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How to use the KLSE Futures and Relative Strength to enhance your share market performance
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by William Wermine
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Profit and protect yourself from the volatility and hard sell downs in the KLSE no matter what the market
does by using a KLSE Futures Hedging model. Do what the hedge funds do and the unit trusts don't.
Why be a crowd follower and jump off the cliff with everyone else when the market collapses? Take the time
and effort to familiarize yourself with the hedging process. It could save you from financial disaster.
The KLSE as of Dec 2000 is in a strong downtrend and is on course to test the 640 level and perhaps lower.
Most Malaysian unit trusts have suffered massive losses in the last year. Those individuals who hedged with
futures have at least maintained their equity. Those who used Relative Strength combined with a hedging program
have actually profited and earned between 15 to 30 % return.
How do we use the KLSE futures contract to hedge?
The KLSE Futures contract is a two way contract. That means you can sell first and buy later. If you hold a
portfolio of index related shares you can sell an equivalent number of futures contracts. For example if you
hold 700,000 RM of shares you could sell 10 contracts of futures. At the price of 700 the futures contract
is worth 70,000 RM. (Ten x 700 RM = 700,000). There is no such thing as a perfect hedge but the example mentioned
would protect you from the worst of the crash.
If we add the relative strength model for choosing shares to be in the hedging model we can actually profit
in a market collapse.
Before explaining the RS or relative strength model, you need to understand:
Why was the KLSE Futures contract created?
It was conceived to allow knowledgeable, wealthy investors, institutions and foreign funds a way to protect themselves
during bear markets. Speculators also use the contract to make small profits but they are minor players whose function
is to provide liquidity
Unit trusts are not allowed by law to hedge. Thus during market downturns the average investor must sit tight and hope
for recovery, which sometimes can take many months or even years. During this time the investor must continue to pay
management charges and watch his capital decrease. Hope is a poor paymaster.
For those with patience, the market will finally recover.
But there is a better way.
You could hedge by selling futures against your shares. The secret to hedging is to have a tested model to time the
placement of the hedge. One that works well with the KLSE is the 18 bar moving average method.
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When
price closes below the 18 moving average you hedge. When price closes
above the 18 MA you remove your hedge.
Of course, this method never picks the top or bottom but captures
a good piece of the trend.
Hedge funds use similar models. It is much more efficient to hedge
rather than sell your cash shares. You save heavy commission costs
as futures commissions are much lower than share commissions.
Liquidity in futures is also much better than many shares which
at times are illiquid.
How can you improve the performance of the hedging model?
My hedging team uses a relative strength (RS) model to enhance performance.
Simply put, you can measure the performance of the KLSE index compared
with individual shares. You would only select shares that are outperforming
the index. In that way you would earn more on your futures contracts
relative to your losses on your shares. |
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The chart of Nestle with the RS indicator shows that Nestle is performing 27% better than the KLSE index.
This is the type of share you need in a hedging portfolio.
If a share is performing worse than the index you must get rid of it.
My team at Phillip Futures actively manages hedging portfolios of shares and futures. We are fully licensed
by the Malaysian Securities Commission and shares are held by our custodian Phillip Capital Management.
Please call W W Foo or Kok Chee Leong, 03 2711 2681/21666205 for questions/ information.
2001 is going to be a volatile year with the possibility of more collapse. Be prepared and familiarize yourself
with the hedging process.
Think of it as an insurance policy against financial disaster.
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