I Shorted Rio Tinto and Champion Iron

I made my 2nd and 3rd trades for 2022 – Rio Tinto short and Champion Iron short via CFD..

Short closure for Rio Tinto and Champion Iron on 19 Jan 2022

Summary

  • Rio Tinto
    • shorted from 14-18 Jan at 110.12 – 110.60
    • closed on 19 Jan at 110.159 to 110.68
    • position size is $120k
    • incurred net lost (including commission and holding charges) of about $100
  • Champion Iron
    • shorted from 17-18 Jan at 6.27 – 6.46
    • closed on 19 Jan at 6.26 – 6.28
    • position size is $180k
    • incurred net profit of about $2.9k

Why I Entered the Positions

  • This is a short-term trade against iron ore prices
  • Iron ore commodity prices may have peaked
  • Iron ore-related stock prices may have peaked
  • Fundamentals have not turned around yet to validate optimism in iron ore stock and commodity prices

Why I Exited The Position

  • China started to ease financial conditions, buoying sentiment for iron ore at least for the short-term
  • Iron ore commodity prices starting to surge
  • Iron ore-related stock prices seem to have more short-term upside momentum

Conclusion

This is one of the cases where it pays to be agile. I closed the positions quickly when China started to ease conditions and was fortunate enough to still make a small profit.

Sometimes, there is an initial over-reaction at the open and prices rise/fall too much relative to the impact of any fundamental event. In such cases, closing positions too quickly at the open may not be optimal. Experience trading in the stock/sector is needed to make accurate judgement calls.

China Begins To Ease Financial Conditions

man turning on vintage boombox placed on red car
China Starting To Adjust Financial Policies

China has started the easing of financial policies in order to combat a slowdown in economy growth. On Monday, it cut borrowing costs of its medium-term loans. Bond yields fell as bonds became more attractive. Today, it has made more cuts to various lending rates. These moves are intended to increase borrowing by firms and stimulate the Chinese economy.

This could be the start of a period of sustained policy easing, which would stabilize market sentiment for Chinese-related stocks and make it a good entry point for beaten-down stocks. Indeed, HK property and tech stocks have soared. But no one really knows how much policy easing will occur and in what form, as China remains concerned about having too much debt.

This is not an all-clear signal to buy any Chinese-related stock, there still needs to careful select of sectors and stocks which are most likely to take advantage of the stimulus. Do take control of any greed creeping in, catching falling knives is really enticing but some knives may drop further.

Is Iron Ore Ripe For A Pullback?

yellow excavator
Mining

Iron ore is used in the production of steel. China is the dominant user of iron ore, and imports it mostly from Australia and Brazil. Like many commodities, it is highly volatile. Prices often overshoot and undershoot fundamentals by a large degree.

Last May (2021), benchmark iron ore prices reached a record high of around $233.10 per metric ton. It subsequently plunged below $90 in Nov 2021, before staging a steady rebound. The price as of today is about $124.

1-Year Iron Ore Price Chart

The rebound was driven mainly by expectations of higher demand this year. However, there is no certainty of actual demand meeting these expectations. There are too many forces at play affecting both supply and demand to be able to accurately predict future price. Some of these forces are Chinese property sentiment, policy developments on infrastructure, weather and mining output curtailments.

Iron ore stocks have rebounded by as much as about 50% based on this optimism. If the optimism proves to be unfounded, expect the prices to retrace. It may be opportune to take a small bet against iron ore, or monitor closely for developments in the sector to gather more clues on future trend before entering a position.

Comparison Of Shorting Methods

Shorting is a good skill to add to your trading skillset, as it allows you to take advantage of a wider array of market conditions, and also increases the variety of strategies you can employ. There are many methods of shorting the market. The most common are:

  1. Buy put option
  2. Sell call option
  3. Sell via CFD

Buy Put Option

DescriptionPurchasing the option to sell an asset at a certain price by a certain date
CharacteristicsBreakeven point is a moderate distance away, thus probability of a trade being profitable is significantly lower than 50%.

As downside is capped while upside is unlimited, the magnitude of wins are much larger than losses.
Typical win/loss patternMany small losses, few big wins
Preferred Market Conditions Volatile environment where moves are relatively large, so that it is easier for you to reach breakeven point, and upside potential can be maximized
ProsHighest profit potential, profits can be several multiples of capital invested.
Losses for each trade are capped.
ConsHighest risk, entire capital sunk in a trade can be lost.
Value of option declines over time.
May be difficult to accurately assess win rate and risk/reward ratios and balance them optimally, as calculations for options can be complex.

Sell Call Option

DescriptionSelling the option to others so that they can buy an asset at a certain price by a certain date
CharacteristicsBreakeven point (for the person buying your option) is a moderate distance away, thus the probability of a trade being profitable is significantly higher than 50%.

As downside is unlimited while upside is capped, the magnitude of losses are much larger than wins.
Typical win/loss patternMany small wins, few big losses
Preferred Market Conditions Stable environment where moves are relatively small, so that it is difficult for the person who bought your option to reach breakeven point, and the number of losses can be minimized
ProsOption position will earn more money over time due to decay of option value for the person who bought your option.
ConsA single loss can be huge and completely wipe off gains from many successful selling of call options.
May be difficult to accurately assess win rate and risk/reward ratios and balance them optimally, as calculations for options can be complex.

Sell Via CFD

DescriptionEstablishing an agreement to sell an asset at the current price, and buying it back at a future price
CharacteristicsBreakeven point is a short distance away, thus the probability of a trade being profitable is slightly lower than 50%.

Upside and downside are balanced, unless stock price increases more than 100%. Downside is theoretically unlimited while upside is capped at 100%. Downside would breach 100% once the stock price increases more than 100%.
Typical win/loss patternWins and losses are about equal in magnitude and frequency.
Preferred Market Conditions Stable to moderately volatile environment, where stock price gains do not exceed 100%.
ProsRelatively simple pricing mechanism makes it easier to accurately assess win rate and risk/reward ratios, and balance them optimally.
ConsHolding CFD positions will incur financing charges, thus it may be expensive to hold them for too long.

Conclusion

In theory, different trading conditions would be best served by different shorting techniques. In practice however, many traders do not employ all the techniques. They usually stick with either options or CFDs. For beginners in shorting, I would recommend to try out both and find the one which fits your style better.

Good luck!

Omicron Found in 2nd China Port City

China has just found Omicron in Dalian, a major port city. Omicron has now spread to 2 major Chinese port cities. This may cause global supply chain issues to worsen as movement restrictions are imposed, and add to inflation.

This development is not market friendly, as higher inflation will cause faster central bank tightening. US and European market futures are slightly red, so there isn’t a major impact on general market sentiment yet.

If you are trading, you probably need to monitor closely whether it worsens and brings down the markets in a significant way.

Effect of The Impending Earnings Season

Just a quick note to serve as a gentle reminder. The earnings season will start this Friday with the reporting of the big US banks like JPMorgan Chase and Citigroup. This adds an element of unpredictability to the markets, as no one can be certain of how an earnings report will turn out.

If you are initiating a trading  position and planning to hold for at least a few days, do take into account of the added unpredictability. Earning reports can sometimes have more effect on a stock/sector/overall market than fundamental factors, even if the reports seem to be less relevant.

Good luck!

I Shorted Dow Jones via CFD

I have made only 1 trade this year so far – shorting the Dow Jones Industrial Index (DJIA). Indices are actually not my favorite asset class to trade, however it was the most logical choice for me at that time.

Statement from my CFD account for the period 31 Dec 2021 – 11 Jan 2022.

I am sharing the details of the trade, in case anyone is interested in them.

Summary

  • I opened DJIA (US 30) short positions from 36,820 to 36,943 (see blue box in the image above)
  • I closed the short positions at 36,296 (see green box in the image above)
  • Position size was around $1.1M (in SGD)
    • 1 point = 22USD
    • Position accumulated via 11 trades of 2 units each
  • Profit was about $16.7k (roughly 1.6%)
  • Position was entered on 6 Jan and closed on 7 Jan

Why I Entered The Position

Why I Exited The Position The Next Day

  • The probability of continued downward movement decreased
    • DJIA went down a reasonable amount from entry price (>1.5%)
    • There was no fresh news flow putting additional downward pressure
  • Maintaining the position was a bit tiring
    • Indices are active almost throughout the entire day, unlike stocks which are traded for about 6-8 hours per day. Thus more time is used to concentrate on monitoring the prices
    • Indices prices fluctuate every second, resulting in more ups and downs within the same period as compared to stocks. Thus more emotional stress is inflicted

Conclusion

Trading is always about probability, not certainty, so I was glad this trade worked out for me. This is the trading off-season for me, I have not been spending much time trading and researching. It is probably time to get going again!

Has The Fed Minutes Release Killed The Global Market Rally?

The Feds released the minutes of their December meeting 2 days ago. It was more hawkish than expected, with ultra-easy conditions slated to end faster. Markets have reacted negatively to it, but are still very close to all-time highs.

This is going to be a long-term drag on market sentiment. The balance of market forces have changed. With policy now acting against the market, coupled with sky-high valuations, the probability that the red-hot market rally will end is now high than ever.

In my humble opinion, it is best to minimize exposure to stocks which have run up a lot, and also stocks with high gearing ratios. If you have high conviction that a stock will fall, you can also consider shorting it.

2022 S&P Targets

It’s time once again to rev up for the new year!

dashboard with control and measuring devices in automobile
Revving up for the new year!

The CNBC Market Strategist Survey gave a snapshot of the predictions for S&P in 2022. In summary, the targets range from 4400 to 5330, with an average target of 4985 and median target of 5050. Given that S&P closed at 4793.54 yesterday, there is roughly upside of 4-5% according to the biggest banks in Wall Street.

Interestingly, the predictions for 2021 were included, and ranged from 3950 to 4800. This means that almost everyone got it wrong for 2021. This serves as a reminder that these price targets are really “best guesses”.

Nonetheless, the 2022 predictions indicate that the “experts” do not think that the returns of the best part of the last 2 years will most likely not be replicated. In my humble opinion, it would be prudent to rotate into other markets for better returns. Cheers!

Will Shorting Be Profitable In 2022?

It has been a torrid time for short sellers since March 2020 lows. For almost 2 years, stocks and commodities have risen relentlessly. S&P has risen more than 100% during this time, lifting many boats in many markets. Many short positions have been decimated during this time, given the pervasive buy-the-dip mentality. Will shorting be profitable in 2022?

Shorting is far less popular than the traditional “longing” of stocks, commodities and other asset classes. The key reason is that losses from shorting can be theoretically infinite, while losses from longing can be at most 100% (given no use of margin/leverage). There is another reason – longing stocks/bonds will generate persistent income over time while shorting will actually cost money to sustain. Thus shorting has to be more precise, as short positions may cost too much to be held for a sustained period.

However, shorting can be an extremely profitable technique when it is successful. Stock and other asset prices in general tend to fall faster than they rise. Also, given that there are fewer traders shorting compared to longing, shortists would be competing with less people in the shorting game.

In much of 2020 and 2021, short trades have been crushed. However, with high valuations and impending policy shifts, would 2022 be a more fruitful year for short sellers? I personally believe so, but do be careful, as nothing is 100% certain in the markets, and shorting is more complex than longing, so do trade with care!