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jueves, 17 de septiembre de 2015

¿Trading on shares or trading on indices?

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Many investors are openly wondering the benefits of investing in stocks versus futures on indices and vice versa. Like most of the answers to the questions generated by the market the correct answer is "it depends ...."

In favor of trading on stocks, we have the existence of a higher volatility in the oscillation of their prices compared to the movement that may experience an index, which in principle could help the trader. But from my point of view, that increased volatility is not worth the excess of risk for the traders that use stocks rather than indexes.

Indeed, suppose that one day, after a good close in New York, a favorable trend in Asian markets, and an appropriate context in the price chart of Apple, we decided to open a long position in the underlying, buying shares of Apple, or futures on this stock. Everything happens as planned, the Nasdaq opened higher, and Apple as an integral member of this index, and a correlation coefficient (Beta) near unity, also rises. However, shortly after the opening, the news that due to recent acquisitions by the company, there has been a significant need for liquidity appears, and therefore Apple has made a share placement by accelerated process, 5% below the closing levels of the previous session ... Although our expectations were correct, and we choose the good side of the market at the same meeting, Apple quickly adjusts its price downward as a result of the new fundamental information released to the market, and the trade become a losing position ... If our expectations had been wrong, and the market was down, Apple would fall even more thanks to the news and the market forces which would cause the transaction to produce more losses.

However, if instead of starting the long position with a single asset we had done on a basket of securities of multiple assets (such as futures on the Nasdaq), in which Apple does not weight more than 3%, the temporary decline in this stock almost would not have affected the long position in an environment of rising market. In addition, by making transactions in shares instead of indices, we are supporting an additional risk compared with the situation of index trades, which is the specific risk of the asset on which we trade. The above example is only one of the possible cases, but we could have many situations such as a profit warning, a notice of corporate purchase, a devaluation of the currency of a country in which the company have large investments , a personal circumstance of the president of the company, etc, etc ...

A first consideration is the importance of trading with competitive commissions. Whether you are trading in stocks or in futures or CFDs, it is important to be very picky about their broker with regard to transaction costs. There is a gulf between what a specialist broker can offer and what can be found in a bank or general broker. 

But the important thing here is to compare the costs of trading stocks and indexes.  If we divide the equivalent transaction cost of trading cash equities between the transaction cost of trading with index futures, it is much cheaper to trade with futures than make a trade by a similar amount in stocks. Therefore, for a trader who have a more limited trading capital, index futures are more suitable.

Since in the intraday trading the price movements in the market are smaller, the transaction cost component has a very significant impact on the overall result of the transactions, and so this factor is not negligible. It is therefore vital to trade with competitive commisions.

Therefore, unless we have specifically insider trading information on the stock on which we will open the position (a situation which unfortunately almost never happens ...) the recommendation is to use indexes rather than stocks for intraday trading. This is because the greater depth and liquidity of the indices helps eliminate the unsystematic or specific risk of each stock, which allows to trade exclusively with systematic or market risk. The use of derivatives in turn dramatically reduces the transaction cost of trades, which has a great influence on the overall result of this type of operation.

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