Difficult economic times call for a re-evaluation of traditional investment strategies. The ‘buy, hold and pray’ strategy which equity investors have long relied on is struggling to perform, and investors are increasingly seeking alternative options — in particular foreign exchange and commodity trading strategies. But for SMSF trustees and retail investors who are all too aware of the performance gap between them and institutional investors, the question of how they can close the gap is top of mind. Daniel Byrne, managing director of easyMarkets, looks at institutional best practice and explains how retail and SMSF investors can trade like professionals, and reap the rewards.

When markets are rising and times are good, a ‘buy, hold and pray’ strategy works fine. Australian retail and self-directed SMSF investors have traditionally been overweight domestic equities, but because equities have performed better than other asset classes over the long term, there’s been no reason for them to question this approach. In fact, so prevalent is the strategy, that it has come to be seen as conservative and ‘safe’.  

Returns from ‘safe’ portfolio construction can’t put food on the table

Unfortunately, times have changed. Since the GFC, the Aussie dollar has appreciated rapidly, interest rates are at all-time lows, volatility at all time-highs, and global equity markets are looking over-valued to many analysts. At the same time, assets which were thought to be de-correlated have moved together in a way investors did not expect, making true portfolio diversification very difficult to achieve.

The bottom line is that the ‘safe’ investment strategy investors relied on is no longer producing returns they can live on.

As a result, many investors have begun to actively broaden their horizons and identify new ways of generating income – including from foreign exchange and commodities trading.

Foreign exchange and commodities trading strategies work, but they require specialist skills

The challenge most investors face is that they don’t have the skills and tools necessary to succeed in foreign exchange and/or commodities trading. Institutional investors have been achieving portfolio diversification and excess returns from trading strategies for years, but there is a significant knowledge and performance gap between institutional and retail traders.

And it’s not surprising. Institutional investors are highly trained, and have at their fingertips the tools and strategies which allow them to accurately size a trade, apply the right trading strategy, assess their risk and use the appropriate level of leverage. Retail and self-directed investors, like SMSF trustees, on the other hand, typically do not have the same training and skills, so struggle to apply the professional investment approach needed to succeed.

The good news is that it is possible for non-institutional investors to educate themselves and become skilled at identifying and using the sophisticated tools and strategies which will allow them to trade like a professional.

Trading like a professional means using the right strategy at the right time, and managing downside risk

There are a number of rules which professional investors stick to. These rules centre on risk management, strategy selection and implementation, and can be used by retail and SMSF trustee investors to achieve the same results.

In summary, professional investors:

1.      Decide how much they are willing to risk with each trade, and don’t deviate.

2.      Decide how much they are willing to risk as a percentage of their account balance, and don’t deviate.

3.      Use a stop-loss mechanism to manage downside, and to limit losses on a trade.

A stop-loss is a tool which allows for losses to be limited if a trade goes the wrong way. The stop-loss specifies a certain point at which the position will close, guaranteeing that there will be no further losses past that point even if the market continues to fall.

4.      Understand the risk management tools available. These include using options to hedge against movements in the opposite direction. Some platforms offer a ‘deal cancellation’ tool, which allows for a trade to be cancelled entirely within a certain time period.

5.      Use the right strategy at the right time.

 Identifying, understanding and implementing the right strategy minimises risks such as:

-          the whipsaw effect, which occurs when the price of a security moves in the opposite direction to the one expected;

-          knowing when to get in and out of trades profitably;

-          understanding when to trade big, and when to trade small, depending on the level of risk, in particular any potential downside.

6.      Understand the London Breakout strategy.

The London Breakout strategy is a precise set of rules which allow investors to follow the institutional capital flow, in other words, to do what the institutional investors are doing at certain times.

The strategy relies on an understanding of the characteristics of global capital markets — in particular at the most liquid time of the trading day — the London Open, when the London exchange opens. At this time, there can be more trading opportunities available.

The London Breakout strategy includes a custom-built indicator that pinpoints trade entry and exit points and gives investors an advantage in that they are able to take nimble, high-probability trades.

The bottom line?

There is no reason that retail investors and SMSF trustees can’t use the same strategies that professional investors use, with the same results. Knowledge is power, and in the case of trading strategies, knowledge means understanding and using tools and strategies which will manage risk while at the same time harness the higher returns and genuine diversification benefits that trading strategies offer the astute investor.

Daniel Byrne is managing director at easyMarkets in Sydney.