Trading Book Reviews

Book Review: Buy and Hedge

[easyazon-link asin=”0132825244″][/easyazon-link]While it may be generally classified as an investing book [easyazon-link asin=”0132825244″]Buy and Hedge[/easyazon-link] by Jay Pestrichelli and Wayne Ferbert could easily be classified as a trading book because of the way it advocates the use of options. I’ll leave the reader to classify it for themselves, though, based on their own definitions of the two terms.

In a nut shell, the philosophy of Buy and Hedge is that any positions one takes in the stock market (and we’re really talking long-only here) should be hedged. Individual hedging is best, but portfolio hedging is also considered acceptable by the authors. Options are the favored tool to accomplish that hedging.

About the first half of the book puts forth the reasoning and justification for hedging. Mainly it comes down to reducing the volatility of your returns. The authors make the statement that the one thing you can control in the investing process is the risk. I’m not totally comfortable with putting it that way, but I get the point they are trying to make.

The second half of the book is focused on options and option strategies which can be used for hedging purposes. In fact, the authors go so far as to recommend strategies (though not necessarily in all cases) where no position in the underlying security (stock, ETF, etc.) is held – the position is totally created with options. This is probably something that will make traditional investing advocates a bit uncomfortable.

It should also be noted that the authors don’t have anything against a straightforward index approach. They just think that it should incorporate a hedging element.

All in all, I think [easyazon-link asin=”0132825244″]Buy and Hedge[/easyazon-link] is a worthwhile read for those who favor playing the stock/ETF market from a longer-term position perspective.

Make sure to check out all my trading book reviews.

Trading Book Reviews

Book Review: Buy Don’t Hold

[easyazon-link asin=”0137045328″][/easyazon-link] [easyazon-link asin=”0137045328″]Buy – Don’t Hold[/easyazon-link] by Leslie Masonson is called a investing book, but I’m tempted to put it in the trading category. It depends on how you prefer to define the difference between the two. The book’s subtitle is “Investing with ETFs using relative strength to increase returns with less risk”.  Using relative strength makes me think trading, but there are definitely elements of the approach outlined in the book which speaks toward what I would probably think of as investing. In any case, as I noted in [easyazon-link asin=”047179063X”]The Essentials of Trading[/easyazon-link], I look at trading and investing as being functionally the same thing, with perhaps a philosophical difference in approach. I’ll leave it to the reader to make their own judgement.

This book is largely a practical text focused on application. The author outlines a very specific strategy for deciding whether the stock market is to be considered in an uptrend, downtrend, ranging, or turning. His “dashboard” comprises a collection of indicators which are very much technical analysis oriented. They include market breadth indicators, sentiment readings, and some basic price studies. The scoring of the indicators provides the user a market reading from which to develop a strategy. From there, Masonson moves on to picking the best trading/investment vehicle based on relative strength readings. In other words, it’s very much a top-down approach.

On the plus side, the author is very good about explaining the various methods he employs in his strategy. He suggests specific tools (most free, some paid, but not necessarily required) and walks the reader through applying things. On the negative side, much of the first third of the book is dedicated to proving how bad an idea buy-and-hold investing is - definitely overkill there – and I thought in general the writing could have been better. Also, while Masonson does demonstrate the value of the dashboard indicators he uses, he doesn’t actually show a good historical look at how the overall strategy would have done. Still, it’s a book which can certainly provide the fodder for research and development for those interested in longer-term stock market trading/investing and/or asset allocation between and among markets.

Make sure to check out all my trading book reviews.

Trading News

More New Margin Requirements

I posted before about the NFA’s new rules on maximum forex trading leverage permissible for traders with US brokerage accounts (see New NFA Retail Forex Leverage Restrictions). Those went into effect on Monday. Tuesday new leverage rules kicked in for the trading in leveraged ETFs. Darwin’s Finance has a good write-up on the subject.

I find it somewhat interesting that margins on short ETFs is higher than on long ones. Granted, equities do tend to move more rapidly to the downside, but a double long ETF is going to move just as quickly as a double short when the market is falling (considering day time frame moves here, which is what the leveraged ETFs are intended to track). It’s basic math, so I see no real justification for the higher margin between the two.

The other interesting part of this is that even with the new margin requirements you can still trade at effectively 4:1 leverage. That’s a fair amount of leverage when you consider how much volatility there can be in the markets underlying these ETFs. Many experienced forex traders don’t go much beyond 10:1 leverage when they trade, and that’s in a lower volatility market (see Looking at Volatility Across Markets)

Trader Resources

Alternative Ways to Play Interest Rate Moves

I’ve written in the past about ways to play moves interest rates. Among the ETFs I’ve mentioned are:

  • TBT – UltraShort 20+ Year Treasury ProShares
  • LQD – iShares iBoxx $ Invest Grade Corp Bond
  • HYG – iShares iBoxx $ High Yield Corporate Bond

The first one is a leveraged short play on long-term US government interest rates. The other two are standard plays on investment and high yield (junk) corporate bonds. Many of those in the latter two ETFs are probably holding them as income investments, but they can also be used in spread trade strategies with a view toward the relationship between different grades of corporate debt, or corporate debt vs. Treasuries.

The TBT, of course, is a flat out play on falling T-Note/Bond prices. Unfortunately, it is a leveraged play (2x) so it isn’t idea for a long-term play on rising interest rates.

Doing a bit of digging, though, I found the Rydex Inverse Government Long Bond Strategy (RYJUX). To quote the fund description:

The investment seeks total return, before expenses and costs, that inversely correlates to the price movements of Long Treasury bond. The fund employs as its investment strategy a program of engaging in short sales and investing to a significant extent in derivative instruments, which primarily consist of futures contracts, interest rate swaps, and options on securities and futures contracts. It invests at least 80% of net assets in financial instruments with economic characteristics that should perform opposite to fixed-income securities issued by the U.S. government. The fund is nondiversified.

This, of course, is a mutual fund rather than an ETF. That means you can’t trade it the same way you could TBT or the others. But that’s kind of the point in this particular case. If you’re looking to play a long-run rise in US interest rates, as is likely to be seen when the Fed begins unwinding its liquidity programs and raising interest rates, you don’t want something you’ll be trading in and out of on a short-term basis. This is probably something you’d look to play in a retirement (IRA, etc.) account.

Of course you could also play the futures and options markets to take a short position in Treasuries, but they have some short-coming when it comes to rolling positions forward in a long-term play.

The wider point I’d like to make here is that there are almost always ways to make a play on your expectations for the market. If you keep yourself educated about what’s available to you in terms of markets and instruments you’ll have the opportunity to be creative with your strategies, and potentially to find a better way to play for a given market move (or lack thereof).

Reader Questions Answered

Futures vs. ETFs Performance Differences

Here’s an interesting, but somewhat complex question about oil trading I had come in by email. Well, at least the answer is complex.

Hi John,

While checking a performance comparison for the last 200 days between USO and the WTI Continuous Contract, I noticed that they had very similar performance up to the end of 2008, and from the start of 2009 they began diverging, with the ETF significantly underperforming the futures contract. What happened around new year’s time that suddenly caused this divergence? And what other ETF can I choose that better mimics the price action of WTI if I would rather avoid trading the futures contract?

Thank you


I’m not an oil trader or analyst (though back in the day I would cover the energy markets on a fill-in basis from time to time), so the really market-specific stuff is beyond my knowledge. I’ll do my best, though, to explain what I suspect is contributing to the difference in performance between the USO and the front month futures, which is basically what the continuous contract tracks.

US Oil Fund (USO) ETF
First of all, we need to look at what makes up the holdings of the USO. According to the fund website, the objective of the fund is:

… for the changes in percentage terms of its units’ net asset value (“NAV”) to reflect the changes in percentage terms of the spot price of light, sweet crude oil delivered to Cushing, Oklahoma, as measured by the changes in the price of the futures contract for light, sweet crude oil traded on the New York Mercantile Exchange (the “NYMEX”), less USO’s expenses.

At this writing the fund is indicated to be long about 45,000 contracts in the July futures, a position with a value of about $2.79 billion as of the May 20 closing price. The fund also shows nearly as much in cash ($2.76 billion). In and of itself, that sort of positioning would be a very good reason why USO is under-performing the front month futures contract. The ETF isn’t fully exposed to it so they cannot possibly match the gains.

I don’t know how those relative weightings have changed over time, though, so I cannot go beyond the current observation to specifically say that’s the entire reason. There may be other factors involved as well (see below). The big cash position definitely stands out, though.

Other Oil ETFs
There are a handful of other oil-focused ETFs out there. Here’s a list:

  • iPath S&P GSCI Oil Total Return ETN (OIL)
  • PowerShares DB Oil Fund (DBO)
  • United States 12 Month Oil Fund (USL)
  • PowerShares DB Crude Oil Long ETN (OLO)
  • United States Heating Oil Fund (UHN)

Some of the ETFs take an approach similar to USO in which they focus their holdings on front month futures to try to track nearby prices. Others, though, such as USL, actually use a spread of futures contracts across an array of months. That creates an interesting dynamic when it comes to comparing performance vs. the front month futures.

Contango and Backwardation
In normal circumstances prices of futures further into the future are priced cheaper than those in the front month. That’s a situation known as backwardation. The price of oil in the ground is less than the price of one in a barrel. Sometimes, though, things flip around into contango, which is when foward prices are higher than current ones.  That can come when near-term demand drops or there’s a glut of supply.

Now, if things hold in either contango or backwardation one would generally not expect to see much difference between the performance of front month oil and that of an ETF which includes holdings of several different month futures. When the situation flips, though, one of the two is going to outperform, potentially by a large margin. For example, if the market goes from backwardation to contango (means forward contracts go from priced less than front month to being price higher) an ETF holding forward months is going to outperform the front month futures (and vice versa in a contango to backwardation switch).

So the bottom line in all this is that you should make sure you know what the ETF you’re trading or investing in is holding so you can know what to expect.

Trading News

Speaking at the Los Angeles Traders Expo

It’s official. I’m going to be doing my first ever trading expo in a couple of months.

Traders Expo - June 2009, Los AngelesActually, it’s been official for a little while, but I’ve only just been provided with some stuff from the organizers. Not only will I be attending the Traders Expo in Los Angeles June 3-6, but I’ll also be speaking at the event.

Here’s what they want me to tell you about it:

Global Markets continue to dole out more volatility. These dramatic movements create trading opportunities that last mere minutes, or even seconds. Attend The Traders Expo in Los Angeles, June 3-6, at the Pasadena Convention Center your best opportunity in 2009 to meet the experts, test the latest products and services, and network with other traders to find out what’s working for them…and what isn’t. You will learn proven strategies and techniques from leading trading experts to help you recognize trading opportunities and give you the confidence necessary to execute and exit the trade at precisely the right moment. Attend free, learn from trading experts, and become a more confident, profitable trader. Register FREE by call 800/970-4355 and be sure to mention priority code 014103 or go here to register online!

I will be speaking on the subject of cross-market trading opportunities in ETFs. That will be an interesting experience, no doubt.

More importantly, though, I’m looking forward to my first opportunity to get out and about among the trading community in a public fashion and hopefully meet some folks I’ve only emailed or at best spoken with on the phone. Let me know if you’re planning on attending.

Reader Questions Answered

Volume in the Forex Market

Here’s an email question that came in recently which relates to volume in the forex market.

Hello John,

I’m a Forex trader. Is there something equivalent to a buy/sell pressure indicator for the MT4 platform that you know about or can recommend.

My trade plans are less effective when the O/S or O/B conditions last for a long time. One of the indicators I use is the stochastic.

Sometimes it undulates above 80 or 30 so I’m never sure when it undulates if it going to break the high/low of the previous wave.

I’ve seen some buy/sell pressure attempted with tricks for getting the currency’s volume or with number of tics but I don’t think it a reliable way to gather this data. Any thoughts would be appreciated…


Pretty much without exception, the volume figures you see in forex are not actual traded volume. They are tick volume, which indicates how many times a given price changed. While it can sometimes be an interesting indication of how active the market was in terms of price choppiness, it gives absolutely no indication of how much actual buy and selling is being done. As such, any technical indicators based upon tick volume are of dubious value from that perspective.

The only readily available public volume figures that I currently know of are in the futures and forex ETFs. They may, at times, be useful. Just keep in mind that they only represent a tiny fraction of what is done on the spot market.

As for the effectiveness of over-bought/sold trading with Stochastics, keep in mind that they will be good during range-bound periods but will kill you in trending conditions.