Long/short equity, FTSE 100 Strategy

With this FTSE 100 strategy we go long and short on shares and stock indexes. We go short stock indexes to hedge long positions in stocks.

Stock indexes: FTSE 100 cash and future

Shares: UK shares with a large market capitalisation, these are liquid and have a tight spread. These shares are well followed by analysts, therefore they are less likely to experience a sharp fall.

The strategy identifies shares that are not in sync with the broader market. When a share declines faster than the FTSE 100 it will find a support area from where it will rally to adjust to its long term trend which is in line with the FTSE 100 trend.  

This is not an intraday strategy, positions are held for a few days to a few weeks, sometimes months.

Key points

The objective is to catch the rallies/declines over a few weeks/months. 

Each share trade has a stop loss, index trades don’t have a stop loss.

We risk a small amount of capital on each share trade (maximum 2% of total funds)

We hedge our long positions (in the event of a market decline)

The amount invested in each share must not exceed 20% of total funds.

How does it work?

  • You need a spread betting or CFD account and your broker must offer UK shares and the FTSE 100 index cash and future. We trade cash prices on shares, also called daily rolling cash or daily funded bet (DFB). Most of the FTSE 100 trades are on the Future (FTSE 100 June, September, December and March). I recommend the IG spread betting platform, it has all these markets.
  • The recommended amount to deposit is £10,000. You can deposit a smaller amount but it is not recommended because if you do the minimum you invest in a share could exceed 20% of your funds. If a share is priced at 2000 and you have £5000 in your account, the minimum you can invest in the share (with a spread betting account) is £2000 (minimum stake 1). This means your investment would be 40% of total funds which is too high. You can still do it but it is more risky. And if you have a CFD account you would be penalised by the high commission. With a CFD account you can invest £1000 in a share priced at 2000 but the minimum commission of £10 would apply. 
  • Make sure the spreads on UK shares quoted by your broker are tight. As a guide the difference between the bid-ask should not exceed 0.5% of the mid price. For example if the share price quoted is 940-943 the spread is 3 pts, this is acceptable as it is 0.3% of the mid price.
  • Make sure the financing charges accrued daily are not excessive. As a guide the annual rate should not exceed 4%.
  • If you trade CFDs make sure the commission rate does not exceed 0.1% on UK shares. Make sure your CFD broker does not charge a minimum commission (unless you have a large fund and the commission you pay on an average trade is already greater than the minimum commission). Some brokers charge a minimum £10 commission on UK shares, so if you trade small amounts you would be penalised by the commission. 
  • If you have a small fund (less than £40,000) it is recommended to open a spread betting account because there is no commission on spread bets.
  • Sign up to receive our trading signals
  • Each time you receive a trading signal, do exactly as it says in the alert. Do not change the levels stated in the alert, always open and close trades at the recommended levels.
  • UK shares trade alerts are straightforward. These are market orders with a stop loss. For the amount to trade please refer to the trading guidelines. A typical alert looks like:

“We buy Barclays (BARC), current price 152, stop loss 137”

  • Index trades are used to protect long positions in shares and to speculate on market declines

 

Guidelines on money management

How to calculate your exposure (position size in £)

Once you know what to buy or sell, the next thing is to calculate how much to buy or sell so that you don’t risk more than 2% of your account value. The amount invested is your exposure. 

  1. Amount to trade on shares

How much to buy/sell depends on the amount of money in your account. Remember your maximum loss per trade should not exceed 2% of the account value.

First, calculate your maximum loss in £ based on the maximum percentage you are comfortable with.

Example:

Say your maximum loss is 2% of the account value and you have £10,000 in your account, your maximum loss on each trade is £200 (2% of £10,000).

Next, check the levels in the alert and calculate your trade size (the amount to trade) based on the size of the stop loss. There are two methods depending on which platform you use, spread betting or CFD.

  • How to calculate the trade size with a spread betting account

Take 2% of the value of your account and divide this by the difference between the opening price and the stop loss.  Example:

 Assuming you have £10,000 in the account and the buy price is 420, the stop loss is 380. The difference between the entry price and the stop loss is 40.

Trade size = maximum loss (in £) divided by difference between the opening price and the stop loss

In this example:

Trade size = £5 (£200 / 40)

In this example you would bet £5 per point and your exposure would be £2100 (£5 x 420) which is 21% of account value.

  • How to calculate the trade size with a CFD account

Take 2% of the value of your account, divide this by the difference between the opening price and the stop loss and multiply by 100.

Assuming you have £10,000 in the account and the buy price is 420, the stop loss is 380. The difference between the entry price and the stop loss is 40.

Number of contracts = maximum loss (in £) divided by difference between the opening price and the stop loss x 100

Number of contracts = 500 ([£200 / 40] x 100)

In this case you would buy 500 CFDs

 

  1. How much to bet on the FTSE 100

When I trade the index the quantity I recommend is for a spread betting account. I recommend to use the IG spread betting platform. The amount to bet on the FTSE 100 is based on an account value. Some brokers called this value “equity”. If you have a different amount in your account you need to adjust the bet.

For example if I say: “Sell FTSE 100 June at 7250. 1 FTSE per £5,000 of funds”

It means if you have £5,000 in your spread betting account you sell 1 FTSE 100 but if you have £10,000 in your account you sell 2 FTSE 100. If you have a larger amount you increase the stake in proportion.

If you sell 1 FTSE 100 and the price is 7250, your exposure is £7,250. It’s like saying you have invested £7,250 in the FTSE 100.

CFD account

There is a difference with a CFD account, unfortunately the value of 1 CFD on FTSE 100 is not always the same as betting £1 on the FTSE 100. If you don’t use IG you need to know how much exposure you get if you buy or sell 1 CFD on FTSE 100. That is very important because if I recommend an exposure of £7,250 on the FTSE you need to select the correct trade size in your CFD account to get the same exposure. For example we know that with spread betting when you buy or sell 1 FTSE 100 your exposure is £7,250 (assuming the FTSE 100 value is 7250). If I wanted an exposure of £14,500 on the FTSE 100 here are the two scenarios with spread betting and CFDs:

Spread betting on FTSE 100: 2 FTSE 100 = £14,500 exposure

CFDs on FTSE 100: 1 FTSE 100 = £14,500 exposure

 

As you can see with a CFD account the trade size is different, at IG you need 1 CFD to get the same exposure as betting £2 on the FTSE 100. And if you use a different broker this trade size could be different. So it is important to know what exposure you get with your broker when you buy or sell 1 CFD on FTSE 100.

What is Net Exposure?

The net exposure is the difference between the value of long positions and short position. For example if I am long £10,000 on stocks and short £6000 on the index, my net exposure is £4,000 long or 40% long assuming I have £10,000 in my account (10,000 – 6,000 divided by 10,000).  It is like saying I am long £4,000. At any time you will have a mixture of long and short positions on shares, if your overall long position is larger than your short position, your account is said to be net long. If your overall short position is larger than your long position, your account is said to be net short.

Example:

FTSE 100 strategy

In this example the net exposure is 33% long (assuming the account value is £10,000). The long exposure is £10,614, the short exposure is £7,305, the difference between the two is £3309 which is the net exposure. To get the percentage net exposure we divide the net exposure by the account value. This means 33% of the account value is long.

Note: the account value is the money in the account if you close all open trades.

If you are more interested in trading the FTSE 100 index, we have another service where we issue trade alerts on the FTSE 100 cash and future see www.e-yield.com