Trading the Daily Cash Dow and minimising the effect of bias – Spreadbetting
Spreadbetting the Dow Cash should be a simple exercise which when you get it right is very profitable. In practice, it is made difficult by the number of methods which can be used to judge entry and exit points and the uncertainty of getting a price which properly reflects the current value of the underlying market when you do trade. It is assumed that you understand the basics of spreadbetting for the purposes of this guide. It is also assumed that you have access to real time data and charts and that you know how to read and interpret these.
The purpose of this guide is to bring together the sum of knowledge, advice, best practice etc. which I have gathered which should be applied when trading the Daily Dow Cash. The contents are by no means the final word and any contributions to this guide are welcomed. The following topics are covered:-
A Simple Overview of Spreadbetting the Daily Cash Dow
Spreadbetting Company Price Bias
Stop losses
Stake Sizing
Position Sizing
Trading Hours and Timing
Do’s and Don’ts
Notes and other ramblings
A Simple Overview of Spreadbetting the Daily Cash Dow
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The Dow is sitting at a level of 10,000. The Spreadbet Company quote is 9,997 to sell and 10,003 to buy. You decide to buy and the Dow moves upwards over a period to 10,025. The quote from the SB company is now 10,222/10,228 (ie. 10,222 to sell and 10,228 to buy). You sell the Dow to close the Buy trade and realise a profit of 19 points (10,222 – 10,003). This is an idealised situation, you have called the direction correctly and the SB company quote straddles the current value of the Dow. In practice it is not often that the SB company quote will nicely straddle the current value and so it is unlikely that you would get two good quotes (one for the entry and one for the exit). The SB company will bias the price they quote and this can have a significant effect upon your potential gains and losses.
The first point to make here is that even though the Dow moved 25 points you will only have realised 19 of them. The other 6 points have paid for the spread.
Using the above example you have probably entered the trade because the Dow is going up. This being the case the SB company will probably have noticed this as well. They will bias their quote to reflect this upward movement and so, even though the current level is 10,000, their quote will probably be 10,000/10,006 (or higher). So, your buy price would be 10,006. When you decide to close the trade you have probably made this decision because the index seems to have reached its high for the moment and your view is that it is more likely to go backwards than forwards now. Again, the SB company will probably have a similar view and will bias their prices accordingly. So, the actual is now 10,025 but the SB quote 10,019/10,025 (or lower). To close the buy trade you will now sell at 10,019 to achieve a profit of 13 points (10,019 – 10,006). This would be a typical trade, the Dow has moved 25 points in your favour but you have only managed to bank 13 points. You have given away 12 points in spread and bias.
In the above example you can quickly see that had you got the direction wrong and the Dow had gone down that your loss would have quickly been very large as the SB company moved from a positive bias to a negative bias.
Spreadbet Company Price Bias
It is widely accepted and known (the obvious exception being spread betting company glossy promotional literature) that the SB companies quote, whilst being based on the underlying instrument, can be heavily biased in the current direction of movement or in an anticipated direction of movement. This is most obvious immediately before, at and immediately after the open of the days trading. It can occur frequently during the trading day as the SB company anticipates movements and attempts to balance their quote taking into consideration, amongst other factors, the Futures price and other SB companies prices. This bias can be very significant and can make the difference between a profitable trade or a trade that loses even though you have called the direction correctly. When the quote is significantly out of step with the actual level of the Dow then do not trade it. Every point of bias that you give away is a point you need to get back to be in a winning position for the trade. I have seen the quote as much as 50 points away from the actual and 6 to 12 points is not uncommon.
When the current level is 10,000 and the spread is 6 points and the spread betting company price to buy is 10,006 ie. 6 points above the current level (not uncommon) then a small reversal on the actual or a change of sentiment could cause the SB company to reverse the bias. It is unusual that they would do this in one step but it can be done in two or three quick steps which would not be uncommon. The position you are in now is that the original bet would have cost you 6 points to close if you had closed it as soon as you had opened it (ie. the spread). Your new position is that the actual index has reversed by one point but the SB company has reversed its bias and is now quoting 9,999 to buy and 9,993 to sell. You now have a loss of 13 points if you close at this point.
Taking another view, the SB company can also let the actual catch up with their quote. This means that if you had bought at 10,006 when the actual was 10,000 and the actual now moves up to 10,006 the SB company may not move its quote. So, the index has moved in your favour but to close you will still have a 6 point loss. This is not uncommon and can be seen a number of times a day when trading the Dow.
The bias is an aspect of spreadbetting that is not discussed very often but you need to be aware of it if you are to maximise your gains and minimise your losses when trading the Dow using spreadbets. One of the trading methods discussed later will allow you to take advantage of this bias.
Use Stop Losses
Stop losses are an integral part of spreadbetting. A stop loss is designed to do exactly what you expect it to, it stops a loss when the loss is at an acceptable level and before it becomes a serious loss. All traders will have trades which go against them for one reason or another. How you react to a trade which is failing and at what point you take the loss will determine whether you are successful in the longer term with your trading.
A stop loss should be at a level that you are comfortable with and properly reflects the noise of the instrument you are trading. It is pointless setting your stop loss level too close to the price you opened the trade at as the spread (typically 6 points) will not allow for any small moves in the actual before you have hit your stop loss. Setting the stop loss at too high a level will result in higher than necessary losses.
Stop losses can be set using a number of different methods. Common among these are:-
A fixed number of points.
A fixed percentage of the underlying instrument.
At or at a point just above or below (dependent upon whether long or short) a pre-determined level for the underlying instrument.
At or at a point just above or below (dependent upon whether long or short) a support or resistance level for the underlying instrument.
At a fixed sum of capital.
At a fixed percentage of available capital.
The level you choose for your stop loss will also be affected by the target gain you wish to achieve, your actual average gain per trade and the ratio of successful trades to unsuccessful trades. It is important that you keep accurate records of all your trades so that this can be calculated.
| Example. If your average gain per winning trade is 10 points and your average loss per losing trade is 15 points then you need a minimum of 6 successful trades out of every 10 trades to breakeven.
6 x 10 points = 60 points gained Increasing the number of points gained for each successful trade would, in this example, move you into profit as would increasing the number of winning trades. |
You need to find the point for yourself that suits your trading method and avoids stopping potentially successful trades early but still stops unsuccessful trades.
The key point with stop losses is that wherever you have set them and whatever method you have used to select them that you apply them with absolute discipline. A failed or poor trade is one where you have no plan or ignore your stop loss. A successful trade is one that makes a profit or minimises the loss in accordance with your plan. When you have to use your stop loss and you have entered a properly considered and planned trade then think of it as a good exit not as a poor trade.
Stake Sizing
It is important when spreadbetting that careful consideration is given to the size of stake you will use when entering a trade. Too large a stake and a loss will possibly be too large to allow you to continue trading, too small a stake and gains will not properly reflect the return expected for the capital used or the risk taken.
Stake sizing is a critical element when you are in a stop loss situation. If your stake size is too large in relation to the available trading capital then the loss you are contemplating could stop you from implementing the stop loss in a decisive and timely manner. If you cannot take the losses when you hit your stop loss then your stake size is too big.
As a rule of thumb I use between 0.02 percent and 0.06 percent of available trading capital as a stake size. This equates to between 20 pence and 60 pence per thousand pounds of trading capital. For a normal trade I will typically use 0.035 percent and 0.04 percent as stake sizes. These values are chosen because they give a good return for a successful trade but keep losses (if a stop loss is properly applied) within a comfortable zone.
Using a percentage of available trading capital has some major advantages over other stake sizing methods. It ensures that the stake size grows in a controlled and properly proportioned manner when winning. It also avoids any temptation to increase stake size after a losing trade. Losing trades are a regular occurence when trading using spreadbets and increasing the stake after a losing trade will eventually lead to a significant loss.
There are examples of trading methods which use a doubling method to cover losing trades. Each time you lose you increase the stake size by multiplying the previous stake by two. Three losing trades in a row and the fourth trade requires a stake which is eight times the original stake. This is a good way to quickly find yourself in a very uncomfortable position where your potential loss is far in excess of any that you had originally planned for and is disproportionally large in relation to your available trading capital. Don’t do it is a good rule to use for this one.
A good method of choosing a stake size is to first determine the stop loss level for the trade. I will use a tight stop in some cases and a wider stop when I am looking for a bigger move. You can also use support and resistance to determine the stop loss level. If you are trading at £5 per point and using a 15 point stop then your stop is at a £75 loss. If you think it reasonable that the market could move 30 points against you before the trade is stopped then use half the stake size. Using this method you first determine your stop and this determines the stake size rather than tightening the stop because the stake is too big for the trade plan.
Position Sizing
Position sizing is very different to stake sizing. With position sizing you are adding further trades to a successful position or are partially closing a successful position to lock in profits. Lets assume you have gone long and the actual index has risen and reached a resistance point. If you consider it likely that it will continue to rise and go through this resistance point then you might open another trade. On the other hand you may consider it to be 50:50 as to whether the rise continues. If this is the case then you could close the trade but risk missing further gains if it does break upwards or you could close a part of the original trade and leave a part running. By part closing you have locked in a portion of the profit and you have covered the possibility of a further rise.
Trading Hours and Timing
Unless you have a crystal ball and know what the Dow is going to do then don’t enter a trade before the open. Nothing can tell you what the market will do other than hindsight when its already done it. When you are trading the Daily Cash Dow you are trading what it is doing today. What it did yesterday and what you and others expect it to do today and tomorrow are relevant but should not be the basis of a trade entry.
As a rule of thumb do not enter a trade for at least the first 20 minutes of trading. This is a minimum and I would typically look at 30 to 40 minutes before entering a trade. There is no rush, you’ve waited long enough for it to open so don’t rush into your first trade of the day. See what the market is doing, get a feel for any news which is expected and look at the effect of any news which has been released. By not entering any trades in the first 30 minutes you will miss some good opportunities but you will also miss some large losses. Remember that the Dow has a staggered open and that not all stocks trade immediately on the open. Just because it is going up from the open does not mean that it will continue going up. The Dow can change direction very quickly at the open as stocks open for trading and sentiment changes.
The market will, on occasions, move significantly towards the close of trade. This period is usually the last half hour to hour of trade. I will not usually enter new trades in this period and will look at closing any that are still open within this period. Again, you will miss some significant moves but you will also miss some large losses.
When looking at entering a trade you want to enter when the odds of a successful trade are in your favour. The price quoted by the SB company should be favourable to your view and the Dow should already moving or be about to move in a direction you anticipate. As you have no idea which way the Dow will actually move then the price is important as if it is strongly biased and if the trade moves against you then you are quickly into a significant loss or stop loss situation. Patience pays here, don’t trade if you cannot get a good price, there will be other opportunities.
Do’s
# “Do have a general trading plan and a specific plan for every trade.”
# “Do record every trade you make.”
# “Do analyse your results.”
# “Do have a stop loss defined before you enter a trade.”
# “Do have patience. There will be other trades and other trading days. There is no rush.”
# “Do use conservative stake sizing.”
# “Do let winners run whenever possible.”
# “Do use position sizing to take profits when in doubt.”
# “Do use your stop loss.”
# “Do stick to penny stakes until you are consistently profitable. If you are undisciplined when trading pennies or cannot make a profit however hard you try then give it up.”
# “Do have a longer term target against which you can monitor your progress. I use a 2 year plan with targets for each week.”
Don’ts
# “Don’t trade in the first 20 minutes to half hour.”
# “Don’t enter any new trades in the last half hour.”
# “Don’t trade if the price is not good.”
# “Don’t trade just because someone else has traded.”
# “Don’t increase the stake after a loss.”
# “Don’t trade if you are feeling down, unwell or tired. You’ll feel even worse if you get it wrong and it will cloud your judgement.”
# “Don’t expect every trade to be profitable. Take the loss and move on.”
# “Don’t re-enter a trade after being stopped out just because it starts to move the way you originally thought it would. Its caught you once so don’t let it catch you again. Only re-enter if it is a properly planned trade and you can still get a good price.”
Notes and other ramblings
# Understand why you are in the markets. Gambling thrill or to make money?
# Use an approach and don’t deviate from it.
# Use money management at all times.
# Establish a trading plan before the markets open.
# Have a detailed plan for each trade.
# Have entry and exit points and understand risk reward ratios.
# Learn to accept many small losses.
# Trade markets from the short side.
# Standing aside from a position is a position.
# Speculation is a business. Develop a business plan.
# Survive to hang around for the big moves.
# Don’t blame the market for your losses. You are the sole reason for losses.
# Write out a trading plan for all potential situations you may face.
# Do not concentrate on break-even levels when you are losing. Break-even levels have no bearing on the future success of a position.
# Don’t liquidate a winner to keep a loser.
# Develop and maintain an exit plan. Follow this plan with rigid discipline.
# Greed kills.
# Never add to a losing position. A losing position means you are wrong.
# Nothing new ever occurs in the markets.
# Don’t try to predetermine your profits.
# The key to wealth in trading is simplicity. Avoid techniques you don’t understand.
# Don’t be overly curious about the rationale behind a move.
# Trade your money not the markets.
The classic text Reminiscences of a Stock Operator published in 1923 (available for download from here) offers timeless wisdom for all investors and traders: “Men who can both be right and sit tight are uncommon. I found it one of the hardest things to learn. But it is only after an investor has firmly grasped this that he can make big money. It is literally true that millions come easier to a trader after he knows how to trade than hundreds did in the days of his ignorance.”
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