Trading Tips - Position Trades with CHAOS Levels: Example with BPCL

In this issue of trading tips, we give an example of buying in BPCL and how CHAOS levels enabled us to identify two buying opportunities, in recent months.

In early October 2001, the three chaos lines were inter-twined with each other, thus suggesting a sideways market. Then, the chaos lines changed direction and gave a buy signal. A buy signal comes when the three chaos lines are aligned to give a bullish trend. This alignment is:



GREEN - At the top
RED - In the middle
BLUE - At the bottom

This happened on October 12, 2001. See chart below. The stock could have been purchased for 159.45, at the close. Note that prices continued to drift sideways for many days even after the buy signal was received.

But, soon enough BPCL began an impressive up move.

On December 10, 2001, almost 2 months later, BPCL rose shaprly but could not sustain the highs, and close lower. This was a Range Expansion – A sharp rise / fall with a large range. This is usually a sign that the stock will experience at least short term exhaustion. We could have exited around Rs 212, for an excellent profit.




A second chance to enter BPCL came in January 2002. After a sideways drift for more than a month, BPCL again gave a chaos buy signal on January 23, 2002. The three Chaos lines were aligned in a bullish trend. Buying could have been done around 210.45. After a sideways drift for a few days, BPCL broke out to new highs. A range expansion took it to 280 where profits should have been taken. This happened around February 11, 2002.

For best results, a chaos buy signal should be supported by some additional inputs. In case of BPCL, in October, our newsletter had identified this stock as having broken out with the potential for new highs. In January, BPCL was trading sideways for over a month and could breakout in either direction – up or down. Once the Chaos buy signal came, we could anticipate that the breakout would be up and take positions.

No positions should be taken without a clear concept of the EXIT route if things do not go our way. For Position Trades, stop loses should be put around 10% below the buying price.

How to Become a Trader: 11-Step Plan for Success.

The fact is that the overwhelming majority of new traders lose their trading capital when they start. Markets have a way of seductively looking predictable and tradeable, but that's only until you take a position. At that point, they go nuts and you lose your money.

But now, I'm going to turn around and tell you that yes, it is possible to make money in trading . There are some basic ground rules you need to know, and you have to have or develop a lot of patience. Advice (even mine) must be taken and viewed with a critical eye. The trick is to learn a lot, watch what other people are doing, and then you will have the foundation to pick out what is right and wrong for you. Trading is an intensely individual effort.

The 11-Step Plan to Trading Success

1. Get some books that give a basic overview of the stocks, options and futures markets.

2. Get a book on technical analysis of stocks and futures.You're welcome to do fundamental analysis if you want (growth prospects, industry profile, interest rates, etc.), but I'm a technical trader, so you get my point of view here.

3. Read the books. If you feel impatient, well, then this is good training. Sit and read. Yes, the markets are in motion now, but they will still be in motion when you are ready to trade. There is no single grand missed opportunity here. The markets will give us opportunities every day.

4. Now get a book on trading discipline, money management, etc., if you haven't already read some things about those topics. Don't overdose on psychology; everyone will pretty much say the same things. One iteration of, "Control risk, stay capitalized, use stops" is about all you need, though you may need to read it a few times

5. Figure out how you're going to get your data. A good idea is to subscribe to a data service like Technical Trends. (http://www.technicaltrends.com). They give you data including intra day data during market hours) and a free software and a daily newsletter

6. Start watching markets. You may notice that you have not started trading yet. Good. Yes, you probably just missed that huge move in Rolta. So what? Be patient. Say it with me again: Markets are in motion now, but they will still be in motion when you are ready to trade. Do not be led astray by the feeling of missing the train. So, start watching markets. Find your favorite technical formations and indicators. Watch the markets go up and down, or not.

7. At some point, you should start looking at a market and saying, "It's going to go up. It's right there in front of me. When this starts to happen, it is a sign that you are ready to paper trade. Set up a simple way for yourself to track the following things:

* The date you took the trade

* The date you exited the trade

* Your entry price

* Your exit price

* Net result after subtracting commissions and fees

* The reason you took the trade

* The reason why you exited

* Anything about why it did or didn't work.

And then write down your entry price. Be realistic to the point of pessimism; you're not trying to convince yourself to trade, here, you're trying to demonstrate that your reasoning is sound. You already know that you want to trade, and that you want to win. The easiest thing to do is to take the closing price for the day. Whatever you do, do not use the high or low for the day as an entry or exit price. It's just not realistic.

8. Now that you're here, paper trade like crazy. Do as many markets as you want, because it's free. This will give you a great idea of how much work you can handle. Never pull tricks like letting things drift for a few days, and then going back to discover that if you'd exited on Wednesday, you would have had a nice profit, so you make your paper exit occur on that Wednesday. If you didn't make that decision on Wednesday, it's lost forever. This is a dry run for what you will do when you are trading. Never, ever, give yourself slack by being generous with entries and exits, omitting bad trades, changing your mind after entry, none of that. You are lying to yourself, and you are trying to hurry and convince yourself to trade, not to prove that your method works.

9. Paper trade until you have had at least half a dozen trades in strongly trending markets, in whipsaw (violent ups and downs without actually going anywhere) markets, in gradual trend markets, and in doldrums markets. This will take many weeks to the better part of a year. Impatient? So what? One more time: Markets are in motion now, but they will still be in motion when it's time for you to take real trades. Work on your system

10. When, and only when, you have adequately tested your system on paper and found that it worked pretty well in many circumstances, and it's something you have time to do, and you have the money to risk, then go find a broker (with low commissions) you like and open an account.

11. Get going! You tested your system, right? Then look for signals and take them just as aggressively as you did on paper. Change nothing about your approach in the real market. If you are being timid, then you lack confidence in something; stop trading and figure out what's wrong. Are you taking losses? Are they unexpected? Really? Then stop trading and figure out why your paper trading didn't take account of what is happening now. If there is a fatal flaw (a couple of ticks here or there is making a big difference in the real world, for example), stop and get back to work on your system. Don't tinker with the system in the actual market; this is what I did for a while, and it's just a frustrating way to lose money. If you are taking expected losses but decide that real money going down the drain is too painful, then stop trading and start looking for a new way to approach your trading.

Put Call Ratio

The Put/Call Ratio is the total number of traded put options divided by the total number of traded call options on the National Stock Exchange of India (NSE) on a given day.

Since there are generally more call options traded than put options, the ratio is usually below 1.

Example:

On February 15, 2001: the total number of Calls and Puts traded were:

Number of Calls (contracts): 7723

Number of Puts (contracts): 1693

Put-Call Ratio = Puts / Calls

= 7723 / 1693

= .22 (Rounded off to 2 decimals)

This is an important CONTRARIAN indicator of investor sentiment.

Put/Call ratios are commonly used as a measurement of market sentiment. It is widely believed that the “PUBLIC” is typically wrong on the market and thus should be used as contra-market indicators. In other words, when “PUBLIC” are overwhelmingly buying calls, it is bearish as they are probably wrong in their bet. Conversely, when put volume is at extreme levels, you should turn bullish as the put buyers are probably wrong.

The Ratio is drawn as a line chart.

When the ratio gets too low, it indicates that call volume is high relative to put volume and the market may be overly bullish or complacent. When the ratio gets too high, it indicates that put volume is high relative to call volume and the market may be overly bearish or in panic. Traders look to sell when the ratio gets too low and the market is extremely bullish. They look to buy when the ratio is too high and the market is extremely bearish.

In short term trading, bullish conditions often become more bullish, and bearish conditions lead to more bearishness. Therefore, use of this indicator is more difficult for short-term traders.

Given below are the S&P Nifty and the Put-Call ratio charts. Note that high ratios indicate market bottoms, while a low ratio indicated the beginning of a reaction.



Like most other overbought / oversold indicators, the Put-Call ratio should be used with care.

Why Turtles made a splash ?

Imagine a technically-driven futures trading system with a big reputation where traders are told to expect up to 70 per cent of their decisions to be wrong. At the same time, an extremely basic system where the principal consideration is changes in price and the main aim and challenge is to identify a clear price trend - up or down - and then stick with it in a disciplined way.

The system is the quaintly named Turtle method, a technique that attracted a better than fair share of US media attention during the late 1980s and early 1990s as a whiz bang way of training successful commodity traders. Turtle trading and its founders get three chapters in the best-selling Market Wizards financial books.

The Turtle system, claims Russell Sands - one of the original Turtles, is a very straightforward way of trading futures and currencies. While it can be used to trade shares, it works better on securities that are more likely to exhibit trend-like behavior.

One of the important features of Turtle is it makes no attempt to anticipate markets. "When we go with a trend, we have absolutely no idea how long it will last or how far it will go," says Sands, a protégé of the system's creators, countrymen Richard Dennis and William Eckhardt. Turtle traders start with the basic assumption that markets follow trends. The principal requirement before there is any trading action is that the trend must be firmly in place.

If prices go up for 20 days in a row, for instance, that signals the start of an up trend. The end of the up trend comes when prices reverse for 10 days in a row.

The big thing about the method, says Sands, is that Turtle traders - if they play the game properly - never enter a market too early and never pick the bottom. Prices have to rise for a reasonable period and build up some momentum before any action is justified. Equally, they must clearly show they are on the way down before a position is closed out.

But once a position is taken, it stays in place until the criteria are met for a trend reversal. It therefore takes a certain amount of opposite price movement before a trader quits a position.

The same rules apply for short positions. Sands says he took a sold position in August gold futures about three weeks ago after the price had retreated for the requisite number of days. The gold price when he acted was $US395 an ounce and he expects to stay with the downtrend until the market rallies for, say, 10 days in a row or he is stopped out by sharp movements.

Turtle trading also incorporates price-related stop losses as part of the overall money management strategy.

These rules relate activity to a trader's resources and strive to discourage overtrading. There are other guides that suggest how profitable positions can be enhanced by expanding a position using unrealized profits.

The biggest trap for futures traders, says Sands, is overtrading. An important part of the Turtle method is putting this into context in terms of market psychology and trading behavior and defining the probabilities of overall ruin due to over-exposure.

The Turtle system argues that if traders wish to stay in the game for the long haul they should try to risk no more than 2 per cent of their total funds at any one time. This means having enough in the way of financial resources to make worthwhile trades but also stay in the game. "Running a $20,000 trading account and then trading five or 10 gold contracts on this is suicidal behavior," says Sands. His personal method is to trade one contract for every $30,000 of capital. Although markets can be traded with less capital, it increases the risk of being wiped out.

An extreme example is a gold trader with a $5,000 account. With such a small amount, setting a stop loss at 2 per cent of account size is obviously uneconomical as it represents scope for just a $1 price move.

If the gold price is given $5 to move, the money at risk in a 100-ounce contract is $500, or 10 per cent of total funds. But someone with $30,000 will be risking less than 2 per cent of their total funds. The same small trader will, of course, make a more impressive profit if he wins. But then, however, trading becomes more of a function of courage rather than a discipline.

"Obviously the bigger risk you take when you trade, the bigger the reward if you're right. But equally, the smaller you trade, the less chance you will go bust," says Sands. The Turtle philosophy is to trade many times as small as possible in order to stay trading forever. This is important, says Sands, because 60 to 70 per cent of the time the identified trends fizzle out and traders wind up losing a small amount of money. The compensation comes when a solid trend is identified which rewards the trader handsomely. "Maybe 30 per cent of the time you are right and when I win with Turtle I can make between five to 10 times what I've previously lost," claims Sands.

The 12 Commandments Of Technical Analysis

There are no hard and fast rules about technical analysis, But Here Are 12 Guidelines that will help you succeed.

1. Always assume the current trend is in force until the majority of evidence indicates otherwise.

The biggest mistake most traders make is selling too soon. The second biggest mistake is buying too early. You want confirmation from multiple sources before you take action. Stocks always move in funny lines and unless you have the discipline to ride out the smaller jiggles, you will be furiously trading without ever capturing longer, sustainable trends. Trends are persistent so give yourself the opportunity to ride those trends for all they are worth.



2. The more frequently a trendline is touched, the more valid that trendline becomes.

Trend-lines are fickle but can also be very faithful. The best trend-lines will regularly tell you they love you by repeatedly touching the prices, over and over again. The more a trend-line is touched, the more dependable that trend-line is.


3. The longer a trendline is in force, the more valid that trendline becomes.
This is a corollary to the above principle. Trend-lines that have been in-tact for an extended period of time are usually very reliable. Some traders mistakenly think that something that has gone up for a long period of time cannot continue much longer. Not true. Long trend-lines are very dependable and very worthy of your consideration. Of course, nothing last forever but jump on board and enjoy the ride until it reverses. One thing about long trend-lines -- once they are broken, it is usually time to get very worried.



4. Uptrends live above 50 and downtrends live below 50.

Stocks that wiggle back and forth between positive and negative RSI readings are bad news. Persistency is the quality you should admire most in a stock so concentrate on those that have a recent track record of staying in positive territory and avoid those stocks that cannot generate enough buying pressure to stay above 50.



5. Generally, you should avoid making new purchases when RSI is in overbought territory and avoid selling existing positions when RSI is in oversold territory.

Like a rubber band that is stretched too far, stocks that rise into overbought territory are usually ripe for a near-term pullback. Conversely, stocks in oversold territory should experience a bounce. In both cases, the best time to take action is as soon as they move out of these extreme readings. One caveat is that the more volatile the stock, the longer they can survive in overbought/oversold territory. Volatile stocks can move fast and continue moving fast so change your guidelines to extremely overbought or extremely oversold for these types of stocks.



6. Trendlines get broken all the time. RSI will tell you if you should re-draw your trendline or if a trend reversal is developing.

One thing you need to get used to is that trend-lines are never as straight as you want them to be. Every time a trend-line is broken, you need to make a decision whether a trend reversal is developing or whether you should re-draw your trend-line to incorporate the new low. Do not take a guess - ask your RSI friend what to do. A trend-line break accompanied by a positive RSI reading tells you that things are still okay and that it is time to draw a new trend-line. A trend-line break accompanied by a negative RSI reading tells you that a trend reversal is possible (not absolute) and that you need to be wary of a potential sell.



7. Breakouts above resistance are usually good times to buy.

Breakouts below support are usually good times to sell. Breakouts are to technical analysis what voters are to politicians - they are supposed to get your attention. Whenever you see a breakout, you should assume that there has been a powerful shift in investor perception. Either a lot of new buyers have jumped on board or a bunch of sellers are running for the exits. In either case, a significant change has occurred and you should take action. The Stock Market is pretty smart. Things go up or down for good reasons. Breakouts deserve your attention.



8. Always look at three factors before buying or selling - trendline analysis, support/resistance lines, and momentum indicators.

The point of all this technical analysis stuff to play the odds. Nothing is guaranteed but a lot of things are probable. You want to find those circumstances when the odds are most in your favor. The way you improve your odds is when you have confirmation from several sources. You want to find stocks with clear trends, favorable support/resistance characteristics, and positive momentum indicators.



9. Your best buys will usually occur after a stock recovers from a deeply oversold reading.

Your buys will usually comes from two sources - stocks that are already moving up (buying high and hoping it goes higher) or finding trend reversals (buying low, hoping to sell higher). If you are looking for bottoms, your most profitable buys will come from stocks that are recovering from deeply oversold readings. This does not mean that you should automatically buy stocks that are deeply oversold. It does mean that when a deeply oversold stock does turn positive, it usually produces big gains.



10. Resistance, once broken, becomes your new support level.

Conversely, support, once broken, become your new resistance level. Pretty straightforward stuff but often overlooked. This principle is important because it helps you identify your mistakes. Buying on breakouts is usually a very good idea. However, if a stock does a quick turnaround and drops below that old resistance (now support) you may have been pushed into a bad trade. Making mistake is not fun, but not admitting them when they happen is very expensive.



11. Let your winners run and cost your losses.

During the course of your trading career, you will have many opportunities to capture a quick buck. While it may be tempting to grab a quick 10% gain, you should not sell until there is compelling reasons to do so. You will probably have a lot of small, profitable trades but there will always be that one or two trades each year that makes you a bunch of money. The success of your year will depend upon that one or two monster trades. On the other extreme, holding on to your losers will probably result in deeper losses. You will screw up - guaranteed. We all do, but the important thing is to cut your losses and look for the next monster trade. Stocks go up and down for good reasons. Do not try to figure out why. Just go find a new, more friendly sandbox to go play in.



12. Expect 1 out of every 3 trades you make to be losers.

Technical analysis will constantly test your faith. Not only should you expect to lose money on about 1 out of every 3 trades, you find that your losers usually come in bunches. You might have 10 good trades in a row and then 5 dogs. It is easy to lose your faith when everything you touch seems to turn into dust. However, if you minimize the impact of your mistakes by quickly cutting your losses, you will be able to prosper as a technician.


These are time-tested principles that will help you sway the odds into your favor. Apply discipline, logic, and probabilities to your stock picks and you should do very well. Re-read these principles frequently. I do and I find it helps me avoid the big mistakes. I hope it help you too.



WARNING:
The above information is provided for general information only, and is not intended for trading purposes. You should carefully consider whether any trading in which you expect to engage will be suitable for you given your financial objectives and financial condition.

TECHNICAL ANALYSIS : QUESTIONS AND ANSWERS

This Article is actually a reply sent by Bob Fulks, a respected technical trader, to questions raised on technical analysis.


Question 1) I realize no method is perfect, but can technical analysis be as effective a method for equity (or other market) selection and timing as compared to analyzing fundamentals or some other method?

Answer 1)

The two methods are quite different. The reasons equities change price is due to both longer term fundamental factors, such as revenue and profit growth, and short-term psychological factors, such as people thinking it will be worth more tomorrow. The problem with fundamental analysis is that if no except you understands that an equity is undervalued, the price may not move up for years. Fundamental analysis tends to work if there are industry analysts following a stock and promoting it to their clients. Technical analysis just looks at what is happening now and doesn't much care why it is happening. Most people on these lists care primarily about
technical analysis.


Question 2) If the answer to #1 was positive, is automating the process to a trading system the next logical step? Do real/full-time traders use trading systems to make real income?

Answer 2)

Many people look at charts and make decisions on chart patterns. The human brain is very good at recognizing patterns that are almost impossible for a
computer to interpret. But it is hard for a person to be objective. There are hundreds of indicators and it is easy to look at enough indicators and
see what you want to see. Trading systems are objective but can only handle situations that they are programmed to handle. Lots of traders make real
income using trading systems, (even though many academics will tell you that technical analysis doesn't work.)


Question 3) If the answer to #2 was positive, would you recommend the TradeStation software to a close friend? Is the product a necessity for a serious ta/system trader? If you had it to do again, would you plunk down another $2400+ dollars for it? If not TS then what?


Answer 3)

If your trading system is more than a few lines in length, (and it better be), there is really no other choice. There are other products but they tend to be limited in what kind of systems you can create. SuperCharts has many similar features but the lack of the PowerEditor makes it nearly impossible to write other than very simple indicators and systems.

In addition, there are a large number of programs for TradeStation that are available from many sources. This makes it easy to build upon the work of
others and helps you learn the many quirks of programming the product. People hate Omega Research because Omega tends to do dumb things that
alienate their customers. I could never figure out why. I was an executive of a software company before I started trading and we would never think of
treating our customers the way Omega treats theirs. TradeStation is the only choice now but there are companies trying to end that dominance. Many
users would quickly move to another product if they had a real choice. It certainly is not perfect but as of now, it is about the only game in town.
Lots of people can make it do marvelous things. To put the cost in perspective, the cost of the software will be insignificant when you consider the cost of the time you spend learning to use it and the cost of all the money you will lose learning to trade.


Question 4) If the answer to #3 was positive, were you successful and what were your experiences developing your own profitable system? Did you find it necessary to obtain one from another source? If so, how does one evaluate these sources?

Answer 4)

Don't plan on making money with the canned systems and indicators that come with the product. These are really just examples to learn from. To create a
profitable system, you will need to write your own system in their EasyLanguage. The language is pretty easy to learn if you have any computer
programming experience but can be pretty difficult if you don't. Most of the power is in the library of functions which take a lot of time to learn
to use effectively.

There are also several newsletters, such as TSExpress, that explain many of the idiosyncrasies of using the product. I suggest you buy several of these
and get all the back issues. It will save you a lot of effort. Developing a trading system that really works seems to be hard for a lot of
people. Recent threads on this list have been discussing this topic in detail. I think the main problem is that people try to use the popular
indicator functions. There are many popular indicators such as MACD, RSI, ADX, etc., that have been developed over the years to help people try to
see changes in trends on charts. These always look good on charts. They were developed as stand-alone indicators to show some feature and work
pretty well for this.

But many people try to combine a bunch of them together to generate buy/sell signals. In my opinion this cannot work well. After all, most of
these indicators start by using the price as the input. The indicator functions then manipulate the price lots of ways to derive a new value for
the indicators. People then manipulate these indicator values lots of ways to create a trading signal. But, by the time the original price data has
gone through all of these transformations, it is impossible to understand what is really happening. They then tune lots of parameters until
TradeStation tells them that combination of parameters would have made money if they had that code with those values to start trading a few years
ago. And then they get discouraged when they lose money trading the system. I feel that it is better work directly with the raw price data and
manipulate it in ways that make logical sense to you.

The other option is to purchase a trading system from someone. In my experience, this rarely works because there are so many variables in every
style of trading. It is very unlikely that you will find a good system that actually works and that fits your style of trading. Besides, most of the
ones that you can buy for any reasonable price are worthless. Why would anyone sell you, for a few thousand dollars, a printing press to print
money? Most of the ones you can buy are locked so that you cannot see the code (called "Black Boxes"). If you don't know how something works, it is
hard to really have enough confidence in it to trade it.

There are many vendors selling professionally developed components that you can use to help develop your systems. (Jurik Research, SirTrade, etc.)
There are also consultants that will help you develop systems for a fee. Many are very experienced.

Question 5) I don't mind putting in hours and hours of reading and research and adding this to my share of hard-knocks, but I want to feel that my initial learning efforts are headed in the right direction. Any comments or opinions from individuals who are truely "walking-the-walk" would be very much appreciated.

P.S. My apologies to those who've heard these questions for the 10,000th time. Maybe a FAQ for new comers is available?

Answer 5)

I thought your questions were well thought out and worth the effort to answer. These are obviously my personal opinions. Others will probably disagree.

Bob Fulks