Why England vs. Germany is a winner
By Tom Hougaard.
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 crème de la crème 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 realized that there is a statistical correlation between the two stock indices signifi cant 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.
Take 9 March 2011 as a good example. The DAX closed the night before at 7164. The FTSE closed at 5974. Both indices were down about three to four points on the day. During trading on 9 March the DAX and the FTSE diverged by more than 49 index points: the DAX was up 53 points while 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 7131. The FTSE closed at 5937. The spread between the two indices had gone from 1243 points during the day to 1194 points at the close. 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 stoploss? 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.
CFD trading and spread betting carries a high level of risk to your capital with the possibility of losing more than your initial investment and may not be suitable for all investors. Ensure you fully understand the risks involved and seek independent advice if necessary. These products are only intended for people who are over 18.