is that it doesn't require the trader to make long term judgements about the market direction. It also allows the trader to reduce the amount of time that capital is in the market and at risk.

This strategy provides an attractive balance between risk and returns although fees are a particular concern with this approach, see the page 'Why is it so Difficult to Make Money Trading' above.

To make the most of this strategy the trader would normally use leverage. Leverage comes in many forms but effectively multiplies the investment magnifying any profit or loss.

In the US Market there are a wide range of leveraged ETFs providing 2* and 3* Leverage however in the UK there are only two LUK2 and SUK2.

LUK2 is a leveraged long ETF which should increase or decrease in value by two times the daily increase or decrease of the FTSE 100 Index.

SUK2 is a leveraged short ETF which should increase or decrease in value by minus two times the daily increase or decrease of the FTSE 100 Index. This is what is commonly know as an 'inverse' ETF because it moves in the opposite direction to the underlying index.

5 Day chart of LUK2 and FTSE

The red line represents the FTSE 100 Index, the blue line represents LUK2. The chart clearly demonstrates leverage at work, for one and two percent moves in FTSE, LUK2 is moving two, three and four percent. There is however one major concern with this chart, there is very little volume in LUK2. The breaks between the shaded areas show periods where no trading has taken place. A priority concern in entering any investment is 'Who am I going to be able to sell this to ?' With SUK2 the low volume situation is even worse.

5 Day chart of SUK2 and FTSE

The concern here is that on Tuesday not a single trade was completed in SUK2. On this basis I would avoid LUK2 or SUK2 despite them providing exactly the sort of leverage I would be looking for. This might not be the end of the story though, volumes in both products have increase significantly over the past few months and they may one day become as actively traded as their American counterparts. A US based equivalent of SUK2, QID which tracks the US NASDAQ 100 index sees an average daily volume of nearly eight million shares.

In the meantime I will investigate whether there is a market maker actively trading these ETFs. A market maker is an organisation whose roll it is to provide liquidity in the market by committing to trade in selected stocks and funds. If there is an active market maker the low volumes could be less of a concern provided that the spreads are reasonable.

I am also investigating using individual stocks as a proxy for the whole market, in particular I am looking at banks, miners and asset managers. I will post my thoughts on this approach in the coming days.

Another area I am investigating is the efficiency in terms of fees, spreads and execution of using ETFs vs Covered Warrants vs Individual stocks for placing days trades on the FTSE.

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