Trading and Investment Strategies: An Introduction to ...

[Pages:126]Trading and Investment Strategies

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Trading and Investment Strategies: An Introduction to Analyzing and Developing Efficient Portfolio Management and Currency Trading Strategies

By: Abrin Berkemeyer Jacob Billington Kieran Cochrane Matthew Puksta

Advisors: Professor Hossein Hakim and Professor Michael J. Radzicki

This report is submitted to the faculty of Worcester Polytechnic Institute as fulfillment of the Interactive Qualifying Project; a partial fulfillment of the Bachelor of Science Degree.

This report represents work of WPI undergraduate students submitted to the faculty as evidence of a degree requirement. WPI routinely publishes these reports on its web site without editorial or peer

review. For more information about the projects program at WPI, see .

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1 ABSTRACT

The purpose of this report is to provide an introduction to investing through the analysis of our Interactive Qualifying Project. The report spans the concepts of basic economics, investable markets, creating a methodology for investing, and a breakdown of individual strategies. These concepts, all taken into consideration, culminate in the presentation of our four individual strategies in this report; all of which were implemented over the course of the project. Our individual strategies demonstrate the steps of trading strategy development, implementation, and results analysis. Three of the four strategies present different currency trading techniques: a trend following strategy, a stochastic, average directional index, and relative strength index strategy, and a strategy based off of major economic news. The fourth strategy is an equity based strategy focused primarily on trading stocks that are affected by election years.

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2 ACKNOWLEDGEMENTS

We would like to thank Professor Radzicki and Professor Hakim for being our project advisors. Without their help, guidance, and overall knowledge of the investing world, our IQP experience would have been undoubtedly limited. Professor Radzicki's guidance with coding automated trading served great functionality in the project. Professor Hakim's availability to answer questions and to discuss his personal trades gave substantial insight into trading currencies in this project and the real world.

Furthermore, we would like to thank the WPI Investment Association for allowing us to share what we learned during this IQP with our peers and WPI for this opportunity.

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3 CONTENTS

1 Abstract .......................................................................................................................................................2 2 Acknowledgements ...................................................................................................................................3 4 Introduction ...............................................................................................................................................6 5 Background.................................................................................................................................................7

5.1 Financial Terminology......................................................................................................................7 5.2 Basic Economics ...............................................................................................................................7

5.2.1 Supply and Demand .................................................................................................................7 5.2.2 Business Cycles..........................................................................................................................8 5.3 Investable Markets ............................................................................................................................9 5.3.1 Equity Market............................................................................................................................9 5.3.2 Currency Market .....................................................................................................................15 5.3.3 Options Market .......................................................................................................................18 5.3.4 Futures Market ........................................................................................................................21 5.4 Entering and Exiting a Market ......................................................................................................23 5.4.1 Long Positions.........................................................................................................................23 5.4.2 Short Positions ........................................................................................................................23 5.4.3 Relationship between Long and Short Positions ...............................................................24 5.4.4 Positions in the Options Market...........................................................................................25 5.4.5 Positions in the Futures Market............................................................................................25 5.4.6 Entry Order Types..................................................................................................................25 5.4.7 Exit Order Types ....................................................................................................................26 5.5 Market Movement...........................................................................................................................26 6 Methodology ............................................................................................................................................28 6.1 Strategy Development ....................................................................................................................28 6.2 Analyzing a Trade............................................................................................................................30 6.3 Indicators and Strategies ................................................................................................................31 6.3.1 Moving Averages ....................................................................................................................31 6.3.2 Stochastic Oscillator ...............................................................................................................33 6.3.3 Relative Strength Index..........................................................................................................34 6.3.4 Average Directional Index.....................................................................................................35 6.3.5 Long Term Equity Trading ...................................................................................................35 7 Abrin Berkemeyer's Strategy..................................................................................................................36 7.1 Personal History and Background Information .........................................................................36 7.2 Strategy Development ....................................................................................................................36 7.3 Final Strategy....................................................................................................................................40 7.4 Implementation, Results, and Analysis ........................................................................................41 8 Jacob Billington's Strategy......................................................................................................................44 8.1 Foreign Exchange Strategies..........................................................................................................44 8.2 Equity Market Trading ...................................................................................................................47 8.3 Results...............................................................................................................................................48 9 Kieran Cochrane's Strategy ....................................................................................................................52

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9.1 Strategy development......................................................................................................................52 9.2 Results...............................................................................................................................................58 10 Matthew Puksta's Strategy......................................................................................................................62 10.1 Equity Trading and Portfolio management.................................................................................62 10.2 Results...............................................................................................................................................68 11 Conclusions ..............................................................................................................................................69 12 Citations ....................................................................................................................................................70 13 Appendix A: Trade History and Strategy Code ..................................................................................72 13.1 Abrin Berkemeyer's Trades And Code ........................................................................................72 13.2 Jacob Billington's Strategy Code...................................................................................................74 13.3 Kieran Cochrane's Trades And Code ..........................................................................................76 13.4 Matthew Puksta's Trades ............................................................................................................ 103 14 Appendix B: Journals ........................................................................................................................... 104 14.1 Abrin Berkemeyer's Journal Entries.......................................................................................... 104 14.2 Jacob Billington's Journal Entries.............................................................................................. 116 14.3 Kieran Cochrane's Journal Entries ............................................................................................ 117 14.4 Matthew Puksta's Journal Entries.............................................................................................. 122 15 Terminology Glossary.......................................................................................................................... 125

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4 INTRODUCTION

The purpose of this Interactive Qualifying Project is to learn how to manage one's wealth through creating and implementing different investment strategies. Managing one's wealth is one of the most under-emphasized needs for most college aged students today. Protecting and growing one's savings is something that is rarely taught. As a group of Worcester Polytechnic Institute juniors preparing to enter the workforce in less than two years, we sought to learn, develop, and test strategies that we could use in our future to invest and manage our wealth.

Entering the working world, it is important to start saving for retirement as soon as possible. One of the most proactive ways to prepare for the future is learn how to manage one's own wealth. More often than not, personal retirement funds and investment funds are overlooked as they are managed by others. Today, through the use of technology and the internet, everyone has the opportunity to manage their own wealth without the use of money managers. Even with resources readily available, people still rely on money managers to invest their money for them due to a lack of knowledge in investing.

The Trading and Investment Strategies Interactive Qualifying Project is an in depth examination of the methods and strategies used on investable markets in order to gain long-lasting investing experience. Through simulated trading experience, we learned how to invest in different markets and develop strategies for trading them. For example, trading currencies can be a great means for consistent short term returns but requires a lot of time and management, whereas trading equities can provide sustainable growth in the long term as one prepares for future financial needs. In either case, the ultimate goal is capitalize on returns and grow wealth over time.

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5 BACKGROUND

5.1 FINANCIAL TERMINOLOGY

The following definitions are basic financial terms related to investing: Asset: An asset is property of a person or company that is regarded to have value. Liability: A liability is a financial obligation or debt. Liquidity: Liquidity is a measure of the amount of time it takes to convert assets to cash. Solvency: Solvency is an entity's ability to pay off long-term debt. Volatility: Volatility is a measurement of risk and is the rate that the price of a security

changes. Interest Rate: An interest rate is the cost of borrowing money and interest is paid on a

percentage basis. Interest rates may vary depending on the risks associated with lending money.

5.2 BASIC ECONOMICS

Economics is the study of resource allocation and decision making. With any type of investing, economics have a fundamental role. Two economic principles that are advantageous to understand before investing are supply and demand and business cycles.

5.2.1 Supply and Demand

The main principle behind the supply and demand of an asset is that as supply increases, demand decreases, and as demand increases, supply decreases. As a result of the relationship between supply and demand, pricing is affected. When demand is high and supply is low, the buyer of the asset is willing to pay a higher price due to the asset's current rarity. Using the same logic, when supply is high and demand is low, the price the buyer is willing to pay for asset at hand decreases due its abundancy. When the amount of supply meets the amount of demand for an asset, the price is said to be at equilibrium. The figure below illustrates these principles:

Trading and Investment Strategies

Supply and Demand

Equilibrium

Supply Demand

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Here the equilibrium point can be seen where the supply and demand lines cross.

Price

Quantity

5.2.2 Business Cycles

A business cycle is an explanation of economic activity and movement. Business cycles are applicable on a small scale to companies and on a larger scale to countries. Business cycles are marked by four distinctive periods: peaks, contractions, troughs, and expansions. The peak of a business cycle is the height of economy activity. The peak is followed by the contraction period. The contraction period is a time of decreasing economic activity, generally marked by decreasing employment and decreasing sales. Following the contraction period, the trough is the lowest point and bottom of economic activity. The trough is followed by the expansion period in the business cycle. The expansion period is a time of increased economic activity, generally marked by lower unemployment rates, increased sales, and high growth. The figure below depicts the business cycle:

The Business Cycle

Peak

Trough

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