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Why IG is a volatility winner worth buying

Michael Taylor explains why IG’s robust business model and increased market volatility make it an attractive long trade
Why IG is a volatility winner worth buying

It’s been a few weeks since I highlighted any long trades. In fact, all of them aside from Fevertree Drinks (FEVR) – which has still not hit the entry point suggested – have been short trades. But then it’s always wise to trade the direction of the trend – recently, largely down – because to do otherwise would be gambling on picking a market bottom. But this week, IG Index (IGG) has caught my eye as a potential riser. 

I believe that strong stocks in a weak market have the potential to emerge ahead of the pack when the bull eventually stirs. IG Index could be one of these. It provides online trading in the form of leveraged products such as contracts for difference (CFDs) and spread bets, as well as offering sharedealing accounts and individual savings accounts (Isas). And when volatility increases, trading activity goes up. 

Not only that, when stocks fall the market is constantly in the news and people who were otherwise not interested in the stock market suddenly decide to give it a go. Not all of these will be successful of course, and the attrition rate is high as we can see from the client statistics of the major spread bet providers, especially after European Securities and Markets Authority (ESMA) regulation came in during 2018.

But if only some of these traders stay trading, for IG it can be very profitable. Last week I paid almost £2,000 in trading commissions, and that’s before any overnight fees are taken into account. While these are way above my usual fees, and will go down as volatility subsides, for now we are likely to see increased levels of volatility for the next few months. 

In its industry, IG is by far the sector leader that is listed here. As a client, I have minor complaints about Level 2 Dealer and some administration issues, but I know that IG has a sustainable business model that does not profit from losing traders. I recently spoke with IG’s head of global communications to confirm this in writing, and this point has appeared in the company’s recent third-quarter update: “The Group’s revenue does not benefit from client trading losses, nor is it exposed to client trading profits.” This is important for two reasons. Firstly, IG is motivated to retain profitable clients who are more likely to generate more fees and commissions, and secondly IG is not exposed to any risk as client positions are hedged.

Therefore, there is no foul play and no market risk – provided the company continues to hedge its positions effectively.

Looking at Chart 1, we can see howIG’s share price has traded over the pastfew years. Having made a high at 960p, it fell all the way to 450p before rising again to come within touching distance of the 960p resistance. It then fell back to under 500p again. For an investor, I would imagine this would cause a mighty annoyance, but forany trend follower the stock has been a delight in recent years. 

Looking at Chart 2, we can see a narrower range emerging in the stock over the past nine months. The lows in the support zone have been tested twice in March, each time with long downward wicks which show bid support and strength. Average volumes have been higher over the past few weeks and IG Index’s stock has been no exception. Volumes were high even in this range on both days when the stock saw the support zone tested, which means both buyers and sellers were actively engaged in the market. 

Right now we are seeing the stock rally, and the share price is trading above all of the moving averages and trending upwards nicely on increased volumes in a weak market. I believe we will see resistance at the 740p zone identified on the chart (red line). I have marked this price level as significant because the price made a high with a shooting star candle (the opposite of a hammer) – again on increased volume. 

Should the price fail to break this barrier at the first time of asking we should monitor how the stock responds. We should be on the lookout for signs of strength; we can do this by checking the daily candles and see how the stock reacts to dips. If the stock is going to crumble back downwards then this is no good for traders wanting to get long – but if the stock is consistently bought and ready again for another test of the level then this is something we should be watching. We can also monitor Level 2 for increased buying activity at a certain price (if iceberg orders are frequent, we can assume there are buyers). Traders such as myself will be watching to see who emerges from this price action battlevictorious. I intend to position myself long on IG Index stock should we see a breakout.

As traders, we want to protect our downside. We can do that by splitting our position into two parts. We can take a position on the breakout, and then put the second half of our position onto the bid just below the key level in the form of a limit order. Very often, a breakout will retest this and this gives us an opportunity to load our second part of the position at a much better price.

By getting as close as we can to the level where we would exit the trade, we reduce our risk. And if the trade would continue without our second half of the position that’s great, as the position would move to profit straight away. Manoeuvring ourselves into positions like this will generate alpha for us over the long term.

There is further justification in that IG Index will see increased revenue from the recent volatility, which is likely to continue.

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