Tuesday, 10 April 2018


Three different fonts???

Clarity of thought is important when devising a trade. Some mental maths and risk assessments have to be made in real time as a trading opportunity emerges; you can be a few minutes late and lose out on the bulk of the profits.

Here's a market signal that I've utilised repeatedly to achieve short term profits within the contra (T+3) period - this essentially means no money down and pure, clean profits. I can share it with you as the signal constitutes just 50% of the trade - the other half is practice, trading execution, and intuition, all of which you'll have to do yourself.


Example 1 : correlation between VS and the KLCI. Source : Bloomberg

Let me explain the concept further. You will need these very specific market conditions for this trade to work:

1) A fundamentally strong company with stable earnings prospects.

2) It should fittingly be a market leader - this means that its valuations are fully priced into its shares. To put another way, it has to be a momentum stock that has outperformed the broader sector or market over a long period (say, a year).

3) A weakening broader market environment. As you may know, a weak market drives down momentum stocks the hardest. It's not rare for these stocks (or the sector) to fall hard first, preceding the entire market's decline.

4) In a peak-to-trough phase, the momentum stock has to lose at least 20% in value over the short term (say, three months). It's better if there was an earlier attempt of bargain buying to prompt the stock into recovery but ultimately fizzled.

5) This loss in momentum should precede the broader market's decline. When the market decline happens, the stock should fall even further, but this is more indicative of fear and loss of liquidity, which is when you should buy the stock.

Example 2 : A crude visualization of how this works.

6) At the trough (defined here as the stock's lowest price point in at least four months or more), the stock has to exhibit sustained buying interest. This means it has to fail to breach new lows, perhaps over a period of several days.

7) As soon as market pessimism abates, the stock is expected to rise faster and further than others in the market. Remember that the stock may be considered overpriced before, but with intact fundamentals, there will always be buyers at the trough. For companies with long term fundamentals, short term volatility is almost always a good opportunity to buy. And if you plan accordingly, you can derive both short term and long term profits from the trade.

8) Last but not least, it is best if the stock has a good proxy to amplify the magnitude of profits. Like a warrant.

A major part of this trade involves the understanding of how momentum stocks relate to the broader market. They're correlated but not efficiently so - this is why you can get market beating returns form momentum stocks in the first place. A generally positive market means that investors are enthusiastic. This enthusiasm provides a foundation for the stock to rise further, thus maintaining its momentum.

The trend of course reverses when the market turns sour. In this scenario, newly formed pessimism (and the increasing urge to take profits) reinforce themselves until the stock stages a precipitous decline. This can lead to a significant selldown even when markets are still okay - the correlation is first broken, then prices begin to move in the opposite direction. Because of this, momentum counters can start collapsing at the first sign of broader market troubles - it now falls harder than the rest of the market.

You can find real value in the presence of extreme pessimism. One of my favorite signals is when the momentum counter stages a quick recovery after a large decline, but then it quickly fizzles out, also known as the 'dead cat bounce'. The subsequent decline in VS shares actually preceded the sudden and vicious fall in the FBM KLCI a few weeks later (the index fell by 1.88% on April 4, its largest one-day decline since the VIX episode in February).

VS price chart, March - April. I'm no fan of technical analysis and its hilarious charting terms, but I can appreciate the shock value of this particular metaphor.

Prior to the KLCI's sudden fall, VS Industry - a long time favorite for its market beating margins and preeminent leader status in the local electronics manufacturing services (EMS) space - staged a far more vicious decline; between March 28 and April 3 it fell by a staggering 23%. If you stretch the timeline a bit further, to early March, the stock has lost a third of its value in a few weeks. There was nothing fundamentally wrong with the company itself; the stock was paying the price for its momentum status.

So the stock lost 33% of its market value when the KLCI only fell by 2%. VS likely fell first amid a wave of profit taking; after a brief recovery, it fell further as market volatility shocks the KLCI into that 2% decline. It was clear that the decline in VS was overstretched relative to the market (need I mention again that it's a fantastic company with solid valuations?). Now is the time to devise a simple trade to profit from this mispricing.


VS seemed to have hit a nadir around the RM2 mark on April 3 as it closes at a nine-month low. Even for a momentum stock, a 33% decline in one month is too fast; it only makes sense amid a stock market collapse scenario, and that clearly wasn't happening. I began anticipating a potential rebound, but this needs to be validated by strong buying support at the RM2 mark.

April 3-4: Support emerges near the RM2 mark.

The average trading volume (turnover) for the two day period between April 3-4 was a much-higher-than-usual 14.5 million shares, which is highly suggestive of an attempt to support the stock price. By April 5 it was time to make a move - this was a calculated risk, though the parameters of the trade became clearer by this point:

Scenario 1:

1) Buy into the stock at around RM2.

2) A stop-loss level at below RM1.95 (which would suggest an immediate failure in price support).

3) A profit target of RM2.15 (7% upside).

The right approach in this situation was to trade VS-WA, a fairly volatile company warrant with a RM1.65 exercise price. It has historically traded at a premium to the mother share (after factoring in the exercise price), but this spread has narrowed considerably as VS continued to fall.

The most appealing thing for me was that VS-WA had been trading at RM1 as recently as March 29; it traded at a low of 51.5 sen just four days later, or a loss in value of nearly 50%. Bear in mind that the warrant only expires in January 2019, so at the moment it still has real intrinsic value.

Scenario 2 (with a more lucrative profit opportunity) :

1) Buy VS-WA when the mother share is around RM2.

2) A staggered stop loss level at 53.3 sen, 52 sen and 51 sen for the warrant (likely to occur when the mother share drops to RM1.95 - see Scenario 1)

3) A 10 sen profit target for VS-WA (18% upside) - the warrant is likely to reach this level when the mother share hits the RM2.15 mark (a 15 sen premium from the RM2 level).

So on April 5, armed with the knowledge of two things : 1) the market signal mentioned above and 2) validation of price support for VS shares, I plunged in decisively with an exposure of 100,000 warrants.

This next chart is very important. It's a five-minute chart for VS-WA in the early hours of April 5.

As you can see here, the payoff was immediate.

The average price upon entry was around the 55 sen mark. During the afternoon session VS came close to the RM2.15 mark. I disposed of everything at the 62-65 sen level; the rapid appreciation of the warrant signaled that it was time to exit. Note that everything goes back to square one for me after the trade is concluded; I have no strong opinions on the future price direction of either VS or VS-WA beyond this particular period.

Thanks to this strategy, I realized a 10% gain on the trade within about six hours. Minus fees, this translated to a profit of RM7,452.57.

 Intraday position. Net profit is the difference between the 'total amount due' for the 'buy' and 'sell' contracts.

So there you have it : no money down and pure, clean profits.

P/S : The market signal I described is obviously not unique to VS ; it's applicable to many stocks that have lost significant value in a short span of time. I pay extra attention if the stock of a fundamentally solid company falls by more than 20% in a month.

The lesson is : value emerges when a good stock falls, but you have to learn to maximize your profit potential within acceptable risk parameters (hence the scenario comparison).

The exact same approach would have applied to PMETAL, which finally staged a comeback on April 9. I did not benefit from this as I was focusing on.... Round 2 with GBGAQRS (more on this in the next post).

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