Friday, September 26, 2008
Let's pause for a while and think about the events happening right now. The only words you hear these days are bankruptcy, take over, rescue package, jobless claims, and so on. Lehman goes bust, Washington Mutual taken over by J P Morgan, AIG almost going bust if not rescued, Merril Lynch gone, Investment Bankers become house cats.
What can a trader do at such times? Well, the answer is definitely not in black or white. Never keep an open position without a stop loss. Do not expose yourself to a huge loss. At the same time, volatile times are best for making profits once you set a good stop loss order. Make money but at the same time, play safe. It is definitely possible.
Thursday, September 18, 2008
The Stochastic oscillator compares where a security’s price has closed relative to its price range over a specifically identified period of time. This is a predictive indicator in that it gives advance signals for buying and selling.
The indicator has been developed from the basic observation that prices tend to close near their high in an upward trending market and near their lows in a downward trending market. Further, as an upward trend matures, price tends to close further away from its high; and as a downward trend matures, price tends to close away from its low.
How is Stochastics Used ?
This indicator is often used to predict trend reversal. The indicator tries to determine when prices start to cluster around their low of the day for an up trending market, and when they tend to cluster around their high in a down trending market. Lane's theory is these are the conditions, which indicate a trend reversal is beginning to occur.
The stochastic indicator is plotted as two lines. They are the %D line and the %K line. The %D line is more important than the %K line.
The stochastic is plotted on a chart with values ranging from 0 to 100. The value can never fall below 0 or above 100. Readings above 80 are strong and indicate that price is closing near its high. Readings below 20 are strong and indicate that price is closing near its low.
A very powerful move is underway when the indicator reaches its extremes around 0 and 100. Following a pullback in price, if the indicator retests these extremes, a good entry point is indicated.
Ordinarily, the %K line will change direction before the %D line. However, when the %D line changes direction prior to the %K line, a slow and steady reversal is usually indicated.
When both %K and %D lines change direction, and the faster %K line subsequently changes direction to retest a crossing of the %D line, but doesn't cross it, this is a good confirmation of the stability of the prior reversal.
Many times, when the %K or %D lines begin to flatten out, this is an indication that the trend will reverse during the next trading range.
These are just some of the important and popular oscillators and indicators. There are many more. You need to study and pick the one that best suits your personality, apply the indicator and specialize to maximize profits.
RSI, unlike what the name may suggest, is an indicator of a security’s strength to itself. It does not compare a security with an Index or a security with another security. The formula for RSI is:
D - Average of downward price change
How is Relative Strength Index Used ?
RSI is an indicator that follows price and ranges between 0 and 100.
The most popularly used Relative Strength Index is the 14-day RSI. Other regularly used ones are 9-day and 25-day RSIs. The lower the number of days used for calculation, the shorter the time frame it can be used for. It also tends to be more volatile. The practical application of RSI needs some experience as it cannot be applied directly.
The RSI usually ranges between 30 and 70 in an ideal market. The tops and bottoms are usually formed before the underlying price. In a bull market, this range may be 40 to 80. Similarly, in a bear market, it may range from 20-60.
RSI very often displays chart-like pattern such as double top, inverted head and shoulders and so on even though they may not show on the actual price charts. One can identify such patterns to trade successfully.
This is where the Relative Strength Index surpasses a previous high (peak) or falls below a recent low (trough).
Support and Resistance
Supports and Resistances are sometimes more clearly on the RSI chart than on the price charts.
When the price makes a new high but the RSI does not do so, it is called a divergence on the RSI chart. Eventually, prices correct and move in the direction of the RSI. Thus, divergences are indications of impending reversal. When the RSI turns and falls below its most recent trough, a confirmation of the reversal is obtained and a “failure swing” is said to have occurred.
MACD is a lag momentum indicator that shows the relationship between moving averages of prices. It is the difference between a 26-day and a 12-day exponential moving average. On top of this, a 9-day exponential moving average is plotted. This 9-day EMA is called the signal or the trigger line and is used to spot buying or selling opportunities.
How is MACD Used ?
MACD is best used in markets that are prone to wide swings in a trading sense. The three best methods of using MACD effectively are:
The primary use of this indicator for trading is to buy when the MACD rises above the signal line and to sell when the MACD falls below its signal line. Another use is to buy when MACD goes above zero and sell when MACD goes below zero.
MACD can be put to use as an overbought/oversold indicator too. When the shorter MA pulls away too much from the longer MA, it means that the security/Index is over-extended and that it is likely to return to realistic levels soon. This of course, depends on the nature of the movement of the security or Index that is being analyzed.
The divergence of MACD from the price may indicate that an end to the current trend is at hand. A bearish divergence happens when the MACD is making new lows but the prices do not. Similarly, a bullish divergence occurs when MACD is making new highs but the prices do not make new highs. Divergences are more important when they occur at the overbought/oversold levels.
Tuesday, September 16, 2008
First proposed by John Bollinger, Bollinger Bands are one of the most popular overlays. This indicator gives you an idea of how the volatility for a security is related to the price levels over a specific period of time. An integral part of the Bollinger Bands is Standard Deviation. Standard deviation ensures that volatility is immediately factored in. The bands can expand or contract based on the volatility.
Bollinger Bands are actually made up of 3 distinct bands. The attempt is to capture a majority of a security's price movement within the bands. A simple moving is at the core of the band and is at the middle. The upper one is the SMA + 2 standard deviations and the lower one is the SMA -2 standard deviations. An example is 20 SMA with 20 SMA + 2 standard deviations and SMA – 2 standard deviations.
The SMA and the number of deviations can be adjusted to suit the personality of the security that is being analyzed.
Saturday, September 13, 2008
The main variables that make up the Parabolic SAR are Step and Maxmum Step. Wilder suggests keeping the values at 0.02 and 0.20. Parabolic SAR performs best in trending markets
The higher the value of the step, higher is the sensitivity of the indicator with respect to price change, but that does not mean that a very high step is desirable. When it is too high, the indicator is too volatile and this limits its usefulness. The Maximum Step is used for adjusting the SAR as price moves. The lower the Maximum Step, the higher the distance to the trailing stop from the price.
Sunday, September 7, 2008
Indicators are the lines formed out of calculations based on the price, volume, time, or another related parameter.
Indicators that are derived and plotted over the price chart use the same scale as the price and are known as Overlays.
Some of the popular Indicators are the following:
- Moving Average Convergence Divergence (MACD)
- Relative Strength Index (RSI)
- Williams %R
Some popular Overlays are the following:
- Moving Averages
- Moving Average Envelopes
- Parabolic SAR
- Bollinger Bands
Wednesday, September 3, 2008
It is well known that Technical Analysis is useless without the proper combination of Risk and Management. I'll add Mind Management to this list.
My personal choice of indicators are the following:
- Williams% R
In this series, we'll focus more on the behavior and the use of indicators, understanding what they are trying to say and not restrict our focus to the math angle.
The most important element also is the study of waves. Study need not be to the depth of an Elliot or O'Nealy, but enough to give practical chances in the market. The aim is always to ride a good position as far as possible and to cut out a bad one early.
Sunday, August 31, 2008
Very simple. If you don’t have money, you cannot trade. This means protecting your money is your prime concern when you trade frequently. Profits will come eventually. The best way to minimize risk is not to trade when conditions are not to your liking. Also, trading in a sideways market is not healthy for a professional trader. Volatility is alright as long as you know how to manage risk. Use leverage only if you can trade responsibly, not recklessly. Leverage is a curse for those who do not trade responsibly.It is famously said that you should trade money that you can lose. For most of us, that amount is very difficult to define. You should spend a lot of time to think what it is for you. There are established money management calculations to help in doing this. Before starting to trade, you should indulge in judicious planning. When you have started active trading, never forget to keep the concepts of Money Management in you mind all the time.
Trading is Boring
The popular myth that draws most people to the stock markets is because they think that trading is easy and exciting. This is as far as it can get from the thruth. Trading is boring to professionals when executed well. There is Buying and Selling. But the most time should be spent in Waiting. Waiting for the right opportunity to surface, waiting while holding good positions. If you seek thrill, try the roller-coaster ride, your kids too can enjoy !
Five Steps that Pros follow to Make the Most of their Trades
- Do analysis take a position
- Keep a smart stop loss. Stop loss triggered ? You're out of the position. The position goes in the direction you predicted ? Move to step 3
- The market is communicating that you are right, in that case, add to the position.
- Trail the position with smart stop losses.
- Out of the position only when your stop gets you out.
"Investing in a market where people believe in efficiency is like playing bridge with someone who has been told it doesn't do any good to look at the cards."
"It has been helpful to me to have tens of thousands (of students) turned out of business schools taught that it didn't do any good to think.”
~ Warren Buffet on Efficient Market Hypothesis
Keep smart trailing stop losses. Kick out the loser smartly.
Patterns in Day TradingWatch your breath when you take a position in day trading. It will definitely not be normal. My observation is that more brittle the emotional make-up of the individual, more hurried is the breathing. In any case do emotional traders really survive eventually ? Maybe if they learn to channelize it into useful energy. But that is a hard and long story. We will deal with that some other time.
Being Humble is not just a heavenly virtue heard in churches. The mature trader is always humble, after being battered time and again in the markets. So why not start it a bit earlier ? Believe me, it pays to be humble, otherwise one goes to the market every day with confidence only to be smashed time and again. This is very common among traders early in their career.
There is a danger here that if it becomes a habit it can lead to losses.
You make money if you are right with your directional call. It is observed that many traders make losses on days that the market goes in the direction that they are not comfortable with.
If your system is solid and you are following the correct risk management and money management technqiues and still noting that you are making losses, more often than not, the culprit is market direction.
Simply stop trading for a while. Wait for the trend to reverse (if it does happen) and only then start again.
In situations where the prices move up violently such as the point SL 7, shown in the figure, stop loss may be kept by following other methods such as mid points of large-bodied candlesticks, gaps and so on.
Technical Analysis is one thing, but if you correctly trail the position with smart stop losses, you will see that you will be able to ride the profits since the stock continues to make higher highs and higher lows. Similarly in the case of a position where you are short and the stock or futures product makes lower highs and lower lows, you can keep moving your stop loss lower and lower (but higher than the last wave’s top.)
Trailing stop loss is an art that can take a life time for many to master.
I take a position and keep a smart stop. Now I want to trail. There is a scare early that probably makes a peep at marked to market loss. If I'm right (which is not that big a deal for any self-respecting analyst) then I should be well on my way to break even and profits. This is natural.
Now how do you know when to exit ? This is a tricky question for many, especially for those who do ultra-short term trading, scalping, jobbing, whatever the name.
Do I book my profit a couple of points after my "target profit?" No, say experts, trail till your last breath :). The best way to deal with, in my experience is, once you have reached a level of good profits, (that can come handy in loss making up for loss making trades) start tightening the stop. But never loosen your grip. If your stop is reached, make an exit. If there is a jump and your stop loss level is exceeded, exit at whatever best price you get. I for one, never keep a stop loss. Its always mental (Warning: This is only for experienced traders, beginners must always keep real system stop losses.)
But there is some skill required when you keep a mental stop loss, because the mind starts playing games. So observe your behavior carefully. Note down every step, discuss with an expert and then come to a conclusion on what works best for you.
- You decided to trade
- Did the homework
- You went after other's systems and it didn't work. Sounds familiar ?
- You decided to trade
- Did the homework
- Trading is very personal. One person's indicator is another person's misdirection. Or something to that effect. Get the message ?
- Get the system checked by an "expert" (a very rare species, let me warn you.)
- This is a system that you will go by for the time being. It works for you. You will know soon enough anyways. The market is a ruthless teacher, isn't it ?
- If this system is true to your personality, you will grow with it. By growth, I mean you will only have to make nudges and pushes to the system, not overhauls.
- One key clue that can be noted from your performance is that you know instinctively that you have committed a mistake when you really do. This is the verification that indeed the system you have chosen is consistent with your psychological make-up
The US (United States of America) markets are so far the model and in every way a huge giant. Very deserving for someone who has laid the foundation of capitalism and enterprise, encourging the best talent in the world to themselves. The stocks here are very liquid and you have an entire universe of big and small stocks in different markets. NYSE (New York Stock Exchange) and Nasdaq are the premium stock exchanges. CME at Chicago (Chicago Mercantile Exchange) and CBOT (Chicago Board of Trade) are leading derivatives exchange with an awesome array of products on offer for trading. One wonders if the basic idea of derivatives is being served purposefully or is it excessive trading behavior that Warren Buffet at Berkshire Hathaway says will go ka phut. I love futures and I hope some one will really prove that the excess is required :)
Japan is by far the biggie in Asia. Hong Kong too does premium, cool business. Nikkei still stands tall even though it saw a mountain and a valley.
Singapore, China, India are other markets of note. Thailand, Indonesia, Malaysia too have their own niches catering to regional demands.
Europe is another story altogether. These guys somehow manage to do things efficiently. Neat and tidy. London is one global hub. Other than that there are giants in Germany, The Netherlands. France and Italy lag a bit behind the leaders.
Canada, Russia, some south American markets like Brazil, Argentina and so on have their own places. Now, it will be interesting to see how things shape up in the future. Imagine a situation where terrorism drives people indoors. It will be a different world with the new trading pits being the bunkers, basements, underground haunts. The networked world will pose interesting changes. Lets see.
Follows a mix of quantitative and qualitative methods to pick stocks and is a medium term investor. He is known to have turned $ 5,000 into $ 200,000 within a year early in his career. He is also famous for following a strict stop loss criteria for his holdings.
Listen to the market. It talks to you. If you are right, there is a subtle message it gives
In the futures market, the risk takers have already loaded up and they show their approval by moving the market in your direction.
If you are wrong better be out with your normal stop.
- Impulse Trading
The reason is very simple. When you don't make enough money trading your Edge, how can you hope to do so with something that you are unsure. If you are in it for the long run, abandon such behaviour. You may be lucky a couple times, but the law of averages will hunt you down easily.
- Timing Entries
Example: Suppose you use a simple Stochastics buy signal to enter. If you scalp based on 1 min chart, allow the Stochastics to give a clean buy. In case of futures trading you always get a pullback to enter safely. The key of course, is how well you ride the trade when you are right and cut out the loser early.
Almost always, check the higher level time period chart. It helps if you are in the direction of the larger trend.
- Impulse Trades are a strict No-No
- If you do take it by mistake, don't do it again if you want to be a serious profit-making trader
- Ok, you did take an impulse trade ? Do the following:
Watch it more carefully than you would do with a normal trade that follows your system.
Keep a stop loss or limit in mind immediately and no matter what, GET OUT at that level. If it moves in your direction, trail it with the same rigourous discipline.
Without confidence it is not possible to achieve much in other streams of life. In the equity markets, it is doubly true. If you lack in self-confidence, doubts may creep up in your mind. This may lead to indecision, which in turn lead to missed opportunities and losses. For day-trading and short interval trades, confidence is of utmost importance.On the other hand, on down days be careful. In many instances, you may be tempted to book small profits just to make your day balance sheet look pretty. This is not the issue. When you are faced with loss-making trades sooner or later, that same daily balance sheet will not look pretty at all.Never be far away from the correct principles of trading no matter what your mind is tempted to think. It is just too painful to reinvent the wheel.
In order to be a successful investor/trader, you must be very disciplined. Stick to the plan of action. This means that you will stick to trading policies, trading plans and so on. Know your objective and work accordingly.
Do not seek to implement new ideas that come all the time during markets. Remember, ideas are just ideas. If you feel there is value in them, they have to be thought about, refined, tested and then brought to the trading room. If you try to implement new ideas immediately to trading all you will do is to erode capital and confidence.
Do not allow hope to loiter anywhere close to your trading system. Hope has the potential to do maximum damage to your capital.
No Risk No Return. This phrase is well known and it is not required for most of us. But for those who find taking the plunge difficult, it applies strongly. In addition to this, you will not learn unless you dive.
Despair generally arises when you are not applying your rules and are taking the wrong bets. The thinking process is retarded when despair arises. Take a break, take a deep look and you will generally find that you are doing something very wrong. That is, if you are following generally known good principles of trading.You will notice that in your bad times, if you have very little capital left, you will start compromising on the very principles that will give you any hope of recovering from your losses.
When in doubt, don’t. Follow this simple rule and you will be better off in trading. There are many factors that influence the markets. At any point in time, even technical indicators, support levels, patterns may conflict each other. For example, there is a buy signal on the basis of 15 min charts but weakness in the 1 hour chart. If you cannot verify and come to a clear conclusion, just leave that opportunity alone. There will be many more coming your way.
Famous quote by a famous personality who made fame and money in his life time - J W Marriott.