Trading Simulation Assignment - Essay Example

Your ID: Your JMU user Trading Simulation Assignment 0 Introduction Foreign exchange trading has gained a lot of popularity in the twenty first century, where it has grown to the worth of over USD 3.5 trillion. This has attracted many investors, who are interested in earning returns on their investment. In order to offer delineation to factors that affect the forex market outlined below is a report on trading in futures market, with currency pair, the Sterling pound (GPB) ant United States dollars (USD) GPB/USD. The table below offers a delineation of trade was conducted during the period starting 9th February 2012 to 19th February 2012. Date Trade Currency Contracts Maturity Price 9/2/2012 Buy GBP/USD 10 March 2012 1.5854 15/2/2012 Sell GBP/USD 10 March 2012 1.5765 15/2/2012 Buy GBP/USD 10 March 2012 1.5685 16/2/2012 Sell GBP/USD 10 March 2012 1.5765 19/2/2012 Buy GBP/USD 10 March 2012 1.5835 19/2/2012 Sell GBP/USD 10 March 2012 1.5860 1.1 Analysis of portfolio value and risk of the portfolio. This report a delineation of trading including strategies adopted, but before this, so as to effective mitigates the risk of earning high losses or losing considerable amount of profit due to speculation behaviors. There was need to establish stop loss point at $1.5650 and the take profit point as $1.5900. Having specified the spot loss point together with the take profit, this acted as the bench mark in trading so to manage my portfolio effective and avoid cases where I incur excessive losses. This implied that, in order to ensure the value of the portfolio does not follow below the pre-specified rate, constant evaluation of information and other factors that would affect the value of the portfolio were critically analyzed as delineated in the by the daily monitoring of the market below. In addition, it was necessary to evaluate the growth of the various portfolios by calculating the percentage return obtained from holding such stock, as outlined in table below. This would ensure us to validate our previous trading strategy in an effort to revise the accordingly to ensure that they are not viable but also valid. The total returns can be outlined as follows Date Total Capital %return Information ratio=( Rp - Ri)/? 9/02/2012 $250000 - - 15/02/2012 ( 250000- 5562.5) = 244437.5 {( 244437.5 -250000)/250000}= - 2.23% (-2.23% - 0.25) /4398.84 = - 0.0006 16/02/2012 (244437.5+5000) = 249437.5 {(249437.5– 249437.5)/ 244437.5)= 2.05% (2.05 – 0.25)/4398.84= 0.0004 19/02/2012 (249437.5+ 1562.5) = 251000 { (249437.5-251000)/ 249437.5 }= 0.63% (0.63-0.25)/4398.84= 0.0001 As shown in the table in the last column Information ratio, the second trade has the highest figure showing that at this period implying this portfolio can increase returns than any other portfolio. In the first trade, the information ration was observed to be – 0.0006, when compared with initial benchmark shows that, the economics news which was the basis of the strategies taken were invalid. In the second trade the information was the highest and even higher that the benchmark, due to expectation on effect of economics news to the direction of the market. Compared to the other trade, third performed fairly as compared to other trades due inadequacy of economics news that would strongly influence the direction of the market. In addition to these, what if analysis was conducted so as to ascertain the effect of economic information to the prices prevailing in the market. What if analysis (scenario analysis) involved development of scenarios that is Best scenario, worst scenario and base scenario. Another aspect that was employed in order to effective manage the asset portfolio was the decision, not to invest all the capital at hand. If I all the capital I had then, in the event of loss I would be forced to borrow more resources so as reinstate the maintenance margin account. So as to ascertain the value of portfolio each time the market value of the portfolio was ascertained and deviations from the base price of future which was predetermined to be 1.58840, calculated so ensure the direction of the deviations and take the necessary investment decision. 1.2 Analysis of the various strategies. Now let us turn our attention to activities in the trading period 9th February 2012, On this day, I made a buy of 10 GPB/USD futures contracts. This trade strategy was based on the economics news on the goods trade balance of the UK, which is one of one key figure that investors consider in fundamental analysis. The United Kingdom economy is trade driven, thus if an improvement in the balance of trade which had been anticipated by various market players occurred, this would result to trade surpluses. Trade surpluses, in turn leads to natural appreciation, due to increase in currency flowing into United Kingdom. With this expectations the futures contract would gain more pips, therefore, this was opportunity to trade in GPB/USD futures (Nekritin, 2010). In addition, the ”BoE interest decision” was expected to remain constant at 0.5% and Bank of England asset purchase facility was also expected to increase with ? 50 billion that is, from ?275 to hit the ? 352 billion mark. This would make futures contract to gain a considerable number of pips in the near future. (myfxbook, 2012) In addition, using the moving average concept in order to analyze the trend in the market, and predict the price of the contracts, it was interesting to note that on this date the bid price was expected to be at it’s lowest. Therefore, there this was an opportunity to make a buy (myfxbook, 2012). Source:www.cme.com Based on these expectations about various market parameters then, there was a strong basis to start trading, since posting a buy at this time when the futures market was reacting to information would result to more profitability. 10th February 2012, On this day, the Bureau of Economic Analysis together with the U.S. Census Bureau, were expected to release information on the trade balance. Trade balance is simply the difference between the total value exports and imports. The earlier released information indicated a trade deficit (negative) of -$47.75; the market players had predicted that trade would enlarge, thus causing volatility in the foreign exchange market. With expectation that trade deficit was in the verge of increasing, this would only lead to the depreciation of USD. A depreciation in the value of the USD, implies that the GPB/USD future contract ask price would increase. This offered an opportunity to close trade, as an investor could realize profit through sale of the futures contract. Although it was noted that the trade deficit increased by $0.45 billion, the fact that the United Sates economy is not trade as compared to their British counter part, implies a medium a significant influence on the direction of the market. This due to the fact, United States is largest importers in the world but it is not the largest exporter. Therefore, trade balance information only has had very low influence on the value of USD. Acting on this analysis on tenth it was not good day trade. 11th February 2012, Even though, this day was the national foundation day; therefore, there was no trading in the market. It was necessary to carry out post analysis of the information earlier released. As depicted by the price in the market the USD had gain value against the sterling pound. The same results was also supported by sentiment of allies close to the president of United States who advocating for payroll tax cut and highly anticipated speech in Virginia by the President of the United States. Many analysts expected that this would be the situation in the market until the highly anticipated inflation report by the bank of England where upon release of the report the price of futures contract was expected to increase significantly since the sterling would appreciate in value. Therefore, based on this prediction it was not a good to close the trade. 12th February 2012, On this day, as delineated the market was facing a down ward trend in the prices of futures contract. Therefore, it was not optimal time to close the trade. Downward trend After careful analysis on the expectation of various expectations by the experts on the offing it was necessary to hold on the stock. In addition to this the prices were still as many inventors had floated the contract to the market after the release of earlier information that indicated the value of the dollar was on the verge of appreciating. February 13, 2012. On this day, one the key issues that influenced the market was, the presidents of the United States, Barrack Obama comments on the budget especially on the issue of payroll tax reductions for the middle class. (The White House, Office of the Press Secretary , 2012) In addition to this the president advocated for an increase in creation of employment opportunities, which will see the economy recover and also an outline to reduce the federal government deficits. These sentiments, if positively observed they would lead to improvement in the economy of United States thus leading to the appreciation in the value of USD. This implies a decrease in the ask price of the GPB/USD futures contract. Although on this day prices were so approaching the stop loss point it was advisable to hold on to the futures based on expectation of information to released earlier on. Therefore, it was advisable to go long. 14th February 2012. On this day several information was expected to be released, which would influence the direction of the market. One is the “RICS Housing price balance survey”. This is a survey showing the strength or weakness of the housing market. The strength of the housing market was expected to decline from the previous -16% to -17%. This implies that the value of sterling pound would depreciate thus negative affecting the future market (myfxbook, 2012). Therefore, having this in mind the only decision was not close the trade on this day since it would have amounted to higher even below the predetermined stop loss point. (Royal Institution of Chartered Surveyors, 2012) The strategy not closed trade was later validated by the release of information where, the expectation matched the actual values, where the national statistics office sated the actual CPI to be -0.5% (Office of National Statistics , 2012) In addition, Even Treasury's Geithner Speech on the economy status was likely to be dovish, thus making the USD to depreciate in value. The reaction to such speeches in the past has been found to have little or no influence on the direction that the market takes. Therefore, it was not sufficient to close the trade on this day (Reuters, 2012). The prices of the contract were rapidly decline, and this would only result into panic selling thus negatively affecting prices. therefore having in mind the expectation on information to released in the next day and the level of surprise the market may experience it was not wise to close the trade. 15th February 2012, On this day, the anticipation on the market due the release of information on inflation in Britain “bank of England Quarterly report inflation report”. Where, many experts anticipated that the inflation levels are observed to be declining, thus having the implications that, the sterling pound would appreciate in value. This would results to a price increase in futures contract prices but according to my view such information is not sufficient to keep the market prices on the rising trend (myfxbook, 2012). With this foundation it was not only necessary but also sufficient to close the trade so as to avoid further losses if the increase in prices were short lived. Go Long for 10 pound @1.5854 Initial margin = $24300 Maintenance margin = 18000 Date Price ($ per Sterling pound) Profit/ loss Margin Account Commission per contract Notes Thursday, February 9, 2012 1.5854 $24300 $250 9/02/2012 1.57041 -$9368.75 18000 Obtain $ 3068.75 from the cash to reinstate margin 10/02/2012 1.57639 $3737.50 21737.5 13/02/2012 1.5733 1931.25 19806.25 14/02/2012 1.5663 -$4375 $18000 Obtain $ 2568.75 from the cash to reinstate margin 15/02/2012 1.5765 6375 $24375 Gross profit/ loss = -$ 5562.5 Total commission = $250 Net profit/ loss = - $ 5812.5 After a clear analysis of market and the economics news in the offing, it could clearly be anticipated that the future contract prices would increase, based on the following parameters in the futures market. One, the international labor organization was schedule to release information on the level of unemployment rate. Many experts were of the opinion that the unemployment cases were on the rise, thus negatively affecting the future prices. The statistics on the Average earnings including bonus were expected to increase, thus countering the direction of the market. This can depicted on the chart where the chart appears to having experience so smoothing effect on 15th after the increase in rapid increase in prices of contracts. Smoothing effects in the short run Source:www.cme.com The Federal Open Market Committees was scheduled to release it minutes of last meeting; the anticipation was that, with many of committee members being quoted previous advocating for buying back some of the bond. This would imply that, supply of US dollars would increase, thus causing the price of GPB/USD futures contract to increase significantly (myfxbook, 2012). On this premise, it was necessary to open a trade. This resulted to a decision to go short for four futures contract. 16th February With the strategies initiated on previous trading, where through study the various factors affecting the market prices were supposed to increase after the release of information about national consumer confidence in the UK. It was necessary to close the trade and realize the returns, since as it can be observed from the past trends the prices have been stabilizing thus limiting the capability forecasting the direction of the market. The table below outlines the returns obtained by closing the trade. Go Short for 4 pound @1.5685 Initial margin = $24300 Maintenance margin = 18000 Date Price ($ per Sterling pound) Profit/ loss Margin Account Commission per contract Notes 15/02/2012 1.5685 24300 $250 15/02/2012 1.5687 125 24425 16/02/2012 1.5765 4875 29300 Gross profit= $ 5000 Total commission = $250 Net profit/ loss = $ 4750 17th February, After the price futures approached the resistance point earlier established, and with various economic news set to be released, the futures contract prices were expected to increase. This was based on the expectation that sterling pound would appreciate and U.S dollar would depreciation due to the following reasons, it was advisable to not open a trade as futures price were increase in anticipation (myfxbook, 2012). Resistance point Source:www.cme.com One, the producer price index (YoY) was anticipated to decrease, thus leading to depreciation of US dollar. Second, the producer price index excluding high volatile commodities were also declining. Third, the number of building permits in the US was expected to remain unchanged. Fourth, the U.S Bureau of Statistics was expected to announce a decline in consumer price index. The sterling on the other hand was expected to appreciate as National Statistics Office was expected to announce an increase in the level of retail sales ex-fuel (YoY) (myfxbook, 2012). 18th February, On this day there were information schedule to be released, therefore, in order to make the right move; after careful analysis of the market, the resistance point that previous dominated the chart had been surpassed. The prices were approaching the predetermined take profit point it was necessary to wait for a fortnight before. This decision was reached upon a carefully prediction using the moving averages, where prices were bound to decline with a slight margin as compared to other trading periods (myfxbook, 2012). 19th February, With market prices nearly hitting the take profit point which was early determined and with expectations of financial information that would cause volatility in the market, after a careful analysis using the market was bound by the resistance point it was not necessary to hold on the futures contract any more. Therefore, the only profitable decision was to close trade. To avoid situations where the losses would exceed the 194 pips mark. In addition, there was a strong Fibonacci point on that day at 1.58500 at 68%, therefore it would only be profitable to go short. Fibonacci point. Source:www.cme.com Go short for 4 futures contract yielded the following returns as shown in table below. Go Short for 4 pound @1.5835 Initial margin = $24300 Maintenance margin = 18000 Date Price ($ per Sterling pound) Profit/ loss Margin Account Commission per contract Notes 19/02/2012 1.5835 $23737.5 $250 19/02/2012 1.5860 1562.5 $25237 Gross profit= $ 1562.5 Total commission = $250 Net profit/ loss = $ 1312.5 1.3 Overall profitability In overall the exercises after considering undertaking both the fundamental and technical analysis the final result can be presented in the table below. Total gross Profit in Dollars $ 1000 Total net profit in dollars after trading $ 250 Percentage return (2 decimal places){ W1} 0.4% Standard deviation of returns (2 decimal places) ( W2 ) 4367.79 Information ratio ( W3 ) 0.0000341 Workings W1. Percentage return = total returns (-5562.5+ 5000+1562.5) = 1000 Divided by the initial capital 2500000 100/2500000= 0. 4% W2. Standard deviation = mean of returns = 1000/3= 333.33 (-5562.5- 333.33)2 + (5000-333.33)2 + (1562.5-333.33)2 = 58049479.17/3 =19349826.39 19349826.39 =4398.84 W3. Sharpe information ratio ( Rj- Rm)/? = (0.4- 0.25)/ 4398.84= 0.0000341 The table above also contains further analysis, so as to ascertain the level of riskiness of the returns obtained from portfolio, and the information ratio to demonstrate the effect of information in decision making. In this case, decision made after analyzing the economics news resulted into increased profits. 1.4 Conclusion and reflection Although I managed to earn some considerable amount of profit in overall, at the first trade, expectations from economics news do not always materialize since not all investor are caught unaware by the release of this information. On the first trade, expectation that the prices of futures contract would increase due to the appreciation of the sterling pound on the releases of information, which indicated improvement of the British economy was invalid. In this case I had not considered technical analysis as I was inexperienced forex market analyst. This made me to lose trebly. Therefore, investors need to critically monitor the significance of the information to be released in the market. At some point in the trading prices, drop unexpectedly, like the case on the 13th February, where prices were below the stop loss point earlier determined. Closing trade at this day would have amounted to huge losses. Therefore, this made me to panic and when prices started to increase, I hurriedly rushed to close the trade on 15th February. Therefore, I found necessary to bridge the trading skill gap I learned that, Trading is a skill that one needs to study and master, as well as consider analyzing any economic news in offing. As I observed there is a needs to pre-analyzed, analyzed when actual released and also post analyzed. This made to developed what if situations for every scenario in order analyze the effect of economic information in the offing. Utilizing these newly gained skills, I was able to accurately predict the direction of the market as reflected by the other two trades where I made considerable returns. In this reference, an investor needs to develop three scenarios, worst, best and the base scenario this helps the investors to analyzes the riskiness of his portfolio as well as ascertain how well he or she has managed his portfolio. At first, I sidelined technical analysis, since I did not have the necessary skills that would help carry out technical analysis, but as later observed in 15th February technical analysis is essential, so as to observe the trend in the market and through use several of prediction tools one can be able to predict the direction which the market is taking. In conclusion continuous monitoring of the stocks market is also necessary so as to effective manages one portfolio. Continuous monitoring helps also in benchmarking as preventing inventors in running to huge amount of losses. In addition, it also helps investors to indentify the various factors that influence the direction which the market will take. Works Cited Che, T.-W. (2012, February 17). Futures and Commodity Market News: U.S. Dollar Strengthens as Consumer Prices Climb By 0.2% in January. 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