Spotlight Trade - China ETF
In todays issue:
- Step-by-Step overview of Spotlight Trade - China Equity Index ETF
- Update on active trades
Trading Rule #1 -Market Portfolio
The China Equity ETF is one of the over fifty markets that we follow and review daily. Over the past month or so there has been a lot of talk about the lifting of covid lockdowns and restrictions being lifted in China and the impact it will have on Chinese and international equity and commodity markets. The reopening of China is currently being perceived by the markets as a good news but this narrative could change later in 2023 if increased commodity prices impact inflation and governments around the world have to further increase interest rates.
We don’t trade based on new events we only make trades based on the strict rules of our trading strategy which looks for the strongest trending markets and currently the strongest markets tend to have a China related theme to them.
We are trading the ZCH ETF on the TSX but other international China Equity ETF’s such as GXC in the US are showing similar price patterns.
You can see on the above chart that ZCH is showing a nice trending pattern of higher high and higher lows over the past couple of months. ZCH has is also approaching a new 6 month high resistance level of $17.67 which is shown by the dashed purple line and purple circle on the chart.
You will also notice on the chart that the price has broken out above the 200 DMA which is the blue line on the chart. You can also see from the chart that the 50 DMA, which is shown by the red line, has just crossed the 200 DMA to form a bullish golden cross.
The fact that the China Equity ETF has closed above the 200 DMA, has formed a bullish golden cross and is quickly approach a six month high confirms that this market is showing strength and one that we should be on our watchlist.
We have now zoomed into to the ZCH chart above to see the current price action
Our Trading Rule #2 identifies potential trade setups for securities on our watchlist.
The China equity ETF became a potential trade set-up when it broke out and closed above the 6 month high of $17.67. The breakout is illustrated by the purple circle on the chart.
Some traders may have identified this as a potential trade set-up when it broke out above the 200 DMA which is shown by the blue arrow or when the faster 50 DMA average cross above the slower 200 DMA which is shown by the red arrow. Its is always encouraging when multiple trade signals line up.
Trading Rule #3 - Entering the Trade
Our trading rule number 3 states that we will enter the trade if there is a follow through on the breakout .
The orange line on the above chart is the high price of the ZCH ETF once it broke out and closed above the 6 month high. We placed a buy on stop order to enter the trade at $17.87 if the price continued to trade higher. You can see by the purple box that the next day the price continued higher and our buy on stop order was filled and we were in the trade.
Our Trading rule #4 states that we must know where we will get out if we are wrong and the upward trending price does not continue. By placing a stop loss for all active trades we control our bet size. The backtesting of our trading strategy indicates that we have a 40% success rate. In other words we will be stopped out for a loss on approximately 60% of all trades we enter. We are ok with that because our backtesting has also shown that on winning trades we make approximately 3 times as much as we lose on our losing trades. A 40% success rate with a profit of 3 times our loses makes our trading strategy profitable.
For this trade we placed our stop loss at $16.88 which is shown by the brown line and arrow on the above chart.
We calculate our stop loss using Average True Range which measures the average volatility of this ZCH ETF over the past 20 days.
You can see from the graph in the bottom of the stock chart that the ATR was $0.33 when we initiated the trade.
In order to give the trade some breathing room we use a 3 x ATR which in this case is $0.99.
We calculate our $16.88 stop loss price by subtracting the 3 x ATR from our $17.87 purchase price. As soon as our entry order is filled we place our stop loss order with our broker so that the trade will automatically be closed if the stop loss price is hit.
Trading Rule #5 -How much to Buy
Once we know our entry price and stop loss price we can calculate how many shares of the ETF we should purchase.
In this case we are willing to risk 0.50% or $500 of our theoretically $100,000 portfolio if we are wrong.
By dividing our bet amount of $500 by the difference between the purchase price and stop loss price we determined that we can buy 505 shares of the ZCH. Defining the bet size of ever trade is the key to long term trading success.
We currently have 10 active trades. Over the past week we entered into 2 new trades which are shown in orange in the table. Along with the China ETF trade we just discussed, our trading strategy also got us into a position in a Canadian equity trade. This leaves us about 85% invested.
It is interesting when you look at our active trades that the majority of them have a China market theme to them. Along with ZCH that we just discussed we are in a number of material commodities that could also be showing strength because of demand resulting from the reopening of China. Gold is also well represented in the markets we hold which could be an indication of anticipated higher inflation from the increase in commodity prices.
I would prefer to see a more diversified portfolio but we don’t question what our trading strategy rules tells us to do. I am assuming we will either do very well or be stopped out on a high percentage of our trades but we need to be careful not to attempt to predict what the market will do as it will make it more difficult to follow our rules.
Please let us know if you have any questions or comments.
Good luck and good trading!
We are not suggesting that you should purchase the securities that we highlight in this blog but rather see the steps, and the thought process, we go through to remove emotions from the trading process and systematically implement our trading rules.
It is our belief that each trader should develop their own trading strategy that fits their personality and with rules they understand and can systematically execute. If you are interested in building a personalized Trading Strategy please check out the FREE Preview of our Trading Course "How to Build a Systematic, Rules-Based, Trading Strategy" and get started trading your way to financial freedom!