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

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

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



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

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

But, soon enough BPCL began an impressive up move.

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




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

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

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

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

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

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

The 11-Step Plan to Trading Success

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

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

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

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

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

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

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

* The date you took the trade

* The date you exited the trade

* Your entry price

* Your exit price

* Net result after subtracting commissions and fees

* The reason you took the trade

* The reason why you exited

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

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

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

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

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

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

Put Call Ratio

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

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

Example:

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

Number of Calls (contracts): 7723

Number of Puts (contracts): 1693

Put-Call Ratio = Puts / Calls

= 7723 / 1693

= .22 (Rounded off to 2 decimals)

This is an important CONTRARIAN indicator of investor sentiment.

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

The Ratio is drawn as a line chart.

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

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

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



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