Developing your plan

To build a plan that suits you, you must first understand yourself.
“In order to develop a trading plan that is right for you, you must undergo some form of self-discovery,” McPhee explained. “You need to assess your levels of risk tolerance, patience and time available, just to name a few.”
The important thing to remember is that your trading plan should not be complicated.
“Never picture your trading plan as a detailed document containing pages and pages of information because then it will overwhelm you and may deter you from compiling one in the first place,” he said.
Think in the simple terms of the three main questions and once you have answered those questions, then you can add some detail to it as time goes by. Developing a trading plan will help decision-making significantly. It will provide you direction and purpose and have you making sound trading decisions.

How do you build one?

McPhee says we should concentrate on a few specifics.
“Primarily, your trading plan answers three questions. First, under what circumstances will you enter a trade? Second, how much money will you commit to or risk on the trade? Lastly, under what circumstances will you close the trade?” he said.
You also need to be aware of a number of secondary issues.
“There are also broader issues to list as well, including which market you will trade, capital, drawdown rules, shutdown, reviewing process, and rewards to name only a few.
“All traders need to review what they are doing on a regular basis. From your reviews, you will modify your processes and rules, which are listed in your trading plan. It is all part of the evolution as a trader.”

Six simple rules for your trading plan

Number One: Don’t bet the shop. You should only ever risk a small portion of your overall pool of available funds. Number Two: Use stops. Don’t be afraid to cut a losing trade at a pre-determined exit point. Always plan for failure. Number Three: When you’re ahead, stay in the game. Use trailing stop losses if possible. Number Four: Go with the trend. Number Five: If you’re trading stocks, stay with stocks that have good volume. Number Six: Nothing obvious to trade – don’t trade.

What to look for
However, it’s tough to know which stocks you should buy and which you should avoid.
The majority of companies are all pitching the same story: revolutionary technology that is just minutes away from commercialisation.
However, the results have been a long time coming. And some of the companies that have come close have found that to be successful you need to do a whole lot more than just produce energy. You also need success in the cutthroat world of alternative energy capitalism.
For this reason, investors need to look at a multitude of factors. How much does the technology cost up front? How costly is the energy produced? How it positioned for government subsidies? When are they likely to get to market? And, most importantly, does it even work?

Five stories
In Australia, there are a number of listed companies that are currently vying for the mantle of Australia’s leading alternative energy company.
Ceramic Fuel Cells (CFU) is one of the more advance producers of energy efficient fuel cells. The company was formed from a unit of the CSIRO in 1992 and listed on the ASX in July 2004.
The company develops fuel cells that generate energy from hydrogen rich fuels through a hydrochemical reaction.
CFU says their solid oxide fuel cell technology can achieve up to 60% electrical efficiency using natural gas and can reduce carbon dioxide emissions by more than 60% compared to coal fired electricity generation.
Also generating fuel cells, but rather cells that derive their energy from the sun, Dyesol (DSC) makes dye-sensitized solar cells. The company was founded in 1995 and listed on the ASX in 2005.
According to the company, dye-sensitised solar cell technology is best described as ‘artificial photosynthesis’.
The company uses an electrolyte, a layer of titania (a pigment used in white paints and tooth paste) and ruthenium dye sandwiched between the glass. As light hits the cells, the dye excites electrons, which is then absorbed by the titania and becomes an electric current.
On the wind energy front, it’s been a tough time for Infigen Energy (IFN), which has struggled in recent years.
The stock had performed well in share price terms in its previous incarnation, when it was known as Babcock and Brown Wind Partners.
However, despite becoming the best performer of the dysfunctional Babcock and Brown family as the companies collapsed during the GFC, the stock was still heavily in debt and has experienced steep losses for shareholders in recent years.
The company has strong wind-generating assets in Australia, the US and Germany, but is still yet to show any sign of share price recovery.
Another sector that is aiming to be the leader in this new technology is geothermal energy. The company grabbing the attention in this sector is Geodynamics (GDY).
GDY looks at enhanced geothermal systems, which was previously known as hot fractured rock geothermal energy.
The company is the largest listed company in the sector. Enhanced geothermal energy is produced using heat extracted from underground basaltic rocks by circulating waters through an artificial reservoir or underground heat exchanger.
According to GDY, this could provide a massive source of carbon-free renewable energy.
Finally, alternative energy technology is looking to harness the power of waves. On the local market, the leading proponent is Carnegie Wave Energy (CWE).
CWE uses its own technology and aims to develop Australia’s first commercial wave energy unit. The unit will be based in near Garden Island, Western Australia.
The company says it is different to its competitors because its technology is fully submerged and generates power onshore rather than offshore. CWE says the technology has been proven at pilot scale and is now in its commercial demonstration phase.

iPhones and Blackberrys
When financial services comparison website Cannex reported on Australian stockbrokers last year, the two brokers that RECEIVED five star ratings both offered the webIRESS platform – Amscot Discount Stockbroking and First Prudential Markets.
The webIRESS platform has remained popular with active traders and the platform is available for iPhones and BlackBerry devices.
In particular, the webIRESS platform has been the platform of choice for busy, but still trading, business executives using BlackBerrys.
Access to the webIRESS platform will usually cost you unless you make a certain amount of trades each month. The amount will vary broker from broker.

Brokers all right
Commsec was the first broker to release an iPhone app. The iPhone app allows traders access to MOST features, such as watch prices, setting up watch lists and viewing charts. More recently, it’s received some poor reviews from users after a recent update.
Westpac has recently launched a new web-based mobile trading platform and this uses the same set-up and style as Commsec.
Bell Direct WAS one of the first brokers to move into the mobile market. In addition to mobile accessibility, it also allows traders to SMS orders.
Surprisingly, while Macquarie Edge and E*Trade have led the market in many areas, we are still waiting for them to deliver truly first-class mobile-trading applications.

Strategy counts
To become a successful trader, you need to have a strategy that you can clearly articulate.
No one in the hedge fund arena is able to get large institutions to invest with them if their strategy comes down to a shrug of the shoulders and the statement: “We just look for stocks that are going up”.
The race for hedge fund money is extremely competitive and the key decision-makers are looking for hedge funds
to have strategies that are relatively easy to communicate to investors.
But this isn’t just to make the marketing easier. When institutions are looking to invest, they need to ensure that the hedge fund complements their many other investments. To do this, they need to know how the hedge fund will invest their money.
So, successful hedge funds, like successful traders, must have a strategy. You have probably heard the experts discuss how important it is to have a trading plan. This is the same as a hedge fund’s strategy. Your strategy or plan needs to be clear, not open to interpretation and easily replicable over and over again.

Long/short
The strategy we outlined earlier, in which a hedge fund takes both long and short positions, is the most common type of hedge-fund strategy.
One common form of this strategy involves the investment manager investing the majority of their cash into stocks they believe are likely to outperform the market. The manager then also takes a number of short positions in stocks they believe are likely to underperform the market.
In a perfect world, the best performing stocks rise as the market moves higher, while the weaker stocks that the manager has as short positions struggle lower. This allows the manager to produce a return well ahead of the market.
However, if the market falls, while the manager loses on their long positions, the short positions, assuming they fall in line or more than the market, produces a positive return for the market. While the manager is still likely to see losses on their portfolio, these losses should be less than the market (or regular, long-only funds).
Retail traders can apply this strategy to their own trading. Rather than having only long positions, a number of short positions can also be taken, providing the trader with a level of protection should the market fall sharply.
Hedge funds will often use a set of criteria to calculate how much short exposure they should have.
For example, one common tool is to measure the overall market index, such as the S&P/ASX 200, against a long-term trend-following indicator such as the 200-day moving average. While the index is above the moving average, fewer shorts are needed than when the index is below the moving average.

Global macro
One of the advantages that hedge funds have over more common investment strategies is their ability to look offshore for opportunities.
This style of investment management, known as ‘global macro’, attempts first to identify countries that are likely to generate above average economic growth.
For example, at the moment, most global macro managers would probably avoid taking positions in economies in the US or Europe. These countries have clearly been the hardest hit by the global financial crisis and may take some years before their economic growth recovers.
Another way of identifying economies that are likely to outperform is by performing demographic analysis.
In this example, the hedge fund manager might take short positions in Japanese stocks, due to the fact that the population of Japan is ageing and this will result in a greater share of economic growth needing to be diverted to social welfare. By the same token, a country such as Vietnam, with a greater proportion of young workers, is likely to experience economic growth that is above the globe’s average.
These funds don’t necessarily have to invest in stocks and shares. Many of these funds will take positions in currencies that they believe will appreciate because of global factors.
For example, a hedge fund could buy the Australian dollar in the expectation that as the global economy improves, this will result in greater demand for commodities. The Australian dollar’s performance is closely tied to the global demand for commodities and this would allow the hedge fund to benefit from its view on the world’s economic growth.
By the same token, global macro funds that are concerned about economic growth, especially in large developing nations such as China or India, might look to short sell industrial commodities such as copper.

Event driven
Event driven strategies look to benefit from situations that occur – or might occur in the future – in the market, rather than looking for stocks or securities that are over or undervalued.
The most obvious example is those hedge funds that look for companies that are likely to be taken over in the near term.
There are a number of ways of identifying stocks that have the potential to be taken over. One way is to look for companies in which competitors have started to buy up stock in the company. Any shareholder that owns more than 5% of a company needs to disclose this to the ASX and therefore this information is fairly easily available.
Another way of identifying companies ripe for takeover is by looking for sectors in which takeovers have already occurred. For example, BHP’s recent failed takeover of Canadian fertiliser company Potash might mean that other fertiliser stocks will be next in the firing line.

Quantitative
Quantitative strategies, often known just as ‘quant’, are the domain of the eggheads. These strategies are extremely system-based and look to identify certain characteristics that have in the past delivered strong returns.
For example, one simple strategy might look for stocks that have recently announced better-than-expected earnings. The investment manager would invest in these stocks in the expectation that the company could continue on this path and make further positive announcements.
In reality, quant managers will have very many different characteristics that they might look at.
In addition to looking for companies that are constantly upgrading their earnings, they might also look for stocks that are consistently outperforming the market in terms of their share price performance. They might then look for industry sectors that are also beating the market. The stocks that meet all three of those criteria are then included in the hedge fund’s portfolio.

Arbitrage
We’ve left the arbitrage sector of the industry to last – and with good reason. This is an extremely difficult strategy for the smaller trader to try and use.
Arbitrage opportunities occur when two similar securities become mispriced. The trick is to buy the cheaper security and sell the more expensive security in the expectation that they will eventually move back in line.
Why is it so hard for smaller traders? In the first instance, looking for arbitrage opportunities is a full-time job. With so many large financial institutions looking for these kinds of trades, they typically come and go in the blink of an eye.
Additionally, very often the mispricing is extremely small. This means that the transaction costs are often more than the benefit of taking the arbitrage. Larger institutions can often negotiate very low transaction costs, but retail traders are usually stuck with much higher costs.

Lessons to be learnt 
All of the strategies used by hedge funds can be applied to individual traders in one way or another. Even arbitrage, which is notoriously difficult for smaller traders to implement, can help individuals in their understanding of the market.
The most important lesson from hedge funds is for smaller trader to have a clear strategy when approaching the market. All of these types hedge funds are successful in the industry to one extent or another because they maintain their faith in their investment ‘world view’.
Individual traders will find themselves far more successful if they look to hedge funds, identify how they want to look at the market – and stick to it.

The rising dragon

Inflation hasn’t really been a problem for western economies over the past 20 years. There are a couple of theories why inflation has been tamed in this time. One theory is that inflation has been controlled by a change in central banks’ thinking in the 1980s.

Central banks, such as the Reserve Bank of Australia and the Bank of England, now focus all their attention on making sure inflation is at a reasonable level. Before this, central banks tried to ensure the economy was going well, that jobs were being created, and that currencies were relatively stable, but now they just focus on inflation. Another theory is that China’s entry in the global economy as a major manufacturer has kept the prices of goods low.

But we are now in an environment in which central banks are actually trying to encourage inflation. Most particularly, in the US, the Federal Reserve has been trying to generate inflation as a way of kick-starting their economy. And, while China has helped the world keep prices low over recent years, they now have problems with inflation. There is an expectation that China will soon be suffering from inflation of more than 6% a year – well above the danger zone for the economic powerhouse.

Just Right

It’s important to remember that inflation isn’t necessarily a bad thing. A healthy level of inflation, say around 2%-3% per year, is actually a sign of a growing economy.

High inflation is bad, but so is very low inflation. The Japanese economy, which has been struggling for 20 years, has been hard hit by deflation, when prices actually fall. So, inflation is just like Goldilocks’ porridge: it’s best when it’s not too hot and not too cold. We want it to be just right.

State of play

At present different parts of the world are facing different inflationary problems. While the US and Japan continue to struggle with very low inflation, the rest of the world is becoming worried about high inflation levels.

Inflationary effects are most obvious across Asia. China began raising rates last year to head off inflation. The European Central Bank, even in the midst of its member state’s debt crisis, has been forced to raise rates in July and said it might need to do it again soon.

Commodity corner

Inflation is a nasty business, but that doesn’t mean that astute traders can’t make money from it.

The major trade for those who are worried about inflation is gold. This is because gold is seen as a store of value. No matter what happens in the world, gold will still be valuable. The actual value of gold will change depending on financial conditions, but unlike paper money, gold has a ‘real’ value.

But it’s not just gold that benefits from inflation. Other precious metals such as silver can also experience big gains in an inflationary environment, while agricultural commodities, such as wheat and corn, also generally trade higher.

The bad guys
The big polluters basically come down to the big energy users, because the really big polluters in the country have been cracked down upon for years.
The first real corporate environmental laws were introduced at state level back in the 1970s. The major laws were focused on pollution and illegal waste disposal, but there was also a focus on marine laws, especially regulation of fishing. But there are numerous other laws including illegal vegetation clearing, logging, water theft and illegal trade in flora and fauna.
So, you’ll find it much easier to think of it as an energy tax. And, with coal one of the dirtiest of energy production methods, it’s no surprise that coal enterprises are the hardest hit.
For the big boys, it isn’t so bad. Citigroup says that with a carbon tax of $23 per tonne, BHP, Rio Tinto and Wesfarmers, the three biggest coal operators, are likely to see total profits fall by about 0.5%.
However, it’s the single-focus thermal coal miners that will be hit hard.
Analysts says that companies such as Queensland coal producer New Hope Corp and the NSW miner Whitehaven coal will take a sizeable cut in profits. The government is providing both companies with sizeable compensation packages.

Steel got the blues
The steelmakers are one of the most exposed to the effects of the carbon price. This is because steel requires a lot of energy to be refined.
Despite a large compensation package, steel stocks, most notably BlueScope Steel and OneSteel, have continued to lose ground since the announcement of the carbon tax.
Without compensation, OneSteel’s earnings would be down almost 15% in the 2012-13 financial year, while BlueScope’s earnings would be facing a whopping 60% drop.
Aluminium, also a heavy user of energy in the refinement program, will drain away profits for its producers. Most notably, Alumina is facing a 20% cut in profits, but will benefit from a compensation package the near term.

Energy
The impact on the energy sector is particularly evident in the liquified natural gas space. Analysts have said that companies such as Woodside Petroleum and Santos face a large increase in costs.
However, the government’s compensation packages mean that much of the costs will be shifted to the taxpayer.
Woodside has said that it is pleased that the compensation is in line with that offered in the original emissions trading scheme back in 1999.
As for the retailers, such as Origin Energy and AGL, some analysts believe they could benefit from the carbon tax.
This is for a couple of reasons. First, they can easily pass any costs on to the consumer, and second, the government’s subsidies for green energy mean they can take advantage of government funding to improve their energy production mix.

Mixed deal for transport
The picture is mixed for transport companies.
Airlines were particularly hard hit because fuel accounts for such a large proportion of their costs.
Qantas said the new tax would cost it $115 million it the first year and warned it would need to raise prices by at least $3.50 per ticket.
Virgin said costs would rise by $45 million and it would raise prices by $3 per ticket.
On the other hand, rail operators could experience some benefit from the carbon tax.

Construction
The construction sector is also likely to feel the effects of the new carbon regime.
Building material companies have been notably vocal about the effect of the carbon tax, because of highly price competitive overseas competitors and the easy availability of substitutes.
On the Australian market, the two companies most likely to suffer in the materials sector are Boral and CSR.
Cement maker Adelaide Brighton and building materials producer Brickworks are two more companies that are in the firing line. Both companies have warned that the carbon tax would reduce 2012-13 profits.

Not all losers
Of course, it’s not all bad for the carbon tax. Some shares instantly appreciated on the news.
Unsurprisingly, the best performing sector of the market since the carbon tax’s announcement has been the alternative energy space.
When the details of the carbon tax were announced, many alternative energy companies rocketed 20% higher over the next few days.
Ceramic Fuel Cells, a maker of low emissions energy cells, jumped 15% on the next day of trading, while West Australian wave energy developer Carnegie Wave Energy soared 23%.