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Fixed-odds: Shorting the FTSE

Created:
1 April 2008
Updated:
19 November 2008
Written by:
John Piper

When the FTSE crashed through 5800 on Monday 21 January, I cleaned up on the positions I'd opened earlier in the month. To win £1,000, some of the bets were placed using stakes of less than £100.

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Markets heading for a big fall!

In this article, I'm going to explain why I chose these bets. When I recommended them 10 days earlier, the FTSE was around 6200. I needed the index to fall 400 points in a little more than two weeks for some of these bets to win. In the event, it did a lot more than that.

This story really starts on 11 June 2007, when I published a piece spelling out the likelihood of big falls in the market. Remember that, back then, the sub-prime crisis had yet to break and there were few clouds in the sky.

Once the storm hit shortly thereafter, the FTSE fell more than 900 points to 5821 on 17 August. A failed upwards break to 6754 in July merely added to the pile of negatives at that time. That was the first piece of the jigsaw and the resistance established then has proved effective ever since.

The importance of options expiry

A common feature of the summer sell-offs and the January 2008 falls was options expiry. The two weeks directly before expiry tend to be calmer than the two weeks directly after expiry. Every now and then there are five weeks between one expiry and another but that does not alter this factor. The action immediately after expiry can be wild. The 1987 crash is the best example I know, but 21 January 2008 was a more recent example – and options expiry is a feature I use in many of my forecasts.

The major players keep stock markets in a range running up to expiry because that suits their book. Afterwards they let them rip because that gives them the opportunity to sell options at high prices and this is aided by the fact that all those traders who had bought options have just seen them expire. So they buy some more – maybe as a form of portfolio insurance. So, I always watch options activity closing when doing market analysis.

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A major sell signal in November

After August's lows at 5821, the FTSE bounced back to 6751 before falling once more. The resulting bearish case was as follows:

• The post-August move was a ‘failed re-test’ of the previous high at 6754.

• It established the presence of ‘minus development’ above 6750. Minus development is a technique that demonstrates determined buying or selling – in this case the latter.

On 2 November, I identified a major sell signal: the completion of five downward waves, confirming an impulsive decline off the top (see chart 1 below).

The very fast action we have seen in 2008 stemmed from this sell signal back in November 2007:

Observe the range of sell signals shown on a more recent chart (see Chart 2, below):

• The failed break and the later failed re-test.

• The Elliott Wave patterns and in particular the initial five-wave decline shown on the earlier chart.

• The breakout below the triangle – a well-documented triangle at that.

• There were also longer-term trend lines on the weekly chart which had been broken.

Chart 1

Fast action

I not only believed the market was going to fall, but was going to fall fast. 'Fast' action is the key to fantastic returns on longer-term fixed-odds bets of the sort offered by BetonMarkets and BetsforTraders.

According to the Elliott Wave Theory – which I use extensively in my trading decisions – movement in the main direction of the market is formed of five-wave sequences (see below), whereas corrections occur in threes.

The Wave Principle also holds that the third wave is usually the longest and the fastest. And since each set of waves forms part of a smaller and larger set of waves, the third wave of a third wave can be explosive. The decline I recommended shorting on 11 January was more than just the 'third of a third' – it was a 'third of a third of a third!' If you look again at the daily chart (below) you can see that it formed a part of 'THREE', a part of 'three' and is labelled '3' itself. Also, options-expiry was due on 18 January – the scene was most definitely set.

Chart 2

Dark forces and a 1000-point fall

The final piece of the jigsaw was the market's feeble performance over Christmas. All in all, it led me to conclude a fall of more than 1000 points was imminent. In the event, the FTSE fell 1416 points.

Choosing the bets

So those are the techniques I use to forecast the direction of the market. But that's only part of the challenge: next I have to pick the actual bets.

At the start of this article, I mentioned the 5800 level. Some of the bets I was talking about were the 5800 'One Touches'. If you buy a One Touch, it wins instantly if the specified level is touched. But there are other ways to play a possible decline than merely buying a One Touch and I did recommend other bets.

The bets themselves

Here is a complete list of the bets I recommended to my subscribers:

• On 9 January, buy the 6408 'No Touch' with BetOnMarkets expiring on 8 April – guide price £22 per £100 of possible winnings.

• On 9 January, buy the 6430 ‘No Touch’ with BetsforTraders expiring on 18 February – guide price £30 per £100.

• On 11 January, buy the 5800 'One Touch' with BetOnMarkets expiring on 25 January – guide price £10 per £100.

All these bets have done well out of the decline we have seen. The 5800 One Touch went to 100, for a 900 per cent gain, on Monday 21 January. If I had been cleverer, I could have bought a 5400 One Touch at an even lower price. There again, £10 per £100 is an excellent risk/reward ratio and the further away I made the strike price the lesser were my chances of success.

I bought the 5800s on 11 January because it had then become clear that the expected decline had begun.

I bought the 'No Touches' two days earlier because we had seen solid spike-highs on the market. The Elliott Wave Theory and price spikes (or minus development as they are known in Market Profile) form the backbone of my approach to markets. When we see a solid price spike, and that on 9 January was a solid 50 points, we know that the extreme (meaning the price away from market action – in this case a high) is solid resistance and that the market is less likely to go there. That does not mean the price will not go there, merely that it is less likely. A spike shows you price rejection (in Market Profile terms) and if price is rejected once it may well be again.

A trading idea

So there is one trading idea for you and let me spell it out:

• Wait for a solid price spike and then buy a 'No Touch' beyond the extreme of the spike (the extreme away from current price action).

• How long forward? Deciding when the bet expires is a question of balance. You want the shortest term possible because that gives you the best chance of success.

• But you also want the lowest price and the price goes lower the longer you make the time frame.

• Where should you set the price? The key rule is beyond the spike itself but if there are also key support/resistance levels in the vicinity or any round numbers then it may pay to set the price beyond those as well. And here is one more tip:

• BetonMarkets is a great site but it always pays to compare prices and, in 2007, BetsforTraders launched a website offering similar bets. So always check prices on both sites. Both companies also offer incentives to new clients.

• Recently I opened my bet with BetsforTraders and then closed it with BetonMarkets because it was a much better price – in fact, it was the 6408 No Touch I mention above.

I hope this short piece provides good food for thought.

As ever, good luck in the markets!

■ 'Binary Betting – An introductory guide to making money with binary bets' by John Piper is available to readers at a special offer price of £10, FREE p&p. To order, visit our book shop at: www.investorschronicle.co.uk/books.

■ The author welcomes feedback and can be contacted at john@john-piper.com and you can visit his website at www.johnpiper.info

■ John runs two market services and one of these exclusively covers binary betting.

MORE ON FIXED-ODDS FINANCIAL BETTING...

Click on the links below for more guides on fixed-odds betting:

Introduction to fixed-odds betting

The mechanics of fixed-odds betting

A bet for every movement

Advanced fixed-odds betting

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