Stock Market
Tips to be careful while advanced stock trading
Advanced Stock Trading Strategies - Tread With Caution
By Team Shepays
2 days ago
The Financial Market has evolved a lot. More and more financial products are being introduced on a regular basis, thus creating more scopes and opportunities for traders. Advance Stock Trading strategies involve technical indicators and complex financial products like Options, Futures, Forward, SWAP, etc. So let’s learn a few advanced Stock Trading Strategies.
Advanced Stock Trading Strategies
Let's learn a few advanced trading strategies-
A. Interest Rate SWAP
Interest Rate SWAP is an Over-The-Counter (OTC) derivative instrument. The main purpose of the Interest Rate Swap is to hedge your financial position. In any kind of derivative SWAP, there are two private parties (Financial institutions, businesses, individuals, Funds, etc) who exchange cashflows or liabilities from different financial instruments.
The two parties involved in an Interest Rate SWAP are called counterparties. In an Interest rate Swap, one party will receive a Fixed Interest rate and the other party will receive a Floating Interest rate at regular intervals.
Example: Mr. A has bought a fixed-rate bond with a coupon rate of 6%, and Mr. B has a floating rate bond that resets after every 6 months. Both of them entered into Interest rate SWAP, where Mr. A will receive the floating rate and Mr. B will receive a fixed rate of 6%.
On every rest date, both parties will check the Floating rate that is available in the market. The floating rate can be LIBOR, EURIBOR, MIBOR, etc. as set by the counterparties during the inception of the SWAP contract.
If the Floating rate on the reset date is more than the fixed rate of 6%, then Mr. B will pay the difference to Mr. A, and vice versa.
Interest Rate Swap is usually entered by parties to offset the current exposure. So say if you are holding a fixed rate bond and feel that the floating rate in markets may rise, but you don’t want to sell your fixed bond, then you can enter an Interest Rate SWAP, where you will find a party holding a Floating rate bond and exchange the proceeds at every reset date. In this way, you can keep your fixed-rate bond and still enjoy the increasing floating rate in the market.
B. Trading a Short Squeeze
Before understanding Trading on a Short Squeeze, let's understand what is short selling first? Short selling is when you sell a stock without owning that stock. The stock that is sold is first borrowed from a Margin account and then sold.
Short Sellers believe that the stock price will fall. So they will sell the stock first and buy it back when the stock price falls. The difference in selling and buying price is the profit that the short sellers will earn.
Short Squeeze happens when instead of the stock price falling, the stock price starts to rise. If the stock price rises, then short sellers start to panic and rush to buy back stocks immediately. So for a short period, the share price rises sharply. This temporary rise in Stock price is termed a Short squeeze.
How to trade a Short Squeeze?
You will have to time the short squeeze perfectly. If you can enter the stock before the short squeeze and exit the stock at its peak, then you will be able to earn huge profits in a short period.
C. Event-driven strategy
Event-driven strategies are designed to benefit from the temporary change in stock price by the Corporate Action events. When a company announces any Corporate Actions like a merger, acquisition, bankruptcy, reorganization, etc, then there is a temporary change in stock price either before or after the Corporate Action event.
You need to be an expert to do an Event-driven strategy. Once the Corporate Action is announced, you will have to analyze the effect of the Corporate Action on the stock price and perform trade accordingly. The analysis ranges from determining the effect of Corporate Actions on the investors, understanding the current economic scenario, studying the current regulatory environment, determining the new price target, calculating the appropriate synergy value, etc.
Company A is planning to takeover Company B in an open market bid. The current share price of Company B is INR 50 and Company A has made an open Offer of INR 55. After seeing the Tender Offer by Company A, company B announced a Buy-Back offer at INR 60.
So after seeing the chain of events, you will have to analyze the situation and understand whether the takeover will happen and at what price. So if the Takeover war goes on, then the Bid price will keep on increasing. This is the perfect opportunity for an Event-Driven strategy. If you can buy the shares of Company B now, then there is a high probability that you will make a huge profit in a short period.
The event-driven strategy allows you to earn huge profits but you need to have the skill to analyze the Corporate action event.
What are Floating Rate Bonds?
Floating rate bonds don’t have a fixed coupon rate. The coupon rate of a Floating rate bond changes at every regular interval. The Interest rate is usually a money market reference rate like LIBOR, EURIBOR, etc. As the market reference rate changes, the coupon rate of the floating rate bond also changes.
What is LIBOR?
LIBOR is an abbreviation of London Interbank Offered Rate and is an average of the estimated rates submitted by the top banks in London. The estimated rates are predictions of individual banks of the borrowing rates.
What is Short Selling?
Short selling is when you sell a share without actually owning the share. The selling is done by borrowing the shares from a margin account and repaid by buying back when the price of the share goes down.
What is Short Squeeze?
Short Squeeze is the temporary rise in share price when several short-sellers panic and try to buy back shares at the same time. The share price reaches its peak and starts to subside when the panic buying stops.
What are Corporate Actions?
Corporate Actions are events that will bring material change to an organization. There are two types of Corporate Actions - Mandatory and Voluntary. In a mandatory Corporate Action, the shareholders don’t have a voting right, but in the case of voluntary Corporate action, shareholders can vote their opinion.
What is a SWAP?
SWAP is a derivative contract between two parties where both the parties agree to exchange financial instruments, cashflows, liabilities, etc. The most common type of SWAP is plain vanilla SWAP, where one party agrees to pay a fixed interest rate and another party will pay a floating interest rate at regular intervals. The floating rate is mostly the Interbank Offered rate that is running in the market.
Blog Summary:
The objective of the blog is to make you aware of the several advanced trading strategies that are available in the market. As the market is evolving, more and more advanced strategies are evolving to protect investors and to earn money with lesser risk.
Derivatives play an important part in the execution of advanced trading strategies. There are mainly 4 kinds of derivatives (Future, Forward, Options, and SWAP). All the derivative instruments are used in advanced strategies to either hedge or make short-term profits.