Exchange Trade Warrants
- Part 3
- Part 3
Top down Technique
As the name implies, the ‘Top Down Technique’ starts with the global picture and finishes with the selection of an Australian Blue Chip share. Trends in the broad market can last for periods of 3 to 6 months and equity warrants are the best derivative product for trading over this time frame. The following charts show the DJIA and All Ords forming major lows during October of 1998. October effect has been a common occurrence during the past few years. Note that these charts are weekly and show the chartist the big picture. The October low of 1997 can also been seen in these charts.
With the Dow and the All Ordinaries having fallen to old support levels the probability of a fourth quarter rally is greatly increased. The warrant trader can plan the entire trade in advance of the anticipated rally. If the upward trend doesn’t occur then the warrant trader will simply await the next trading opportunity.
The fourth quarter of the calendar year has proven to be a period when the broad market has rallied on the heals of sharp declines in the third quarter. This is not to say that the trader is attempting to predict the future but is anticipating the most probable direction of the market given its recent behavior. No action will be taken until the market begins to move upwards.
Selecting an Industry Group (Sector)
The obvious warrant to trade would be an index warrant. But greater leverage will be achieved by locating a leading blue chip share that has bottomed out with the broad market and trade an equity warrant issued over this share. The top Blue Chip shares in Australia (Ie. Household names) are NCP, NAB, CBA, BHP and TLS. The next step is to search the relevent industry groups (sectors) with the intention of finding one that is tracking the All Ordinaries Index. The relevent groups are Banks, Telecommunication Services, Media and Materials. The following chart shows how sub-Indexes can be compared with the All Ordinaries Index. (Note that the older Sector Indexes are being used instead of the new GICS Industry Groups.)
This part of the process is subjective and each trader must be prepared to back their own judgment. We are looking for an index that is very similar in shape to the All Ordinaries Index during the past 3 to 6 months. (If in doubt; trade an Index warrant)
It would seem that the banking index has tracked the All Ords into this low more than the other sectors. This points the warrant trader in the direction of the leading bank shares. Out of this group the National Australia Bank has the greatest influence over the behavior of the banking sector at the time of this analysis.
The Blue Chip Share
The following bar chart for NAB shows that its price activity has bottomed out along with the indexes. Technical analysis is applied to this chart to fine tune our entry and exit points even though we are trading a warrant.
Entry - Count Back Line Method (Close above $20.00)Exit - NAB’s recent high of $23.50
Note - Identifying a target exit price is mandatory when trading warrants. Warrant Selection
To select a warrant choose one with an exercise price slightly less than the exit price of NAB and ‘Number of days to expiry’ that is at least double the time that this trade is expected to last for. The ideal parameters are $23.00 with a March 1999 expiry. (Fourth quarter rally should be over by Xmas.) NABWBD has an exercise price of $22.00 and expiry date of 29/07/99. If the ideal parameters can’t be found then look for a warrant with a lower exercise price and greater time to expiry This selection process is completed before the actual entry signal has been given and allows the warrant trader plenty of time for decision making.