Posted: 2010-03-08 23:58 Traders Corner  Presenter: Giulietta Talevi Guest(s): Garth Mackenzie Summit TV is joined by Garth Mackenzie founder and editor of Traders Corner and manager of the Imara Managed Futures Fund for an update on the short term trading portfolio Giulietta Talevi: Welcome to Traders Corner. Garth, let’s take a look at the second most recent trade that you have put on for Traders Corner - the pairs trade of Shoprite and Spar - how has that panned out for you? Garth Mackenzie: It worked out quite well. We closed out the trade during the last week and made a bit of money. If you have a look at the graph of Shoprite - recall we went short of Shoprite and long of Spar on this pairs trade - first of all if we look at Shoprite notice there was a reasonably strong uptrend we identified and we identified that about 10 days to two weeks ago there was quite a sharp short squeeze up. We managed to short some Shoprite at R77 that day - it was very overbought and it was trading a long way from its uptrend - in the last week I covered that short at R74.65 so I bought it back so we made a bit of money on that leg of the trade. If we then look at the Spar leg of this trade notice also that there was quite a steady uptrend and the two share prices do mirror each other fairly closely - but it didn’t get as overbought as Shoprite did and there was a disconnect between the share prices of the two companies. That is why we entered this pairs trade. In this case I bought 21 contracts of Spar at R72.40 and then in the last week I closed those out at R74.05. Giulietta Talevi: A slight profit there. Garth Mackenzie: A slight profit on both legs. If you have a look at the graph of the relative of the two shares - the graph takes the price of Shoprite and divides it by the price of Spar - you will notice that for a long time the two share prices tracked each other quite closely in a fairly tight range in that area that I have highlighted there but then there was a massive move out of kilter with the relationship between the two, and the ratio between the two got up to where we traded there at 1.0635. Normally the ratio had been around 0.95 on average between the two so this got very far out of line with the historical average so I shorted Shoprite and bought Spar at a time when the ratio was quite far out as it was there. In the last week you will notice that this relationship between the two pulled back to what was a resistance line - it now became a lateral support line - and I managed to close out the trade at a ratio of 1.008 so we made some decent money on this trade. Giulietta Talevi: Did you make money on both legs of the trade? Is that quite common - was it quite fortuitous? Garth Mackenzie: In this case we made money on both legs of the trade which is not always the case with a pairs trade. Very often you will find that you make money on the one leg and you lose on the other leg. The idea is that you want to make more on the winning leg than what you lose on the losing leg. In this case we managed to make money on both sides which is obviously terrific but it doesn’t always work out that way. Giulietta Talevi: Did you close out both legs at the same time? Is that customary or can you close out one leg and then wait for the other to do what you want it to do? Garth Mackenzie: If you go into it as a pairs trade like we have here where you are betting on the one stop relative to the other you have to monitor the two share prices at the same time very carefully and this ratio between the two share prices - you can do that quite easily with a simple MS Excel spreadsheet. You shouldn’t what we call “leg it” where you enter one leg and not the other - or close one leg and not the other - because then all of a sudden it’s no longer a pairs trade. You’ve got a naked exposure on the one side either long or short which wasn’t your original intention for going into the trade. When you do a pairs trade like this you need to obviously enter the two shares at the same time and exit them at the same time as well. Giulietta Talevi: You seem to have closed out on the ratio that you were hoping it would trend towards. This is sort of towards the ideal ratio… Garth Mackenzie: Correct. I was hoping it would trend down towards a ratio of parity - of one basically - and it got reasonably close to that. We didn’t quite get parity but we got pretty close to it. If you actually have a look at the mechanics of this trade and break it down into its constituents we traded R150,000 nominal exposure per leg and we shorted Shoprite at R77 and then covered that short at R74.65 so we locked in a profit of R3,800 there including all costs. The Spar leg we went long at R72.40 and closed it at R74.05 so we made a profit there of R2,500 also after taking into account all the costs. The ratio when we entered the trade was 1.0635 and we closed it just above a ratio of one at parity so we locked in a total profit here of R6,340 which is quite nice and it seems with hindsight like it was the right time to exit this trade. Giulietta Talevi: Exactly, because I noticed that Shoprite shares have been trending higher in the last couple of days. That was your second most recent trade. Your most recent trade was a bit of a riskier bet against the market - can you tell us what you’ve done there? Garth Mackenzie: I went short of Naspers. If we have a look at the chart here I will explain why we did this trade. Notice that this stock had broken below this uptrend and that uptrend actually goes back quite a long way - more than a year - but for purposes of explanation zooming in a bit on this graph we also identified that there was a newish downtrend emerging so what I decided to do was to short some Naspers at R290 because of the resistance created by that new downtrend line that I thought was emerging. I set a stop loss at R303. What subsequently happened is the stock traded above that resistance line and it’s a trade that I’m uncomfortable with so I actually decided to exit it at R295 and we did incur a loss there of just over R2,000. That was less than the loss we were originally willing to take because obviously I’ve cut it short of the stop loss - but I just felt that being short this stock in this market which is fairly strong at the moment was probably not the right trade. Giulietta Talevi: You were uncertain about this trade from the beginning - does it happen to you often that you enter a trade where you’re not wholly convinced of its merits and you will exit regardless of whether it’s done what you wanted it to do or it’s gone completely against what you wanted it to do? Garth Mackenzie: I think the first mistake here was I was a bit nervous about this trade right from the word go - so I probably shouldn’t have entered it to begin with to be honest. Having done that then I looked at it and was uncomfortable for a couple of days thereafter. You need to take all of your trades and look at them every single day and ask yourself “am I still comfortable with this trade - would I still enter this trade today?” With this Naspers trade I just looked at and I thought the market is fairly strong at the moment - it seems to be pushing higher and this stock doesn’t seem to be coming down like I thought it might so let’s rather just get out of it and move forward… Giulietta Talevi: Is this a trade where it is the timing that’s the issue rather than the merits of the trade or the position that you’re taking - so Naspers is maybe a share to short but the timing was wrong? Garth Mackenzie: I think that could be the case here. I gave a detailed explanation last week - the fundamentals of why I thought it might become a short now. I’m not going to go into that again this week - but I’ve noticed it has become a relatively weak stock. If you look at the trading action in the past week Naspers actually hasn’t been pushing up to the same extent that the market has so that tells me that it has moved from being one of the strongest shares in the market and it actually looks like it has turned over to become one of the weaker shares. I think at some stage perhaps this stock will still be a short - but as you say maybe the timing was incorrect in this case. Giulietta Talevi: This weeks trade is not a share at all actually... Garth Mackenzie: It’s actually an exchange traded fund. We are looking at the NewGold exchange traded fund - this exchange traded fund represents the rand price of gold so if we have a look at the chart here notice that there’s a large triangle type structure emerging there, and particularly I want to have a look at the downtrend that’s in place going all the way from the highs. It’s lasted more than one year and the market is currently bumping up against that downtrend. If I zoom in a bit on this chart and we just take the last three months worth of trading action notice that there is a large downtrend that I spoke about before and bring that short term little trend line in there notice that the structure that’s emerged is what we call a “bull flag” as it looks a bit like a flag with what looks like a flag pole and the flag itself. Normally that will shoot out to the upside - we need to see it break above R84.50 in this case to justify the flag and justify an upside breakout - but the safest place or the place with the best risk to reward ratio to trade one of these types of formations is when the stock is trading at the bottom of that flag structure as it is at the moment. What I’ve done is I’ve bought some of these NewGold ETFs at R82.80 which is at the bottom of that flag structure and I’ve put a stop loss at R80.50 which is quite well out of the way of the bottom of that structure. If it gets down there then I will have to concede that I am wrong and that this trade hasn’t worked out… Giulietta Talevi: Take us through the mechanics of the trade then... Garth Mackenzie: We are buying it at R82.80 as mentioned and the stop loss is at R80.50. The risk on each share is R2.30 therefore and we are risking 2% of our trading capital on this trade. We’ve got about R255,000 trading capital now so that will allow us to risk R5,100 on this trade. If we take the portfolio risk and divide it by the risk per share that leaves us with R2,270 in shares so rounding that off I can do 22 single stock futures contracts here. That’s what I have done for the Traders Corner portfolio for this week. Giulietta Talevi: You’re choosing the NewGold ETF rather than a gold share for example - any particular rationale behind that? Garth Mackenzie: Mainly because I like the technical structure of the ETF. The shares are great to trade - we’ve traded them before on this programme both successfully and unsuccessfully. I like the gold shares to trade because they’ve got a lot of volatility - but at this stage I just really wanted to trade this particular structure because I like the technical formation. You will probably find that if this works out the gold shares are also likely to move upwards… Giulietta Talevi: Where is the portfolio at the moment? Garth Mackenzie: I’m just going to break it down into two separate slides this week. Obviously we’ve got our Shoprite and Spar pairs trade where we locked in profits on both legs. We are still long of the Vodacom shares specifically for the odd lot offer that by the way was approved by a board meeting of Vodacom directors last week. Naspers I mentioned we closed out and took a small loss there. Then we are sitting long of these NewGold exchange traded funds for this week. Taking it all into consideration that’s the way the portfolio stands at the moment. We are just above R255,000. Obviously remember we started with R250,000 so it really has been a difficult grind this quarter - but we are a little bit up nonetheless and we are looking out towards Easter when we’re going to wrap up this series of Traders Corner and hopefully have some money to give to charity. Giulietta Talevi: Exactly. Hopefully the gold price will shoot up in the next week or so. www.summit.co.za Transcripts: 082 962 2772 tr/met Printing? Please think of the environment. Comments Related to this transcript: Comment on this transcript... Name : Email : Comments :