Tuesday, October 03, 2006

Dragon pattern

Dragon Pattern:

This pattern can be traded in any timeframe. The example is shown with the help of chart of Punjab National Bank.

Elements of this pattern, Tail, 2 Legs, Back, Head which constitute a dragon are shown in the chart.

In this pattern, back may rise to touch bottom tail hook. After the second leg is in the place, buy breakout at the back. It may face a resistance at the top of the tail forming head.

It can be noticed that, this pattern is nothing but "W" bottom.

Monday, September 18, 2006

Wisdom

I came across an article on http://highchartpatterns.blogspot.com/. This article is about sitting aside and watching the market. I liked this article very much, because initially I was scapegoat of overtrade. To become a successful trader person requires a great deal of descipline and patience. Sitting aside is nothing but earning zero money (saving the capital.) The way any trader/investor tries to improve his entry, exit stragegy, similarly he should invest some time on improving his state of mind, psychology.

Have a look at this article:

"A gap-up in an extended market near resistance almost always only invites selling. It's a perfect scenario if you are already in positions and want an exit, but very much a must-avoid situation if you are a break-out trader looking for new positions. Not all gap-ups are negative though: for example, a gap-up in a market that has recently bottomed can become a very powerful trend day.

What this market now desperately needs is a shallow pull-back or some horizontal basing. The more extended the market, the higher the chance of break-outs failing.

When novice traders talk about trading they talk about the excitement and thrill of the job. However they soon realize that the professional traders who are consistently profitable year over year are not thrill-seekers, but disciplined traders who have conquered the desire to always be in a trade. The reality of trading is that it requires an inordinate amount of discipline and patience.

There are times in the market when the best thing is to just sit aside. Then there are other times when you are so busy that you realize by the closing bell that your stomach feels hollow as you haven't eaten anything all day, that your eyes are burning from staring at your screens all day, and that your back is killing you from sitting tensely in one position all day. Take your cue from the market. Do not force trades -- if the set-ups emerge, take them as they come -- be that 10 trades in one day. If they do not emerge, then sit back and just watch --be that 1 trade in ten days. You cannot conjure up set-ups-- the opportunity has to arise or else you will do nothing but chop up your account.

Print out this sign and put it on your wall: Every Trade is a Business Transaction. What does that mean? It means that there should be a reason for every single trade -- why you enter and why you exit. Every single trade is an important business transaction that has to be thought out and given great importance. The hungry beast that devours accounts of new traders, without a doubt, is the demon called over-trading. When your trading resembles less a person playing a video game and more a person playing chess, is when you will start to be on your way to becoming a profitable professional trader."

Friday, September 15, 2006

Weekly Review

No new Paper trade was initiated.
On 11th Sept, 2006 market tanked by more than 3%.

1. Tata motors Ltd, trailing stop hit, profit booked.
2. Suzlon stop loss hit.
3. ITC is going nowhere. Removed the position.
4. Bharat Forge, profit booked at resistance.


Trading Rules

- Trade in the direction of the primary trend.

- Have a predetermined exit strategy.

- Plan trades before the market opens.

- Have a reason for every trade.

- Predetermine the amount of risk you’re willing to assume.

- Stay focused.

- Maintain discipline.

- Be patient and wait for the best opportunities.

- Incorporate the inevitability of loss into your system.

£

Thursday, September 14, 2006

My Trade Plan

I will try to chalk out a trading plan for myself.

I often came across following questions,
What is better? Fundamental Analysis or Technical Analysis?
Should I use technical indicators or oscillators?
Which indicator/oscillator or the set of indicators/oscillators are the best?
Which technical analysis software should I use?
Fibonacci, Gann, Elliot?
Candlestick or bar charts?
I want to keep above questions aside. The fact is that each individual is a unique. What one finds good other may not be comfortable with it. Therefore I will try to use the strategy I am comfortable with.

I will ignore the tips, newsletters. That is I want to eliminate dependency with others also I want to keep myself responsible for my own actions.

Objective:

The objective is quite clear, earning money. (Nobody is here to loose money or willing to loose money.)

One thing is very clear to me that not all trades will be winners, there will be loosing trades. What matters is how to make sure that the amount you loose is lesser that amount you win. This is nothing but mastering risk-reward ratio.

Style:

I am employed individual. Therefore I do not even consider to day trade or scalp.
If I keep position overnight, I do not feel anxious. Also I am not worried about opening gaps.

Interest:

I treat trading as a source of income. This means I treat it as a business. The most important thing is I am happy in what I am doing. Psychology is very important in every phase of the trade.

Trade Plan:

Preparation/scanning:

Trade liquid futures, preferably future on nifty stocks. (I have stopped trading in cash market, simply because I am short of time.) This reduces my scanning time.

Take a look at the EOD chart without any predetermined mind set.

Identify important support and resistance points or zones. Draw support and resistance lines.

Identify swing high and swing low points on the chart.

Try to connect swing high and swing low points. The slope of the line gives the direction of the trend.

Identify the current trend and underlying trend. There could be 3 readings. The stock may be in uptrend or in downtrend or range bound.
Entry:

I prefer to enter into a postion in 3 different ways.

1. Congestion area/pullback.
2. Breakout.
3. S/R.
1. Congestion area/pullback:

On the chart identify congestion area or pullback. The most important thing is to try to understand the psychology behind congestion area and pullback. I will limit this discussion with respect to uptrend.

Once a congestion area or pullback is spotted then questions to be asked:
Are weak hands already out of the stock?
Is congestion or pullback is formed with lower volume?
Can I find a low risk trade opportunity?

Entry point can be above previous day’s high. And the stop loss point can be below latest swing low.

2. Breakout

To have a breakout trade, the chart should show the resistance line or area. If the stock comes out of a range with a convincing volume then buy at breakout. The stop can be just below the resistance line. One variation can be buy on next day just to make sure that there is no manipulation.

3. S/R

If support and resistance line/areas are well defined, then buy at resistance with stop loss below the resistance line.


Risk:

I am currently limiting my total risk to 10% of my principal.
I am limiting Risk per position to 2.5%. This means at a give time I will have 4 positions open.


Position Size:

Currently I am trading in Futures and not in stocks. Therefore I can not take the advantage of variation in the position size based on the stop loss price and risk.

I will enter the position only if position size (underlying contract unit) is well within my risk appetite.


Exit:

For a trending stock, use trailing stop loss.
For a range bound stock, exit at resistance.

In above trade plan, no indicator, no oscillator, no candlestick patterns are mentioned.
Well, above plan seems to be very very simple. Isn't it? It is very simple. But I know what is difficult is the fact that following it judiciously.

I believe the trading is about personality, mind, comfort. All these make an impact when you initiate, manage and exit a trade.

£

Wednesday, September 13, 2006

Trend Following

The wisdom of Gary Anderson:

Contrarian behavior is natural. People like bargains. Buying low and selling high makes a good deal of sense. Trend following is an unnatural act. Buying a stock making a new high requires a different sort of discipline, one that takes time to master. Of course, if making money in the market were a natural thing, everybody would be rich. They are not; therefore doing what comes naturally doesn’t work.

A word on predicting: “Don’t.” For a trend follower, it is enough to detect the presence of a trend. To go on and make a prediction about it is redundant. So I do not make predictions, and that free’s up a lot of mental RAM. I look at the data. If I detect global trending — that is, determine that the market is in a trend following mode — I react by buying into strength. The opposite is true during momentum driven declines. Now you know everything I know.


Sunday, September 10, 2006

Drawdown

Drawdown is simply the amount of money you lose trading, expressed as a percentage of your total trading equity. If all your trades were profitable, you would never experience a drawdown. Drawdown does not measure overall performance, only the money lost while achieving that performance. Its calculation begins only with a losing trade and continues as long as the account hits new equity lows.

Suppose you begin with an account of 10,000 and lose 2,000. Your drawdown would be 20%. On the 8,000 that remains, if you subsequently make 1,000, then lose 2,000, you now have a drawdown of 30% (8,000 + 1,000 - 2,000 = 7,000, a 30% loss on the original equity stake of 10,000). But, if you made 4,000 after the initial 2,000 loss (increasing your account equity to 12,000), then lost another 3,000, your drawdown would be 25% (12,000 - 3,000 = 9,000, a 25% drop from the new equity high of 12,000).

Drawdown recovery
The best illustration of the importance of money management is the percent gain necessary to recover from a drawdown. Many think that if you lose 10% of your money all you have to do is make a 10% gain to recoup your loss. Unfortunately, this is not true.

% Loss of
Capital
% of Gain
Required to
Recoup Loss
10%11.11%
20%25.00%
30%42.85%
40%66.66%
50%100%
60%150%
70%233%
80%400%
90%900%
100%broke
Table 1. Notice that as losses (drawdown) increase, the percent gain necessary to recover to breakeven increases at a much faster rate.
Suppose you start with 10,000 and lose 10% (1,000), which leaves you with 9,000. To get back to breakeven, you would need to make a return of 11.11% on this new account balance, not 10% (10% of 9,000 is only 900--you have to make 11.11% on the 9,000 to recoup the 1,000 lost).

Even worse is that as the drawdowns deepen, the recovery percentage begins to grow geometrically. For example, a 50% loss requires a 100% return just to get back to break even (see Table 1).


Guidelines to Long-Term Trading Success

Guidelines that should help your long-term trading success.

1. Risk only a small percentage of total equity on each trade, preferably no more than 2% of your portfolio value. I know of two traders who have been actively trading for over 15 years, both of whom have amassed small fortunes during this time. In fact, both have paid for their dream homes with cash out of their trading accounts. I was amazed to find out that one rarely trades over 1,000 shares of stock and the other rarely trades more than two or three futures contracts at a time. Both use extremely tight stops and risk less than 1% per trade.

2. Limit your total portfolio risk to 20%. In other words, if you were stopped out on every open position in your account at the same time, you would still retain 80% of your original trading capital.

3. Keep your reward-to-risk ratio at a minimum of 2:1, and preferably 3:1 or higher. In other words, if you are risking 1 point on each trade, you should be making, on average, at least 2 points. An S&P futures system I recently saw did just the opposite: It risked 3 points to make only 1. That is, for every losing trade, it took 3 winners make up for it. The first drawdown (string of losses) would wipe out all of the trader's money.

4. Be realistic about the amount of risk required to properly trade a given market. For instance, don't kid yourself by thinking you are only risking a small amount if you are position trading (holding overnight) in a high-flying technology stock or a highly leveraged and volatile market like the S&P futures.

5. Understand the volatility of the market you are trading and adjust position size accordingly. That is, take smaller positions in more volatile stocks and futures. Also, be aware that volatility is constantly changing as markets heat up and cool off.

6. Understand position correlation. If you are long heating oil, crude oil and unleaded gas, in reality you do not have three positions. Because these markets are so highly correlated (meaning their price moves are very similar), you really have one position in energy with three times the risk of a single position. It would essentially be the same as trading three crude, three heating oil, or three unleaded gas contracts.

7. Lock in at least a portion of windfall profits. If you are fortunate enough to catch a substantial move in a short amount of time, liquidate at least part of your position. This is especially true for short-term trading, for which large gains are few and far between.

8. The more active a trader you are, the less you should risk per trade. Obviously, if you are making dozens of trades a day you can't afford to risk even 2% per trade--one really bad day could virtually wipe you out. Longer-term traders who may make three to four trades per year could risk more, say 3-5% per trade. Regardless of how active you are, just limit total portfolio risk to 20% (rule #2).

9. Make sure you are adequately capitalized. There is no "Holy Grail" in trading. However, if there was one, I think it would be having enough money to trade and taking small risks. These principles help you survive long enough to prosper. I know of many successful traders who wiped out small accounts early in their careers. It was only until they became adequately capitalized and took reasonable risks that they survived as long term traders.

10. Never add to or "average down" a losing position. If you are wrong, admit it and get out. Two wrongs do not make a right.

11. Avoid pyramiding altogether or only pyramid properly. By "properly," I mean only adding to profitable positions and establishing the largest position first. In other words the position should look like an actual pyramid. For example, if your typical total position size in a stock is 1000 shares then you might initially buy 600 shares, add 300 (if the initial position is profitable), then 100 more as the position moves in your direction. In addition, if you do pyramid, make sure the total position risk is within the guidelines outlined earlier (i.e., 2% on the entire position, total portfolio risk no more that 20%, etc.).

12. Always have an actual stop in the market. "Mental stops" do not work.

13. Be willing to take money off the table as a position moves in your favor; "2-for-1 money management1" is a good start. Essentially, once your profits exceed your initial risk, exit half of your position and move your stop to breakeven on the remainder of your position. This way, barring overnight gaps, you are ensured, at worst, a breakeven trade, and you still have the potential for gains on the remainder of the position.

14. Understand the market you are trading. This is especially true in derivative trading (i.e. options, futures).

15. Strive to keep maximum drawdowns between 20 and 25%. Once drawdowns exceed this amount it becomes increasingly difficult, if not impossible, to completely recover. The importance of keeping drawdowns within reason was illustrated in the first installment of this series.

16. Be willing to stop trading and re-evaluate the markets and your methodology when you encounter a string of losses. The markets will always be there. Gann said it best in his book, How to Make Profits in Commodities, published over 50 years ago: "When you make one to three trades that show losses, whether they be large or small, something is wrong with you and not the market. Your trend may have changed. My rule is to get out and wait. Study the reason for your losses. Remember, you will never lose any money by being out of the market."

17. Consider the psychological impact of losing money. Unlike most of the other techniques discussed here, this one can't be quantified. Obviously, no one likes to lose money. However, each individual reacts differently. You must honestly ask yourself, What would happen if I lose X%? Would it have a material effect on my lifestyle, my family or my mental well being? You should be willing to accept the consequences of being stopped out on any or all of your trades. Emotionally, you should be completely comfortable with the risks you are taking.

The main point is that money management doesn't have to be rocket science. It all boils down to understanding the risk of the investment, risking only a small percentage on any one trade (or trading approach) and keeping total exposure within reason. While the list above is not exhaustive, I believe it will help keep you out of the majority of trouble spots. Those who survive to become successful traders not only study methodologies for trading, but they also study the risks associated with them.

Friday, September 08, 2006

Weekly Review

No trades initiated this week.
Profit booked in PNB. Trailing stop loss of 460 Rs. hit.