A.R.T Core Portfolio Trading Plan June 2015

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1 A.R.T Core Portfolio Trading Plan June 2015 ABSOLUTE RETURN TRADING PTY LTD ACN

2 Trading ASX Equities Long/Short using CFDS CFDs are a very powerful and effective tool if used correctly. Using moderate leverage (5 times) on a $20,000 account, taking it to $100,000, and then making a 20% return on that leveraged amount, equates to a 100% return on your initial investment. However, leverage can add to risk and the leverage that CFDs offer means that it is essential to trade them with a professional, developed and strictly adhered to trading plan. Position sizing & risk management strategies found within such trading plan are the key to achieving objectives as a trader. A.R.T. Core Portfolio MDA The A.R.T. Core Portfolio is a Managed Discretionary Account (MDA) which is a service where an investment manager (A.R.T.), on behalf of their clients, will control a portfolio of investments both long and short across the ASX using CFDs. The A.R.T. Core Portfolio is traded using very strict, developed, advanced trading rules. Such rules are based around the key elements of risk management, position sizing, record keeping and stock selection. We know that not all trades we enter will be profitable so it is essential to know the maximum total drawdown per position and the percentage effect that will have on the total portfolio size. We will never risk more than 1.5% of the total portfolio per position at the initial stop loss level. There are no guarantees that a stock won t gap across that stop but we will generally exit a position as soon as it goes against the reason why we entered the trade in the first place, and as such often the full 1.5% limit is far from breached. Below is the trading plan we follow. It is simple and easy to implement. It is proven and doesn t make great assumptions about where a market, or stock, is headed but essentially just follows momentum. We will be trading ASX equity CFDs both long and short so we aim to profit regardless of the underlying market strength. A long only portfolio in current market conditions we see as overly aggressive and somewhat foolish. Liquidity rules will ensure that the total managed funds of each MDA strategy doesn t grow too large and as such we want to keep our portfolios to manageable sizes and concentrate on growing the wealth on a select group of clients who understand what we are trying to achieve and share our vision. In time we will release MDAs across other markets and are currently testing traders on both the US market and the Hong Kong market.

3 A.R.T. Core Portfolio Trading Plan Client portfolios are traded using Contracts for Difference (CFDs), both long and short on Companies listed on the ASX. Their portfolios will be managed by a strict set of trading rules relating the 4 points below. 1. Discipline. Essentially the discipline to follow this trading plan without mistakes. 2. Risk Management. Cutting losses short and letting profits run. Selfexplanatory. 3. Position Sizing. Use position sizing to achieve objectives. Position sizing may change according to market type and client objectives. 4. Psychology. Everything is 100% psychological. Being in the right mental state to trade is essential. CFDs provide leverage into positions which exacerbates profits, but also losses and so it is essential that they are traded by market professionals using strict trading rules ensuring optimal performance. There are several aspects relating to how the trading will take place which are outlined below. Finding entry signals Determining what to trade, and when, is obviously important. The following methods will be used for client portfolios. 1. Technical Analysis 2. Seismo technical charting software. 3. Company announcements/reports. 4. Fundamental & sector analysis. 1. Technical Analysis Technicals (or charting) is kept quite simple. All signals are tested for efficiency and the most positive signals are traded. Different market types will tend to favour different setups and as such it is important to be adaptable across these differing market types. Some favoured entry setups include the following;

4 channel breakouts bounces off support/resistance positions that have traded away from their mean and traded as the position reverts back to the mean ascending/descending triangles on volume breakout MACD/RSI signals Bollinger band signals 1. Seismo. Seismo trading software is used to scan the ASX markets and look for trading opportunities both long and short. Seismo has 19 scans 10 long, 9 short. 1. Uptrend 2. Downtrend 3. Bullish Price Cross Up 4. Bearish Price Cross Down 5. Price Gap Up 6. Price Gap Down 7. Reversal Turning Up 8. Reversal Turning Down 9. Oversold Crossing Up 10. Oversold Crossing Down 11. Best price performers up 12. Best price performers down 13. DMI Cross Up 14. DMI Cross Down 15. Return to Up Trend 16. Return to Down Trend 17. Extreme Oversold 18. Extreme Overbought 19. Dividend play The strongest signals are found in scans 1, 2, 3,4,13 & 14 - Scans 3 and 4 will generate most of the entry signals. - Scans 7 and 8 are seen as early signals and generally will not generate trades but will alert us to potential entries. - Scans 1 and 2 will on occasion generate strong entry signals and they also confirm that an open position is still trending in the desired direction. A.R.T. would never have a long position open if Seismo was indicating that the position was in a downtrend. - Scans 13 and 14 generally confirm an earlier signal found in 1, 2, 3 or 4. - Scans 15 and 16 are also early signals and best placed on a watchlist. Seismo is not a black box, however, in that it doesn t simply tell us what to buy or sell. A scan might find us several strong signals yet we might trade none. We take into consideration many other aspects of what is happening in the world around us. It is important to study the underlying economic fundamentals, both macro and micro along with sectors, other charts, upcoming data releases and so on. We obviously favour long positions if the

5 underlying market is trending higher and short when lower. Volume is also a very important factor and a strong signal with confirmed strong volume will often be traded. This is a screenshot from Seismo Trading Software which found 18 stocks in the ASX300 in an uptrend. The strongest uptrend in the ASX300 was Webjet (ASX: WEB)

6 There are 5 general market conditions, and depending on which condition the market is currently in will determine the makeup of any portfolio. Market General Exceptions Condition Portfolio Strong Bull Long Only Defensive Plays Bull Bias Towards Sector Plays Long Neutral Equal Sector Plays Long/Short Bear Bias Towards Sector Plays Short Strong Bear Short Only Gold, Defensive Plays Generally the portfolio is trend following. It doesn t try to pick tops or bottoms but rather follows what the market is doing. On occasion when uncertainty reigns then all positions might be closed and trading suspended until the path is a little clearer. 3. Company announcements. One of the best times to trade a position is post results or post earnings guidance, company market updates and so on. Analysts take time to update their target prices after upgrades/downgrades and the fund managers/brokers even longer to reallocate funds towards/away from positions post these reports. These give great opportunities for traders to capitalise on early movements and thus become a great time to make good returns in a short space of time. It goes without saying that trading rules apply during this period as per any normal period. A.R.T. compiled data about the August 2014 reporting season and found that entering a position post report in the direction that the price gaps upon resumption of trading would have been a very profitable strategy, returning on average 5.59% from 31 long gap trades until momentum subsides and the position was closed. Short gap trades would have generated 20 trades for an average return of 1.95%. Please note there were obviously far more company reports than 59, but we only compiled data on highly capitalised, high liquidity stocks.

7 AUGUST 2014 REPORTING SEASON ANALYSIS 4. Fundamental & Sector Analysis. Fundamentals obviously still play a large part in stock selection, as does sector and market analysis. The investment managers at A.R.T. are constantly reading company reports and announcements, monitoring directors buying/selling shares, profit upgrades/downgrades and so on. We subscribe to various newsletter and daily broker reports and whilst we don t blindly follow any particular analysts we might have a stronger conviction to enter a trade if both fundamentals, technicals and analysts share the same view on where a company is heading. The market will always have a type or condition as seen above and generally positions will be traded in the direction of market trend with various exceptions. Sectors will also have these types and can therefore be traded separately from the general market if found to be moving against it. Resources in Australia over the past 2 years could fall into this category. If a stock is seen to consistently have earning 'shocks' or bad news announcements or downgrades then we may 'blackball' a Company and simply not trade it. Sirtex (SRX) might fit under this category at present on the ASX.

8 On March 17 Sirtex announced disappointing results of their SIRFLOX clinical study. After closing the previous session at $39, they resumed trading post announcement at $15, wiping out 18 months of uptrend. 5. Risk Management & Position Sizing Of more importance than entry are risk management and position sizing. Risk management relates to keeping losses small and letting winners run to their full potential. To achieve this we use stop losses and trailing stops. The loss and the stop loss level of any trade will be not more than 1.5% of the total trading capital. If the total portfolio size, for example, is $100,000 and we decided we would risk 1.5% of the total portfolio per trade then we risk 1.5% of $100,000 or $1,500. The total trade size is not $1,500 but rather the maximum loss per trade at the stop loss level. Generally the market type will determine the amount of risk taken. For example, when the volatility (VIX) is high (say above 20) we may risk at maximum 1% per trade. If volatility is normal we will generally risk 1.5% per trade. Stop losses will be determined using ATR (20) - Average True Range of 20 days. The ATR does not provide an indication of price trend, simply the degree of volatility. As the position becomes more volatile the ATR will increase which leads to a smaller position size.

9 The stop loss will be no less than 2 times the ATR. For example if stock ABC is trading at $5 and has an average true range of $0.25 then the stop loss will be put in place at $4.50 (assuming a long position). If the stock closes within a short distance of the stop and the market is seen to be volatile and the charts look likely to head against the position then the position will be closed. We also do not have to wait until a stop is reached before closing a trade if we feel that the reasons we entered the trade are no longer valid. Thus position sizing is related to the total amount risked and the ATR. There is a simple formula to determine the position size. P = C/R P is the position size. C is the cash being risked per share. R is the risk per share. Example: BHP is trading at $40. Its ATR is $0.80. Therefore the stop loss is set at $40 - $1.60 = $ Therefore R = $1.60 Now we are risking a total of $1,500 so C = $1,500. Therefore the position size (or P) = 1500/1.6 = 937 shares. Comprehensive tests have shown that a random entry selection (i.e. deciding whether to go long or short by a coin toss) in combination with a strong money management and position sizing strategy will generate ongoing positive returns. This sounds hard to believe but it emphasises the importance of exit strategy and position sizing. By using such a sound strategy we aim to make consistent positive returns, regardless of the underlying market. Expectancy This statistic is of vital importance as it shows us how much the portfolio is making for each profit compared to each loss. As per the example above the risk multiple or 1R is $1,500. We are risking $1,500 per trade so a $1,500 loss is -1R. Expectancy is simply the mean, or average, R multiple generated. Thus if the R multiple is positive then the trading system is making money and conversely if it is negative then the portfolio is losing money. Obviously the higher the expectancy the better but it will depend on the type of portfolio traded.

10 A longer term, less actively managed portfolio should produce a higher expectancy. An actively managed portfolio which generates over 20 trades a month should produce a lower expectancy but can still generate higher returns. If the system generates 240 trades a year, the average risk is 1.5% and the expectancy is 0.3 then the return for the year will be 72R (or 108%). If the system generates 20 trades a year and the average risk is 1.5% and the expectancy is 2.5 then the return will be 50R (or 75%). Reward-to-Risk Ratio This is simply the minimum reward for entering the trade compared to the amount of risk undertaken. The minimum acceptable reward-to-risk ratio is two to one, 2:1. Thus if channel trading and the amount we are risking is $1,000 and the top of the channel where we are expecting the position to head would generate a $1,500 profit then the reward-to-risk ratio is 1.5:1 and thus the trade would not be entered. Trailing Stop The trailing stop is of vital importance as it ensures that large profits are not eroded, whilst at the same time giving the position every chance to continue on its trend. Generally the initial stop will be moved to break even when the position has moved favourably by 2 times the ATR (or 1R or 1 times the amount risked). As the position moves even more favourably then the trailing stop will be continually manually adjusted depending on a number of factors including underlying market conditions, support/resistance levels on the applicable chart and so on. Patience is a key skill to have as a trader. If the portfolio can generate several 5-10R trades per annum then the portfolio has a substantial chance of generating high double digit returns. Target Price Depending on the type of trade, occasionally a target price will be put in place and whatever comes first the stop loss or the target price will see the closing of the trade. An example of target price would be when a stock is trading in a channel we

11 would buy at support and sell at resistance. The target would always be a minimum of 2R versus the stop loss which is always -1R as discussed above in Reward-to-Risk ratio. Here BHP is seen to be range trading between around $32.00and $ Going long below support at $32.00 and short above resistance at $35.00 would be a good example of range trading. Time in trade Obviously when a stop, trailing stop or target is reached then the trade will be closed. When a trade is struggling or there are seen to be better opportunities elsewhere then the trade will be closed. Some trade opportunities might be very short term a position might be entered and closed intra-day. Others might be open for a year. Essentially we are after the trades that return multiple times the risk. From experience a portfolio best performs when several 5R+ trades are found within the year. The majority might be between -1R and +1R but it is the multiple-r trades that make a great trading year.

12 Performance Review Positions will be reviewed on a daily basis and stops adjusted accordingly. At the end of each month we will conduct a comprehensive performance review outlining the areas of strength and weakness in the portfolio. The trading will be adjusted accordingly. Trading Journal Every time a trade is entered, details will be put into the trading journal. The trading journal will be similar to the test trading spreadsheet you will find in the A.R.T. Test Trading Report which is attached to the in which you received this PDF. The trading journal is not only used as a record of trades, but as importantly it will assist with the daily, weekly and monthly review of each trade. What trades are working in the current market environment and what trades are not. The market might be consolidating or even reversing indicated by a number of false breakouts. Certain markets types may favour certain trade types. All of this will be uncovered by analysing the trade journal. Trade Journal definitions Start - starting portfolio balance Current current portfolio balance Performance - % portfolio return for the period Expectancy = (Probability of Win * Average Win) (Probability of Loss * Average Loss) and determines how profitable the strategy is Total P&L the total $ profit/loss for the month Stop Limit - the maximum acceptable loss per trade Trade # - simply the number of each trade for the month Date opened date the position was opened Closed date the position was closed Trading Days simply the amount of trading days the trade has been open or remained open Symbol 3 letter ASX stock symbol L/S whether the trade is long (L) or short (S) QTY quantity bought or sold Bought/Current the price which the position was bought Sold/Current the price which the position was sold ATR (20) the Average True Range of the stock based on the past 20 trading days Initial Stop Stop loss level Trail the trailing stop which is adjusted as the position becomes profitable Initial Risk the total dollar amount risked on the trade Comm. the total commission for both the entry and exit P&L the net profit/loss of the position R Multiple a reward to risk ratio. E.g. If I risk $500 and make $1000 on the

13 trade then my R Multiple is 2. If I risk $500 and hit my stop and lose $500 then my R Multiple is (1.00). % wins the percentage of winning positions for the month Why use CFDs? The portfolio will trade ASX Equity CFDs or (contracts for difference) as they allow us to leverage into a position. This admittedly adds to risk but as we are using a very tight trading strategy we see leverage as an important part of achieving exceptional returns as it allows us to have more positions open than we would otherwise be able to. CFDs also allow us to short positions without having to borrow stocks or use warrants or options (which are both extremely inefficient means of shorting stocks). What are the profit expectations? As an absolute return trading portfolio the aim is to profit each month regardless of the underlying market. Some months will prove more difficult than others as false breakouts and volatility are seen but by strictly following rules and analysis of each trade, to determine what is working and what isn t, then the portfolio aims to consistently outperform the underlying market using the leverage that CFDs provide. Mistakes It is of vital importance to keep mistakes to a minimum. Every trader makes errors which can severely hamper the performance of the portfolio. If we were to make 2 mistakes per month, and each mistake was to cost us 3R then the total cost would be 72R which would potentially turn a profitable year into a losing year. Additional rules & routines A.R.T. has developed portfolio rules & routines ensuring we give the trading portfolio the best possible chance of success. These include morning strategy discussions, position monitoring throughout the trading session, generally not holding positions whilst a company is reporting, reduced risk when volatility is high and so on. If the portfolio win percentage was to drop below 30% then some serious questions would arise regarding the competence of the entry system during that period. An extraordinary meeting would take place to discuss options that might include replacing the head trader or adjusting risk on each trade.

14 Summary Experience, a developed trading plan, treating trading like a business, discipline and strong psychology are all essential elements to successful trading. This trading plan is a guide to ensure the rules are in place and to help keep mistakes to a minimum. For further information on the services of A.R.T. please contact us on (02) or on Absolute Return Trading Pty Ltd (ACN: ) an Authorised Representative (AR No ) of HLK Group Pty Ltd (ACN: ) which holds an Australian Financial Services Licence (AFSL no ). Any information or advice contained within this document is general in nature only and does not constitute personal or investment advice. We will not accept liability for any loss or damage, including without limitation to, any loss of profit, which may arise directly or indirectly from the use of or reliance on such information. You should seek independent financial advice prior to acquiring a financial product. All securities and financial products or instruments transactions involve risks. Please remember that past performance results are not necessarily indicative of future results. The information found within this document may be accessed worldwide however it is not directed at residents in any country or jurisdiction where such distribution or use would be contrary to local law or regulation. Absolute Return Trading Pty Ltd is not registered with any US regulator including the National Futures Association ("NFA") and Commodity Futures Trading Commission ("CFTC") therefore products and services offered on this website is not intended for residents of the United States.

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