Hedge-fund secrets laid bare

A few weeks ago, Trader’s Bulletin gave you access to the first in a series of unique reports from our hedge-fund insider. That first report gave you some background into hedge funds, but the second one really gets down to the nitty-gritty of how they make their money – and it’s now ready for you to download.

NO LONGER AVAILABLE

You don’t need to be an investor in a hedge fund to appreciate the techniques they use – and to learn a few things from them.

For me, the main lessons we humble traders can pick up from our hedge-fund counterparts, and apply to our day-to-day trading are these:

• Don’t be blinded by earnings per share.

In its simplest form, the earnings per share (EPS) is the profit made by the company in the last year, divided by the number of shares. You can then divide the EPS by the share price to get the price/earnings ratio.

Let’s say the company you’re looking at made a profit of £2m last year, and has four million shares. Its EPS would be £0.50.

Many investors hold a great deal of store by these figures to tell them whether a share they are buying is good value for money, however the profits made last year, don’t tell you much about assets a firm may have taken on in that year, nor do they give you any information about dividend pay outs.

• Watch your costs

Looking for trading opportunities, and then catching profits is the fun bit of trading. Checking up on the costs you’re paying, monitoring the spreads and financing charges, is the less-glamorous flip-side of the coin. However, if you ignore this side, you’re making the job of earning a profit considerably harder for yourself.

If your spread-betting firm is less generous than others on the spread – a point here, a point there, can lead to quite a dip in the success rate of whatever strategy you are applying.

But spreads aren’t the only way that you can be losing out by using the wrong broker – rolling charges are another consideration if your trades run from one session to the next. Plus, the margin requirement of your spread-bet firm will also affect how much capital you’ll need to have tied up in one trade at a time – and the kind of leverage you use can have a big impact on your profitability (see below).

Over the coming weeks I’ll be bringing you a full report on trading costs, and a warts-and-all look at what individual brokers offer (and what they don’t).

• Having an intelligent exit strategy

For most of us, at best, an exit strategy is little more than a commitment to take profits of cut our losses at a particular price point. At worst, it is a blind plan to “see what happens”!

If we want to improve on our exit strategies, we need to be constantly reevaluating our reasons for getting into a position, and whether those reasons remain valid, and whether our risk levels can be justified.

We should also be weighing these factors against how the money we have tied up in one position could be working harder for us elsewhere.

As ever, with successful trading, it’s not about “being right” or “being wrong” – it’s simply about maximizing profits.

• Be smart about leverage

Leverage is often branded as the villain in tales of traders who’ve had their accounts wiped out by sudden market moves.

Personally, I feel that this bad name is misplaced.

What leverage can do, however, is turn novice traders into greedy traders – and greed is something we should always be on guard against.

Trading on margin (or leveraged trading) simply means that when you place a spread bet that X company’s shares will rise from 172p to 174p – you don’t need to put down the entire value of those shares at 172p each. It also means that if the value of those shares gets wiped out to zero – you’ll be liable to foot the bill for those shares at 172p each.

Of course, simple risk management procedures (the use of stop losses) can protect you from worst-case scenarios. And provided you manage your risk, there is absolutely no reason why you can’t use leverage in your favour, just like any hedge-fund manager.

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