CONSULTING ANALYST, INTERTRADER
I ADMIT it. It’s an attention seeking title, playing on the emotions of every football fan in England since 1966. “England vs. Germany” is also a trading strategy which seeks to play two stock indices against each other. It is perfect for financial spread betting, because you don’t have to factor in currency risk.
The FTSE 100 consists of 100 companies, of which 10 make up about 45 per cent of the index value. The German Dax consists of 30 stocks, representing the creme-de-la-creme of German commerce and industry. Together, they are considered the two leading stock indices in Europe.
Clem Chambers, the brilliant head of ADVFN and even more brilliant technical analyst, taught me the interplay between the two stock indices and how stocks are executed in block trades using volume-weighted average price (VWAP). I realised that there is a statistical correlation between the two stock indices significant enough to bet on.
I began to explore how to trade the two against each other in a straight arbitrage strategy, and came up with the idea that if the two diverged by more than 40 points from the previous night’s close, I should short the one that was strong, and buy the one that was weak.
Last Wednesday was a good example. The Dax closed the night before at 7,164. The FTSE closed at 5,974. Both indices were down about three to four points on the day. On 9 March the Dax and the FTSE diverged by more than 49 index points. The Dax was at one point up 53 points. At the same time, the FTSE was up only four points on the day. So I shorted the Dax and bought the FTSE in equal amounts. The Dax closed at 7,131. The FTSE closed at 5,937. The spread had gone from 1,243 points to 1,194 points. Although I did not capture all the 49 points on the table, it serves to illustrate the strategy well.
Now, let’s deal with “what can go wrong?” In one sentence: where is your stop-loss? The answer is, you can’t have a normal stop-loss. You have to use a monetary stop-loss, and you have to be there to watch the screen. In that sense, it is more suited to the short-term traders of the City and beyond. Happy Trading.
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