The Trader’s Handbook Ep4

The Trader’s Handbook is brought to you by IG Markets South Africa in collaboration with The Finance Ghost. This podcast series is designed to help you take your first step from investing into trading. Open a demo account at this link to start learning how the IG platform works.

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Intro: Welcome to The Trader’s Handbook, a limited podcast series brought to you by IG in partnership with your host, the Finance Ghost. Over the course of our upcoming episodes, we are delving deep into the world of trading, helping both novice and seasoned traders alike navigate this exciting field. Join us as we unravel the intricate strategies and insights that define this dynamic landscape and the beautiful puzzle that is the markets. IG Markets South Africa is an authorized financial services and over the counter derivatives product provider CFD. Losses can exceed your deposits.

The Finance Ghost: Welcome to episode four of The Trader’s Handbook, which is a collaboration between myself, The Finance Ghost and IG Markets South Africa. I’ve had a lot of fun with this so far, and the feedback from the market has been really good in terms of people engaging with the content and enjoying what we’re doing and obviously just learning about trading, which is entirely the point here. As ever, I’m joined by Shaun Murison from IG.

Shaun, thank you so much for doing this with me. And what a week it’s been, right? I mean, we’ve had headlines full of concepts like this Nikkei carry trade and when the Fed might decrease rates. That’s always in the headlines, let’s be honest. But the markets were all over the place at the start of this week. We saw the Nikkei with double-digit moves two days in a row, basically, first down and then up. Tons of volatility in the US for investors. I think this is where it really makes sense to kind of sit tight and do the whole “be greedy when others are fearful” and take advantage of the volatility to pick up companies that you like below your assessment of what their value should be. So I did that for Meta, Microsoft and Uber – added all three of those to my portfolio.

But investing is very different to trading. And I must say, the more I play around in my demo account, I think the more I learn this, in some cases the hard way. So for traders, this was an exciting week, right? I mean, volatility is what creates opportunity in this world, isn’t it?

Shaun Murison: Well, that’s exactly it. Exciting moves. Again, I’ll say that you’re taking a contrarian approach – when things are falling, you like to pick them up. But sometimes fortune does favour the brave.

Just to clarify, when we talk about volatility, we’re talking about that range of price movement on a share index, commodity, FX, or any financial instruments. So high volatility is referring to a large range of price movement over one of those instruments. If we’re talking about high volatility, we’re talking about a high range of price movements. The market is transacting between the lows and highs quite a great distance apart. When talking about low volatility, markets are idling in short price range.

So naturally speaking, when you’ve got high volatility, the opportunity to make a reward is greater because the markets are moving further. But with that, obviously, if you’re on the wrong side of it, there’s inherent risk as well. You need to balance out your risk relative to reward on those trades. But also when you see that market volatility, there are dislocations in the market like you saw. Markets start to correlate. You know, sometimes it’s broad-based selling, and then you do get some instruments that are oversold and you can pick those up at a bit of a steal and hopefully it bounces and you can make some money off of that.

Just going back to the technical analysis side of things for traders out there and for yourself, I think there’s a really cool technical indicator that can help you assess volatility of a particular market, and that’s called the average true range. And it’ll really just show you how much a market moves over a course of a day, week, hour on a normal basis. And we are looking for probability size of movements when we are trading.

The Finance Ghost: Yeah, that makes sense. There’s a lot of maths, there’s a lot of measuring your win rate. And we’ll get into all of this in this podcast series for sure. But what is interesting is these big days do kind of come out of nowhere, right? I’ve read a lot around having a trading plan and journaling and all of that kind of stuff. I think it’s that Mike Tyson quote – you can have the best plan until someone hits you in the face. I’m definitely hashing that quote, but it’s roughly like that. And the market definitely hit a few people in the face earlier this week.

So how do you approach these days where you just get these huge moves? You wake up and the market’s gapped 10% lower and you’ve got to now manage your portfolio.

There’s no plan for that, clearly, or at least it wasn’t in your plan for that week.

Shaun Murison: Look, I think there are two types of volatility. Sometimes it’s unexpected. If you’re in the market already, you’ve really got to just sort of assess what’s happening and do some damage control. If you’re not in the market, you wait to see where opportunities may lie and we talk about certain markets dislocating and sometimes becoming a little bit oversold. You might realize that this share’s come down a little bit too much. It’s not really correlated to the news that’s going out. But what we do is again, we look for what’s probable in the market. So a good habit for traders is looking for what news is out on the day, what could cause volatility. Make your assumptions and see if you want to be a part of that. That’s what’s scheduled. Then like I said, there’s always those black swan events, things that happen that we don’t expect. And at that stage we just really got to just take stock of what we’re doing, manage that downside risk where we can. And if opportunities present themselves, that’s where we’re going to look to jump in.

The Finance Ghost: So speaking of overcooked negativity in moves, when all hell broke loose on Monday, I thought to myself, okay, I had some time on Monday afternoon when the US market opened. And I thought this is a really cool opportunity to play around in my demo account and see what happens. So I tried my hand at trading the open. I think that’s the correct term. And the thesis I went in on, which again is much easier with “Monopoly” money, but I do try and treat it seriously as real money, which is why I use a small percentage of the allocation I’m allowed in my demo account. And I laugh at myself every time – it’s not real money and I still put a small amount in. But I did feel like the negativity was overcooked. So other than the investing I did with my actual money, I then took my demo account and I looked at the open, I thought, okay, let me buy those same names effectively, roughly at the open. I learned some pretty interesting lessons around, you know, how to put an order into the market in that situation. You put a price in and it’s already run past that price and then you click the wrong button. I mean, it’s still proper noob stuff, but that’s the point of having the demo account, right? And I think what’s also interesting with the demo account is it’s taught me some lessons around being greedy, not sticking to a thesis, especially when you’re going short on something, which is not what I did on Monday.

I think when you’re going short on something, you’ve got to say to yourself, this is either going to work quickly or I kind of need to go away. I think a show or two ago we talked about those Mr Price shorts. Right now, those Mr Price shorts are not working. I’ve kind of left them to see what happens because I still think it’s too high. Time will tell, obviously. But when things went well on Monday and I bought at the open and watched these prices keep going, I banked the profits a couple of hours later because I thought, okay, I’ve got to get my head around the fact that trading is different to investing. Yes, I wanted these companies. I’ve bought them in my investing account. That’s different here. I’m looking to literally make a quick profit and go away onto the next idea.

That’s kind of how I’m starting to learn that investing and trading are actually quite different things. And that’s where this podcast is just so valuable. But it made me wonder, are there traders who are literally only trading the open and the close? Because that’s where so much of the activity is. Is that a trading style that you’ve seen play out for people and how they operate each day?

Shaun Murison: There’s certainly people that do trade opening and closing sessions and for various reasons; we’re always looking at when opportunity is presenting itself.

So if it’s at the open or if it’s at the close, but if you look at them specifically, in the mornings when exchanges are open, markets adjusting to overnight news, or maybe company results are coming out, there’s obviously a lot of activity. So that’s where you are going to get quite a bit of volatility in that market, a large range of price movement.

When you start looking at the closing session, you have that end of day auction. There are a number of reasons why traders would go in and high volume would pass through that. Auctions, there’s a lot of liquidity, so you can get big orders out there, but then you also have day traders, you know, the high frequency guys that I like to hold their positions overnight, so they might look at exiting positions into the close if that’s part of their strategy.

In general, when you look at a normal trading day, market movements are more pronounced in the open and into the close. So the first, maybe the first hour after that opening session, the hour into their close, if you’re looking at the JSE – 9am is the open, 5pm is the close. We have low periods of volatility during lunchtime, that’s where people have lunch, I suppose.

And then there’s also obviously a correlation to what’s happening in international markets. 3:30pm to 4:30pm local time, depending on whether daylight savings or not, is when US markets open. You have quite a flurry of activity around there when you start looking at other instruments. Things like forex markets, they don’t have formalized exchange, but you’ll find big moves also do correlate to when the relative exchanges of those currencies and of those equity markets do open. US opens at 3:30pm locally and closes at 10pm and there’s a lot of volatility around those periods. Obviously in  strategies where you’re looking for market movements, you want to look at where there is activity.

The Finance Ghost: So when you say day trading, which is a term that’s come up before, these are people who generally are opening and closing a position on the same day, they’re not holding it overnight. But in many cases I guess it’s even more focused than that. I can imagine a world in which people are trading, maybe it’s their full-time gig, maybe they have their own business and they only trade for a couple of hours a day. I guess in that scenario they’re looking for maximum ban for buck in terms of time investment. So rather than sit there and try and trade lower volatility for a few hours in the middle of the day, they look at it and say, well, most of the action’s either in the morning or the late afternoon when the US markets open. That goes back to having that trading plan. Right? Like, when during the day do I do this? What am I looking to achieve? It’s very much a scientific process, isn’t it?

Shaun Murison: Yeah, I think a lot of the day traders might not be using as much technical analysis, maybe they’re using technicals, but again news-driven content. So knowing when that market volatility is going to happen, trying to just capitalize on the momentum that comes from that big news item event. Obviously interest rate decisions are big events, inflation news, your CPI inflation etc. If you’re looking at the US markets jobs data, especially the US non-farm payrolls data. Looking for that high volatility event and trying to capitalise on short-term momentum there. And once that momentum is done, the markets adjust quite quickly, then looking to get out of your trade.

The Finance Ghost: Yeah. So let’s dive more into that concept of how different trading is from investing.

When an investment is going your way, it’s great, obviously, but I think when a trade is going your way, it’s particularly exhilarating to see yourself up. On a leveraged basis, you can be up 30% of the money you actually put down on margin in the space of a day if it’s a volatile day, which is really, really cool, obviously. But the opposite can also happen. When a trade is losing money, it’s not so fun. You think of all the things you could have done with that money instead, like, you know, going out to a restaurant, depending how much you’ve put down, that’s the least of your problems. You know, the horror stories are out there of people losing enough to buy a restaurant, never mind take someone out to eat there. Risk management etc. is all very important.

For investing with a long-term lens, markets go up. Not always individual companies, but markets do. If you look over a long enough cycle, they go up. It’s inflation, it’s growth, it’s all those things. So, you know, when you’re investing, if you get in a little bit too high, provided it’s a company you’re happy to own long term, it’s an easily fixable problem. It comes down below your assessment of fair value, you buy more. Typically, you bring down your average in-price, you dollar cost average in, and you hold it for a long time and things work out more or less okay. It’s the old joke: if you liked it at R100 a share, you’ll love it at R80. And if you’re right about the company, maybe it’ll be at R120 a year from now, and you averaged in at R90 and life is good.

Now, trading seems to be quite different. Firstly, on your shorts, you can’t just let them run forever because you will be on the wrong side of it. It’s almost guaranteed. Unless you manage to pick out a company that is heading for the dustbin. Possible, but difficult.

People talk a lot about cutting losses quickly and letting their winners run. I see this kind of terminology coming through a lot in trading, certainly more than talking about fair value and that kind of thing. I’m going to let you talk a little bit about that and why this sort of terminology comes through. Cutting losses, letting winners run, and what are the strategies that people are using out there to make those decisions? Is it a scientific process? Every single time there’s a loss, you cut it? Or every single time there’s a winner, you let it run to a certain level? How do people actually do this in practice?

Shaun Murison: I think the long-term trade is the short-term trade gone bad! Look, there are different types of market environments and they’re conducive to different types of strategies. You do obviously always need to cut losses and manage that downside risk. That’s going to ultimately be your success in trading. Things don’t always go favourably for you. But I think two basic concepts, or for me, there are two different types of market environments.

The first one we look at is a trending environment. That’s where we see a market that’s committed to a direction, could be up or down. In this type of environment, you look to run with your winners, ride out that trend, so to speak. You’d manage your risk by having an initial stop loss, which is simply an order in the market to pre-determine your loss if it moves unfavourably against you. But then you try to ride out that trend. If that market’s moving in your favour, you can use that stop loss now to lock in profits and try to see how much of that trend you can capitalise on.

The second type of market environment, I’d say, is a range-bound price environment. So we see a market that’s just idling between levels. In that type of scenario, you’re looking to trade towards targets. You’re not looking to ride out your winners. You’re saying, well, the habit of this market is it’s moving between maybe R5 a share and R10 a share. You want to buy maybe closer to the R5 and sell closer to the R10.

You might look at having your stop loss somewhere below, like major lows or major reversals or price reversals, just when that price has started to tick back. Another idea of managing that risk, where you can cut your losses or put in a stop loss, is by managing volatility in the market. And earlier on, I mentioned that indicator, that average true range. And that’s quite a nice idea where you buy, looking at that average true range figure, using that distance as a stop loss figure from your entry point, because it gives you a probable size move, which should hopefully give you enough breathing room in a trade before it goes profitable. Sometimes it does move a bit against you first, but hopefully accounting for that volatility in that particular market can help keep you in the trade before it turns profitable. There are lots of different methods around it.

But I think the key point here is in a trending environment, we want to try ride out that trend, run with our winners, try lock in as much as we can. Cut those losers short in a trading or range-bound environment. We’re just assessing our risk relative to reward, trying to risk less than what we’re looking to make, in the simplest of terms.

The Finance Ghost: Yeah, I notice a lot with, again, it’s stocks that I follow, really, but they often are range bound. The thing will bounce between R400 a share and R440 a share, and it’ll do it ten or 15 times in a row before it breaks in either direction. And I guess that’s where it’s almost a self-fulfilling prophecy, right? Traders are actually making that happen basically because people are buying at the R400, they’re selling it close to the R440, and that puts pressure on it. There’s got to be a lot of additional buying or selling pressure to get the thing out of that range beyond just people believing that it will turn, because I think you’ve used it before on this podcast to say that the markets are really just a voting machine. At the end of the day, if enough people believe a price will turn at a level, and they put in their trades accordingly, then guess what? It will happen.

Shaun Murison: Look, I think a lot of the time what’s happening is whether you’re trading technically or fundamentally or investing, everyone has a perceived value where there’s value, and it does correlate on a chart. Quite often you see little areas where you see these long wicks on the candles where prices have been rejected at lows and bought back up. And it’s for varying reasons that people perceive that level. So maybe not always a self-fulfilling prosperity, but also just perceived level of value. And they know the top of that range might be where markets think that the share is expensive at that particular point in time. When you start looking at these ranges and breaking out of ranges, that’s where you’re going to need the sentiment to change or some new additional information. And that might come from a macro theme or might come from company results. Any news that changes that sentiment and breaks that habit of that particular market. But like I’ve said before, we like to trade the habit until that habit changes. So if it’s in a range, we’re looking to trade between levels. When it breaks out, we can look to assume that a new trend is forming and we’ll trade it accordingly.

The Finance Ghost: Yeah, that’s interesting, because that goes back to my more contrarian style, which works quite well in investing. Jury’s out on whether it works in trading – doesn’t look like it does. Perhaps. We’ll see. In investing, it can work really, really well. You’ve just got to have the presence of mind and have done the research to figure out what you want to buy and at what price, then it works. So, speaking of different types of trading, I see a lot of concepts come up like swing trading, momentum trading. Maybe those things are relatively similar, you can confirm or deny, but how do these things actually work? What is swing trading and momentum trading? Are these longer-term things where fundamentals start to play a role, or are they still very much chart driven styles?

Shaun Murison: Look, I think these are chart-driven styles. They’re technical analysis concepts. But like I always say, I do believe that good technical analysis will reflect what’s happening fundamentally in a market, technical analysis being the summation of all the market forces out there – rational investor, irrational investor, institutional investor, retail investor.

When we start talking about swing trading, it’s a form of trend following. In short term trading, it’s a form where you hold your positions a little bit longer than you would in something like day trading. And the basic idea is just to identify a general market trend. And we know markets don’t move in straight lines. And you’re looking to, let’s say that’s an uptrend, you’re looking at buying into the dips. If it’s a downtrend, you’re looking at selling short term rallies that move against that trend. So, the idea is to capture portions of that trend and try compound your returns by trading between the swing highs and swing lows. And we talk about swing highs and swing lows. We’re just talking about the highs and lows of price activity.

When you’re using this type of approach, and with all trend type of systems, we’re generally looking to risk less than what we’re looking to make out of a trade. You might look at risking R1 for every R2 to R3 you’re looking to make. It’s very, very popular.

You’re happy to hold your positions overnight, maybe for a couple of days to a couple of weeks, depending on how long those trends stay intact. But as a trend following system.

The Finance Ghost: Makes a lot of sense, and you’ve touched on something there that I know we’ll do in shows to come, which is that win-loss ratio and planning out the trade. And actually measuring whether it makes sense. I think before we get into candles, something else you raised earlier, which is another thing we’re going to cover in shows to come. But there’s another type of trading that I still want to ask about on this show, which is scalping, which sounds a lot like making a lot of really small profits. I mean, is that what scalping is? Sounds like quite hard work. And it’s like grating cheese. You know, you get a whole lot of little pieces.

Shaun Murison: Yeah. So scalping falls into the day trading, high frequency trading categories. And so here as a trader, you’re looking to trade, take small but more frequent profits out of the market. So to do that, you probably take slightly bigger positions in the market to try and magnify those profits a little bit more. And generally, you’re not holding your positions overnight. You’re what we refer to as an intraday trader. Now, this goes against a lot of the convention here. We might say a day trader might not risk R1 to make R2, you might do it the other way around, risk R2 to make R1. The success of a system like that, a lot of people disagree with that, but the success of a system like that is that you have to have a high win rate. The frequency of being right relative to the frequency of being wrong needs to be higher.

A lot of strategies around scalping are news driven as well. So they’ll look at, you know, high news events, which we mentioned a few times on the show, and just look at where those high volatility events try to catch a portion of the move that comes after the news gets released. But it’s really about quick moves, lots of trades intraday trying to small but frequent profits out of the market.

The Finance Ghost: The cheese grating example is hot off the press. You can tell that I made my little one pasta yesterday and he’s four. So, you know, he’s at that very fussy eating age where you actually have to convince him that grated cheese was actually the block of cheese that he saw just previously and it’s now actually just a different shape. But in some ways, maybe that analogy makes sense, actually, because the size of the slice of the cheese is the kind of trading style you’re actually going for. You’re either grating it or you’re cutting big chunks and hoping that works. And it all comes down to what works best for, not just a four-year-old on a pasta, but you as a trader and your personality and what you actually enjoy, what you’re naturally good at. I think that’s a great place to bring this podcast to a close, actually, and we’ll deal with some of the other stuff on the next one, which is how do you figure out what kind of trader you are and what kind of trader you should be in terms of style?

Shaun Murison: Well, firstly, you’ve got to practice and see, but I think one of the key factors here is time. What time do you have to allocate to markets? You mentioned it earlier on, and I agree with you, the scalpers, the day traders, the high frequency guys, although they’re trading over shorter time periods, they’re actually a lot more active in the market. They have to have their finger on their pulse. They’re watching a lot more closely. If you have a day job, which obviously most of us have, something like swing trading is probably a little bit more conducive to timescale. When do you have time to analyse markets? When do you have time to execute the markets?

Obviously, the great thing now is that we have technology on hand. We can look at markets, do a bit of analysis, and we can place the orders in the system. We don’t have to be watching it all the time to be engaged. But I think the type of strategy you employ is relative to the time available to you.

You can’t be a scalper or an intraday or day trader if you are working a full-time job. Something like swing trading I think would be suitable for most.

I just want to add that when you’re trading, when you’re in a trade, there’s a lot of emotion. When you see your bank balance going up or down, obviously there’s a lot, you don’t think as clearly. So automating as much as you can is really, really beneficial to you. So exactly what you’re saying is that make all the important decisions of where you want to get in, where you want to get out, and where you want to get out if the market moves favourably or unfavourably against you before you actually get into the trade. And there are so many tools available to you as a trader, with technology now you have access at the palm of your hand. The apps, if you’re using a computer, all the apps you can set in where you’d like to buy, where you’d like to sell. We call it limits. Where you take profits, stops, orders to exit, if the market does move against you. So you can automate a lot of those processes. And it doesn’t have to be that time consuming. You don’t have to sit and watch it all day, every day.

The Finance Ghost: Yeah, I love that. You can imagine a world in which you research something you want to buy, you put your buy order in the market, you set up a stop loss if you want to go that route so that, you know, that’s your maximum at risk. And if you get super unlucky, right, and it gaps below that – we’ve actually talked about that before, and there is actually a way that IG allows for that from memory. And how does that work if the market does gap below your stop loss? I mean, it does happen sometimes. If you’ve been really unlucky and you’re in a single stock, terrible news. Overnight, the thing gaps, you know, 15% lower.

Shaun Murison: So if you’ve got a stop loss in the system and the market’s closed and opens, you can get slippage. Slippage is you have your stop orders to say hey, if the market gets here or below, get me out. Right. But if that price is not available, what’s going to happen is we’re going to get you out at the next available price. Now, that is a conventional stop loss.

There’s a really cool feature that we do have, which are called guaranteed stop loss. You pay a slight premium for that, but you won’t have gap risk. You’d have your stop loss in the system. And if the market did get past that, we’ve guaranteed you your price.

You pay a slight premium for that, but you’re not subjected to that huge amount of slippage that you might have got if you didn’t have a guaranteed stop. Basically what it’s saying is that with normal stops and slippage, you can lose more than you expected to lose if you’re on the wrong side of the market with that stop loss, although you can bypass it by using something called a guaranteed stop loss, which we do offer.

The Finance Ghost: Got it. Okay, fantastic. I think what I’m learning about trading, if we can use an Olympics analogy, that air pistol event, I think it was, that everyone is now using as memes, the Turkish guy who kind of walks up and just shoots from the hip with both eyes open, you know, versus the lady from South Korea with all the fancy tech and everything else. I think trading is a little bit more the science, you’ve got to actually be more the lady who’s ultra prepared and everything else, rather than the Turkish guy who maybe got slightly lucky or whatever, coming up there with not much of a system and shooting.

I think investing, you can get away with that a little bit more. It’s still not good. You know, you’ve still got to do your research, etc. But you can get away with it if you like a stock and you have an idea of its value and you just buy it at the end of the month when you’ve got some money. Long term, you’re probably going to be okay.

Trading, you can’t behave like that. You can’t just wake up on a Wednesday and go, okay, today’s my day. Let me go on and see what looks good and have a punt. That doesn’t work. That’s what I’m definitely learning about the differences and I think that’s what we’ll cover in shows to come – stuff like trading plans and reading the candles and what are the different types of markets and technicals and everything else. There’s so much. That’s why I’m so glad we’re doing this as a series.

Shaun, I think we have to leave this one there just to avoid it getting too long. Thank you as ever for making time for this. And thank you to IG Markets for investing like this in new traders and people trying it out. And to the listeners, go and set up your demo account. It is honestly the only way. You’ve got to go and do that. You’ve got to go see it for yourself. You’ve got to feel the exhilaration of a trade working. You’ve got to feel the pain of one going against you. And you’ve got to try and understand in both cases why that happened. Go visit the IG Market South Africa website, open up that demo account. And Shaun, I thoroughly look forward to our next episode. Thank you for all of these insights.

Shaun Murison: Great, thanks a lot.

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