Thursday, June 07, 2007

Trading By Intermarket Themes

Very large traders--those managing portfolios of 50, 100 million and more--cannot simply dump that kind of money on individual stocks or futures contracts without disrupting the market and getting terrible prices. What this means in practice is that, once you've gotten truly big, you have to trade themes, not just individual positions. Those themes can be expressed through multiple trades and markets, enabling the portfolio manager to put significant capital to work.

One of the themes emphasized on this blog recently has been the relationship between interest rates and equity prices. The above charts, taken from this morning's trade, illustrates how awareness of a theme can benefit even the short-term trader. Once ten-year rates blew through 5%, we saw significant selling pressure in the NYSE TICK and a move of the S&P 500 Index to multi-week lows.

You could play the theme by selling bonds, selling stocks, selling interest rate sensitive sectors vs. other, non-sensitive sectors, etc. Such themes wax and wane: sometimes they're sector themes (energy shares outperforming tech); sometimes they're market themes (international bourses outperforming U.S.); and sometimes they intermarket themes (falling bonds, falling stocks).

A savvy trader can think like a portfolio manager by observing the emergence of themes and generating alpha not only through market timing, but by shrewd selection of markets to trade. Once you begin to think thematically, it's easier to be long certain areas, short others. This creates natural hedges and diversifies your capital. I'll have much more to say on how traders can think like portfolio managers in an upcoming post.


Are Rising Rates Taking a Toll on the Stock Market?