Traders make money from fluctuations in price levels. By using leverage, traders can maximize return on capital. Leverage involves using margin to make more money than you can with your own funds.
Margin trading provides high rewards when you are right, but may also cause huge losses if you are wrong.
Traders are then confronted with some confusion: Leverage or margin trading can enhance return but carries high risk. This becomes a difficult decision since traders should not go for any increase in risk, but should at all times try to leverage their money for more profits.How can these two opposing viewpoints be reconciled.
The Answer:
If margin trading can be used with an always known and strictly limited risk, it becomes High Leverage with Low risk. (HLLR).
The instruments of HLLR are Put and Call options.
Buyers of puts and calls gain an enormous amount of leverage while applying only a small amount of capital. They also have limited and well defined risk.
Advantages of Option buying:
You do not have to possess large amounts of capital. (Remember, all trading activities require that you should be well capitalized.)
As an option buyer you enjoy all the benefits of margin trading when your are right, without the risk associated with leverage, if you are wrong.
Total risk is always known and limited. The maximum risk is the cost of your option.
A Trading Plan:
Successful trading depends on knowledge, courage of conviction, the discipline to execute your plan, and hard work required to develop the knowledge, courage & discipline.
In trading options, you must have the financial and the psychological strength to face adverse situations when they arise. (This applies to all trading methods).
Thursday, November 19, 2009
Improve the performance of your Trading System
Trading Systems offer profitable opportunities for making money. The Profit Test feature in Trend Mechanic allows you to test and them implement systems in real time trading. But, all systems go through periods of drawdowns. Often, the periods of drawdown are so severe that the trader abandons the system, or even system trading. While losses are inevitable, here are some suggestions to change the trading style to that we can remain in the business. There are two aspects to trading systems which can be adjusted to increase our chances of winning consistently.
First, we can try to reduce losing trades. This is not possible in a casino, but trading is a mind game, so it is possible in trading. We can try to identify conditions that are more favorable to our winners and include them in our system. We should also identify circumstances where a loser is more likely, and skip those trades. For example, if we notice that most of our winners are entered on days where the overall market has moved in the same direction as our trade, then only enter trades when the overall market is moving in the correct direction. This means that our trade is in the same direction of the overall market, rather than against it.
Another example might be that trades that are entered just before major news announcements, like the union budget or quarterly earnings, often get stopped out as losers due to increased volatility, so you should skip those trades. A study of past trades can be rewarding. It should be possible to identify many patterns of profitable & losing trades.
Second, we try to improve the average size of winners versus losers. Increasing the ratio of profits to losses so that the winners win more on average than the losers lose depends on the way you handle your stops. Having large winners in relation to losers can make up for a low win percentage, and mean that you will still make money playing the game. One method is to have a trailing stop that moves up as a trade becomes a winner. If you have fixed stops for losing trades that limit losses, but trailing stops for winning ones that allow winners to grow, then you are increasing your chances of your average winner being larger than your average loser. Generally it is better to be strict on losers by having ttighter stops that keep losses to a minimum and generous with winners by having stops that allow profits to grow. In any case you want to make losers small and winners large, so never add to a losing trade – that would be doing the opposite of what you want to achieve.
As traders, we should do whatever we can to improve the performance of our trading system, in the manner described here.
First, we can try to reduce losing trades. This is not possible in a casino, but trading is a mind game, so it is possible in trading. We can try to identify conditions that are more favorable to our winners and include them in our system. We should also identify circumstances where a loser is more likely, and skip those trades. For example, if we notice that most of our winners are entered on days where the overall market has moved in the same direction as our trade, then only enter trades when the overall market is moving in the correct direction. This means that our trade is in the same direction of the overall market, rather than against it.
Another example might be that trades that are entered just before major news announcements, like the union budget or quarterly earnings, often get stopped out as losers due to increased volatility, so you should skip those trades. A study of past trades can be rewarding. It should be possible to identify many patterns of profitable & losing trades.
Second, we try to improve the average size of winners versus losers. Increasing the ratio of profits to losses so that the winners win more on average than the losers lose depends on the way you handle your stops. Having large winners in relation to losers can make up for a low win percentage, and mean that you will still make money playing the game. One method is to have a trailing stop that moves up as a trade becomes a winner. If you have fixed stops for losing trades that limit losses, but trailing stops for winning ones that allow winners to grow, then you are increasing your chances of your average winner being larger than your average loser. Generally it is better to be strict on losers by having ttighter stops that keep losses to a minimum and generous with winners by having stops that allow profits to grow. In any case you want to make losers small and winners large, so never add to a losing trade – that would be doing the opposite of what you want to achieve.
As traders, we should do whatever we can to improve the performance of our trading system, in the manner described here.
Advantages of Systematic Trading
Advantages of Systems Trading:
There are many reasons why futures traders are turning to mechanical trading systems as their primary trading style. One of the biggest mistakes traders make is allowing emotions, excitement or fear, to overpower their logic and control over their trading. With systems trading, the trader relies on the system to select the trades; thus, freeing the trader from the burden of emotional fear and greed decisions.
Why there is NO Perfect System:
Selecting a trading system can be a difficult task. All system results are hypothetical, because they are based on past results and have the huge benefit of hindsight. The disclaimer for hypothetical results typically reads: “Past Performance does not guarantee future results.” Many trading systems seem too good to be true. Smart consumers know that when something looks too good to be true, it usually is.
Although trading systems are designed to select the most statistically desirable trades, they cannot completely or accurately predict market trends and cannot guarantee success. Countless factors contribute to market changes: price, volatility, news, shortages, wars, interest rates, increasing or decreasing money supply, etc. While some systems work in a bull market, some in a bear market, others do best during a choppy market.
What Goes Up Must Come Down:
While there is no system that can consistently assures success, that does not imply that systems trading is never profitable. Trading systems may deliver large profits during certain phases and then provide large losses later. Newton’s law of Gravity tells us that: “What goes up must come down.” Financial markets mimic this by having Bull markets and Bear Markets. Market prices will never continuously move in an upward trend. In the same way, the equity curve of any trading system will never continuously move positively. The equity curve for any high risk investment will fluctuate up and down; there will be winning and losing periods for any system.
While every trader will find himself in a losing period at times, there are strategic moves to attempt to minimize losses. A common strategy is diversification. By utilizing multiple trading systems, the trader is acknowledging that there is no trading system that can consistently make a profit. Many traders choose to use multiple automated systems, so that when one begins to lose during a certain market period, another may profit. The overall performance is not tied to only one set of rules.
Basic Techniques for Multiple Systems Trading: Portfolio vs. Selective
With portfolio systems trading, the “portfolio trader” runs multiple trading systems at the same time. The idea behind this style of multiple systems trading is that if one system suffers a loss then another system will hopefully receive a gain, thus minimizing or eliminating the loss. However, this style not only minimizes losses, but also minimizes profits: if one system is trending upward and profiting while another system is losing, then the losing system will reduce or eliminate the profit. The minimum account size for an individual trader using “portfolio trading” tends to be relatively high, because each system is trading a separate set of contracts each with margin requirements, thus portfolio system trading tends to be used primarily by high volume or high net worth traders.
The selective style falls into the category of multiple systems trading, because the trader utilizes several different systems, one at a time. Selective systems trading is designed to improve the trading performance of the systems based on modifications to the “working time” of any given system in the Market. The basic idea is to switch (turn one system off; turn a different system on) a trading system when the equity curve is expected to stop rising. While the strategy of the “portfolio trader” is to avoid taking major losses by balancing losing trades on one system with winning trades on another, the “selective trader” replaces a system that is losing or predicted to stop winning with a different system. There is no perfect method for predicting downward trends and ensuring consistent profit; profit cannot exist without loss. The process of predicting a downward trend in selective system trading is very complicated and will never be perfect; the goal is to minimize extended losing periods. A hypothetical example is detailed below.
Example: Hypothetical Selective Systems Trading Strategy for Determining when to Change Systems
Basic guidelines:
Switch system when the account has an overall daily loss at the close of the trading day.
Switch system after the account has a 5 consecutive days of overall daily profit.
Conclusion
While there are many advantages to systems trading, it must be acknowledged that there is no perfect system. While we would all like to hope that technology will advance to the point where a perfect system can be created, we must accept that the day may never come. Until that day, we feel the that the best approach is through the simultaneous use of multiple systems with a selective timing approach, so that if one system is not performing the other systems in the portfolio have an opportunity to potentially compensate and make for a smoother equity curve.
Risk Disclosure: Futures, and options trading contains substantial risk, is not for every trader, and only risk capital should be used. Any form of trading, including forex, options, hedging and spreads contains risk. Past performance is not indicative of future results. No representation is being made that any account will or is likely to achieve profits or losses. There have been no promises, assurances or warranties suggesting that any trading will result in a profit or will not result in a loss. Because there are no actual trading results to compare to the hypothetical performance results customers should be particularly wary of placing undue reliance on these hypothetical performance results.
There are many reasons why futures traders are turning to mechanical trading systems as their primary trading style. One of the biggest mistakes traders make is allowing emotions, excitement or fear, to overpower their logic and control over their trading. With systems trading, the trader relies on the system to select the trades; thus, freeing the trader from the burden of emotional fear and greed decisions.
Why there is NO Perfect System:
Selecting a trading system can be a difficult task. All system results are hypothetical, because they are based on past results and have the huge benefit of hindsight. The disclaimer for hypothetical results typically reads: “Past Performance does not guarantee future results.” Many trading systems seem too good to be true. Smart consumers know that when something looks too good to be true, it usually is.
Although trading systems are designed to select the most statistically desirable trades, they cannot completely or accurately predict market trends and cannot guarantee success. Countless factors contribute to market changes: price, volatility, news, shortages, wars, interest rates, increasing or decreasing money supply, etc. While some systems work in a bull market, some in a bear market, others do best during a choppy market.
What Goes Up Must Come Down:
While there is no system that can consistently assures success, that does not imply that systems trading is never profitable. Trading systems may deliver large profits during certain phases and then provide large losses later. Newton’s law of Gravity tells us that: “What goes up must come down.” Financial markets mimic this by having Bull markets and Bear Markets. Market prices will never continuously move in an upward trend. In the same way, the equity curve of any trading system will never continuously move positively. The equity curve for any high risk investment will fluctuate up and down; there will be winning and losing periods for any system.
While every trader will find himself in a losing period at times, there are strategic moves to attempt to minimize losses. A common strategy is diversification. By utilizing multiple trading systems, the trader is acknowledging that there is no trading system that can consistently make a profit. Many traders choose to use multiple automated systems, so that when one begins to lose during a certain market period, another may profit. The overall performance is not tied to only one set of rules.
Basic Techniques for Multiple Systems Trading: Portfolio vs. Selective
With portfolio systems trading, the “portfolio trader” runs multiple trading systems at the same time. The idea behind this style of multiple systems trading is that if one system suffers a loss then another system will hopefully receive a gain, thus minimizing or eliminating the loss. However, this style not only minimizes losses, but also minimizes profits: if one system is trending upward and profiting while another system is losing, then the losing system will reduce or eliminate the profit. The minimum account size for an individual trader using “portfolio trading” tends to be relatively high, because each system is trading a separate set of contracts each with margin requirements, thus portfolio system trading tends to be used primarily by high volume or high net worth traders.
The selective style falls into the category of multiple systems trading, because the trader utilizes several different systems, one at a time. Selective systems trading is designed to improve the trading performance of the systems based on modifications to the “working time” of any given system in the Market. The basic idea is to switch (turn one system off; turn a different system on) a trading system when the equity curve is expected to stop rising. While the strategy of the “portfolio trader” is to avoid taking major losses by balancing losing trades on one system with winning trades on another, the “selective trader” replaces a system that is losing or predicted to stop winning with a different system. There is no perfect method for predicting downward trends and ensuring consistent profit; profit cannot exist without loss. The process of predicting a downward trend in selective system trading is very complicated and will never be perfect; the goal is to minimize extended losing periods. A hypothetical example is detailed below.
Example: Hypothetical Selective Systems Trading Strategy for Determining when to Change Systems
Basic guidelines:
Switch system when the account has an overall daily loss at the close of the trading day.
Switch system after the account has a 5 consecutive days of overall daily profit.
Conclusion
While there are many advantages to systems trading, it must be acknowledged that there is no perfect system. While we would all like to hope that technology will advance to the point where a perfect system can be created, we must accept that the day may never come. Until that day, we feel the that the best approach is through the simultaneous use of multiple systems with a selective timing approach, so that if one system is not performing the other systems in the portfolio have an opportunity to potentially compensate and make for a smoother equity curve.
Risk Disclosure: Futures, and options trading contains substantial risk, is not for every trader, and only risk capital should be used. Any form of trading, including forex, options, hedging and spreads contains risk. Past performance is not indicative of future results. No representation is being made that any account will or is likely to achieve profits or losses. There have been no promises, assurances or warranties suggesting that any trading will result in a profit or will not result in a loss. Because there are no actual trading results to compare to the hypothetical performance results customers should be particularly wary of placing undue reliance on these hypothetical performance results.
Thoughts on Trading
1. A trade is neither right nor wrong. A trade can only be pofitable or not profitable. a) Profitable is good. b) Unprofitable is bad. Do something!
2. Therapy for traders on a losing streak:
a) Brag about your losses. Tell everybody. Get on the phone!
b) You’ll soon discover that for a losing trade the only thing to brag about is how small you kept the loss, how quickly you stopped the bleeding.
3. The market is uncaring. If you hang on to losing trades, telling
yourself “I’m right, I know I’m right”, the market will reduce your
trading capital down to zero.
4. As an individual trader, you’re competing against guys with PhD.s in math and physics, against giant super-computers.
a) The PhD.s are probably smarter than you.
b) Your computer is no match for the competing computers.
c) Always know where the escape hatch is for each and every trade. How fast can you get through it? Practice!
5. If you start believing that you have some special insight into the market, that you’ve “cracked the code”, discovered “the natural order of the market”, that the market will go where you say, then put your money in Bank Fixed Deposits and take a long vacation. Motorcycle drivers who stay afraid of their machines die of old age. Those who think they are “daredevil charlie” land up in hospitals.
6. The market is a mechanism for transferring wealth. It does so by causing pain. Great wealth transfers in times of great pain. Losses are a way of causing pain. Trading is a business. You go to work in the morning, go home at night, and earn a paycheck at the end of the week. Keep the size of your trades reasonable.
7. Once in a while a sure thing comes along. It’s a good day to skip trading and take a walk on the beach.
8. Getting market direction right is only the first step of a trade.
Selecting the best trade (trading strategy) is the next step. For
example, is it better to go long a put (it will decay against you)?… or to enter a call spread for a credit (it will decay for you)? The answer depends on market conditions. Money management is the 3rd step. Your goal is to make a profit, not show the world. Your profit/loss statement will accurately reflect your trading at the end of every day. Read it carefully. Understand its message.
2. Therapy for traders on a losing streak:
a) Brag about your losses. Tell everybody. Get on the phone!
b) You’ll soon discover that for a losing trade the only thing to brag about is how small you kept the loss, how quickly you stopped the bleeding.
3. The market is uncaring. If you hang on to losing trades, telling
yourself “I’m right, I know I’m right”, the market will reduce your
trading capital down to zero.
4. As an individual trader, you’re competing against guys with PhD.s in math and physics, against giant super-computers.
a) The PhD.s are probably smarter than you.
b) Your computer is no match for the competing computers.
c) Always know where the escape hatch is for each and every trade. How fast can you get through it? Practice!
5. If you start believing that you have some special insight into the market, that you’ve “cracked the code”, discovered “the natural order of the market”, that the market will go where you say, then put your money in Bank Fixed Deposits and take a long vacation. Motorcycle drivers who stay afraid of their machines die of old age. Those who think they are “daredevil charlie” land up in hospitals.
6. The market is a mechanism for transferring wealth. It does so by causing pain. Great wealth transfers in times of great pain. Losses are a way of causing pain. Trading is a business. You go to work in the morning, go home at night, and earn a paycheck at the end of the week. Keep the size of your trades reasonable.
7. Once in a while a sure thing comes along. It’s a good day to skip trading and take a walk on the beach.
8. Getting market direction right is only the first step of a trade.
Selecting the best trade (trading strategy) is the next step. For
example, is it better to go long a put (it will decay against you)?… or to enter a call spread for a credit (it will decay for you)? The answer depends on market conditions. Money management is the 3rd step. Your goal is to make a profit, not show the world. Your profit/loss statement will accurately reflect your trading at the end of every day. Read it carefully. Understand its message.
Overtrading: Are you Guilty ?
The first rule to understand is this: Futures trading may not be suitable for everyone. The risk of loss can be substantial.
One of the most common mistakes made by FNO traders is overtrading.
When you create a trading position which is much larger than justified by your capital, this is overtrading.
What is too large? A simple rule is to ensure that any single loss should not exceed 2% of your trading capital. If your trading positions require you to take a loss which is larger then your volume is too large – you are overtrading.
Here are some psychological signals that you are taking more risk than proper:
Sweating during trading hours while sitting in an AC room
Watching Television but switiching channels hoping that some channel will provide you with “suitable” news
Closing your position at a loss which actually brings you relief, only to see that the market moves in your favor after you exit
Shouting at your spouse, children, office people for no apaprent reason (the real reason is that you are losing money on a large position)
Calling your broker every five minutes seeking assurance that your positions are correctly placed.
This is not the life of your dreams, is it ? The solution is to reduce your volume and trade small. But, you will ask, how can I trade small and make a living ? I will answer this question here.
On trading small volumes:
My thinking is that if you’re a good trader with good ideas, each trade you make isn’t significant. It’s the sum total of a lot of good ideas over a lot of years that will make you wealthy. Everyone is wrong sometimes and what happens If you risk it all (or most of it) on a single trade, and you’re wrong? If what I’m saying makes sense, then trading small makes sense. Good opportunities come along fairly often.
Trading with a small capital
Use the Mini Nifty contract
Trade only in stock futures which have a small value
Learn how to hedge with options
One of the most common mistakes made by FNO traders is overtrading.
When you create a trading position which is much larger than justified by your capital, this is overtrading.
What is too large? A simple rule is to ensure that any single loss should not exceed 2% of your trading capital. If your trading positions require you to take a loss which is larger then your volume is too large – you are overtrading.
Here are some psychological signals that you are taking more risk than proper:
Sweating during trading hours while sitting in an AC room
Watching Television but switiching channels hoping that some channel will provide you with “suitable” news
Closing your position at a loss which actually brings you relief, only to see that the market moves in your favor after you exit
Shouting at your spouse, children, office people for no apaprent reason (the real reason is that you are losing money on a large position)
Calling your broker every five minutes seeking assurance that your positions are correctly placed.
This is not the life of your dreams, is it ? The solution is to reduce your volume and trade small. But, you will ask, how can I trade small and make a living ? I will answer this question here.
On trading small volumes:
My thinking is that if you’re a good trader with good ideas, each trade you make isn’t significant. It’s the sum total of a lot of good ideas over a lot of years that will make you wealthy. Everyone is wrong sometimes and what happens If you risk it all (or most of it) on a single trade, and you’re wrong? If what I’m saying makes sense, then trading small makes sense. Good opportunities come along fairly often.
Trading with a small capital
Use the Mini Nifty contract
Trade only in stock futures which have a small value
Learn how to hedge with options
Trading with Market Flow
Learning to trade with the market is a key part of improving trading results. There are many trading systems that work well in some market conditions and not at all in others. There are few, if any, systems that work in all market conditions. Trading results are improved when the trader has a variety of techniques available, and selects the one most appropriate for the current market conditions.
Trading success does not come from finding the Holy Grail; it is the mastery of several different aspects of trading that leads to success. It takes time, effort and money to learn this. Mastering trading, like many other professions is well worth the investment you make.
Consider a two-year period in the Nifty. Buy and hold investors who bought in May of 2001 ended up in pretty much the same place in May of 2003. Strategies with long holding periods showed draw downs during the first half of the period, and gains during the second half. The net result of holding during the 2001-2003 period was essentially breakeven.
Short-term traders could make profits during the first half of the period by using effective shorting strategies, and profits during the second half of the period by using effective long strategies. Trading with the Market requires one to have a variety of strategies that are known to work in different Market environments, and a method for determining which strategy to use.
We have developed a number of different scans that find setups suitable for a variety of different market conditions. There are scans that look for long and short pullbacks, volume accumulation, volume distribution, and various patterns. We have tested these scans in bullish, bearish, and trading range market periods; so we know which ones work best in any given market environment. We make a careful analysis of the current market conditions each evening then select the right tool for the job.
The key to selecting the best trading system to use for current market conditions is determine whether the current market is in a narrow trading range, a wide basing area, or a trend. Once we determine what the current market environment it is we know which of the trading tools to use because we have tested each tool in these different market conditions.
We use trend lines on the NIFTY to determine whether to focus on long or short scans. If the NIFTY is above an ascending trend line, we select tools that perform well in an up trending market. If the NIFTY is below a descending trend line, we select tools that perform well in a down trending market. We have also found moving averages to be effective tools for determining which trading tools to use. Backtesting results indicate that several of our systems respond well to limiting Long Entries to periods when the 30-day zero lag moving average for the NIFTY is moving up.
When the NIFTY broke above the descending trend line in April 2003 it implied that it was time to stop focusing on tools that perform well in down trending markets and select another tool. A trend line break does not imply the immediate start of a new trend. It indicates that something has changed; the market may base awhile then resume the original trend or start a new one. In either case the indication that something has changed in the market indicates that the trader must change with it. The way traders change is to change the tools they are using and their position sizing.
After a trend line break we reduce position size. The reason for this is that swing trading in bases carries more risk than trading in trends, so reducing position size is one way to compensate for this. After the April break of the descending trend line the market bases for four weeks. During this basing period we focus on tools and techniques that have tested well in this type of environment and also continue to trade half size positions. At some point the market will either break above or below the base, and attempt to start another trend. When it does we will trade with the break using the appropriate set of tools.
When the Market is in a clear trend, either up or down, we focus on tools and techniques for Swing or Intermediate term trades. When the Market is range bound , we generally focus on Short Term or Swing trades. The Market conditions tell us which type of trading patterns and techniques to focus on, and the type of trading determines the exit strategies.
Short Term Trading involves taking quick profits on the breakout. We typically exit after 1-2 days, or after a quick pop. This approach can be profitable in range bound markets when the market is only moving up or down a few days at a time. Holding periods of more than a few days in this type of market usually just churn the account.
Swing Trading requires the market to be moving in a large basing range or trending. We place a stop under the low of the setup pattern and close positions as the stock approaches support or resistance. This tends to be more profitable than Short Term trading when the Market is trending or trading in bases that take at least five days to move between the top and bottom of the range.
Intermediate Term trading generally is preferred when the market is strongly trending. We will place an initial stop under the low of the set up pattern and hold while market conditions remain favorable. We will sell when the Stock or the market breaks a key Trend Line or shows signs of topping.
Range bound markets are generally poor places for intermediate term trading. Short term or Swing trading techniques can provide better results. In Narrow bases, where the market moves between the top and bottom in less than four days we limit ourself to short term trading techniques when the market is bouncing off support or resistance, or stand aside. Narrow ranges require quick, decisive action. We just focus on taking a quick profit on the initial move after a trigger.
When the market is in a wide base where it takes at least five days to move between the top and bottom of the range swing trading can be effective. We focus on entering trades when the market is bouncing off support or resistance and avoid taking trades in the middle of the range. The reason for this is trades taken in the middle of the basing area have less time to work out than ones taken on either end. We refer to the middle third of a basing area as the ‘no zone’, and avoid taking new trades in this area.
Intermediate term trading works best when the Market is in a clear up or down trend. We watch for the break of an intermediate or long-term trend line, or a successful retest of a base breakout as possible beginnings of a new trend. We focus on Swing Trading until the market makes a higher low. After a higher low is established we can draw a trend line and consider Intermediate term trading techniques until the trend line is broken.
In order to use Intermediate term trading techniques, the market must be in a clear trend. An up trend usually is not clear until the market has formed a higher low. Until a higher low is formed it is often safer to focus on short term or swing trading rather than intermediate term trading.
Sometimes the market conditions will allow you to use more than one trading style. When the market channels up active traders may use both Intermediate and Short Term Trading techniques. To use short term trading in a channel focus on entering longs as the market bounces off the bottom of the channel, and taking profits as the Market approaches the upper channel boundary.
Successful traders analyze the market to determine the trading system and techniques most suitable to the current conditions. Ignoring market conditions can lead to significant draw down’s for most systems. It is important to have multiple techniques in the traders toolbox that have been tested in bull, bear, and trading range markets, then select the right tool for the current market environment.
Summary
The Market is a strong force that influences the outcome of most trades. Taking all trades generated by a system regardless of Market conditions will likely give you lots of practice at taking draw downs and stop losses. Having different systems that test well for Bull, Bear, and sideways Markets and selecting the right tool for the current Market conditions can improve your results.
Rather than focusing on Short, Intermediate, or Long Term trading consider developing expertise in all three and letting Market conditions determine which set of rules to use.
Trading success does not come from finding the Holy Grail; it is the mastery of several different aspects of trading that leads to success. It takes time, effort and money to learn this. Mastering trading, like many other professions is well worth the investment you make.
Consider a two-year period in the Nifty. Buy and hold investors who bought in May of 2001 ended up in pretty much the same place in May of 2003. Strategies with long holding periods showed draw downs during the first half of the period, and gains during the second half. The net result of holding during the 2001-2003 period was essentially breakeven.
Short-term traders could make profits during the first half of the period by using effective shorting strategies, and profits during the second half of the period by using effective long strategies. Trading with the Market requires one to have a variety of strategies that are known to work in different Market environments, and a method for determining which strategy to use.
We have developed a number of different scans that find setups suitable for a variety of different market conditions. There are scans that look for long and short pullbacks, volume accumulation, volume distribution, and various patterns. We have tested these scans in bullish, bearish, and trading range market periods; so we know which ones work best in any given market environment. We make a careful analysis of the current market conditions each evening then select the right tool for the job.
The key to selecting the best trading system to use for current market conditions is determine whether the current market is in a narrow trading range, a wide basing area, or a trend. Once we determine what the current market environment it is we know which of the trading tools to use because we have tested each tool in these different market conditions.
We use trend lines on the NIFTY to determine whether to focus on long or short scans. If the NIFTY is above an ascending trend line, we select tools that perform well in an up trending market. If the NIFTY is below a descending trend line, we select tools that perform well in a down trending market. We have also found moving averages to be effective tools for determining which trading tools to use. Backtesting results indicate that several of our systems respond well to limiting Long Entries to periods when the 30-day zero lag moving average for the NIFTY is moving up.
When the NIFTY broke above the descending trend line in April 2003 it implied that it was time to stop focusing on tools that perform well in down trending markets and select another tool. A trend line break does not imply the immediate start of a new trend. It indicates that something has changed; the market may base awhile then resume the original trend or start a new one. In either case the indication that something has changed in the market indicates that the trader must change with it. The way traders change is to change the tools they are using and their position sizing.
After a trend line break we reduce position size. The reason for this is that swing trading in bases carries more risk than trading in trends, so reducing position size is one way to compensate for this. After the April break of the descending trend line the market bases for four weeks. During this basing period we focus on tools and techniques that have tested well in this type of environment and also continue to trade half size positions. At some point the market will either break above or below the base, and attempt to start another trend. When it does we will trade with the break using the appropriate set of tools.
When the Market is in a clear trend, either up or down, we focus on tools and techniques for Swing or Intermediate term trades. When the Market is range bound , we generally focus on Short Term or Swing trades. The Market conditions tell us which type of trading patterns and techniques to focus on, and the type of trading determines the exit strategies.
Short Term Trading involves taking quick profits on the breakout. We typically exit after 1-2 days, or after a quick pop. This approach can be profitable in range bound markets when the market is only moving up or down a few days at a time. Holding periods of more than a few days in this type of market usually just churn the account.
Swing Trading requires the market to be moving in a large basing range or trending. We place a stop under the low of the setup pattern and close positions as the stock approaches support or resistance. This tends to be more profitable than Short Term trading when the Market is trending or trading in bases that take at least five days to move between the top and bottom of the range.
Intermediate Term trading generally is preferred when the market is strongly trending. We will place an initial stop under the low of the set up pattern and hold while market conditions remain favorable. We will sell when the Stock or the market breaks a key Trend Line or shows signs of topping.
Range bound markets are generally poor places for intermediate term trading. Short term or Swing trading techniques can provide better results. In Narrow bases, where the market moves between the top and bottom in less than four days we limit ourself to short term trading techniques when the market is bouncing off support or resistance, or stand aside. Narrow ranges require quick, decisive action. We just focus on taking a quick profit on the initial move after a trigger.
When the market is in a wide base where it takes at least five days to move between the top and bottom of the range swing trading can be effective. We focus on entering trades when the market is bouncing off support or resistance and avoid taking trades in the middle of the range. The reason for this is trades taken in the middle of the basing area have less time to work out than ones taken on either end. We refer to the middle third of a basing area as the ‘no zone’, and avoid taking new trades in this area.
Intermediate term trading works best when the Market is in a clear up or down trend. We watch for the break of an intermediate or long-term trend line, or a successful retest of a base breakout as possible beginnings of a new trend. We focus on Swing Trading until the market makes a higher low. After a higher low is established we can draw a trend line and consider Intermediate term trading techniques until the trend line is broken.
In order to use Intermediate term trading techniques, the market must be in a clear trend. An up trend usually is not clear until the market has formed a higher low. Until a higher low is formed it is often safer to focus on short term or swing trading rather than intermediate term trading.
Sometimes the market conditions will allow you to use more than one trading style. When the market channels up active traders may use both Intermediate and Short Term Trading techniques. To use short term trading in a channel focus on entering longs as the market bounces off the bottom of the channel, and taking profits as the Market approaches the upper channel boundary.
Successful traders analyze the market to determine the trading system and techniques most suitable to the current conditions. Ignoring market conditions can lead to significant draw down’s for most systems. It is important to have multiple techniques in the traders toolbox that have been tested in bull, bear, and trading range markets, then select the right tool for the current market environment.
Summary
The Market is a strong force that influences the outcome of most trades. Taking all trades generated by a system regardless of Market conditions will likely give you lots of practice at taking draw downs and stop losses. Having different systems that test well for Bull, Bear, and sideways Markets and selecting the right tool for the current Market conditions can improve your results.
Rather than focusing on Short, Intermediate, or Long Term trading consider developing expertise in all three and letting Market conditions determine which set of rules to use.
Why buying on dips is generally a good idea
What The Professionals do, and Don’t Want You To Know
Judging from my email, it is apparent that I have not explained a very important concept very well – one that professional traders DO NOT want you to know about.
Here it is:
You want to be buying stocks on down days in the market – not selling!
You want to be selling stocks on up days in the market – not buying!
I get emails that go something like this:
“Sudarshan, I just bought XYZ stock. Is this a good trade?”
First of all, I can’t predict the future, so I have no idea if it will be a good trade. Second, the stock was bought on a major up day in the market. So, when the market pulls back, it will likely pull the stock with it and this person will get stopped out!
Now, I realize that buying on down days can be psychologically hard to do. After all, those in the media are saying things like this:
“The market sold off hard today as investors are worried about ‘X’.”
“The Nifty is down 100 points today on ‘X’ concerns.”
With all this negativity, it is no wonder why you could be worried! But, you have to learn to ignore the media.
“But what if I buy a stock on a down day and the market continues to sell off?”. Good question, but you could also say the following: “What if I buy on an up day and then the market sells off”!
At least in the first scenario, you got in after a wave a selling has already taken place. That is certainly a lot better than getting in before a wave of selling has taken place!
So…
Wait for a down day in the market. Now run your scans. Look for stocks that are up. Or, if the market is trading at the bottom of it’s intraday range, look for stocks that are trading at the top of it’s intraday range.
You are looking for stocks that have relative strength – stocks that are stronger than the market. Many times, these stocks will just trade sideways until the overall market reverses.
Then you will be sitting pretty. You will have already established a position. Now you can just watch all the novice traders move the stock in your direction.
You NEED these traders to buy after you buy. You NEED these traders to sell after you short.
That is a sensible way to make money trading stocks.
Judging from my email, it is apparent that I have not explained a very important concept very well – one that professional traders DO NOT want you to know about.
Here it is:
You want to be buying stocks on down days in the market – not selling!
You want to be selling stocks on up days in the market – not buying!
I get emails that go something like this:
“Sudarshan, I just bought XYZ stock. Is this a good trade?”
First of all, I can’t predict the future, so I have no idea if it will be a good trade. Second, the stock was bought on a major up day in the market. So, when the market pulls back, it will likely pull the stock with it and this person will get stopped out!
Now, I realize that buying on down days can be psychologically hard to do. After all, those in the media are saying things like this:
“The market sold off hard today as investors are worried about ‘X’.”
“The Nifty is down 100 points today on ‘X’ concerns.”
With all this negativity, it is no wonder why you could be worried! But, you have to learn to ignore the media.
“But what if I buy a stock on a down day and the market continues to sell off?”. Good question, but you could also say the following: “What if I buy on an up day and then the market sells off”!
At least in the first scenario, you got in after a wave a selling has already taken place. That is certainly a lot better than getting in before a wave of selling has taken place!
So…
Wait for a down day in the market. Now run your scans. Look for stocks that are up. Or, if the market is trading at the bottom of it’s intraday range, look for stocks that are trading at the top of it’s intraday range.
You are looking for stocks that have relative strength – stocks that are stronger than the market. Many times, these stocks will just trade sideways until the overall market reverses.
Then you will be sitting pretty. You will have already established a position. Now you can just watch all the novice traders move the stock in your direction.
You NEED these traders to buy after you buy. You NEED these traders to sell after you short.
That is a sensible way to make money trading stocks.
Requirements of Successful Trading
This is not a list of “trading rules”; it’s a list of requirements for successful trading. Most worthwhile truths are simple, and this list contains only five items. Like most rewards life offers, market profits are not as easy to come by as the novice believes. Making money in the market requires a good deal of education, like any craft or business. If you’ve got the time, the drive, and the right psychological makeup, you can enter that elite realm of the truly professional, or at least successful, trader or investor. Here’s what you need:
1. A method.
I mean an objectively definable method. One that is thought out in its entirety to the extent that if someone asks you how you take your decisions, you can explain it to him, and if he asks you again in six months, he will receive the same answer. This is not to say that a method cannot be altered or improved; it must, however, be developed as a totality before it is implemented. A prerequisite for obtaining a method is acceptance of the fact that perfection is not achievable. People who demand it are wasting their time searching for the Holy Grail, and they will never get beyond this first step of obtaining a method.
2. The discipline to follow your method.
This requirement is so widely understood by the true professionals that among them, it almost sounds like a cliche´ . Neverthless, it is such an important cliche´ that it cannot be sidestepped, ignored, or excepted. Without discipline, you really have no method in the first place.
3. Experience.
Paper trading is useful for the testing of methodology, but it is of no value in learning about trading. Why? Because the markets are not merely an intellectual exercise. They are an emotional (and in extreme cases, even physical) one as well. To put it mildly, you will find it impossible to approach your task with the same cool detachment you displayed in your living room. This new situation is real, it matters, it is physical, it is dangerous, other people are watching, and you are being bombarded with stimuli. This is what your life is like when you are actually trading. You know it is real, you know it matters, you must physically pick up the phone and speak to place orders, you perform under the scrutiny of your broker or clients, your spouse and business acquaintances, and you must operate while thousands of conflicting messages are thrown at you from the financial media, the brokerage industry, analysts, and the market itself. In short, you must conquer a host of problems, most of them related to your own inner strength in battling powerful human emotions, in order to trade real money successfully.
There is only one shortcut to obtaining experience, and that is to find a mentor. Locate someone who has proved himself over the years to be a successful trader or investor, and go visit him. Observe not only what he does, but far more important, what he does not allow himself to do.
4. Accept the Fact that Losses Are Part of the Game.
The perfect trading system does not exist. Expecting, or even hoping for, perfection is a guarantee of failure. Speculation is akin to batting in cricket. A player scoring 60 runs in a one day match is good. A player scoring 100 is great. But even the great player fails to hit 60% of the time! He even gets out for low scores often. But he still deserves to be called a good player, because although not perfect, he has approached the best that can be achieved. You don’t have to be perfect to win in the markets, either; you “merely” have to be better than almost everybody else, and that’s hard enough.
Practically speaking, you must include an objective money management system when formulating your trading method in the first place.
How about the last requirement for successful tradiing ?
5. The Mental Fortitude to Accept Huge Gains.
This comment usually gets a hearty laugh, which merely goes to show how little most people have determined it actually to be a problem. But consider. How many times has the following sequence of events occurred? For a full year, you trade futures contracts, making 1000 here, losing 1500 there, making 3000 here and losing 2000 there. Once again, you enter a trade because your method told you to do so. Within a week, you’re up 4000. Your friend/partner/acquaintance/broker/advisor calls you and, looking out only for your welfare, tells you to take your profit. You have guts, though, and you wait. The following week, your position is up 8000, the best gain you have ever experienced. “Get out!”, says your friend. You sweat, still hoping for further gains. The next Monday, your contract opens limit against you. Your friend calls and says, “I told you so. You got greedy. But hey, you’re still way up on the trade. Get out tomorrow.” The next day, on the opening, you exit the trade, taking a 5000 profit. It’s your biggest profit of the year, and you click your heels, smiling gratefully, proud of yourself. Then, day after day for the next six months, you watch the market continue to go in the direction of your original trade. You try to find another entry point and continue to miss. At the end of six months, your method finally, quietly, calmly says, “Get out.” You check the figures and realize that your initial entry, if held, would have made a profit of 450,000.
So what was your problem? Simply that you had allowed yourself unconsciously to define your “normal” range of profit and loss. When the big trade finally came along, you lacked the self esteem to take all it promised. Who were you to shoot for such huge gains? Why should you deserve more than your best trade of the year? You then abandoned both method and discipline. To win the game, make sure that you understand why you’re in it. The big moves in markets only come once or twice a year. Those are the ones which will pay you for all the work, fear, sweat and aggravation of the previous eleven months or even eleven years. Don’t miss them for reasons other than those required by your objectively defined method.
[Excerpts from an article by Robert Prechter]
1. A method.
I mean an objectively definable method. One that is thought out in its entirety to the extent that if someone asks you how you take your decisions, you can explain it to him, and if he asks you again in six months, he will receive the same answer. This is not to say that a method cannot be altered or improved; it must, however, be developed as a totality before it is implemented. A prerequisite for obtaining a method is acceptance of the fact that perfection is not achievable. People who demand it are wasting their time searching for the Holy Grail, and they will never get beyond this first step of obtaining a method.
2. The discipline to follow your method.
This requirement is so widely understood by the true professionals that among them, it almost sounds like a cliche´ . Neverthless, it is such an important cliche´ that it cannot be sidestepped, ignored, or excepted. Without discipline, you really have no method in the first place.
3. Experience.
Paper trading is useful for the testing of methodology, but it is of no value in learning about trading. Why? Because the markets are not merely an intellectual exercise. They are an emotional (and in extreme cases, even physical) one as well. To put it mildly, you will find it impossible to approach your task with the same cool detachment you displayed in your living room. This new situation is real, it matters, it is physical, it is dangerous, other people are watching, and you are being bombarded with stimuli. This is what your life is like when you are actually trading. You know it is real, you know it matters, you must physically pick up the phone and speak to place orders, you perform under the scrutiny of your broker or clients, your spouse and business acquaintances, and you must operate while thousands of conflicting messages are thrown at you from the financial media, the brokerage industry, analysts, and the market itself. In short, you must conquer a host of problems, most of them related to your own inner strength in battling powerful human emotions, in order to trade real money successfully.
There is only one shortcut to obtaining experience, and that is to find a mentor. Locate someone who has proved himself over the years to be a successful trader or investor, and go visit him. Observe not only what he does, but far more important, what he does not allow himself to do.
4. Accept the Fact that Losses Are Part of the Game.
The perfect trading system does not exist. Expecting, or even hoping for, perfection is a guarantee of failure. Speculation is akin to batting in cricket. A player scoring 60 runs in a one day match is good. A player scoring 100 is great. But even the great player fails to hit 60% of the time! He even gets out for low scores often. But he still deserves to be called a good player, because although not perfect, he has approached the best that can be achieved. You don’t have to be perfect to win in the markets, either; you “merely” have to be better than almost everybody else, and that’s hard enough.
Practically speaking, you must include an objective money management system when formulating your trading method in the first place.
How about the last requirement for successful tradiing ?
5. The Mental Fortitude to Accept Huge Gains.
This comment usually gets a hearty laugh, which merely goes to show how little most people have determined it actually to be a problem. But consider. How many times has the following sequence of events occurred? For a full year, you trade futures contracts, making 1000 here, losing 1500 there, making 3000 here and losing 2000 there. Once again, you enter a trade because your method told you to do so. Within a week, you’re up 4000. Your friend/partner/acquaintance/broker/advisor calls you and, looking out only for your welfare, tells you to take your profit. You have guts, though, and you wait. The following week, your position is up 8000, the best gain you have ever experienced. “Get out!”, says your friend. You sweat, still hoping for further gains. The next Monday, your contract opens limit against you. Your friend calls and says, “I told you so. You got greedy. But hey, you’re still way up on the trade. Get out tomorrow.” The next day, on the opening, you exit the trade, taking a 5000 profit. It’s your biggest profit of the year, and you click your heels, smiling gratefully, proud of yourself. Then, day after day for the next six months, you watch the market continue to go in the direction of your original trade. You try to find another entry point and continue to miss. At the end of six months, your method finally, quietly, calmly says, “Get out.” You check the figures and realize that your initial entry, if held, would have made a profit of 450,000.
So what was your problem? Simply that you had allowed yourself unconsciously to define your “normal” range of profit and loss. When the big trade finally came along, you lacked the self esteem to take all it promised. Who were you to shoot for such huge gains? Why should you deserve more than your best trade of the year? You then abandoned both method and discipline. To win the game, make sure that you understand why you’re in it. The big moves in markets only come once or twice a year. Those are the ones which will pay you for all the work, fear, sweat and aggravation of the previous eleven months or even eleven years. Don’t miss them for reasons other than those required by your objectively defined method.
[Excerpts from an article by Robert Prechter]
Be prepared for the trading day!
The process of maneuvering around the financial markets and trading profitably has become an even more difficult task. We must be prepared and equipped with the appropriate tools in order to trade successfully.
The first and most important weapon to obtain is knowledge. As the saying goes, “knowledge is power,” and this is what will initially separate you from the majority of people who try their hand trading the markets. Secondly, proper money management is extremely important and should be taken very seriously in order to survive and play the game for many years. Lastly, preparation before the trading day is something that is mandatory in order to give yourself an edge against those you are competing against. This last tool, preparation, refers to having a trading game plan and knowing what you are going to do given certain movements in the market.
At first glance, preparation may not seem pertinent to succeeding as a trader, but have you ever placed a trade and then come to realize that you did the wrong thing? Or how about this one? The
market makes a huge move in one direction or the other and you are stuck wondering how you should adjust your trade. Instead of reacting immediately, you stop to think and before you know it, the opportunity has passed you by. These are things that should not happen to you and the proper preparation will keep you out of these costly and frustrating situations.
The first and most important weapon to obtain is knowledge. As the saying goes, “knowledge is power,” and this is what will initially separate you from the majority of people who try their hand trading the markets. Secondly, proper money management is extremely important and should be taken very seriously in order to survive and play the game for many years. Lastly, preparation before the trading day is something that is mandatory in order to give yourself an edge against those you are competing against. This last tool, preparation, refers to having a trading game plan and knowing what you are going to do given certain movements in the market.
At first glance, preparation may not seem pertinent to succeeding as a trader, but have you ever placed a trade and then come to realize that you did the wrong thing? Or how about this one? The
market makes a huge move in one direction or the other and you are stuck wondering how you should adjust your trade. Instead of reacting immediately, you stop to think and before you know it, the opportunity has passed you by. These are things that should not happen to you and the proper preparation will keep you out of these costly and frustrating situations.
Be prepared for the trading day!
The process of maneuvering around the financial markets and trading profitably has become an even more difficult task. We must be prepared and equipped with the appropriate tools in order to trade successfully.
The first and most important weapon to obtain is knowledge. As the saying goes, “knowledge is power,” and this is what will initially separate you from the majority of people who try their hand trading the markets. Secondly, proper money management is extremely important and should be taken very seriously in order to survive and play the game for many years. Lastly, preparation before the trading day is something that is mandatory in order to give yourself an edge against those you are competing against. This last tool, preparation, refers to having a trading game plan and knowing what you are going to do given certain movements in the market.
At first glance, preparation may not seem pertinent to succeeding as a trader, but have you ever placed a trade and then come to realize that you did the wrong thing? Or how about this one? The
market makes a huge move in one direction or the other and you are stuck wondering how you should adjust your trade. Instead of reacting immediately, you stop to think and before you know it, the opportunity has passed you by. These are things that should not happen to you and the proper preparation will keep you out of these costly and frustrating situations.
The first and most important weapon to obtain is knowledge. As the saying goes, “knowledge is power,” and this is what will initially separate you from the majority of people who try their hand trading the markets. Secondly, proper money management is extremely important and should be taken very seriously in order to survive and play the game for many years. Lastly, preparation before the trading day is something that is mandatory in order to give yourself an edge against those you are competing against. This last tool, preparation, refers to having a trading game plan and knowing what you are going to do given certain movements in the market.
At first glance, preparation may not seem pertinent to succeeding as a trader, but have you ever placed a trade and then come to realize that you did the wrong thing? Or how about this one? The
market makes a huge move in one direction or the other and you are stuck wondering how you should adjust your trade. Instead of reacting immediately, you stop to think and before you know it, the opportunity has passed you by. These are things that should not happen to you and the proper preparation will keep you out of these costly and frustrating situations.
Donchian's guide to trading
Richard D Donchian first published his ideas in 1934 to help stock market traders. Donchiian is one of the most respected technicians on wall street, specially in commodities.
General Guides
1. Beware of acting immediately on public opinion. Even if correct, it will usually delay the move.
2. From a period of dullness and inactivity, watch for and prepare to follow a move in the direction in which volume increases.
3. LIMIT LOSSES, ride profits – irrespective of all other rules.
4. Light positions are advisable when a market position is not certain. Clearly defined moves are made frequently enough to make life interesting, and concentration on these moves to the virtual exclusion of others will prevent unprofitable “whipsawing”.
5. Seldom take a position of an immediately preceding three day move. Wait for a one day reversal.
6. Judicious use of stop orders is a valuable aid to profitable trading. Stops may be sued to protect profits, limit losses and to take positions from certain formations such as triangles. Stop orders are apt to be less treacherous and more valuable if used in proper relation to the chart formation.
General Guides
1. Beware of acting immediately on public opinion. Even if correct, it will usually delay the move.
2. From a period of dullness and inactivity, watch for and prepare to follow a move in the direction in which volume increases.
3. LIMIT LOSSES, ride profits – irrespective of all other rules.
4. Light positions are advisable when a market position is not certain. Clearly defined moves are made frequently enough to make life interesting, and concentration on these moves to the virtual exclusion of others will prevent unprofitable “whipsawing”.
5. Seldom take a position of an immediately preceding three day move. Wait for a one day reversal.
6. Judicious use of stop orders is a valuable aid to profitable trading. Stops may be sued to protect profits, limit losses and to take positions from certain formations such as triangles. Stop orders are apt to be less treacherous and more valuable if used in proper relation to the chart formation.
Breakouts: Follow the momentum
Traders who trade breakouts and breakdowns do so because they are following momentum – a market making new highs or lows.
Trading breakouts and breakdowns requires a trader who can withstand a retracement because stocks that break through key price levels will often come back to test those price levels. While learning the process of trading breakouts, the trader must be prepared for many wrong calls as he/she learns the rules. Once the rules have been learned you will realize that not all breakouts and breakdowns are the same. This will ensure you get less number of calls going wrong.
Breakouts have their foundation in the theory that price will tend to continue in the direction of an expansion of volatility. All trend start with some kind of a breakout. The trader who catches these can ride a trend for a long period, with substantial gains.
Problems with breakouts / breakdowns:
Often, the breakout results in a short term surge which eventually fails. This happens when the breakout occurs in the very last leg of a trend. Immediately thereafter, a correction begins causing losses to the breakout trader. Even if the trend remains intact, the trader may have to sit through a correction holding a losing position.
Selection of breakout / breakdown candidates:
Select charts that show an ongoing trend.
1. The trader should try to identify the type of breakouts or breakdowns that are most likely to follow through then the rewards can be large. Generally a wise breakout / breakdown trader will be looking for strongly trending stocks that consolidate with light volume and clean price action. (Clean price action means a chart with well defined trending moves & shallow pullbacks). Avoid charts where recent price action looks like a whipsawing market.
2. On breakout, price action should suggest a decisive move in the trend direction. The signs can be:
a) Gaps
b) Range expansion (RE)
c) Price moves above Short term averages
d) Green & red Alligator turn in the trend direction
e) Price breaks a previous well defined top or bottom.
Please understand that the presence of any or all of these signs is not a guarantee of a profitable trade. But it does enhance the probability of getting it right.
Anticipating a breakout:
Although as traders we always try to buy at the lowest price and sell at the highest price, being too early on the entry often does not help the breakout / breakdown trader. Entering slightly late, after a breakout or breakdown, is often a better method because at least a trader has witnessed the key price level violated. Yes, that may mean sitting through the correction, but the expansion of volatility principle is working on behalf of the trader.
Trading breakouts and breakdowns requires a trader who can withstand a retracement because stocks that break through key price levels will often come back to test those price levels. While learning the process of trading breakouts, the trader must be prepared for many wrong calls as he/she learns the rules. Once the rules have been learned you will realize that not all breakouts and breakdowns are the same. This will ensure you get less number of calls going wrong.
Breakouts have their foundation in the theory that price will tend to continue in the direction of an expansion of volatility. All trend start with some kind of a breakout. The trader who catches these can ride a trend for a long period, with substantial gains.
Problems with breakouts / breakdowns:
Often, the breakout results in a short term surge which eventually fails. This happens when the breakout occurs in the very last leg of a trend. Immediately thereafter, a correction begins causing losses to the breakout trader. Even if the trend remains intact, the trader may have to sit through a correction holding a losing position.
Selection of breakout / breakdown candidates:
Select charts that show an ongoing trend.
1. The trader should try to identify the type of breakouts or breakdowns that are most likely to follow through then the rewards can be large. Generally a wise breakout / breakdown trader will be looking for strongly trending stocks that consolidate with light volume and clean price action. (Clean price action means a chart with well defined trending moves & shallow pullbacks). Avoid charts where recent price action looks like a whipsawing market.
2. On breakout, price action should suggest a decisive move in the trend direction. The signs can be:
a) Gaps
b) Range expansion (RE)
c) Price moves above Short term averages
d) Green & red Alligator turn in the trend direction
e) Price breaks a previous well defined top or bottom.
Please understand that the presence of any or all of these signs is not a guarantee of a profitable trade. But it does enhance the probability of getting it right.
Anticipating a breakout:
Although as traders we always try to buy at the lowest price and sell at the highest price, being too early on the entry often does not help the breakout / breakdown trader. Entering slightly late, after a breakout or breakdown, is often a better method because at least a trader has witnessed the key price level violated. Yes, that may mean sitting through the correction, but the expansion of volatility principle is working on behalf of the trader.
Trading Breakouts effectively: A short course
This is a short course on breakout trading.
When you think of breakouts, what comes to mind? Stocks making daily highs, two-day highs, weekly highs, all-time highs? As you see, breakout means a lot of things to a lot of people. So, why do so many people lose money day trading breakouts? Why are traders constantly buying stocks when they hit intraday highs, only to have them rollover within minutes. How many times have you shorted a stock on a breakdown through a critical support level, go get coffee, come back and see the stock has bounced and you just bought a five-thousand rupee cofee? Well, this article will give you the “secret” that so many breakout day trading professionals use everyday to take themselves from ordinary to extraordinary.
The ideas discussed here are applicable to breakouts in all time frames. Many of the examples are for day traders or swing traders but the concepts are universal.
Basic Principle. Prices move between contraction and expansion. Contraction represents a trading range or similar area of congestion. A breakout occurs when prices emerge out of contraction. The process of contraction can be considered a period of rest, when either the bulls or the bears are building up their energy. Finally, this energy is unleashed leading to a breakout from a congestion area.
Congestion areas have overlapping bars. Visually, it is often easy to identify well defined support and resistance levels in a congestion since these areas look like a straight line.
Expansion has price bars which do not overlap – they move in any one direction with relatively similar open and close positions.
Rule 1: A false breakout often takes place when there is little or no congestion near the breakout location. Even if the breakout is genuine, prices will often retrace sharply if there is no congestion to the left of the breakout area. On the other side, if the breakout emerges out of nearby consolidation or congestion, this area will act as support, thus avoiding a sharp retracement.
For Short term traders, this pattern is reflected in the opening gap. If the market was consolidating in the previous afternoon, then a gap open has more chances of success / follow through. On the opposite side, if the previous day closed with expansion bars, thern today sees a gap open, there remains the possibility of a sharp intra day correction since there is no congestion to the left of the gap.
Secondary Indicator – Volume. Ideally, volume should increase on expansion bars, decrease on retracements. But this may not always happen, specilaly in short term trading with smaller time frame bars. Always, it is price which is supreme.
Rule 2: A breakout that emerges from a period of contraction is a tradable breakout. The initial target for a breakout should be any previous support or resistance. A moving average on a higher time frame could also be a potential target for a breakout. Stops are always placed slightly below the support area for buys, or slightly above the resistance for shorts.
First Breakout is the initial move out of consolidation. The consolidation may have taken place at the end of a down move, or as part of a period of rest in an ongoing trend.
Retracement is a reverse move towards the intial breakout level. The stock should find support around the previous consolidation and resume its up move. A retracement is a low risk opportunity to enter a breakout.
Next chance is a breakout that occurs after another small period of consolidation. This consolidation should happen near the high recorded in the first breakout. This is another opportunity to catch the breakout.
Rule 3: A breakout that occurs without a nearby consolidation is a high risk trade. A retracement is likely, which can easily shake out the breakout traders. Such trades should be avoided. if this reads like a repetition of rule 1, it is. Example: A stock has seen a high, a deep retracement then a sharp expansion that takes prices above the earlier high – this is an improper trade since there is no consolidation before the breakout. A move above previous highs is not good enough reason to get in the trade, since a sharp pullback can come any time with no support to hold it.
Rule 4: A wide range bar at the point of breakout is a signal that the breakout has strength. A wide range bar shows commitment and has high odds of follow through. If there is no overhead resistance, then a breakout through a wide range bar could go further than expected.
TRADING TACTICS
Monitor charts for breakouts on any time frame. Our favorites are – 5 minute, 30 minute, 60 minute & end of day.
The First Breakout should be a well thought out trade. Examine the quality of the consolidation from which prices have broken out. A wide range bar on breakout is a plus point. A narrow, tight consolidation lasting 8 to 10 bars is better than a consolidation with many wide bars having long shadows. In there is overhead resistance nearby, the breakout may face difficulties. Consider all factors carefuly. If satisfied, buy a breakout from a consolidation area, with a stop below support. Remember, you do not have to trade.
If there is any doubt, it is wiser to wait for a retracement to enter. Sometimes, a runaway market will not retrace at all. In such cases, the trader lets go of the trade. There will be many more opportunities.
The Next chance entry comes after the original breakout has occured. There may be more than one Next chance entry in a trending market. These trades are low risk, since a protective stop can be placed below the small consolidation that offers the next chance.
GAPS:
If the gap is above/below a consolidation area it is more likely to be sustained. If the consolidation is nearby, traders can enter immediately. If the gap is wide, traders should look for a small consolidation after the gap, then enter in the gap direction.
A gap that occurs after an expansion has strong chances of going through a retracement. Of course, there will always be exceptions. But, it is wise to stay away from such gaps. Wait for retracement or Next chance .
ANTICIPATING A BREAKOUT
Should you anticipate a breakout and take an early position ? No. This is not a good idea. What happens if the breakout occurs in the opposite direction, or the stock simply continues drifting ? You will be left with a trade for which there are no trade management plans.
When you think of breakouts, what comes to mind? Stocks making daily highs, two-day highs, weekly highs, all-time highs? As you see, breakout means a lot of things to a lot of people. So, why do so many people lose money day trading breakouts? Why are traders constantly buying stocks when they hit intraday highs, only to have them rollover within minutes. How many times have you shorted a stock on a breakdown through a critical support level, go get coffee, come back and see the stock has bounced and you just bought a five-thousand rupee cofee? Well, this article will give you the “secret” that so many breakout day trading professionals use everyday to take themselves from ordinary to extraordinary.
The ideas discussed here are applicable to breakouts in all time frames. Many of the examples are for day traders or swing traders but the concepts are universal.
Basic Principle. Prices move between contraction and expansion. Contraction represents a trading range or similar area of congestion. A breakout occurs when prices emerge out of contraction. The process of contraction can be considered a period of rest, when either the bulls or the bears are building up their energy. Finally, this energy is unleashed leading to a breakout from a congestion area.
Congestion areas have overlapping bars. Visually, it is often easy to identify well defined support and resistance levels in a congestion since these areas look like a straight line.
Expansion has price bars which do not overlap – they move in any one direction with relatively similar open and close positions.
Rule 1: A false breakout often takes place when there is little or no congestion near the breakout location. Even if the breakout is genuine, prices will often retrace sharply if there is no congestion to the left of the breakout area. On the other side, if the breakout emerges out of nearby consolidation or congestion, this area will act as support, thus avoiding a sharp retracement.
For Short term traders, this pattern is reflected in the opening gap. If the market was consolidating in the previous afternoon, then a gap open has more chances of success / follow through. On the opposite side, if the previous day closed with expansion bars, thern today sees a gap open, there remains the possibility of a sharp intra day correction since there is no congestion to the left of the gap.
Secondary Indicator – Volume. Ideally, volume should increase on expansion bars, decrease on retracements. But this may not always happen, specilaly in short term trading with smaller time frame bars. Always, it is price which is supreme.
Rule 2: A breakout that emerges from a period of contraction is a tradable breakout. The initial target for a breakout should be any previous support or resistance. A moving average on a higher time frame could also be a potential target for a breakout. Stops are always placed slightly below the support area for buys, or slightly above the resistance for shorts.
First Breakout is the initial move out of consolidation. The consolidation may have taken place at the end of a down move, or as part of a period of rest in an ongoing trend.
Retracement is a reverse move towards the intial breakout level. The stock should find support around the previous consolidation and resume its up move. A retracement is a low risk opportunity to enter a breakout.
Next chance is a breakout that occurs after another small period of consolidation. This consolidation should happen near the high recorded in the first breakout. This is another opportunity to catch the breakout.
Rule 3: A breakout that occurs without a nearby consolidation is a high risk trade. A retracement is likely, which can easily shake out the breakout traders. Such trades should be avoided. if this reads like a repetition of rule 1, it is. Example: A stock has seen a high, a deep retracement then a sharp expansion that takes prices above the earlier high – this is an improper trade since there is no consolidation before the breakout. A move above previous highs is not good enough reason to get in the trade, since a sharp pullback can come any time with no support to hold it.
Rule 4: A wide range bar at the point of breakout is a signal that the breakout has strength. A wide range bar shows commitment and has high odds of follow through. If there is no overhead resistance, then a breakout through a wide range bar could go further than expected.
TRADING TACTICS
Monitor charts for breakouts on any time frame. Our favorites are – 5 minute, 30 minute, 60 minute & end of day.
The First Breakout should be a well thought out trade. Examine the quality of the consolidation from which prices have broken out. A wide range bar on breakout is a plus point. A narrow, tight consolidation lasting 8 to 10 bars is better than a consolidation with many wide bars having long shadows. In there is overhead resistance nearby, the breakout may face difficulties. Consider all factors carefuly. If satisfied, buy a breakout from a consolidation area, with a stop below support. Remember, you do not have to trade.
If there is any doubt, it is wiser to wait for a retracement to enter. Sometimes, a runaway market will not retrace at all. In such cases, the trader lets go of the trade. There will be many more opportunities.
The Next chance entry comes after the original breakout has occured. There may be more than one Next chance entry in a trending market. These trades are low risk, since a protective stop can be placed below the small consolidation that offers the next chance.
GAPS:
If the gap is above/below a consolidation area it is more likely to be sustained. If the consolidation is nearby, traders can enter immediately. If the gap is wide, traders should look for a small consolidation after the gap, then enter in the gap direction.
A gap that occurs after an expansion has strong chances of going through a retracement. Of course, there will always be exceptions. But, it is wise to stay away from such gaps. Wait for retracement or Next chance .
ANTICIPATING A BREAKOUT
Should you anticipate a breakout and take an early position ? No. This is not a good idea. What happens if the breakout occurs in the opposite direction, or the stock simply continues drifting ? You will be left with a trade for which there are no trade management plans.
Breakout trading with less whipsaws
Investors trading in breakouts often buy breakouts to new highs or new lows. Many of these breakouts then end up as whipsaws, when the security begins a sharp correction after a sustained trend or reverses the trend itself. If you’re going to be buying breakouts you need to know how you can improve the percentage of winners by identifying stocks that may have a higher probability of success after a breakout. Many technical ideas that can help a trader to do the filtering.
Many filters can be used to screen breaking out stocks for increased reliability of the trend continuing. By using these filters, traders can substantially improve their odds of success in trading breakouts of any kind.
1. The breakout is accompanied by a trend qualifier. In the Level 1 Seminar, we discuss many trend qualifiers – signals that reinforce the trend. Our favorite is RE -Range Expansion. If the breakout day also has an RE or a gap open then so much the better. This could be a real breakout.
2. Breakout stock has higher relative strength verses the Index. This tells us that the stock is outperforming. When a stock breaks out in price and also in its Relative Strength vs. other stocks, it is much more likely to be a true market leader and is more likely to follow through.
3. Breakout-day occurs on strong volume. Strong volume could be defined to mean at least 30% higher volume that its 20 day average, or the highest volume in past 20 days.You definitely want strong volume on the day of the breakout to show significant demand is coming in. Strong volume can also be defined as the very highest volume since the trading range started.
4. Before breaking out, in the trading range, there were signs of accumulation. In its simplest form, an accumulation day is a day that closes higher with the volume also higher than the previous day’s volume. You can also use accumulation distribution indicators to check if the indicator is giving signs of accumulation prior to the breakout.
5. Indicators leading price breakout could be a sign of strength in the stock. This happens when accumulation / distribution or momentum indicators such as the RSI breakout a day or two before prices breakout.
By checking out on such filters, you can screen breakouts to identify the candidates most likely to succeed.
Many filters can be used to screen breaking out stocks for increased reliability of the trend continuing. By using these filters, traders can substantially improve their odds of success in trading breakouts of any kind.
1. The breakout is accompanied by a trend qualifier. In the Level 1 Seminar, we discuss many trend qualifiers – signals that reinforce the trend. Our favorite is RE -Range Expansion. If the breakout day also has an RE or a gap open then so much the better. This could be a real breakout.
2. Breakout stock has higher relative strength verses the Index. This tells us that the stock is outperforming. When a stock breaks out in price and also in its Relative Strength vs. other stocks, it is much more likely to be a true market leader and is more likely to follow through.
3. Breakout-day occurs on strong volume. Strong volume could be defined to mean at least 30% higher volume that its 20 day average, or the highest volume in past 20 days.You definitely want strong volume on the day of the breakout to show significant demand is coming in. Strong volume can also be defined as the very highest volume since the trading range started.
4. Before breaking out, in the trading range, there were signs of accumulation. In its simplest form, an accumulation day is a day that closes higher with the volume also higher than the previous day’s volume. You can also use accumulation distribution indicators to check if the indicator is giving signs of accumulation prior to the breakout.
5. Indicators leading price breakout could be a sign of strength in the stock. This happens when accumulation / distribution or momentum indicators such as the RSI breakout a day or two before prices breakout.
By checking out on such filters, you can screen breakouts to identify the candidates most likely to succeed.
Trading the Wide Range Bar
A wide range bar has a range (High minus Low) which is higher than the average range. Such a bar may be either bullish or bearish depending on where it takes place in the set up. If it comes at the end of a buying climax, it is bearish. However, it is positive if it is breaking out of a formation. Most of the wide range bars have a pull hack on the following bar. The buy zone is in the lower 50% of the range of the bar. Conversely the take profit zone is 50% to 100% added to the high of the wide range bar. This obviously is for short-term trading. The market tends to rotate by having a narrow range bar after a wide range bar. This is not 100% objective and the definition of a wide range bar is subjective. This is where the art of chart reading comes into focus. This talent ia developed only by looking at many charts over a long period of time.
Wide-Range Reversal Bar after Run Up
When the market is moving aggressively up in new high ground and the following actions take place, it is time to move stops closer or take profits:
1. A wide-range reversal bar.
2. A narrow-range or inside bar comes after the wide range bar.
This type action implies supply is entering the market.
TWO-DAY INTERSECTION
Two wide-range bars to the upside that overlap only a small amount indicate aggressive demand for two bars in succession. The intersection of these two bars is a zone of support/resistance . Orders placed around these points can let one get on board with a small risk. Stops would be just outside the zone.
Wide Range Bar as a breakout.
A price breakout from a consolidation with a wide range bar, is a sign of strength.
Wide-Range Reversal Bar after Run Up
When the market is moving aggressively up in new high ground and the following actions take place, it is time to move stops closer or take profits:
1. A wide-range reversal bar.
2. A narrow-range or inside bar comes after the wide range bar.
This type action implies supply is entering the market.
TWO-DAY INTERSECTION
Two wide-range bars to the upside that overlap only a small amount indicate aggressive demand for two bars in succession. The intersection of these two bars is a zone of support/resistance . Orders placed around these points can let one get on board with a small risk. Stops would be just outside the zone.
Wide Range Bar as a breakout.
A price breakout from a consolidation with a wide range bar, is a sign of strength.
A chart pattern that Swing Traders 'MUST' trade
The One Chart Pattern That You Must Trade
No, it’s not a cup and handle pattern. It’s not a triangle. And it’s not a head and shoulders pattern.
It’s a First Pullback.
What’s a first pullback?
This is just the first pullback after a significant price event. For example:
The first pullback after a trend line break.
The first pullback after a breakout.
The first pullback after break down (short).
The first pullback after a “kicker” candlestick pattern.
The first pullback after a break to new highs.
(I think you get the idea!)
This is the one pattern that you should hope to find the most – that perfect first pullback scenario that swing traders (and day traders) have come to know and love!
No, it’s not a cup and handle pattern. It’s not a triangle. And it’s not a head and shoulders pattern.
It’s a First Pullback.
What’s a first pullback?
This is just the first pullback after a significant price event. For example:
The first pullback after a trend line break.
The first pullback after a breakout.
The first pullback after break down (short).
The first pullback after a “kicker” candlestick pattern.
The first pullback after a break to new highs.
(I think you get the idea!)
This is the one pattern that you should hope to find the most – that perfect first pullback scenario that swing traders (and day traders) have come to know and love!
Buying on dips & Selling on rallies with BAT
Buy Weakness and Sell Strength
Buying weakness and selling strength is the art of buying pullbacks. Stocks that are in up trends will pull back offering a low risk buying opportunity and stocks that are in downtrends will rally offering a low risk shorting opportunity.
As a swing trader, you have to WAIT for these opportunities to happen because…
Doesn’t it make more sense to buy a stock after a wave of selling has occurred rather than getting caught in a sell-off?
Doesn’t it make more sense to short a stock after a wave of buying has occurred rather than getting caught in a rally?
Absolutely! If you are buying a stock then you want as many sellers out of the stock before you get in. On the other hand, if you are shorting a stock then you want as many buyers out of the stock before you get in. This gives you a low risk entry that you can manage effectively.
Buying Pullbacks And Shorting Rallies
Where do you buy a pullback and where do you short a rally? You buy them and short them in the Buffer Area for Traders (BAT). This is how you create the BAT:
BAT – The Trading Strategy
The Buffer Area for Traders (BAT) is a buy and sell zone on a chart that swing traders can use to identify possible reversals in a stock.
This is just simply “area” that we look at to see if a stock that is in a strong uptrend, after pulling back to this area, will likely reverse, and, vice versa for down trending stocks.
BAT is the area in between the 10 period moving average and 40 period moving average.. This is where you, as a swing trader look for reversals back to the upside when going long and reversals to the downside when shorting stocks.
For the 10 period, use the Triangular average, while for the 40 period use the Weighted average. But, the actual choice of moving average type is not very significant. It doesn’t matter whether you use sma’s or ema’s. There is little difference between different methods so don’t get caught up in the variations. We are just using these moving averages to create a zone that we will find our entries for long and short positions.
The area between the two moving averages is a buffer. We use the averages to identify the trend. If the 10 day is above the 40 day, the trend is UP. If the 10 day is below the 40 day, the trend is down.
When going long, wait for the decline into the BAT and when going short, wait for the rally into the BAT.
Swing Points
For a swing point low, the first candle makes a low, the second candle makes a lower low, and the third candle makes a higher low. This third candle tells us that the sellers have gotten weak and the stock will likely reverse.
For a swing point high, the first candle makes a high, the second candle makes a higher high, and the third candle makes a lower high. This third candle tells us that the buyers have gotten weak and the stock will likely reverse.
For our long entry strategy, we are trying to find stocks that have pulled back into the Buffer Area for Traders that have made a swing point low.
Now lets look at a stock on the short side. We are looking for a stock in a nice downtrend with the 10ma below the 30ma. Then we wait for a rally into the BAT that forms a swing point high.
A second setup: Consecutive Price Patterns
Many a time, you will notice that a pullback in an uptrend consists of three consecutive down days with lower highs and lower lows. (or two down days and one inside day).
That is what you want to look for in a pullback. You can buy the stock the first time it trades above the previous candle high. This will also complete the swing point low.
In a downtrend, you will see often that the stock has three consecutive up days with higher highs and higher lows (or two up days and one inside day). The fourth candle continues tol makes a higher high and a higher low. The fifth candle finally makes a lower high and a lower low – completing the swing point.
My point in explaining the pullback in a down trend was this : Pullbacks do not have to consist of exactly 3 consecutive up days (for short trades) or down days (for long trades.) Sometimes you will run your scans and find stocks that have more than that.
One final note: When you are looking for swing points to develop, you always want to look to the left of the chart to see if the stock is at a support or resistance area on the chart. That will improve the reliability of this entry strategy.
Ok, now that we know how to get into a trade, how do we get out? We need an exit strategy.
How To Take Profits And Control Your Losses
Your exit strategy consists of two parts: Where will you get out of the trade if the stock does not go in your favor? Where will you take profits if the stock does go in your favor? These are the two questions that make up your exit strategy. You have to be able to answer these questions before you can place the trade!
Part One – Your Stop Loss Order
First, lets put to rest the debate about where or not you should use a physical stop or use a mental stop. A physical stop loss is an order to sell (or buy if you are short) that you place with your broker. A mental stop is YOU clicking the sell (buy) button to get out of the trade. From a technical perspective, it does not matter which type you use.
Before you get into a trade you will have a plan that will determine when to get out of the trade if it does not go in your favor. You are a disciplined trader that always follows your plan (right?). What difference would it make whether or not you have an actual order placed with your broker or if you are going to pull the trigger yourself? There is no difference. In either case, you will get out of the stock when your plan (exit strategy) tells you to!
Personally, I always use physical stop loss orders placed with my broker. This is because I do not want to sit at my computer and look at a monitor all day long! Ok, maybe that’s a slight exaggeration, but you get the point!
Where is your stop going to be? First of all you need a stop that makes sense and you need it to be out of the “noise” of the current activity in the stock.
Look at the average true range of the stock over the past 10 days. If the average true range of the stock is, say, Rs 11, then your stop needs to be at least that far away from your entry price. It doesn’t make any sense to have your stop Rs 3 away from your entry price when the range is Rs 11. You will surely get stopped out prematurely!
For long positions, your stop should go under a support area and a swing point low.
For short positions, your stop should go above a resistance area and a swing point high.
Part Two – Taking Profits
Use trailing stops! This is an easy and unemotional way of exiting a trade. If this trade is going to be a typical swing trade with a holding time of 2-5 days, then you can trail your stops a few rupees under the two day low. (This is the low of the last two days). Once you have spent 2 or 2 days in the trade, tighten the stop to just the previous day’s low.
Note: Initially, on the day of entry, your stop should be based on your stop loss order. the trailing stops come in, on the day your trade becomes profitable.
If this is a first pullback scenario, then you may want to hold this for a longer time frame. Having some big winners every now and then will fatten up your trading account! In this case you can trail your stops under the swing lows (or highs for shorts) until stopped out.
In either case, you should always determine where your stop is going to be and how you are going to take profits before you get into the trade. Have a solid plan in place (write it down). This will take all of the emotion out of the trade. Then you can relax and trade the “map” that you have created. This will make your exit strategy easy to follow and it will put you on the path to success.
What is so special about this zone?
I have found that for swing trading, a lot of reversals happen in this area. So in order to create a focus in your trading strategy, it is helpful to narrow down your potential stock setups to one area on a chart. This zone provides a number of setups on a daily basis.
We are not really concerned with the moving averages themselves. When a stock pulls back into this zone, look to the left to identify support and resistance, trend lines, candlestick patterns, etc. You are looking for multiple signals all pointing in the same direction.
Will this strategy make me a profitable trader?
You may be surprised by my answer.
The answer is no. There isn’t ANY trading strategy that will make you a consistently profitable trader. Sorry to disappoint you. The only thing that will enable you to consistently pull money out of the markets is YOU.
YOU must have discipline. YOU must be able to take losses. YOU must be able to take your profits. YOU must eliminate fear. Put simply, you must be able to control the emotional and psychological problems that prevent success.
That will be your biggest challenge in learning how to trade stocks with any strategy.
Buying weakness and selling strength is the art of buying pullbacks. Stocks that are in up trends will pull back offering a low risk buying opportunity and stocks that are in downtrends will rally offering a low risk shorting opportunity.
As a swing trader, you have to WAIT for these opportunities to happen because…
Doesn’t it make more sense to buy a stock after a wave of selling has occurred rather than getting caught in a sell-off?
Doesn’t it make more sense to short a stock after a wave of buying has occurred rather than getting caught in a rally?
Absolutely! If you are buying a stock then you want as many sellers out of the stock before you get in. On the other hand, if you are shorting a stock then you want as many buyers out of the stock before you get in. This gives you a low risk entry that you can manage effectively.
Buying Pullbacks And Shorting Rallies
Where do you buy a pullback and where do you short a rally? You buy them and short them in the Buffer Area for Traders (BAT). This is how you create the BAT:
BAT – The Trading Strategy
The Buffer Area for Traders (BAT) is a buy and sell zone on a chart that swing traders can use to identify possible reversals in a stock.
This is just simply “area” that we look at to see if a stock that is in a strong uptrend, after pulling back to this area, will likely reverse, and, vice versa for down trending stocks.
BAT is the area in between the 10 period moving average and 40 period moving average.. This is where you, as a swing trader look for reversals back to the upside when going long and reversals to the downside when shorting stocks.
For the 10 period, use the Triangular average, while for the 40 period use the Weighted average. But, the actual choice of moving average type is not very significant. It doesn’t matter whether you use sma’s or ema’s. There is little difference between different methods so don’t get caught up in the variations. We are just using these moving averages to create a zone that we will find our entries for long and short positions.
The area between the two moving averages is a buffer. We use the averages to identify the trend. If the 10 day is above the 40 day, the trend is UP. If the 10 day is below the 40 day, the trend is down.
When going long, wait for the decline into the BAT and when going short, wait for the rally into the BAT.
Swing Points
For a swing point low, the first candle makes a low, the second candle makes a lower low, and the third candle makes a higher low. This third candle tells us that the sellers have gotten weak and the stock will likely reverse.
For a swing point high, the first candle makes a high, the second candle makes a higher high, and the third candle makes a lower high. This third candle tells us that the buyers have gotten weak and the stock will likely reverse.
For our long entry strategy, we are trying to find stocks that have pulled back into the Buffer Area for Traders that have made a swing point low.
Now lets look at a stock on the short side. We are looking for a stock in a nice downtrend with the 10ma below the 30ma. Then we wait for a rally into the BAT that forms a swing point high.
A second setup: Consecutive Price Patterns
Many a time, you will notice that a pullback in an uptrend consists of three consecutive down days with lower highs and lower lows. (or two down days and one inside day).
That is what you want to look for in a pullback. You can buy the stock the first time it trades above the previous candle high. This will also complete the swing point low.
In a downtrend, you will see often that the stock has three consecutive up days with higher highs and higher lows (or two up days and one inside day). The fourth candle continues tol makes a higher high and a higher low. The fifth candle finally makes a lower high and a lower low – completing the swing point.
My point in explaining the pullback in a down trend was this : Pullbacks do not have to consist of exactly 3 consecutive up days (for short trades) or down days (for long trades.) Sometimes you will run your scans and find stocks that have more than that.
One final note: When you are looking for swing points to develop, you always want to look to the left of the chart to see if the stock is at a support or resistance area on the chart. That will improve the reliability of this entry strategy.
Ok, now that we know how to get into a trade, how do we get out? We need an exit strategy.
How To Take Profits And Control Your Losses
Your exit strategy consists of two parts: Where will you get out of the trade if the stock does not go in your favor? Where will you take profits if the stock does go in your favor? These are the two questions that make up your exit strategy. You have to be able to answer these questions before you can place the trade!
Part One – Your Stop Loss Order
First, lets put to rest the debate about where or not you should use a physical stop or use a mental stop. A physical stop loss is an order to sell (or buy if you are short) that you place with your broker. A mental stop is YOU clicking the sell (buy) button to get out of the trade. From a technical perspective, it does not matter which type you use.
Before you get into a trade you will have a plan that will determine when to get out of the trade if it does not go in your favor. You are a disciplined trader that always follows your plan (right?). What difference would it make whether or not you have an actual order placed with your broker or if you are going to pull the trigger yourself? There is no difference. In either case, you will get out of the stock when your plan (exit strategy) tells you to!
Personally, I always use physical stop loss orders placed with my broker. This is because I do not want to sit at my computer and look at a monitor all day long! Ok, maybe that’s a slight exaggeration, but you get the point!
Where is your stop going to be? First of all you need a stop that makes sense and you need it to be out of the “noise” of the current activity in the stock.
Look at the average true range of the stock over the past 10 days. If the average true range of the stock is, say, Rs 11, then your stop needs to be at least that far away from your entry price. It doesn’t make any sense to have your stop Rs 3 away from your entry price when the range is Rs 11. You will surely get stopped out prematurely!
For long positions, your stop should go under a support area and a swing point low.
For short positions, your stop should go above a resistance area and a swing point high.
Part Two – Taking Profits
Use trailing stops! This is an easy and unemotional way of exiting a trade. If this trade is going to be a typical swing trade with a holding time of 2-5 days, then you can trail your stops a few rupees under the two day low. (This is the low of the last two days). Once you have spent 2 or 2 days in the trade, tighten the stop to just the previous day’s low.
Note: Initially, on the day of entry, your stop should be based on your stop loss order. the trailing stops come in, on the day your trade becomes profitable.
If this is a first pullback scenario, then you may want to hold this for a longer time frame. Having some big winners every now and then will fatten up your trading account! In this case you can trail your stops under the swing lows (or highs for shorts) until stopped out.
In either case, you should always determine where your stop is going to be and how you are going to take profits before you get into the trade. Have a solid plan in place (write it down). This will take all of the emotion out of the trade. Then you can relax and trade the “map” that you have created. This will make your exit strategy easy to follow and it will put you on the path to success.
What is so special about this zone?
I have found that for swing trading, a lot of reversals happen in this area. So in order to create a focus in your trading strategy, it is helpful to narrow down your potential stock setups to one area on a chart. This zone provides a number of setups on a daily basis.
We are not really concerned with the moving averages themselves. When a stock pulls back into this zone, look to the left to identify support and resistance, trend lines, candlestick patterns, etc. You are looking for multiple signals all pointing in the same direction.
Will this strategy make me a profitable trader?
You may be surprised by my answer.
The answer is no. There isn’t ANY trading strategy that will make you a consistently profitable trader. Sorry to disappoint you. The only thing that will enable you to consistently pull money out of the markets is YOU.
YOU must have discipline. YOU must be able to take losses. YOU must be able to take your profits. YOU must eliminate fear. Put simply, you must be able to control the emotional and psychological problems that prevent success.
That will be your biggest challenge in learning how to trade stocks with any strategy.
CrossOvers - An easy path to swing trading
Apply the tm Alligator indicator to your end of day chart.
Watch for a crossover. A bullish cross over must open below the three Alligator lines and close above them on the same day. We repeat that this should happen on the same day. You may relax the rules a bit, to permit a composite (across two days) cross but to be honest I prefer those that happen all in one day. No hesitation normally means that the stock is going to go up. Note that the direction of the three lines or even their order is not considered.
If you are tracking the market during trading, you can buy before the close. otherwise, buy the next day. Put your stop (mental or actual) below the candle that crossed and let them run.
Exiting a cross over is up to you – I expect 3% to 5% and after that everything is golden. My stop is always just below the crossing bar because the beauty of the cross over is – it works or it doesn’t. I use a close as a trigger to sell the stock. In other words an intra-day move below the candle will not cause me to sell but a end of day close below the candle definitely will. While some traders accept a pull back, I prefer the ones that go straight up.
Such crossovers will not come often. I think, we get one in two months, on an average. But, remember there are many stocks to swing trade, so there should be a stream of such patterns coming in. Remember, patience is the best friend of the trader. And impatience is the reason why many traders go broke instead of rich.
If you are trading in Futures, you can also go for the short sell signals. This will increase the number of signals that come in. A bearish crossover takes place when price opens above the three lines and closes below it. The stop is above the high of the crossover day.
The theory behind the Alligator lines is simple. When the lines converge it suggests that volatility is damping out and when they diverge it suggests that the volatility is excessive and needs to come back. A crossover will normally happen when the lines are converging. The crossover is giving a message that the decline in volartility may be over.
So instead of looking at the three lines as just three more lines on a chart – start looking at them as a function of volatility and they might start making more sense to you.
You may also experiment with replacing the Alligator lines with three moving averages to your end of day chart – the 4, 8 and 21 EMA. I have found the Alligator to be a better method.
Watch for a crossover. A bullish cross over must open below the three Alligator lines and close above them on the same day. We repeat that this should happen on the same day. You may relax the rules a bit, to permit a composite (across two days) cross but to be honest I prefer those that happen all in one day. No hesitation normally means that the stock is going to go up. Note that the direction of the three lines or even their order is not considered.
If you are tracking the market during trading, you can buy before the close. otherwise, buy the next day. Put your stop (mental or actual) below the candle that crossed and let them run.
Exiting a cross over is up to you – I expect 3% to 5% and after that everything is golden. My stop is always just below the crossing bar because the beauty of the cross over is – it works or it doesn’t. I use a close as a trigger to sell the stock. In other words an intra-day move below the candle will not cause me to sell but a end of day close below the candle definitely will. While some traders accept a pull back, I prefer the ones that go straight up.
Such crossovers will not come often. I think, we get one in two months, on an average. But, remember there are many stocks to swing trade, so there should be a stream of such patterns coming in. Remember, patience is the best friend of the trader. And impatience is the reason why many traders go broke instead of rich.
If you are trading in Futures, you can also go for the short sell signals. This will increase the number of signals that come in. A bearish crossover takes place when price opens above the three lines and closes below it. The stop is above the high of the crossover day.
The theory behind the Alligator lines is simple. When the lines converge it suggests that volatility is damping out and when they diverge it suggests that the volatility is excessive and needs to come back. A crossover will normally happen when the lines are converging. The crossover is giving a message that the decline in volartility may be over.
So instead of looking at the three lines as just three more lines on a chart – start looking at them as a function of volatility and they might start making more sense to you.
You may also experiment with replacing the Alligator lines with three moving averages to your end of day chart – the 4, 8 and 21 EMA. I have found the Alligator to be a better method.
Stock Selection
Since swing trading is a short term trading method, traders should be open to the idea of short selling, if the market conditions are conducive. For this reason, the swing trading universe of stocks should consist of shares in the Futures & Options list. Traders will enjoy leverage if they trade in Futurers or Options. Even if they wish to trade in the cash segment itself, at leat they will have the advantage of using F&O instruments should they so desire.
Rule 1. The selection of stocks should come from the F&O segment. This is not an iron clad rule, since you may wish to keep some stocks that do not belong o the F&O segment, but the majority of stocks in your list should be from F&O.
From the F&O stocks, you should make a list of about 50 stocks that you will actively track. The stock selection exercise needs o be done once a week. Normally there will be only a few changes from week to week. You can use rank-It to identify stocks for your list. you can also use charts to directly identify stocks for your list. Both procedures are given below.
[LESSON: Use Rank-It! to identify strong & weak stocks.
Open the Rank-It! screen: follow the Scans —> Rank-It! —> EOD menu sequence.
Change the compression to weekly: Click on Compression, then click on weekly. (We will use the weekly time frame, which is the intermediate time frame, to identify our stocks.)
We want to rank the F&O folder, so on the folder list displayed to the left, click on #F&O. Now, click on the Rank-It! button. The process will start. The time taken depends on the speed of our computer. Please be patient.
When the process is complete, a lis of all the stocks is displayed. Each stock has a rank, starting from 1 to 225 or more. The Highest rank is 1. the lowest rank is the last rank. Stocks with high ranks are in strong up trend. Stocks with low ranks are in strong down trend.
From these ranks, select 50 stocks that you will monitor on a day to day basis. Select 20 stocks to represent the primary trend, and, about 30 to represent the intermediate trend. If the primary trend is up, choose 20 strong stocks, from the rank 1 to 75. If the intermediate trend is also up, choose 30 more stocks, from the ranks 1 to 125. If the intermediate trend is down, select 30 weak stocks from the last 80 or 100 stocks.
Explaination: Why not pick the top 20 stocks, or the top 50 stocks ? We suggest that you examine the top 75 stocks and then select 20 from them. You should spread out your selection accross the 75 names. There are many reasons to do so. First, it is quite possible that the top stocks may already be in mature trends. Second, the lower rank stocks, say between 50 to 75 may be improving day by day, moving towards the top ranks. Third, your selection should have a fair sprinking of different sectors. To do this, you have to select from a wide area.
The selection process should focus on stocks with high relative strength, sustained trend and increasing volume. Your choice should be on consistent performers instead of momentum ‘darlings’. These are the stocks favored by smart money. When stocks trend, they become tradable for swing traders since many institutions get involved adding fuel to the stock. Uptrending and downtrending stocks are better swing trading candidates than stocks inside a trading range.
By identifying strong & weak stocks, finally make a list of about 50 stocks that you will work on. You are not going to trade in all fifty. But, this is your universe and you will focus exclusively on it.
NOTE: In the heat of the moment you’ll see stocks you wished you owned, and you’ll be upset that somebody is making money when you are not doing as well. Someone will always be outperforming you, but let’s see where that person is six months or a year or two from now, because today’s darlings usually turn into next year’s dogs.
When this list is made, make a folder with the 50 stocks. Folders can be made in Data management —> Folders —> EOD. If you are repeating this exercise for subsequent weeks, then this folder already exists. You should open this folder and edit it o reflect the new list.
END OF Rank-It! LESSON]
[LESSON: use charts to visually identify stocks for swing trading]
We need trending stocks in our list. When we visually select stocks, we work on the daily chart. The process should identify stocks in visible uptrend or downtrend. Stocks in trading range should be avoided.
Up trending stocks:
Moving Averages should be in proper order. The 10 day simple average should be at the top. The 20 day exponential average should be below the 10 day. The 40 day exponential average should be below the 20 day. Prices should be above the 20 day average.
A clear up trend should be visible. A good uptrend has gaps, laps, wide range breakout bars & breakouts from narrow tight consolidation. Ideally, there should be short pullbacks also. Stocks that pullback are good stocks to trade with.
Relaitve Strength versus the Nifty should be increasing.
Down trending stocks:
Moving Averages should be in proper order. The 10 day simple average should be at the botom. The 20 day exponential average should be above the 10 day. The 40 day exponential average should be above the 20 day. Prices should be below the 20 day average.
A clear down trend should be visible. A good downtrend has gaps, laps, wide range breakout bars & breakdown from narrow tight consolidation. Ideally, there should be short pullbacks also. Stocks that pullback are good stocks to trade with.
Relaitve Strength versus the Nifty should be decreasing.
END OF stock selection LESSON]
An additional exercise can help in filtering out improper candidates for swing trading. For the stocks selected, Also, look at the price history for the stock in question. Does it have a history of large price gaps? Does it seem to trend well when it breaks out from chart patterns? Does the stock move for several days in a row when it breaks out or does it go for one day and soon after reverse course? Questions like these will help you decide if a swing trading approach is best for the stock you are looking to trade.
Rule 1. The selection of stocks should come from the F&O segment. This is not an iron clad rule, since you may wish to keep some stocks that do not belong o the F&O segment, but the majority of stocks in your list should be from F&O.
From the F&O stocks, you should make a list of about 50 stocks that you will actively track. The stock selection exercise needs o be done once a week. Normally there will be only a few changes from week to week. You can use rank-It to identify stocks for your list. you can also use charts to directly identify stocks for your list. Both procedures are given below.
[LESSON: Use Rank-It! to identify strong & weak stocks.
Open the Rank-It! screen: follow the Scans —> Rank-It! —> EOD menu sequence.
Change the compression to weekly: Click on Compression, then click on weekly. (We will use the weekly time frame, which is the intermediate time frame, to identify our stocks.)
We want to rank the F&O folder, so on the folder list displayed to the left, click on #F&O. Now, click on the Rank-It! button. The process will start. The time taken depends on the speed of our computer. Please be patient.
When the process is complete, a lis of all the stocks is displayed. Each stock has a rank, starting from 1 to 225 or more. The Highest rank is 1. the lowest rank is the last rank. Stocks with high ranks are in strong up trend. Stocks with low ranks are in strong down trend.
From these ranks, select 50 stocks that you will monitor on a day to day basis. Select 20 stocks to represent the primary trend, and, about 30 to represent the intermediate trend. If the primary trend is up, choose 20 strong stocks, from the rank 1 to 75. If the intermediate trend is also up, choose 30 more stocks, from the ranks 1 to 125. If the intermediate trend is down, select 30 weak stocks from the last 80 or 100 stocks.
Explaination: Why not pick the top 20 stocks, or the top 50 stocks ? We suggest that you examine the top 75 stocks and then select 20 from them. You should spread out your selection accross the 75 names. There are many reasons to do so. First, it is quite possible that the top stocks may already be in mature trends. Second, the lower rank stocks, say between 50 to 75 may be improving day by day, moving towards the top ranks. Third, your selection should have a fair sprinking of different sectors. To do this, you have to select from a wide area.
The selection process should focus on stocks with high relative strength, sustained trend and increasing volume. Your choice should be on consistent performers instead of momentum ‘darlings’. These are the stocks favored by smart money. When stocks trend, they become tradable for swing traders since many institutions get involved adding fuel to the stock. Uptrending and downtrending stocks are better swing trading candidates than stocks inside a trading range.
By identifying strong & weak stocks, finally make a list of about 50 stocks that you will work on. You are not going to trade in all fifty. But, this is your universe and you will focus exclusively on it.
NOTE: In the heat of the moment you’ll see stocks you wished you owned, and you’ll be upset that somebody is making money when you are not doing as well. Someone will always be outperforming you, but let’s see where that person is six months or a year or two from now, because today’s darlings usually turn into next year’s dogs.
When this list is made, make a folder with the 50 stocks. Folders can be made in Data management —> Folders —> EOD. If you are repeating this exercise for subsequent weeks, then this folder already exists. You should open this folder and edit it o reflect the new list.
END OF Rank-It! LESSON]
[LESSON: use charts to visually identify stocks for swing trading]
We need trending stocks in our list. When we visually select stocks, we work on the daily chart. The process should identify stocks in visible uptrend or downtrend. Stocks in trading range should be avoided.
Up trending stocks:
Moving Averages should be in proper order. The 10 day simple average should be at the top. The 20 day exponential average should be below the 10 day. The 40 day exponential average should be below the 20 day. Prices should be above the 20 day average.
A clear up trend should be visible. A good uptrend has gaps, laps, wide range breakout bars & breakouts from narrow tight consolidation. Ideally, there should be short pullbacks also. Stocks that pullback are good stocks to trade with.
Relaitve Strength versus the Nifty should be increasing.
Down trending stocks:
Moving Averages should be in proper order. The 10 day simple average should be at the botom. The 20 day exponential average should be above the 10 day. The 40 day exponential average should be above the 20 day. Prices should be below the 20 day average.
A clear down trend should be visible. A good downtrend has gaps, laps, wide range breakout bars & breakdown from narrow tight consolidation. Ideally, there should be short pullbacks also. Stocks that pullback are good stocks to trade with.
Relaitve Strength versus the Nifty should be decreasing.
END OF stock selection LESSON]
An additional exercise can help in filtering out improper candidates for swing trading. For the stocks selected, Also, look at the price history for the stock in question. Does it have a history of large price gaps? Does it seem to trend well when it breaks out from chart patterns? Does the stock move for several days in a row when it breaks out or does it go for one day and soon after reverse course? Questions like these will help you decide if a swing trading approach is best for the stock you are looking to trade.
Setups for Swing Trading
Making money with Swing Trading
To make money in the stock market it is necessary to have a disciplined approach to trading. Once you learn the rules and you trade with discipline, you will make money in the stock market.
Swing trading allows you to make money when the market is bullish, or bearish, or just going sideways. That is why it has a distinct advantage over other approaches to investing. The goal is to make money, not to rest one’s hopes on the future of a stock, a sector, or the economy.
When determining if conditions are proper for swing trading, take into consideration whether the overall market is trending or not. This observation alone can be helpful when deciding if stocks are likely to see follow-through for multi-day moves or if they will instead reverse course and not trend at all.
What can you expect ?
First, – only a portion of your trades will be executed. Swing trading is designed to only trade stocks that initially move in the anticipated direction. If the price moves in the opposite direction (continues pulling back or pulling up), the trade is not placed.
Second, – you will be holding positions for a limited amount of time. While swing trading is not day trading, you are only holding positions until targets are met.
Third, – some of your trades will result in losses, however losses are minimized by trailing stops which raises the stops as the stock price rises; this is known as trailing stops. Being disciplined, and following a plan will insure that profits exceed losses which means you will make money.
The Basic Setup
STEP 1 – Identify a stock that is in an uptrend or a downtrend.
STEP 2 – For stocks in an uptrend, identify those that are experiencing a pull-back.
For stocks in a downtrend, identify those that are experiencing a pull-up.
STEP 3 – Once an appropriate candidate is identified, place an order to buy (uptrend) or sell short (downtrend) the stock. You buy above the high of he previous day, and sell below the low.
STEP 4 – Once a stock has been traded (a position opened), place a stop-loss order to limit downside risk and place a limit order to identify the price at which you will take profits. (Ideally, these two orders are placed together. Ensure that both orders should never be triggered.
STEP 5 – At the end of each day, adjust the stop loss prices based on the price movement.
To make money in the stock market it is necessary to have a disciplined approach to trading. Once you learn the rules and you trade with discipline, you will make money in the stock market.
Swing trading allows you to make money when the market is bullish, or bearish, or just going sideways. That is why it has a distinct advantage over other approaches to investing. The goal is to make money, not to rest one’s hopes on the future of a stock, a sector, or the economy.
When determining if conditions are proper for swing trading, take into consideration whether the overall market is trending or not. This observation alone can be helpful when deciding if stocks are likely to see follow-through for multi-day moves or if they will instead reverse course and not trend at all.
What can you expect ?
First, – only a portion of your trades will be executed. Swing trading is designed to only trade stocks that initially move in the anticipated direction. If the price moves in the opposite direction (continues pulling back or pulling up), the trade is not placed.
Second, – you will be holding positions for a limited amount of time. While swing trading is not day trading, you are only holding positions until targets are met.
Third, – some of your trades will result in losses, however losses are minimized by trailing stops which raises the stops as the stock price rises; this is known as trailing stops. Being disciplined, and following a plan will insure that profits exceed losses which means you will make money.
The Basic Setup
STEP 1 – Identify a stock that is in an uptrend or a downtrend.
STEP 2 – For stocks in an uptrend, identify those that are experiencing a pull-back.
For stocks in a downtrend, identify those that are experiencing a pull-up.
STEP 3 – Once an appropriate candidate is identified, place an order to buy (uptrend) or sell short (downtrend) the stock. You buy above the high of he previous day, and sell below the low.
STEP 4 – Once a stock has been traded (a position opened), place a stop-loss order to limit downside risk and place a limit order to identify the price at which you will take profits. (Ideally, these two orders are placed together. Ensure that both orders should never be triggered.
STEP 5 – At the end of each day, adjust the stop loss prices based on the price movement.
Getting Started in Swing Trading
Swing trading means to hold stocks anywhere from one to five days and sometimes more. Swingtraders try to take advantage of certain “key” situations in a stock price’s movement. Such a situation would be a buy after a pullback into solid support during a longer term uptrend. Swing trading is an easy to implement strategy and is excellent for people who are willing to take overnight positions.
Before proceeding further, please understand how the trend is determined in any time frame. The article here explains the process.
Step 1: Define the Primary Trend of the Stock Market
This is best done on Monthly charts. Open the monthly chart for the Nifty. Employ any one of the tools and procedures explained earlier, to define the primary trend.
Primary Trend = PT = Trend as per the method used
Step 2: Define the Intermediate Trend of the Stock Market.
This is best done on weekly charts. Open the weekly chart for the Nifty. Employ any one of the tools and procedures explained earlier, to define the intermediate trend.
Apart from the trend methods discussed earlier, for the Intermediate trend, there is one more method. Apply a simple moving average with a value 30. This is the 30 week moving average. When weekly close is above the average, the trend is up, when weekly close is below the average, trend is down. Whatever method you use, use it consistently.
Intermediate Trend = IT = Trend as per the method used
Step 3: Define the short term Trend of the Stock Market. This is the trend that traders should be looking at. This is done on daily charts. Open the daily chart for the Nifty. Employ any one of the tools and procedures explained earlier, to define the short term trend.
Short Term Trend = ST = Trend as per the method used
At this point, after step 1 to 3, the trader should be aware of the trend in all three significant time frames. Please do not ignore these steps.
DECIDING ON THE TRADE DIRECTION
With clarity on trend in the three timeframes, a decision can be taken on the direction in which swing trades will be taken. It is here that the trend identified earlier will be used.
The second decision that the trader needs to take is to make a list of stocks in which he wishes to rade.
Once the trader knows the stocks he should be working with & the buy / sell action he needs to take, the rest of the trading process becomes mechanical. The Swing Trader now searches for setups or patterns which indicate if a trading opportunity exists in the desired trading direction.
These two issues, stock selection & setups are explained in seperate articles on Stock Selection & Setups for Swing Trading
Before proceeding further, please understand how the trend is determined in any time frame. The article here explains the process.
Step 1: Define the Primary Trend of the Stock Market
This is best done on Monthly charts. Open the monthly chart for the Nifty. Employ any one of the tools and procedures explained earlier, to define the primary trend.
Primary Trend = PT = Trend as per the method used
Step 2: Define the Intermediate Trend of the Stock Market.
This is best done on weekly charts. Open the weekly chart for the Nifty. Employ any one of the tools and procedures explained earlier, to define the intermediate trend.
Apart from the trend methods discussed earlier, for the Intermediate trend, there is one more method. Apply a simple moving average with a value 30. This is the 30 week moving average. When weekly close is above the average, the trend is up, when weekly close is below the average, trend is down. Whatever method you use, use it consistently.
Intermediate Trend = IT = Trend as per the method used
Step 3: Define the short term Trend of the Stock Market. This is the trend that traders should be looking at. This is done on daily charts. Open the daily chart for the Nifty. Employ any one of the tools and procedures explained earlier, to define the short term trend.
Short Term Trend = ST = Trend as per the method used
At this point, after step 1 to 3, the trader should be aware of the trend in all three significant time frames. Please do not ignore these steps.
DECIDING ON THE TRADE DIRECTION
With clarity on trend in the three timeframes, a decision can be taken on the direction in which swing trades will be taken. It is here that the trend identified earlier will be used.
The second decision that the trader needs to take is to make a list of stocks in which he wishes to rade.
Once the trader knows the stocks he should be working with & the buy / sell action he needs to take, the rest of the trading process becomes mechanical. The Swing Trader now searches for setups or patterns which indicate if a trading opportunity exists in the desired trading direction.
These two issues, stock selection & setups are explained in seperate articles on Stock Selection & Setups for Swing Trading
How to determine the trend on any time frame
Employ any one of the tools and procedures below to define the trend.
MACD: Use the buy values as inputs: 8,17 and 9. If the MACD line is above the trigger line, the primary trend is up. If the MACD line is below the trigger line, the primary trend is down.
Keltner Channels: Define a narrow channel with 10 and 1. Ignore the middle line. We are interested in the direction of the two outer channel lines. If both lines are moving up, trend is up. If both lines are moving down, trend is down. Sometimes, you will visually see that one line may be moving up while the other may be moving down. This is a sideways move. In such cases, it is best to wait for the lines to eventually take a direction. With Keltner channels, sometimes the lines appear to be flat. Just assume that the flat lines are sideways. We are interested in the broad view, not in extreme precision.
Linear Regression: Apply a 21 period linear regression line. The Linear Regression is available in the Moving Average indicator. If the line is moving up, the trend is up. if the line is moving down, the trend is down. You can also apply the query – ‘Short term trend is up’ to get this information. In the query, the brown bars represent an up trend. If the bar is not brown, it is a downtrend.
2MA Difference: Apply the 2 MA difference indicator with these settings: MA 1 = 3, MA2 = 10, Calc basis = Close, Average Type = Weighted. Select the Above/Below option. When the lines are green, the trend is up. When the lines are red, the trend is down.
+DMI/-DMI: Apply the ADX indicator with the default of 14. In the Indicators dialog, unchek ‘ADX Plot’ and also unchek ‘Mid Point’. The other two plots ‘ +DI and -DI’ should be checked. We wan to plot the +DI and -DI and we do not want to plot the ADX or the mid line. If the +DI (green) is above the -DI (red), then the trend is UP. If the +DI (green) is below the -DI (red) then the trend is down.
There are as many ways of identifying the trend, as stars in the sky. Do we really need all of them ? No. Eventually, all the methods will take us to the same destination. So, focus on any one method, then stick to it.
MACD: Use the buy values as inputs: 8,17 and 9. If the MACD line is above the trigger line, the primary trend is up. If the MACD line is below the trigger line, the primary trend is down.
Keltner Channels: Define a narrow channel with 10 and 1. Ignore the middle line. We are interested in the direction of the two outer channel lines. If both lines are moving up, trend is up. If both lines are moving down, trend is down. Sometimes, you will visually see that one line may be moving up while the other may be moving down. This is a sideways move. In such cases, it is best to wait for the lines to eventually take a direction. With Keltner channels, sometimes the lines appear to be flat. Just assume that the flat lines are sideways. We are interested in the broad view, not in extreme precision.
Linear Regression: Apply a 21 period linear regression line. The Linear Regression is available in the Moving Average indicator. If the line is moving up, the trend is up. if the line is moving down, the trend is down. You can also apply the query – ‘Short term trend is up’ to get this information. In the query, the brown bars represent an up trend. If the bar is not brown, it is a downtrend.
2MA Difference: Apply the 2 MA difference indicator with these settings: MA 1 = 3, MA2 = 10, Calc basis = Close, Average Type = Weighted. Select the Above/Below option. When the lines are green, the trend is up. When the lines are red, the trend is down.
+DMI/-DMI: Apply the ADX indicator with the default of 14. In the Indicators dialog, unchek ‘ADX Plot’ and also unchek ‘Mid Point’. The other two plots ‘ +DI and -DI’ should be checked. We wan to plot the +DI and -DI and we do not want to plot the ADX or the mid line. If the +DI (green) is above the -DI (red), then the trend is UP. If the +DI (green) is below the -DI (red) then the trend is down.
There are as many ways of identifying the trend, as stars in the sky. Do we really need all of them ? No. Eventually, all the methods will take us to the same destination. So, focus on any one method, then stick to it.
Intra Day Entry Methods
This article discusses three entry strategies for day traders :
(1) KEY BUY :-
It is designed to help trader come into market as a buyer , precisely when the group gripped by fear and fright is anxious to leave the game .The key buy set up involves three simple steps :-
(a) New high -This criterion calls for a stock that has recently made a higher high than it prior rally . High does not imply all time high ,it means that stock should have made a new high no longer than 8 days ago.
(b) Three or more consecutive lower highs – This criterion calls for the stock to experience a 3-bar decline i.e. the high of each down bar must be lower than the prior bar’s high . This concept is applicable in intra day time frames , as well as daily and weekly time frames.
(c) The action – Buy the stock whenever it trades 0.25 to 0.5 above a prior bar high.
(2) 30-minutes Buy :-
In todays volatile market gaps are very common occurrences , and the trader who lacks the ability to deal with them is playing a distinct disadvantage.The first 20-30 minutes is the trickiest time period of the day , particularly when the market is poised to open up very strongly .If the stock that has gapped up and is able to trade to a new high after 30 minutes of trading , the strength demonstrated at the open was not artificial but real.The strength in this case is real because it is being confirmed by continuous buying .
Working Procedure :-
Set Up – (a) – The stock must gap up at the open by 0.6 or more . It is best if the stock does not rally much from its opening price , although stock which gap and stall immediately make the very best candidate for this strategy .
Action – (a) – Once the stock has gapped open , trader must let it trade for a full 30- minutes .
(b) – Once 30-minutes has transpired , the trader sets an alert 0.25 above the high of the day , which is not too far away from from current price.
(c) – Once the stock breaks to a new daily high the trader buys with a protective stop 0.25 below the day low .
(d)- Then the trader would use the trade management and profit taking steps.
(3) Late day breakout description :-
The latter part of the trading day offers the trader one of the best opportunities for picking up micro trading gains . It is because the , the market often continues where it left off before the start of mid day doldroms , providing the traders with new possibilities of trading . The latter part of the day imply time 2.15 onwards .
Set up :- The setup is based by viewing 5-minutes charts.
(a) – Stock must be up on the day .
(b) – The stock must be trading at or above its opening price.
(c) – The stock must be near day’s high .
(d) – The stock must be in sideways base at least 1 and 1/2 hrs.
Action :- (a) – The trader looks to buy 0.25 th above the recent high price , but it is preferable to enter the stock below the daily high . The assumption are made by analyzing 5-min price chart.
(b) – The traders put stop loss just below the lowest price.
(c) – Sells the stocks when its moves higher .
(1) KEY BUY :-
It is designed to help trader come into market as a buyer , precisely when the group gripped by fear and fright is anxious to leave the game .The key buy set up involves three simple steps :-
(a) New high -This criterion calls for a stock that has recently made a higher high than it prior rally . High does not imply all time high ,it means that stock should have made a new high no longer than 8 days ago.
(b) Three or more consecutive lower highs – This criterion calls for the stock to experience a 3-bar decline i.e. the high of each down bar must be lower than the prior bar’s high . This concept is applicable in intra day time frames , as well as daily and weekly time frames.
(c) The action – Buy the stock whenever it trades 0.25 to 0.5 above a prior bar high.
(2) 30-minutes Buy :-
In todays volatile market gaps are very common occurrences , and the trader who lacks the ability to deal with them is playing a distinct disadvantage.The first 20-30 minutes is the trickiest time period of the day , particularly when the market is poised to open up very strongly .If the stock that has gapped up and is able to trade to a new high after 30 minutes of trading , the strength demonstrated at the open was not artificial but real.The strength in this case is real because it is being confirmed by continuous buying .
Working Procedure :-
Set Up – (a) – The stock must gap up at the open by 0.6 or more . It is best if the stock does not rally much from its opening price , although stock which gap and stall immediately make the very best candidate for this strategy .
Action – (a) – Once the stock has gapped open , trader must let it trade for a full 30- minutes .
(b) – Once 30-minutes has transpired , the trader sets an alert 0.25 above the high of the day , which is not too far away from from current price.
(c) – Once the stock breaks to a new daily high the trader buys with a protective stop 0.25 below the day low .
(d)- Then the trader would use the trade management and profit taking steps.
(3) Late day breakout description :-
The latter part of the trading day offers the trader one of the best opportunities for picking up micro trading gains . It is because the , the market often continues where it left off before the start of mid day doldroms , providing the traders with new possibilities of trading . The latter part of the day imply time 2.15 onwards .
Set up :- The setup is based by viewing 5-minutes charts.
(a) – Stock must be up on the day .
(b) – The stock must be trading at or above its opening price.
(c) – The stock must be near day’s high .
(d) – The stock must be in sideways base at least 1 and 1/2 hrs.
Action :- (a) – The trader looks to buy 0.25 th above the recent high price , but it is preferable to enter the stock below the daily high . The assumption are made by analyzing 5-min price chart.
(b) – The traders put stop loss just below the lowest price.
(c) – Sells the stocks when its moves higher .
Brief guide to day trading
This document is a short course on day trading with RT PRO – intra day data & charting service provided by Technical Trends. (www.techncaltrends.com)
The purpose of this document is to answer many questions that we receive daily. We wish to assist users in becoming proficient in the art of day trading. Yes, day trading is an art. There is a sixth sense, or rhythm to day trading. Those who have it do better than those who do not, but everyone who applies the principles outlined in the next few pages has the potential for consistent success in this business.
SECTION 1. DAY TRADING IS A BUSINESS
Trading in a short-term time frame is fun. It is just like playing computer games, except that there is a lot of money involved. So, unless you have money to burn, you should approach day trading as a business.
A. Record keeping.
Keep a record of all your trades. This involves keeping a trading diary. Don’t begin a story for each trade, just mention the highlights – why you took the trade & what went right or wrong.
B. Brokerage.In day trading, high brokerage rates can ruin you. Make sure you pay the lowest brokerage rates available. Many brokers will give you good rates when you negotiate with them.
SECTION 2. THE SPECIALIST TRADER
Traders who are most successful are specialists who use just one or two trading techniques and become experts in their execution. Focusing on one or two strategies will bring repeated success. Every time someone brings out a new strategy, we run to it, hoping it is the magic bullet. Well, we have not found any magic bullet, but we have identified a number of tactics that bring success. Knowing how to execute a particular strategy and being able to find the stocks that are ready to move when you want to trade is the most difficult situation facing day traders. With some study, it is possible to learn techniques to identify stocks that are ready to trade – when you need a trade. This can work out if you specialize in one or two techniques.
A. Your time frame.Traders must define the time frame in which they work. Position traders will typically enter a trade with a time horizon of weeks or even months. Swing traders are looking at trades that may last from a few hours to a few days. Day traders will usually hold stock for less than a day. Sometimes, their position will be closed in just a few minutes. Sometimes, a good trade will be carried overnight becoming a swing trade. In general, day traders will have positions that are closed in less than a day.
There are numerous advantages to day trading as well as disadvantages. Because day traders make more trades than, say, position traders, there are more chances of an error. Another disadvantage is that day traders often miss the big moves that stocks make. Therefore, some day traders let successful day trades develop into swing trades. Confirmed day traders, however, always close their trades before the market closes. An advantage to day trading is not holding trades overnight. Thus there is no risk of a gap open against the trader, the next day.
Finally, if you wish to day trade, you must be willing and able to sit in front of a computer all day and monitor a trade. If you cannot, then you can trade in the swing or intermediate time frames.
B. Goals & Cash management
Every trader must have goals. You must define these goals in terms of money. An example: “I wish to earn Rs 1,00,000 (One lakh) per month with day trading.” This works out to a daily average profit of Rs 5,000. Now, use this information in your cash management. Let’ say you find a great trade and are about to put on a trade. Suppose, you buy 500 shares. Now, the share must move at least Rs 10/- in your favor for you to reach your daily goal of Rs 5,000/-. Here, you must ask yourself if the stock has a daily range that justifies your expectation of a 10/- profit. If the average daily range for the stock is Rs 5/- then why should it move Rs 10/- on the day you put your trade? Then, you have to choose a stock that has a larger daily range, or increase the numbers of shares that you trade. But, your money management rules may not allow you to increase your volume. The only option left is to search out for stocks where the average range is enough to justify taking a position.
Average True Range – the difference between the daily high and low of the stock averaged over a number of days. Stocks with high average range are more volatile, thus offering more trading opportunities. Traders should search for stocks with high true range, or where the range is now increasing after remaining on the lower side.
The bottom line is you have to select stocks to trade that have the potential to generate a reasonable profit. While we will address the selection of stocks again in this course, once you decide on how you will trade every day, and what strategies you will employ, all of the above becomes second nature due to repetition. That is why it is important that you become a specialist. It is imperative that you have a trading plan before the open of the market. Just hoping to stumble across a good trade during the day, perhaps by listening to TV channels, is a sure way of failure in trading.
C. Are fundamentals important to day traders ?
Fundamentals do not matter to the day trader. You want a trade. You do not want the PE, Book Value, Q2 earnings, or any other information of this kind.
D. Market & Limit orders.
When trading highly liquid stocks, place orders at the market. In all other cases, place limit orders. This ensures that you do not get caught in a large spread for an illiquid stock. However, when your stops have been activated & you need to exit your position quickly, then do not wait for a limit order. Exit immediately at the market.
E. Stocks have individual trading characteristics
Stocks have personalities. One advantage of trading the same stocks all the time is you learn how they trade. If you are trading a stock for the first time, you often don’t know how it will move. Some stocks are incredibly volatile, others trade as smooth as silk. The more day traders, the more volume, the more volatility .
You should be looking at highly liquid stocks with an acceptable true range and a small spread.
SECTION 3. TREND & TRIGGER
“Successful trading is very simple. Buy a stock at the right time and sell it at the right time”.
A. TREND.
Traders make profits when the trend is in their favor. Many day traders forget this simple rule. There is only one way to make money – Buy Low & Sell high. If you are selling short then you may change the order, by selling first & buying later. It is a mathematical certainty that profits can be made only by buying at a price that is lower than the selling price.
For the day trader, who does not enjoy the luxury of time, it is all the more essential that the trend should be in his favor when he begins the trade.
B. TRIGGER
The trader need not take a trade even when the trend is in his favor. Once he is aware of the trend, he knows the direction in which he should trade. He should then wait for a trigger, which tells him that the appropriate moment to take the trade is now in hand. Thus, a trigger times the actual trade entry.
SECTION 4. . SETTING UP YOUR CHARTS
MULTIPLE TIME FRAMES
Traders can set up their trend & triggers in a number of ways. One classic & simple way is to use multiple time frames. A trend indicator on a higher time frame indicates the trend direction. The trader then takes trades using triggers in his normal time frame, only in the direction of the trend.
Example: A Day Trader uses two charts for each stock:
Chart 1. Trend. 30 minute chart which is the higher time frame
Chart 2. Trigger. 5 minute chart which is his trading time frame.
TREND CHART
To identify the trend, setup a 30 minute chart. Apply one of the following trend indicators: Escala, Alligator, Moving Average or Time Series.
You should go long only if the trend indicator is in an uptrend. This is how you identify the trend:
For an Uptrend:
Escala Day Trader: Bar color must be green. The Green bar must come after at least three red bars. If the green does not have three preceding red bars, then wait for three consecutive green bars to confirm an uptrend.
Alligator: The three lines should be in proper order. The Top line should be Green, then red, finally blue should be the lowest. Close of the latest bar MUST be above the Red line.
Moving Average: Apply a 20 period exponential moving average. Close of the latest bar should be above the moving average. The moving average should be rising. This means the value of the latest average should be higher than the value of the previous average.
Time Series: Apply a 13 period time series. This indicator is available inside the moving average option. Close of the latest bar should be above the time series. The time series should be rising. This means the value of the latest time series should be higher than the value of the previous time series.
For a Downtrend:
Escala Day Trader: Bar color must be red. The red bar must come after at least three green bars. If the red does not have three preceding green bars, then wait for three consecutive red bars to confirm a downtrend.
Alligator: The three lines should be in proper order. The Top line should be blue, then red, finally green should be the lowest. Close of the latest bar MUST be below the Red line.
Moving Average: Apply a 20 period exponential moving average. Close of the latest bar should be below the moving average. The moving average should be falling. This means the value of the latest average should be lower than the value of the previous average.
Time Series: Apply a 13 period time series. This indicator is available inside the moving average option. Close of the latest bar should be below the time series. The time series should be falling. This means the value of the latest time series should be lower than the value of the previous time series.
We have discussed four trend indicators. Please note that you should use one of these four. The choice is yours.
Note: If you are new to trading, you may think it takes a long time for the trend to emerge on the 30 min chart. This is to your advantage. When the trend emerges, it usually has some staying power.
TRIGGER CHART
This chart is a 5 minute chart of the stock that you wish to trade in. Once you determine the trend, you should be searching for a trigger to enter. The 5 minute chart provides you with the actual entry. It is also used to finally exit the trade.
We will use chart patterns on the 5 minute chart to enter the trade.
For long trades:
The 5 minute chart should have a small dip, after a rally. We want to buy when we sense the end of the dip. The end of this dip is signaled in two ways:
Reversal after dip:
After falling for a few bars, the security has a reversal bar. A reversal bar is defined as: (a) Bar with a greater than average range, (b) Open at the low and close at the High. The actual buying is done above the high of the reversal bar. If you are not filled in the next bar, you should keep the entry stop and wait for two more bars. After three bars have gone by, then cancel the trade if it has not been triggered.
For Short trades:
The 5 minute chart should have a small rally, after a dip. We want to sell when we sense the end of the rally. The end of this dip is signaled in two ways:
Reversal after rally:
After rising for a few bars, the security has a reversal bar. A reversal bar is defined as: (a) Bar with a greater than average range, (b) Open at the High and close at the Low. The actual selling is done below the low of the reversal bar. If you are not filled in the next bar, you should keep the entry stop and wait for two more bars. After three bars have gone by, then cancel the trade if it has not been triggered
Doji after dip:
After falling for a few bars, the security has a DOJI. A DOJI is defined as: (a) Bar with a greater than average range, (b) Open & close almost at the same price, and, (c) the open & close should in the the top half of the bar. The actual buying is done above the high of the Doji. If you are not filled in the next bar, you should keep the entry stop and wait for two more bars. After three bars have gone by, then cancel the trade if it has not been triggered.
INITIAL STOP LOSS:
Once a trade is taken, it must be given sufficient room to work out. Therefore, the initial stop loss should be based on the ATR (Average True Range) of the security. When a trade has been triggered, then you determine the ATR in this way:
Plot the Average True range indicator (Indicator —> Volatile —> Average True Range.) Note the value in the indicator window. This is the ATR. Now, your stop should be at least 2 times the ATR.
Example: You go long at 245. The ATR is 1.5. Then you stop will be 2 * 1.5 = 3 points below your entry price.
PROFIT TAKING:
Traders must allow the market to move as much as possible in their favor. Therefore, they should allow the market to determine the exit. For this reason, profit targets should be avoided. Let the market move in your favor. Keep a trailing stop to exit the market.
TRAILING STOP:
Two indicators can be used as trailing stops. Use the one which you find more comfortable.
Alligator Red Line: The red line is a trailing stop. If prices close below this line, then exit below the low of the latest bar.
Parabolic SAR: The SAR is also a suitable stop. SAR values are available on the screen. These become your exit values.
Exit Strategies – 1
Exits are an important part of trading plans. When you close the trade determines your size of profits, losses & total return.
Yet, traders who pay utmost attention on the right time to enter the trade, will often have just a hazy idea of when to exit. They hope that the trade will close itself. The trade does not end by itself, while the trader does not have a plan to close the trade. Many a time, a profitable trade finally gets closed at break even or worse at a loss.
For most traders, planning an exit strategy is a difficult task. This is mainly for psychological reasons. When you plan an exit, you have to accept that (a) the trade can result in a loss, and, (b) the profit on the trade is limited by some method or definition. But we do not like to bind ourselves with these assumptions.
Unrealistic expectations:
We expect that we will be able to buy at lows, sell at tops.
Lack of control irritates us:
While we can enter the market when we want, it is the market that determines our exit. This lack of control over exits irritates us, finally leading us to ignore it altogether. The truth is we are at the mercy of the market once we enter a trade. It is wise to accept that the market has control over our exits.
Answer:
We must have realistic expectations from every trade. We must accept that the trade can be a loss. A profitable trade is not going to make us as rich as Bill Gates.
Then, we can plan for an exit. While the market will still determine when that exit will take place, we will be in control of why that exit will happen.
Type of Exits:
Initial Protective Stop
Catastrophic stop
Break even stop
Trailing stop
Profit target stop
Factors influencing exits:
Reduce risk.
Protect profits.
Maximize profits.
The purpose of this document is to answer many questions that we receive daily. We wish to assist users in becoming proficient in the art of day trading. Yes, day trading is an art. There is a sixth sense, or rhythm to day trading. Those who have it do better than those who do not, but everyone who applies the principles outlined in the next few pages has the potential for consistent success in this business.
SECTION 1. DAY TRADING IS A BUSINESS
Trading in a short-term time frame is fun. It is just like playing computer games, except that there is a lot of money involved. So, unless you have money to burn, you should approach day trading as a business.
A. Record keeping.
Keep a record of all your trades. This involves keeping a trading diary. Don’t begin a story for each trade, just mention the highlights – why you took the trade & what went right or wrong.
B. Brokerage.In day trading, high brokerage rates can ruin you. Make sure you pay the lowest brokerage rates available. Many brokers will give you good rates when you negotiate with them.
SECTION 2. THE SPECIALIST TRADER
Traders who are most successful are specialists who use just one or two trading techniques and become experts in their execution. Focusing on one or two strategies will bring repeated success. Every time someone brings out a new strategy, we run to it, hoping it is the magic bullet. Well, we have not found any magic bullet, but we have identified a number of tactics that bring success. Knowing how to execute a particular strategy and being able to find the stocks that are ready to move when you want to trade is the most difficult situation facing day traders. With some study, it is possible to learn techniques to identify stocks that are ready to trade – when you need a trade. This can work out if you specialize in one or two techniques.
A. Your time frame.Traders must define the time frame in which they work. Position traders will typically enter a trade with a time horizon of weeks or even months. Swing traders are looking at trades that may last from a few hours to a few days. Day traders will usually hold stock for less than a day. Sometimes, their position will be closed in just a few minutes. Sometimes, a good trade will be carried overnight becoming a swing trade. In general, day traders will have positions that are closed in less than a day.
There are numerous advantages to day trading as well as disadvantages. Because day traders make more trades than, say, position traders, there are more chances of an error. Another disadvantage is that day traders often miss the big moves that stocks make. Therefore, some day traders let successful day trades develop into swing trades. Confirmed day traders, however, always close their trades before the market closes. An advantage to day trading is not holding trades overnight. Thus there is no risk of a gap open against the trader, the next day.
Finally, if you wish to day trade, you must be willing and able to sit in front of a computer all day and monitor a trade. If you cannot, then you can trade in the swing or intermediate time frames.
B. Goals & Cash management
Every trader must have goals. You must define these goals in terms of money. An example: “I wish to earn Rs 1,00,000 (One lakh) per month with day trading.” This works out to a daily average profit of Rs 5,000. Now, use this information in your cash management. Let’ say you find a great trade and are about to put on a trade. Suppose, you buy 500 shares. Now, the share must move at least Rs 10/- in your favor for you to reach your daily goal of Rs 5,000/-. Here, you must ask yourself if the stock has a daily range that justifies your expectation of a 10/- profit. If the average daily range for the stock is Rs 5/- then why should it move Rs 10/- on the day you put your trade? Then, you have to choose a stock that has a larger daily range, or increase the numbers of shares that you trade. But, your money management rules may not allow you to increase your volume. The only option left is to search out for stocks where the average range is enough to justify taking a position.
Average True Range – the difference between the daily high and low of the stock averaged over a number of days. Stocks with high average range are more volatile, thus offering more trading opportunities. Traders should search for stocks with high true range, or where the range is now increasing after remaining on the lower side.
The bottom line is you have to select stocks to trade that have the potential to generate a reasonable profit. While we will address the selection of stocks again in this course, once you decide on how you will trade every day, and what strategies you will employ, all of the above becomes second nature due to repetition. That is why it is important that you become a specialist. It is imperative that you have a trading plan before the open of the market. Just hoping to stumble across a good trade during the day, perhaps by listening to TV channels, is a sure way of failure in trading.
C. Are fundamentals important to day traders ?
Fundamentals do not matter to the day trader. You want a trade. You do not want the PE, Book Value, Q2 earnings, or any other information of this kind.
D. Market & Limit orders.
When trading highly liquid stocks, place orders at the market. In all other cases, place limit orders. This ensures that you do not get caught in a large spread for an illiquid stock. However, when your stops have been activated & you need to exit your position quickly, then do not wait for a limit order. Exit immediately at the market.
E. Stocks have individual trading characteristics
Stocks have personalities. One advantage of trading the same stocks all the time is you learn how they trade. If you are trading a stock for the first time, you often don’t know how it will move. Some stocks are incredibly volatile, others trade as smooth as silk. The more day traders, the more volume, the more volatility .
You should be looking at highly liquid stocks with an acceptable true range and a small spread.
SECTION 3. TREND & TRIGGER
“Successful trading is very simple. Buy a stock at the right time and sell it at the right time”.
A. TREND.
Traders make profits when the trend is in their favor. Many day traders forget this simple rule. There is only one way to make money – Buy Low & Sell high. If you are selling short then you may change the order, by selling first & buying later. It is a mathematical certainty that profits can be made only by buying at a price that is lower than the selling price.
For the day trader, who does not enjoy the luxury of time, it is all the more essential that the trend should be in his favor when he begins the trade.
B. TRIGGER
The trader need not take a trade even when the trend is in his favor. Once he is aware of the trend, he knows the direction in which he should trade. He should then wait for a trigger, which tells him that the appropriate moment to take the trade is now in hand. Thus, a trigger times the actual trade entry.
SECTION 4. . SETTING UP YOUR CHARTS
MULTIPLE TIME FRAMES
Traders can set up their trend & triggers in a number of ways. One classic & simple way is to use multiple time frames. A trend indicator on a higher time frame indicates the trend direction. The trader then takes trades using triggers in his normal time frame, only in the direction of the trend.
Example: A Day Trader uses two charts for each stock:
Chart 1. Trend. 30 minute chart which is the higher time frame
Chart 2. Trigger. 5 minute chart which is his trading time frame.
TREND CHART
To identify the trend, setup a 30 minute chart. Apply one of the following trend indicators: Escala, Alligator, Moving Average or Time Series.
You should go long only if the trend indicator is in an uptrend. This is how you identify the trend:
For an Uptrend:
Escala Day Trader: Bar color must be green. The Green bar must come after at least three red bars. If the green does not have three preceding red bars, then wait for three consecutive green bars to confirm an uptrend.
Alligator: The three lines should be in proper order. The Top line should be Green, then red, finally blue should be the lowest. Close of the latest bar MUST be above the Red line.
Moving Average: Apply a 20 period exponential moving average. Close of the latest bar should be above the moving average. The moving average should be rising. This means the value of the latest average should be higher than the value of the previous average.
Time Series: Apply a 13 period time series. This indicator is available inside the moving average option. Close of the latest bar should be above the time series. The time series should be rising. This means the value of the latest time series should be higher than the value of the previous time series.
For a Downtrend:
Escala Day Trader: Bar color must be red. The red bar must come after at least three green bars. If the red does not have three preceding green bars, then wait for three consecutive red bars to confirm a downtrend.
Alligator: The three lines should be in proper order. The Top line should be blue, then red, finally green should be the lowest. Close of the latest bar MUST be below the Red line.
Moving Average: Apply a 20 period exponential moving average. Close of the latest bar should be below the moving average. The moving average should be falling. This means the value of the latest average should be lower than the value of the previous average.
Time Series: Apply a 13 period time series. This indicator is available inside the moving average option. Close of the latest bar should be below the time series. The time series should be falling. This means the value of the latest time series should be lower than the value of the previous time series.
We have discussed four trend indicators. Please note that you should use one of these four. The choice is yours.
Note: If you are new to trading, you may think it takes a long time for the trend to emerge on the 30 min chart. This is to your advantage. When the trend emerges, it usually has some staying power.
TRIGGER CHART
This chart is a 5 minute chart of the stock that you wish to trade in. Once you determine the trend, you should be searching for a trigger to enter. The 5 minute chart provides you with the actual entry. It is also used to finally exit the trade.
We will use chart patterns on the 5 minute chart to enter the trade.
For long trades:
The 5 minute chart should have a small dip, after a rally. We want to buy when we sense the end of the dip. The end of this dip is signaled in two ways:
Reversal after dip:
After falling for a few bars, the security has a reversal bar. A reversal bar is defined as: (a) Bar with a greater than average range, (b) Open at the low and close at the High. The actual buying is done above the high of the reversal bar. If you are not filled in the next bar, you should keep the entry stop and wait for two more bars. After three bars have gone by, then cancel the trade if it has not been triggered.
For Short trades:
The 5 minute chart should have a small rally, after a dip. We want to sell when we sense the end of the rally. The end of this dip is signaled in two ways:
Reversal after rally:
After rising for a few bars, the security has a reversal bar. A reversal bar is defined as: (a) Bar with a greater than average range, (b) Open at the High and close at the Low. The actual selling is done below the low of the reversal bar. If you are not filled in the next bar, you should keep the entry stop and wait for two more bars. After three bars have gone by, then cancel the trade if it has not been triggered
Doji after dip:
After falling for a few bars, the security has a DOJI. A DOJI is defined as: (a) Bar with a greater than average range, (b) Open & close almost at the same price, and, (c) the open & close should in the the top half of the bar. The actual buying is done above the high of the Doji. If you are not filled in the next bar, you should keep the entry stop and wait for two more bars. After three bars have gone by, then cancel the trade if it has not been triggered.
INITIAL STOP LOSS:
Once a trade is taken, it must be given sufficient room to work out. Therefore, the initial stop loss should be based on the ATR (Average True Range) of the security. When a trade has been triggered, then you determine the ATR in this way:
Plot the Average True range indicator (Indicator —> Volatile —> Average True Range.) Note the value in the indicator window. This is the ATR. Now, your stop should be at least 2 times the ATR.
Example: You go long at 245. The ATR is 1.5. Then you stop will be 2 * 1.5 = 3 points below your entry price.
PROFIT TAKING:
Traders must allow the market to move as much as possible in their favor. Therefore, they should allow the market to determine the exit. For this reason, profit targets should be avoided. Let the market move in your favor. Keep a trailing stop to exit the market.
TRAILING STOP:
Two indicators can be used as trailing stops. Use the one which you find more comfortable.
Alligator Red Line: The red line is a trailing stop. If prices close below this line, then exit below the low of the latest bar.
Parabolic SAR: The SAR is also a suitable stop. SAR values are available on the screen. These become your exit values.
Exit Strategies – 1
Exits are an important part of trading plans. When you close the trade determines your size of profits, losses & total return.
Yet, traders who pay utmost attention on the right time to enter the trade, will often have just a hazy idea of when to exit. They hope that the trade will close itself. The trade does not end by itself, while the trader does not have a plan to close the trade. Many a time, a profitable trade finally gets closed at break even or worse at a loss.
For most traders, planning an exit strategy is a difficult task. This is mainly for psychological reasons. When you plan an exit, you have to accept that (a) the trade can result in a loss, and, (b) the profit on the trade is limited by some method or definition. But we do not like to bind ourselves with these assumptions.
Unrealistic expectations:
We expect that we will be able to buy at lows, sell at tops.
Lack of control irritates us:
While we can enter the market when we want, it is the market that determines our exit. This lack of control over exits irritates us, finally leading us to ignore it altogether. The truth is we are at the mercy of the market once we enter a trade. It is wise to accept that the market has control over our exits.
Answer:
We must have realistic expectations from every trade. We must accept that the trade can be a loss. A profitable trade is not going to make us as rich as Bill Gates.
Then, we can plan for an exit. While the market will still determine when that exit will take place, we will be in control of why that exit will happen.
Type of Exits:
Initial Protective Stop
Catastrophic stop
Break even stop
Trailing stop
Profit target stop
Factors influencing exits:
Reduce risk.
Protect profits.
Maximize profits.
Late in the Day Breakouts & Breakdowns
Late in the day breakouts
Setup, Entry and Exit Guidelines
8 – 10 bar base or consolidation in a tight range
In the upper 1/3 of the preceding bullish move
Above the 20MA on intra-day charts
No significant resistance/congestion to the left
Up on the day, and over the prior bar’s close
Breakout over resistance, on Vol., after 2:00 PM
Buy over resistance, with stop under base
Cover ½ under reversal bar; other ½ far from 20MA, or congestion.
Late in the day breakdowns
Setup, Entry and Exit Guidelines
8 – 10 bar base or consolidation in a tight range
At the lower 1/3 of the preceding bearish move
Below the 20MA on the intra-day charts
No significant support/congestion to the left
Down on the day, and under yesterday’s close
Breakdown under support, on Vol., after 2:00 PM
Short under support, with stop over base
Cover ½ over reversal bar; other ½ far from 20MA, or congestion
Setup, Entry and Exit Guidelines
8 – 10 bar base or consolidation in a tight range
In the upper 1/3 of the preceding bullish move
Above the 20MA on intra-day charts
No significant resistance/congestion to the left
Up on the day, and over the prior bar’s close
Breakout over resistance, on Vol., after 2:00 PM
Buy over resistance, with stop under base
Cover ½ under reversal bar; other ½ far from 20MA, or congestion.
Late in the day breakdowns
Setup, Entry and Exit Guidelines
8 – 10 bar base or consolidation in a tight range
At the lower 1/3 of the preceding bearish move
Below the 20MA on the intra-day charts
No significant support/congestion to the left
Down on the day, and under yesterday’s close
Breakdown under support, on Vol., after 2:00 PM
Short under support, with stop over base
Cover ½ over reversal bar; other ½ far from 20MA, or congestion
How to buy stocks that Gap Open - 1
Conditions that the stock should fulfill:
1. The stock must gap open to the upside on positive earnings, news, or strong buying in the sector.
2. Preferably, the stock should gap above the previous day’s high.
3. The stock should be in an up trend.
Tactics:
Once the stock has gapped open to the upside in the morning and has traded for a complete hour, the entry point at which to buy will be above the high of the 1st hour. In other words, the stock can only be bought after it has traded for a complete hour, and then only if it manages to trade above the highest price of the 1st hour.
The ideal situation occurs when the break above the 1st hour’s high happens several hours after the 1st hour of trading (mid to latter day).
Also, should the “gap open” take the issue from below to above a significant moving average like the 50MA or 200MA, consider it a bullish sign and therefore an extremely compelling play.
1. The stock must gap open to the upside on positive earnings, news, or strong buying in the sector.
2. Preferably, the stock should gap above the previous day’s high.
3. The stock should be in an up trend.
Tactics:
Once the stock has gapped open to the upside in the morning and has traded for a complete hour, the entry point at which to buy will be above the high of the 1st hour. In other words, the stock can only be bought after it has traded for a complete hour, and then only if it manages to trade above the highest price of the 1st hour.
The ideal situation occurs when the break above the 1st hour’s high happens several hours after the 1st hour of trading (mid to latter day).
Also, should the “gap open” take the issue from below to above a significant moving average like the 50MA or 200MA, consider it a bullish sign and therefore an extremely compelling play.
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