In the brave new world of the super trader, anything that's measurable can be traded – even volatility itself.
'Volatility junkie' super traders are a new breed of money makers
Alan McGrath would probably not like to be called a veteran trader of exchange-traded funds and contracts for difference, but with eight years of experience as a trader of both types of investment, he is certainly one of the older sages of the industry.
Mr McGrath, 49, runs the Traders Edge, an online forum with about 140 followers, which is considered one of the more serious trader forums in Australia. He eschews anyone who uses the forum as a "tip sheet" to ramp any particular security, preferring its members to discuss and muse over ideas.
Mr McGrath and many others are part of a new world of investors: full-time traders of securities from the entire universe of investments, regardless of their provenance. They are just as likely to ride the fortunes of the euro or the Hong Kong dollar as they are to trade oil futures. They are super traders, using instruments that connect them to just about every market in the world - and everything that's trading in it.
They do not seek out the best-known shares in the local market, where most of us hope to make a few thousand dollars a year with a few misinformed dabblings. They have no time zone and work as feverishly at night as they do by day. They split the trading day into seconds, not hours. They microtrade, sometimes making hundreds or even thousands of trades a day as they seek to make quick profits from tiny movements of shares and currencies, only to leave the trade almost as soon as they entered it.
They do not see markets with the same eyes as mere part-time investors. Super traders are looking at the markets in terms of whether it's a "risk-on" or "risk-off" market. They work using mathematical probabilities and technical charts.
They buy short and sell long - and do this in a range of securities, sometimes to make money and at other times, to hedge the money they've already made.
In theory, anything whose value can be measured can be traded by the super traders. Ask one if their trading behaviour changes in a bear market and they're likely to say it's business as usual. Ask how they might behave in a volatile market and the response is a little more excited.
That is because super traders are volatility junkies. They don't talk about bear markets - they talk about a market going sideways, with some bearish tendencies.
In the super trader universe, you can trade anything that is measurable, even volatility itself. The Chicago Board Options Exchange Market Volatility Index (known as the VIX) works on measuring the implied volatility of S&P 500 call options and is often termed the "fear and greed index". Some insiders say it might soon be possible to trade the underlying futures contract and make money simply when things get more volatile. Chaos itself might become - for them - just another asset class.
While the super traders might think laterally - and see opportunities that most of us would never have even thought of - they are most definitely human. Mr McGrath is part of a growing trend in trading that is based on sharing experiences and ideas.
"I am a social animal by nature and trading is a lonely business. I went from working in a charity environment and meeting a lot of interesting people to working on my own," Mr McGrath says. "It's probably why I started the forum, just to have a little more social interaction."
Duncan Lin, a trader in market indices in London and Sydney for the past five years, also believes in the shared trading experience. Two years ago in London, he came across the concept of the trading "arcade", which has strongly influenced his approach.
In London, Mr Lin found a true community of traders - many of them former London Stock Exchange floor traders, who pooled ideas and worked in concert.
Mr Lin pools his three fellow traders' capital, as well as their knowledge. His company provides the hardware and software facilities (for which each partner pays a monthly fee), but in all other respects, it is an equal partnership. It also uses social networks to correspond with other trading communities.
Profits are split at the end of the year, regardless of individual performance. Mr Lin says it's about the partners spreading risk and sharing ideas.
"We have one trader who believes in systematic trading, who writes his own automatic trading program - and we allocate a certain amount to his activities," he says.
The Hong Kong-based David Tang is a chartist. He believes in the charts, just as an astrologer might consult his. They work for the most part, he says; it's just that you have to know what you are looking for.
When the Hong Kong market closes, he switches to the international markets, such as gold, oil and the S&P 500, but it is also the time when he indulges his preference for foreign exchange.
He describes himself as both a "swing and intra-day trader". While he says that technical analysis used for currencies often works, it lacks the accuracy when applied to the share markets.
"Share markets are very news driven - stocks will gap all over the place due to unforeseen company news announcements, which could result in dramatic share price movements. With currencies, these types of fundamental shocks do occur, but they are less frequent," Mr Tang says.
Mr Tang's system has been most effective of late while trading the euro/US dollar pair.
He has been able to arbitrage off the debt problems of Europe - every time there are rumbles over debt, the currencies behave along predictable lines. The euro loses against the US dollar, the yen will track the US dollar, the Australian dollar will fall because it is a risk currency, oil will drop and gold will shoot up. It's a domino effect.
"What I have been able to do is take a portion of these moves," Mr Tang says.
In the chartist's universe, there are things called pivot points - changing points in a market - which are calculated daily. If a security moves beyond a pivot point, then there is the likelihood of it moving back. "Currencies tend to move along these pivot points," Mr Tang adds.
There are "moving averages" that are momentum indicators and then there are some highly technical formulae, such as Fibonacci analysis, a mathematical forecasting tool used to identify potential turning points. A trader has to discern if a market is a "trending market" or a more choppy "range-bound" market. Moving averages don't work in a range-bound market, but Fibonacci retracements/projections do.
It has been worked out that when markets are in free fall, they tend to fall no more than between 61.8 per cent and 78.6 per cent of their initial value. If a chartist sees this, he knows that the share has now entered what he terms "the golden-ratio range".
"In an uptrend, the share should retrace towards this zone, find support, then continue to trade higher, in line with the broader term uptrend," Mr Tang says.
But Mr Tang admits nothing is foolproof. Even the super traders make mistakes. He estimates that the Fibonacci analysis works 70 per cent of the time. What happens, for instance, if the share price that is expected to rise after a big fall (as the formula indicates) continues to decline?
"This is the market's way of telling you that your analysis was wrong - and then it's time to pay your tuition fees to Mr Market."