How Does Carbon Trading Work?

Posted by Profitable Trading Tips on Sunday, August 29th 2010

29
Aug

For the trader interested in carbon credits the question is how does carbon trading work? Carbon trading has to do with attempts to reduce greenhouse gas emissions, specifically carbon dioxide emissions. A number of schemes were put forward and the one that gathered a consensus was that of issuing carbon credits which have a monetary value. Carbon and other emissions trading takes place on futures markets on both the NYMEX and on the Chicago Climate Futures Exchange among others. In both cases traders buy and sell futures based upon the Regional Greenhouse Gas Initiative Cap and Trade program and others. RGGI is a consortium of ten eastern US states that use carbon credits to curb greenhouse gas emissions. Europe has been doing this for several years before the USA and Western US states and Canada also have a program. Basically companies such as power plants that produce less carbon dioxide emissions earn money by selling their carbon credits to other companies. How does carbon trading work for the trader? Because these credits are traded on futures exchanges they are available to buy and sell for any interested party. Technical analysis as well as a fundamental knowledge energy prices, weather patterns, and the market itself are important.

How does carbon trading work for the day trader? The trader will trade carbon credit futures on the NYMEX and the Chicago Climate Futures Exchange as well as the European Climate Exchange, Nord Pool, PowerNext and the European Energy Exchange. Trading futures involves buying or selling rights and obligations related to the future delivery or settlement on a contract. Whereas commodity futures typically carry the obligation to deliver or receive thousands of cattle, tons of grain, or kilograms of gold thee is no carbon to be delivered or sold in carbon trading. The traders will simply settle the contract with money at the end of the contract. As with all US futures trading a trader can execute the opposite trade and get out of a contract before the expiration date. In the case of a trader who correctly anticipated a rise or fall in the value of carbon credits this can lead to profits without having to stay in the contract until the settlement date. If the market in carbon credits becomes volatile the trader does not need to find himself trying to outguess the market. Options trading is an option.

How does carbon trading work with options? It is possible to trade options on carbon futures just as with any commodity or other futures contract. The trader who believes that carbon credits will go up in price can buy calls on carbon futures contracts. This gives the trader the right but not the obligation to purchase carbon futures in the event that credits do go up in price. Likewise, the trader who believes that carbon futures will go down in price will buy puts on carbon futures. If the price does go down he or she will profit by selling at the contract or strike price and buying at the new market or spot price. In either case if the anticipated carbon future price change does not take place the trader is only out the premium paid for the futures contract. Although carbon trading in not really trading a disaster like the current BP oil spill it is taking advantage of the potentially severe problem of climate change. In this regard how does carbon trading work. It seems to be effective in encouraging polluting companies to reduce emission so that they do not need to buy carbon credits!

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Popularity: 3% [?]

Trading High Volatility and Low Volume

Posted by Profitable Trading Tips on Monday, August 16th 2010

16
Aug

Trading high volatility and low volume in today’s stock market should come with a warning, “Kids, don’t try this at home.” Certainly many hedge funds are currently sitting out the market volatile moves. The sorts of economic and political indicators that the people who manage over a trillion and a half dollars in assets watch seem a bit crazy these days. Although leaders at the Canada summit agreed to austerity measures it is uncertain how soon and how much and where such fiscal cutbacks will occur. The final shape of financial services regulations is not yet clear. Although Asia seems to be leading the world out of the recession the exact size and shape China’s future growth prospects is also unclear. The fact that hedge funds as a group lost nearly twenty percent of their invested capital just two months ago has taken the edge off of many traders’ zeal. The fact that folks are trading high volatility and low volume is a function of few traders willing to commit their funds to the market and the lower liquidity that goes with low volume. Technical analysis can be more risky when numbers are smaller making the pure technical traders wary.

Trading high volatility and low volume can be very profitable but it is the risk of substantial losses that is keeping many traders on the sidelines these days. Trading options with a strategy such as using straddles in the recovery market may be a better choice than trading stocks directly in high volatility and low volume. In a very volatile market a long straddle is a common means of profiting from excessive volatility when the market does not seem to know, or want to show, where it is going. The risk of a long straddle strategy is that if the underlying stock does not move in price then the trader will lose the price of two premiums. If, however, the market volatility takes the stock high or low the trader will profit by the difference between strike price and spot price minus the two premiums. Another, direct trading, strategy in trading high volatility and low volume is that many traders are only committing small amounts to their trades. The thinking seems to be that if they lose they will only lose on a small amount of capital invested. If they win with extreme volatility then the profits may be substantial compared to the amount invested.

In a more normal market traders focus on a sector, an event, or a trend. Trading the GM IPO and GM’s recovery, trading Toyota and the brake problem, trading banks in light of the pending regulatory changes, or trading freight movement in light of the recovery all could make sense in a more normal market. However, with such small volume and with big jumps in stock prices traders are “staying home” until the market direction and technical analysis make more sense. When trading volume goes up again it will because traders have a sense that the market has become predictable and it will likely come with better liquidity. When the only option of trading high volatility and low volume goes away the chance for extreme profits will go too but so will the likelihood for extreme losses.

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Popularity: 6% [?]

Trading Against the Programs

Posted by Profitable Trading Tips on Wednesday, July 28th 2010

28
Jul

: Image via Wikipedia

Trading against the programs sounds like a grade B horror movie. This thought comes to mind after reading an announcement by UBS AG that they have hired someone away from a competitor in order to “manage electronic stock-trading products.” The press release goes on to say the employee will be global head of direct execution product management, be responsible for the broker’s platform for trade analytics, and be responsible for a customer centered order execution program. In this person’s previous work they specialized in “automated and high-volume electronic trading strategies.” This announcement is a reminder that whether individual traders are day trading the politics, trading catchups, or scalping versus momentum trading they are always, at some level or other, trading against the programs.

Programmed trading exists because e-trading exists. E-trading, or electronic trading, reduces the cost of transactions through automation, improve liquidity, increased competition in the brokerage industry, improved transparency, and made for tighter bid ask spreads. All of this helps the retail investor. However, the ability to trade electronically opens the door to programmed, or algorithmic, trading. While e trading can give the trader quicker access to trades with a greater chance of fast execution it can also leave the trader in the dust, by microseconds, in split second reaction and execution when trading against the programs. Algorithmic programs with their build in technical analysis are set to respond to market changes and react automatically. The signals may be the same that the trader sees on a trade station but when the trader is thinking for a second before executing the trade he or she is a second behind in trading against the programs. If the programmed trading is in small volume it may not make much of a difference. However, if very heavy programmed trading by one computer sets of a programmed response by another programmed computer it may change the dynamics entirely for trading an equity.

A trader may decide in trading Toyota that an announcement by the company does not go far enough and will lead to a consumer backlash. While the trader is analyzing the situation and planning the trade an algorithmic program may have already taken input from a program manager, finished its analysis, and executed the same trade but in huge volume. The market has now changed and the trader will need to re-analyze before trading. In the meantime, in the grade B movie nightmare programmed trading as taken the market either higher or lower than might have happened with trading at a more rational pace. Some have blamed the New York Stock Exchange 1,000 point drop in a day, “Flash Crash” of May 6, 2010, on programmed trading. When programmed trading goes crazy one is reminded of the old saying that programming a computer is like training a dog only that a dog is smarter! The advantage that the human trader has when trading against the programs is that he or she can get out and stay out of a trading situation if the situation seems crazy.

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Popularity: 9% [?]

Trading the Russell 2000

Posted by Profitable Trading Tips on Friday, July 23rd 2010

23
Jul

: Image via Wikipedia

The New York Stock Exchange and the NASDAQ saw exceptional volume as speculators were trading the Russell 2000 during the one day a year when the medium and small cap fund rebalances. The Russell 2000 is a small and mid capitalization stock market index consisting of the bottom two thousand stocks in the Russell 3000 index. Although the Russell 3000 consists of roughly 98 percent of US stocks the Russell 2000 stocks have capitalizations of up to around $1.4 Billion USD and account for about ten percent of all capitalization in the Russell 3000. When the Russell 2000 rebalances it removes stocks whose capitalization has gone up above its upper cutoff and also removes stocks that have gone out of business or are not longer traded on the major stock exchanges. Trading the Russell 2000 when it rebalances is a means of trading the rallies and retreats of the stock market albeit a yearly opportunity.

When the Russell 2000 rebalances, a large number of funds that track the Russell 2000 also rebalance their portfolios. Exchange traded funds such as iShares, ProShares, Direxionshares, RydexShares and many others buy and sell large number of shares in order to rebalance their portfolios to stay in line with the Russell 2000. Trading the Russell 2000 during the once a year rebalancing lends itself to scalping versus momentum trading although throughout the year funds that track this index are a reasonable means of trading the fortunes and trends of the broad range of small and mid cap stocks.

The average market capitalization for stocks in the Russell 2000 is around $530 million and the median is around $410 million. Currently any stock at or above $1.4 billion in market capitalization is at risk of being sold in large volume as it is “balanced” out of the Russell 2000. Although the Russell 2000 only rebalances once a year it is a good example of where the trader does not need to be trying to outguess the market. The cutoffs are fairly clear for the stocks involved, especially for stocks that have prospered in the last year. They will likely be sold in high volume as they are removed from the Russell 2000. This year the volume was impressive with a Friday closing cross volume of 1.04 billion shares in 0.85 seconds!

While the trading the Russell 2000 in this way only works once a year the S&P 500 rebalances quarterly. This occasion also leads to heavy volume as the S&P rebalances its list of five hundred large capitalization stocks. In this case stocks obviously do not escape off the top end but do fall off the bottom if their earnings and stock values suffer sufficiently to be replaced by up and coming companies. Trading both the Russell 2000 and the S&P 500, as they rebalance, has less to do with technical analysis than it has to do with simply looking at each index’s criteria for inclusion and deciding who will likely be replaced in or added to the index in question. Once the trader has chosen his “targets” then a look at the technical aspects of the market and timing will come into play in trading the Russell 2000.

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Popularity: 10% [?]

The Evolution of a Trader

Posted by Profitable Trading Tips on Wednesday, July 21st 2010

21
Jul

If you take a look at just about any profession, you’ll find that people evolve through three stages: novice, competent and expert. Let’s take a look at how this works in the trading profession.

A novice trader is a one trick pony. They have one trading style they cling to for dear life. When they perceive that it no longer works, they’ll find a new system and believe with all their might that THIS is the way… until it too shows itself to be flawed. They are also inflexible and easily become confused when the unexpected happens. And, sooner or later, the unexpected will happen. They have lots of misconceptions, such as “shorting is bad.”

After the novice has been bloodied and bruised enough, he has a decision to make. Perhaps “trading is not for him.” If he sticks with it long enough, he eventually develops the experience to become competent.

A competent trader has “enough tricks in his bag” that he can adapt to a range of situations. However, he knows he needs to keep learning, and that there is always more to know. The overconfidence of the novice is replaced by the experience to know that uncertainty is a permanent fixture in his relationship with his chosen market.

As a trader matures, it gradually dawns on him that there is no “Holy Grail” of trading. There is no perfect indicator, system or money management approach that will GUARANTEE success. Usually, about the time the thankless search for the Holy Grail ends, a trader is competent enough to find his way without needing such an unrealistic psychological crutch.

A competent trader focuses on acquiring the right facts and making disciplined decisions based on these facts. He feels “safe” if he believes he “understands” the situation. For example, he may have a number of ways of picking stocks and a number of ways of playing his stock picks.

Eventually, a competent trader notices that he understands a situation even if the facts are not all in. This is because he can relate it to similar situations he has experienced in the past. He is then ready to graduate to expert.

An expert trader has enough tools, stock trading software and tactics under his belt that he can confidently take advantage of a trading situation without having to rely on detailed systems. In a sense, this is the opposite of the novice approach, because the expert knows what he is doing on an intuitive level. Getting to this point takes lots of hard work, and, as the saying goes, “many are called but few are chosen.”

However, the financial rewards for being an expert trader are greater than in most professions. Being able to pull money out of the market almost at will means you will make a very nice living. However, there is one last hurdle to overcome. It’s a battle that will last a lifetime: always be humble. No matter how good you are, the market is willing to take it all back if you ever forget that it will always be much bigger than you are.

Trade well, with earned confidence, and you will prosper.

Doug Newberry is the Director and Founder of Investing Systems Network. He builds very reliable stock trading software so tens of thousands of all kinds of investors can trade with confidence. Investors in more than 25 countries enjoy his newsletter and his weekly online radio show.