Friday, April 27, 2012

Expansion - Contraction

Summary from the book "The Master Swing Trader" by Alan Farley

Price bars expand rapidly into a climax through rallies and selloffs. Then congestion sets in annd volatility drops as bar range contracts along with price rate of change. This negative feedback characterizes progress until tight congestion signals an impending price movement that again releases into expanding bars. Patterrn readers have a trading advantage here because these entery points capture the eye's attention. Conversely, many math indicators hit neurtal zones in this environment and show nothing of interest.
Expansion - contraction ties closely into reward planning. Odds increae greatly that the next few bars will contract when expansion bars thrust into known S/R. For this reason, the appearance of wide range bares often signals the need for caution. The odds favor a pullback that will draw down profit substantially before ejecting into another move. 

For most trades, plan to exit when price expands into S/R. This strategy tracks the old wsidom that advises us to " enter in mild times but exit in wild times." Aslo consider closing the postion when the market prints a wide range bar that departs substantially from the routine price action but does not occur at a breadout point These often mark short covering moves, stop runs within smaller time frames, annd countertrend climaxes.

My Notes: The language is a bit difficult to grasp at first reading! However, the concepts are sound. There are cycles of contraction and expansion. Take trades during the periods of contraction. Exit on Expansion. 

Friday, April 20, 2012

Patience is the trader's best friend

Nifty remains in a narrow range. This range is getting narrower by the day. Markets that are in contraction tell us that soon enough, a big breakout / breakdown is coming. This happens because markets move in cycles of contraction and expansion. When we see narrow ranges, we can assume that this is contraction and the next phase will be expansion.

For the Nifty, a move above 5400 or below 5200 should give strong momentum. Within this 200 point range, there are unlikely to be many trading opportunities.

Therefore, patience. Wait for the Nifty to move out of its trading range.

Thursday, April 19, 2012

Gaps for the Swing Trader

A breakout from a trading range offers trading opportunities to the Swing Trader. Often, such breakouts begin with a gap. Traders should treat gaps with respect. Gaps provide sufficient power to overcome the resistance provided by a trading range. A breakout gap suggests buying power. There are traders who are willing to pay more to buy. This should be good news for the bulls, because these traders are probably looking for higher levels before they take profits. Enthusiastic buying draws the attention of traders that leads to further buying and price expansion.

BUT,  the Swing Trader must remain cautious if the move lacks heavy volume. Often, the gap fills quickly taking traders into a bull trap. Often, average breakout volume is accompanied by a quick filling of the gap. Traders are confronted with the question: Is this a pullback or has the breakout failed? Since we cannot look into the future, we have to assume that the breakout remains valid so far prices remain above the mid point of the trading range which triggered the breakout.

Practical Application:

The Nifty moved inside a trading range 5200 - 5300. It then broke out of this range on Wednesday, April 18, with a gap. By the close of trading the gap was almost filled. Yet, prices did remain above the trading range resistance of 5300, and much higher than our make or break level of 5250. On Thursday (today), we have to assume that the trend remains up. Prices consolidated before closing at 5340, the top of the day's range. On Friday, we can move our stop to 5300 since this level has held for two days. We continue to have a bullish bias so far the Nifty remains above 5250.

Wednesday, April 18, 2012

A breakout and a Pause

On Tuesday, April 17, the Nifty closed at 5300 approx, which was the top of the range between 5200 - 5300. The day saw a sharp rally from 5220 lows, suggesting that a breakout above 5300 was likely.

Today, the Nifty opened with a big 40 point gap, remained above 5330 and finally gave up the gains to close almost at 5300.

So, what happened?

Well, a breakout is a breakout. The Nifty has broken above 5300 today. Often, a pullback comes in after such breakouts. Today's afternoon decline may be such a pullback. 

When do we know that the breakout is failing? If the Nifty were to go below 5250, intraday, that will be a sure sign of a failure.

This is a trading range. I have written earlier that ranges are the most difficult pattern to trade. The best trades often are the ones that were not taken.

Saturday, April 14, 2012

Make No Mistakes in Trading

Friday, April 13, 2012

How to determine the trend of the market

Richard Russell, in his excellent book on Dow Theory, says:

The trend of the market is determined as follows: successive rallies advancing above previous high points with ensuing declines terminating above preceding low points are taken as bullish indication. Rallies that fail to penetrate preceding high points with ensuing declines breaking preceding low points carry bearish indication. 

In other words, Higher Highs and Higher Lows constitute a bull market, while Lower Highs and Lower Lows represent a bear market.

 For the past few weeks, the Nifty has been making lower highs - 5630, 5500, 5400, 5378, 5302. The lower lows pattern is not symmetrical with the lower highs, but it is visible. It is not symmetrical because after every lower high, we did not have a lower low. We can establish that lows have found support around 5150. If the Nifty closes below 5150, the pattern of lower lows will be confirmed, giving a clear down trend. We should find out next week if the Index is entering a downtrend.

Wednesday, April 11, 2012

Five worst trading mistakes

This is a worth reading article from Business Insider.

The five worst investing mistakes are:

1. Trading Too Much.

2. Scrambling to overcome losses. This means selling profitable stocks to pay for the losers which are held on.

3. Focusing on mutual fund past returns rather than fees. Focus should be on costs.

4. Going with what we know. Investors should diversify rather than stay with what they feel is comfortable.

5. Falling prey to manias and panics.

American Markets take a tumble

On Tuesday, April 10, the Dow closed 213 points lower while the S&P500 was a full 23 points down. This is the backdrop against which our own markets will open today.

A bearish head and shoulder in the Dow and S&P is working its way down. Lower levels are likely.

The Nifty has been in a trading range for many weeks. The range is getting narrower.  A significant breakdown / break out is imminent.  Given the short term trend which remains down, it is possible that we may move lower than 5150 towards 4800. These are not targets, just possibilities.

Traders who have simply followed the short term trend should have remained on the short side for the past few days. On CNBC-TV18 I had explained that the stop for short positions is 5320. We will see if these levels change today.

Have Fun!

Monday, April 9, 2012

Day Trading requires consistency

There is a big difference between day trading and other forms of trading like swing trading, position trading or active investing. The difference arises from the time frames used in day trading. All trades are cumpulsorily closed by a day trader, at the end of the trading session. Therefore, the day trader does not have the luxury of time. He cannot say to himself - ok, the trade is not working out, so let me wait. This is not possible because the trader is under a cumpulsion to end the trade by a certain time. So he cannot wait to find out if his trade is going to work out with more profits, or less losses.

My point is: day traders must be tuned to take profits at some point during the day. They must have sensible guidelines to exit. Day traders should therefore use profit targets, reversal patterns to close the trade. They should not continue with the trade hoping for more and more, because time is against them.

Sunday, April 8, 2012

Trading is a Simple Process

Profitable trading is a very simple process:

    Identify market direction
    Identify key price action decision points
    Determine where to enter trade(s)
    Identify potential profit objective before trade entry
    Set initial stop-loss protection to mitigate risk
    Manage open trade between entry and reaching profit objective

That's it... those few steps above constitute what professional traders do. Everything else and anything else is unnecessary for success.

(From the website:

Saturday, April 7, 2012

High Frequency Trading - seven points of understanding

A large part of the daily volume in Stocks, Futures, Options, Commodities and Exchange Traded Funds is now being generated by High Frequency Trading firms that use computers to generate a small statistical edge for their trading. Since traders like us also use computers, the difference between us and HFT lies in the nature of computers.

In the computers used by HFT, many programs operate in nanoseconds (a billionth of a second) which requires very high speed computers and programming languages that work just that fraction of a second faster. Our computers are much slower, which makes one of the differences between the technical trader and the HFT firm.

Most of the programmers used by the HFT firms have PHD's or masters degrees in engineering, mathematics, programming or quantitative techniques. They are called quants. The best ones make one million dollars a year. Some algorithms hold positions for a fraction of a second, while others for an hour or two. The models used to trade the markets use large volumes of data to capture very small movements. Volumes are high so the small movements multiplied by large volumes give profits.

This is the background in which I started my thinking on HFT's and how they will affect the technical trader.

First, HFT's are here to stay, so we have to accept this. 

Second, Traders must keep on writing to Ministry of Finance, SEBI and stock exchanges to ensure that the firms using HFT do not misuse their power, and adhere to the guidelines set for them. That's important so that the large players do not get away with dishonest practices. 

Third, If HFT's are making money, then who is giving them the money? I believe that it is the retail and technical trader who is taking the other side of the trade - the losing side.

Fourth, technology will help the technical trader. It is only a matter of time before the computers available to traders become fast enough to match the speed of the HFT computers. Then what?

Fifth, Most HFT firms are using the same data to gain a statistical advantage. They are competing with each other to get that advantage just a split second faster. It is a matter of time before the advantage becomes so small as to be unprofitable.

Sixth, In spite of all the technology there is a reason why the HFT firms are focused on the microsecond trades. The reason is simple - this is an area in which the technical trader cannot compete. The best computers and programs are not able to make money in the larger time frames - hours to days. That is the area in which the human brain remains superior.

Seventh, because the algorithms developed by the quants are statistically based, they may actually enhance the efficiency of support, resistance and trend. That should be good news for technical traders.

Sunday, April 1, 2012

Chart Analysis–Shorting Apple is not a good idea

The chart for Apple  was discussed in a post by Peter Brandt. I referred to the post in a different context. Readers wanted to know my opinion on the Apple chart.  So here it is:



1. Prices are making new highs. New Highs are Bullish. If there is one simple rule that we want to imbibe in our minds, it is this.

2. Brandt refers to a possible short sell when prices dip, then rally to a lower high. Assuming this pattern comes about, what is our expectation? What comes after a bull rally? The answer is: A correction. Therefore, we expect a correction if the pattern of lower highs does come about. Corrections are traded only by short term traders, and, that also with a lot of caution.

3. There is support at 500, then at lower levels. A decline could easily stop at these support levels, then see relief rallies.

My Point: Stocks making new highs should not be shorted. What comes on after the new highs is a correction, and corrections are difficult to trade.