Trading Equities: A Huge Market!
In the financial markets, the foreign exchange market is the largest with more than $5 trillion being exchanged on a daily basis.
The equities market is equally huge with many institutional investors and hedge funds moving money on a daily basis. In the United States, there are more than 5000 listed companies which trade on a daily basis. As a trader, these companies present you an ideal opportunity to make money.
However, to make money in equities you need to be extra careful!
Just as in the forex and commodity markets, many people have lost their money in the equities market. This happens when these people make the wrong decisions and stick with them.
How to Trade in Equities
As noted above, since there are thousands of listed companies, the companies have been put into various categories. This is based on the work that they do.
For instance, Chevron and Exxon are listed in the same categories while Facebook and Twitter are listed in the same category. To have a diversified portfolio for your day trading account, you can opt to trade in different categories.
For instance, you can decide to trade in energy and media. Alternatively, you can decide to trade the customer discretionary and utilities.
How then do you select the best industries to venture in?
As We have written before, your role as a trader is not to chose the company that is overvalued or undervalued. You won't make money by doing all the statistical analysis or coming up with models that are paraded around by hedge fund managers and sell-side analysts.
This is simply because you don’t intend to own these companies forever.
In fact, you want to enter a short position today and exit in the evening. The following day you might decide to go long the same company.
Trading Equities - Developing a Strategy
What you really need to know when trading multiple industries is the price movements. If you have a good understanding about how the price moves among various companies or industries you will be good to go.
For instance, there is a good correlation between energy companies and those in the transport industries. For instance, if the price of oil goes up, then it will mean that airlines will pay a higher price for jet fuel. Therefore, with increased oil prices, chances are transport industries will be affected.
Another example is on oil and banking stocks. When oil prices fall, it leads to oil companies being in a reduced liquidity position. Some of these companies might even end up defaulting on their credit obligations.
Therefore, chances are that a decline in oil prices will lead to a decline in oil stocks which will have an impact on financial stocks.
As a result, having this understanding will help you in developing a good hedging strategy.
Market or industry volatility is another thing you need to consider when trading various categories of equities. Some companies are usually in more demand than others.
A good example is internet companies which many investors want to own today. For instance, companies such as Facebook are usually in demand than utility companies.
As a day trader, you actually want to trade companies that are more volatile as this will give you a chance to make more money.
As a day trader, one thing you can always do to maximize your returns is to look out to consolidation (Mergers and Acquisitions).
When a company announces a bid for another company, the market reacts in favour of the company being acquired. In addition, in many times, when the announcement comes, shares of the acquirer tends to go down.
Therefore, in this situation, there are two ways a trader can benefit: shorting the acquirer and buying shares of the company being acquired.
The logic here is simple. Shareholders of a company being acquired will only accept a premium for the sale process to go through. Say company A (trading at $56 a share at a market capitalization of $2 billion), and company B wants to buy it.
The only way this transaction can go through is if company B offered a premium (such as $65 a share). On the other hand, for this sale to go through, company B will need to spend or borrow money which will increase its costs.
Since no investor likes this, the company’s shares will head south, opening an opportunity for shorting.
Activist investors changed the way companies are managed in many parts of the world. An activist investor starts by spotting a company and researching about it.
After this, the investor goes ahead and buys a significant stake in the company if he feels that it is either being mismanaged or it is ripe for consolidation.
After making the purchase, the investor will put pressure on the management to change strategies.
As a day trader, following activists can be very lucrative because shares of the companies they have announced ownership tends to go high.
For instance, according to Bloomberg, shares of a company called Mondelez went high after activist investor Bill Ackman announced ownership. In 2014, shares of Apple went high after activist investor Carl Icahn announced stake.
Activist investors are not always bullish on certain companies. In July 2016, activist investor David Einhorn gave a talk at the 20th Sohn conference. In his talk, he talked about fracking companies and singled out Pioneer Resources.
He noted that these companies were not sustainable in this period of low oil prices where they lose $0.2 for every dollar invested. Well, shares of Pioneer Resources tanked by more than 2.66%.
Investors and hedge fund managers regularly gather at conferences to share their best ideas. These gatherings are important places to get information on the best companies to go long and those to go short.
Years ago, hedge fund manager, David Einhorn spoke at the Sohn Conference in New York. During the conference, he talked against companies dealing with fracking. During his speech, shares of all the 3 companies he mentioned went down by an average of 5%.
At the same conference, hedge fund manager Bill Ackman talked about Zoetis, a company dealing with animal drugs. After he pitched his idea, the shares of the company went up by 10%.
Listed companies are mandated to release quarterly results by the SEC. This earning season presents an opportunity for traders to understand how the company has been doing. It also serves as a good opportunity for the company to issue estimated financial information.
In addition, when releasing the results, the senior management responds to questions raised by analysts. This provides an opportunity for traders to make short term gains.
In many cases, the company’s shares will go up if the company announces good results and guidance thus opening an opportunity to go long.
On the other hand, if the company’s prospects are not good, the shares will tumble creating a short opportunity.
A trader therefore needs to understand a number of things:
- Know when the company is expected to issue quarterly or full year results
- Understand the expected results in terms of EPS (Earnings per Share), and revenue.
- Understand the ‘trigger’ points.
The ‘trigger’ point represents the key metrics that investors will be looking at.
A good example in this is Facebook. It is possible for a company like Facebook to go south even when they issue strong financial performance in terms of revenue and EPS. This is because investors are looking at other metrics such as active monthly users and revenue per user.
The Initial Public Offering (IPO) is also another important opportunity for day traders focusing on stocks.
In the past, when companies list, there is usually a lot of optimism. In most cases, after an initial offering, shares of companies will go up by a huge percentage. For instance, when Shopify listed, the shares went up by 60%. In the same way, Etsy’s shares went up by about 40%. These are sweet numbers to day traders.
However, as a day trader, you should avoid the temptation of continually holding companies after the IPO because chances are usually high that the shares will fall to a new normal.
In conclusion, it is possible to run a successful day trading account with a focus on stocks. A number of successful hedge funds have used this strategy to make a lot of money.
In fact, as a day trader, using the traditional long term investing could hinder you from maximizing the full potential of the account.
External Useful resources about Trading Equities
- Equity Trading on Wikipedia
- Equity Trading – Fundamental versus Technical Analysis - TradingSim