Wednesday, December 30, 2009

What is a Leading Indicator

Mario writes:

"how do you derive leading indicators for any chart? I have been reading John Murphy, but whatever he says as leading indicators (like MACD) have now turned out to be laggging indicators. Kindly help"

Interesting question.

Investopedia defines this as: "A leading indicator precedes price movements, giving them a predictive quality, while a lagging indicator is a confirmation tool because it follows price movement. A leading indicator is thought to be the strongest during periods of sideways or non-trending trading ranges, while the lagging indicators are still useful during trending periods. "

Therefore, a leading indicator is useful during trading ranges. Now, how do we know that we are in a range? This information is available only after some time has elapsed. So, we start using leading indicators after we perceive that prices are in a trading range. It is possible that the range may be getting over by the time we decide to use leading indicators. Therefore, a leading indicator may finally result in a whipsaw. All in all, there is confusion.

Since most indicators are derived from price, they cannot step ahead of price and predict it. Predicitve indicators must be non-price methods, like Fibonacci, Cycles, Waves. These tools use price as one of their inputs, while MACD, RSI and so on use price as their ONLY input.

For this reason, Fibonacci, waves, cycles are much in demand because they have this quality of telling us what future prices will be (If they are correct!). It follows that most of the time, these tools are not correct.

With indicators, leading indicators identify turning points, essentially acting as cycles.

How about this: If you perceive a trend has started, use lagging indicators like Moving Averages, MACD. If you assume we are in a trading range, use leading indicators like RSI, Stochastics, MACD. Yes, MACD can be used both as trend following and as a method to identify 'overbought' and 'oversold' levels. At turning points, you will get chopped, but there will be many trades where you will make money. Finally, your profits should exceed your losses.  Think about it.

Dull days in market

The Nifty continues to inch upward, with a bullish bias. We are around 5200 which is just 20% lower than the all time highs for the Nifty.

The market is also at the psychological resistance of 5180 - 5200.  Since the trend is UP, it is sensible to take trades in the trend direction. Our strategy is to search for dips to buy.A high risk, high reward trade is to buy puts since 5200 is a resistance area. By adjusting your volumes, it is possible to do both trades (for the PUT's , keep volumes low).

Many charts show base building patterns. Perhaps, it is wiser to focus on individual stocks and ignore the movement of the Nifty.

In the Nifty scenarios, briefly discussed above, one possible scenario is for the Nifty to continue going up without any pause. We are likely to stay away if this happens. A dip or consolidation is required for taking a fresh long trade.

What will the New Year bring?

Well, extended trading hours for sure. We could easily continue with choppy market conditions as we move towards the union budget. A traditional pre budget rally is quite possible. Will that be the end of this up move? Maybe.

A New Year Resolution

One, focus on gaining epertise in one or two trading strategies. Two, write your trading journal, every day.

Have Fun!

Tuesday, December 29, 2009

Cerified Technical Analyst - CeTA exams

The first level 1 exams for CeTA certification were held in Delhi on Sunday December 27, 2009. Here are some photographs of the event.







The exams were held at Indian School of Business & Finance ( http://www.isbf.edu.in/ ) . The excellent atmosphere at this higher learning centre added to the pleasure of appearing for the certification.

The next Level 1 exam will be held (I think !) sometime in April 2010. Please visit http://www.taindia.org/ for more information.

Cheers.

Thursday, December 24, 2009

Big up move brings cheer to bulls

On Wednesday, the Nifty rallied below 5000 to a high of 5140+. This was a big trend day.

How did we trade?

On Tuesday, we were short 1 unit in the Nifty and long 1 unit in Tata Steel & Flat in Bank Nifty. On Wednesday, the short position was closed around 5010. Then we went long 3 units in the Nifty around 5050. Two units in the Bank Nifty went long. Towards close, we took profits in one Nifty and one Bank unit, carrying the remaining long trades. These are the same trades that are taken by Day-V subscribers.

What are units? Each trader may have different capital availability, so the relationship between different systems and different instruments can be defined by a ratio. For one trader, one unit may be 50 nifty, for another, it may be 200 nifty, and so on. This is the starting point of position sizing, which viewers should understand and research on. Volumes will differ at different times, so we were short one nifty but went long three, because of stronger momentum on the long side.

Why did we go long?
Probably all short term methods and systems should have been long by 5050. So, this was not rocket science.

Other signs of a Big Move

In our letter on tuesday evening, we did suggest that a big move in either direction could be coming, and, suggested levels for buying as well as selling. Therefore, the view was: a big move is coming, On the downside, if 4920 is taken out, we have a free fall. On the upside we face resistance at 5180 then probably 5400+.

We did not know where the Market was likely move. To my mind, only the market decides that.

Cheers.

Monday, December 21, 2009

Stay in Risk Aversion

WSJ.Com reports : "Analysts at Italian bank UniCredit are warning investors to keep their guard up even as the Christmas holiday approaches.


With the meeting of Dubai creditors today, uncertainty on Greece still looming and year-end seasonal factors, investors should stay in risk aversion mode,” they said in a note today."

What is Risk Aversion? Nobletrading.com says "Risk Aversion is the inverse of risk tolerance. Risk averse is defined as the behavior of a trader to stay away from risky trading practices, even if those have high chances of profits. Risk averse traders prefer low risk, often low profitable, products to trade. Risk aversion is seen in trading of all products including stocks, bonds, funds, options, futures and currencies."

Traders may move money from 'risky' assets to assets where risk is less. The stock market, usually classifies as a 'risky' asset, at least relatively. Money may move to Govt Bonds / Fixed Deposits, which are taken as 'safe' assets.

My Notes;
How do you become risk averse? Suppose you feel that markets may remain uncertain so you wish to avoid risk. What is the next step?
a) Sell exisitng holdings, and, do not invest further
b) Retain existing holdings, and, do not invest further
c) Sell some holdings, and, do not invest further

So, the common denominator is: 'do not invest further' - fresh money stops coming in the market. If this is so, money may stay away till (1) investors are willing to risk again, OR (2) Valuations become attractive to change risk aversion.

This narration does not have an ending. Nifty chart is suggesting a rounding top + a double top (unconfirmed). Maybe there is more downside.

Sunday, December 20, 2009

Standing Aside in Slow Markets

The post title comes from Brett Steenbarger's post in his blog[edited] : traderfeed.blogspot.com. He writes:

Quote
"I haven't traded this week. I placed two trades last week and closed them out quickly, one for a modest winner; the other for a modest loser. So this will possibly make two weeks where, basically, I haven't swung the bat and haven't made any money trading.


I'm fine with that.
.........................
And eventually I'll get market moves worth trading for my style of trading.


But one key to longevity in markets is being able to stand aside when markets aren't giving you good pitches. It's the capital I don't have at risk in markets that allows me to keep my trading capital out of unnecessary risk.

To have a passion for trading--but not a need to trade: that's a great place to be if you're going to last in the markets"

UnQuote

Dr Steenbarger discusses another issue: What would an ideal training program look like? He says:

"It would have to teach the market basics: what a market is, how a market operates, how trends form and change, why markets become more and less volatile, how markets are interconnected, how and why news can move markets.


It would have to teach the trading basics: how to use trading software, how to define and manage risk, how markets move during and across days.

It would have to illustrate patterns that evolve from market operation and then help new traders identify those patterns for themselves: first on paper, then in simulation mode.

It would have to show new traders how traders exploit those patterns as setups: defining risk/reward; entering positions, managing positions, exiting positions.

It would have to help traders tackle those patterns for themselves, first in simulation mode, then in actual trading.

It would have to offer mentorship and coaching: supervision from experienced traders to review performance, correct the mistakes of new traders, and focus the learning process in a goal-oriented way.

It would have to offer these services from actual market professionals who have "been there and done that" successfully.

It would have to be so concentrated as a learning experience that the normal "ten year rule" of developing expertise could be greatly condensed, but it couldn't be so brief that it offers information only without focused skill building.

Developing such a curriculum is no simple task. Implementing such a curriculum is labor intensive--and yet it needs to be reasonably affordable for new traders."

I hope you enjoy reading these posts, as much as I have.

Thursday, December 17, 2009

Markets at 9

One nice aspct of 'breaking news' is the relief it provides to TV channels and the viewers of such channels. The channels can start talking about such 'news' and viewers have something different to watch.

So also with 'Markets at Nine'. I had gone to the airport, returned back around 9:30 PM and opened my email. There was an email from NSE saying market hours will change to 9 AM. I called up my colleague in Chandigarh. Is this correct? Yes, he said, that's what is going on in CNBC for the last three hours.

What is done is done. This decision is unlikely to be rolled back, so we have to accept it. The NSE can add value to extended market timings by adding new instruments for trading - The Dollar Index, Nikkei, Singapore STI, FTSE, DAX, CAC, Kospi ..... etc. It is fairly easy to do this: ask a company to create an ETF for say middle east indices. Then ask SEBI permission to offer futures on this ETF, and, we can begin derivatives trading.

Traders should guard against 'fatigue'. Too much of a good thing can hurt. So also of too much market interaction. Day traders should consider time based strategies - Trade in the open hours only, OR, trade only before the close, and so on.

Tuesday, December 15, 2009

An Extraordinary Mind

The Daily Pioneer pays tribute to Paul Samuelson, architect of modern economics. Please read at http://www.dailypioneer.com/222728/An-extraordinary-mind.html .

The Pioneer tribute says "Paul Samuelson changed economics forever".

In my college days, Samuelson was considered to be 'the' book on Economics. It still is. Mr Samuelson died at age 94, in the USA on Sunday, December 13, 2009. He was awarded the Noble prize for Economics in 1970. He was the mentor of many Noble prize winners, including Krugman who won the prize in 2008.

I took the liberty of pointing out the genius of Samuelson, today on the CNBC show at 9:30 AM. I suggested that 500 years later, people will still remember Mr Samuelson while they will have forgotten the Investment Bankers who price IPO's.

Readers must always remember that there is life beyond stop losses and targets, beyond fund managers and  business magnets.

In fact, successful traders understand this intuitively.

Monday, December 14, 2009

Trading ranges are difficult to trade

The Nifty has gone inside a narrow range, making intra day as well as swing trading difficult. Traders may well identify their own levels of this range, then decide to trade he Nifty when it comes out of these boundaries.

Mid cap and small cap stocks have been outperforming the Nifty. The mid+small cap rally should continue while he Nifty is undecided, If the Index finally breaks out on the upside, then we should see more fun in the mid+small segment, but IF the Nifty breaks down and moves into an intermediate downtrend, I do not think that mid cap rally will continue.

Test or Breakout ?

The Nifty did touch 52 week highs on Friday, Dec 11 before falling on the back of IIP numbers. Now, when price touches a previous top, there are two options: (1) It may be a test of resistance leading to a confirmation that the resistance holds OR (2) It can be a breakout leading to higher levels. Traders need to undertand the significance of Friday's price action, since it may have intermediate implications.

Sunday, December 13, 2009

Does Warren Buffet know technical analysis?

Does Warren Buffet use technical analysis? The answer is: No. I have not read anything that suggests he takes the help of charts for his investing.

How many Warren Buffet type of investors exist in the world? I think, not many. Therefore, it is not neccessary to compare our work with that of Mr Buffet.

Technical Analysis for Long Term Investors

An investor can benefit from the use of technical analysis for her investment decisions.

Long term charts can identify many patterns.

(a) Stocks in parabolic rallies. You should wait for corrections before entering.

(b) Stocks in trading range. These are stocks you may wish to track on lower time frame charts for breakouts.

(c)  Stocks in deep downtrends. These stocks should be avoided till they begin to form bases, or succeed in tests of support.

(d) Stocks in visibly defined uptrend. Such stocks have a pattern of higher highs, higher lows. These are the stocks that you will be investing in.

How about exits?
That requires another blog post.

And, a list of stocks?
Well, you need to do yur own homework. But, I will gladly offer my comments on any ideas that you have.

Cheers.

Saturday, December 12, 2009

Victory for Technical Analysis

I was participating in the Bulls Eye contest on CNBC for the last five days. Two other contestants were followers of the fundamental analysis school. My stocks did better, leading to my win. But, this is really a win for the technical analysis community in India - technical traders as well as technical analysts. Technical Analysis is getting its due share in the advanced economies - USA, Canada, Europe, Australia, Japan, HongKong ..... In India, Technical Analysis will get its due recognition, sooner or later.

Ttechnical analysis is the study of markets through the use of market psychology. It is an art as well as a science. The study is useful for all time frames, for all traded asset classes. It is more focussed than fundamental analysis, and, certainly easier to apply.

Monday, December 7, 2009

Conversations Monday Dec 7

Aakash Gupta says: "I also invest my savings and read trading books like Mr.Gaurav above. I aspire to follow up my engineering with an MBA in finance and have a career in equities.

I would be obliged if you could advise me on how to get the experience and the risk understanding that you have mentioned above."

My Notes: This is a sensible question. True to the Indian tradition, I often use high sounding words which read well but mean nothing. (I do not do this deliberately, just part of our national ethos).  So, some explaination is in order.

Experience: This consists of two parts: the theory of trading with technical analysis, and, the actual implementation of your learning.

To learn the theory you should (a) Read as many books as you can on TA. Don't believe them, just read them. (b) Make a short list of books that impressed you. This will tell you about the methods that make you confortable. (c) Browse the web on TA topics. Every day for a fixed period of time. (d) Make Notes. Write anything. Just random thoughts, but write. (e) Invest in attending TA seminars, conferences, Investor Camps!

To get the experience: (a) begin with position trading, in which you keep positions for days to weeks. (b) Do actual trades. (c) develop a set of rules (99% mechanical) and write them down. Trade ONLY with your rules. Revise the rules once a month. (d) Maintain a trading journal, which should have your observations of what the market does. maintain an errors journal where you note down the periods when you did not follow your rules.

The experience can come from your own trading or from a trading job. The process remains the same.

Still there?

Risk understanding

(a) Collect the money that you wish to invest in the trading business. Put that money in a seperate bank account. This is important. (b) Now define your risk parameters. Not more than 5% of your capital should be invested in any one trade. Not more than 2% of your capital can be used to meet a loss. (c) Assume that you have no other sources of income. Every month, look at the P&L for the month and ask yourself: If I invested X times more, I could earn X times more. At that point, my earnings will have to support my business expenses, my family expenses, savings, taxes, reinvestments in business. Have I reached a point where I can do this? If the asnwer is Not Yet, then ask yourself: can I afford to invest more in trading? These questions and asnwers will get you the required understanding of risk. It takes time, but you will get it.

Friday, December 4, 2009

Falling off the Cliff

I have a message from Gaurav whome I met in Chennai and Bangalore. Gaurav has an excellent job. But he is fond of trading.This is what he writes:

"One of my friends brother is an arbitrager for last 10 years.He told me that he can arrange a trading job but first 3 months I have to just monitor may be they will give me 5000 to 7000.And I am OK with that because may be after 6 months I can get a salary of 12-15K which is 50% of my current salary,but still I will be happy with that.And simultaneously I will trade for my own account"

My Notes:
Have you actually seen someone fall off a cliff? Not in movies, but in real life. Well my friend Gaurav may well be planning to do so.
Arbitrage is very different from the kind of trading that thrills traders. Second, trading on your own account simply increases the risks without any reward. The reward comes to experienced, risk understanding traders. Leaving your job to trade is hardly risk understanding.

This topic had come up earlier also. My advice is:

Do NOT leave your job. Learn to enjoy what you are doing. Please do not track the markets during your work hours. Practice trading on end of day charts. Do this in your free time. Once you feel confident in your paper trades, go ahead and take actual trades on an end of day basis. When you start seeing the results of your learning, then plan to be a full time trader.

Thursday, December 3, 2009

Never a dull day

The Nifty took a day off yesterday, marking time as the bulls were probably tired. But, the trend does not change. For the second consecutive day, the Index closed above 5120. Now, I am not a big fan of numbers. Often, we hear someone say: "If xxx closes above XXXX and remains below YYYY then do this if DDDD is not violated". I always wonder at such statements: what exactly does this mean?

So, the number 5120 is not sacrosant. It is just a convenient level I have identified to focus on. The Nifty was inside a range, and to me, a close above 5120 is required to suggest that a range breakout is taking place. That sems to be happening, as the Index is likely to close above 5120 today, giving us three consecutive close above the resistance.

Our task is not to look at valuations. The NSE website says that the PE for the Nifty is 22.8, hardly low. But, so what? Markets can remain irrational for long periods of time. The trend is up, so go long on dips. Always follow your stops.

Tuesday, December 1, 2009

December begins well

December, a month that usually favors the bulls, has started off with a strong rally. Today, the Nifty closed at 5122, up 89 points. That's a good start. In the morning, I was on CNBC, and I explained the existence of a narrow trading range between 4920 and 5120. A break from the range should give a trending move, I suggested.

Udayan asked me if it was possible to cross 5120 today itself. My answer was: The Nifty was trading at 5060, so another 60 points were easy to cover, since all the signs were suggesting a trending day. This number was eventually hit during the day itself. Sometimes, we are lucky.

Enough of the Markets. Manish T. asks "How was your Jodhpur investor camp experience?".

My experience was good, just as in other camps. People in Jodhpur seemed deeply involved in the market, through investments as well as derivatives. They heard us with rapt attention, then asked a number of questions. The underlying sense was: "we remain afraid of this rally, yet want to join the market." This is a question that is in the minds of most people.

Investors should buy only on corrections, like the one that took the Nifty to 4540, a month ago. Such moves come, two to three times a year. Sometimes, a stock will have its own cycle, so there are opportunities often.

Traders have to go with the trend. They should be long.

Trading Journal

Brett Steenbarger says "Each day I reviewed major turning points in the stock indexes and observed how indicators and correlated indexes behaved. The exercise consisted of identifying--in retrospect--the trading opportunities that were best and the information that might have put me into those trades.


In a sense, I used the journal to reverse engineer markets.

The journals consisted of pages and pages of annotated charts. Although I did not use the term at the time, the goal was pattern recognition.
......
In the beginning, I didn't know what to look for. I spent time with many indicators (including many of the common ones included in charting programs, as well as chart patterns and cycles) that added little value to my pattern recognition. It was the patterns that recurred over time that became my focus.


I realized that if I could just find a few stable patterns, I could work on recognizing them in real time and sustaining profitability.

I spent over a year on those journals before I ever placed a trade. The charts are still organized in folders in my cabinet for reference."

Writing a trading journal every day is a good practice.