Learning @ Bhoomitrader

Average True Range - GV

2010-09-20T17:51:00.017+05:30

Average True Range (ATR) is based on volatility like Bollinger Bands (BB), which finds the simple mean and adds and subtracts the standard deviation from the mean for a band.

Chaikin's Volatility and Vertical Horizontal Filter (VHF) have curves similar to ATR for a given range. While the former two cannot be straightaway used as stoploss bands, both BB and ATR can be, as they are real-time range measurements as against indicators of volatility.

A few of us may be acquainted with the details of ATR, but for those who are not, here it is: ATR is the mean/simple average of the maximum of the following range alternatives, for a period of time:

(i) range between the high and lows of the day;
(ii) range between yesterday's close and today's high (mostly in a rising mkt) or yesterday's close and today's low (mostly in a falling market).

To convert this in to a band, one needs to add or subtract it with a choice of either the close or the extremes. One would choose the close if he wants to play safe and is concerned that he might lose out from the gains; or one would choose from extremes if he wants to make sure that the stoploss does not him out of a trend.

Again one can play with the 'averaging number' - 14 bars or 20 bars - as well as the multiplication factor for the range - whether 1 ATR or 2 ATR (just like the number of standard deviations chosen in BB).

Effectively this throws up three variables for designing. No set of variables work for all markets or stocks. They could work for one range of historical-volatility (HV) patterns exhibited by the market, or stocks, during the testing period. Even if HV changes for the same underlying, performance deviates significantly from the anticipated. This could be a huge amount, since the stoploss could put you out of the trend, with no re-entry in sight. Hence it is likely that on some occasions you would have lost a sizeable part of the trend while taking in all expected whipsaws.

Now comes the worst. I am not well acquainted with foreign markets, for example the US where most designers come from. It is thus logical that they have tested primarily their own markets. Specifically, the US market does not throw up gaps like Indian market does. So, if the US market is as advanced as claimed, then they should be less manipulated than ours, and therefore a smoother market, in terms of absence of gaps.

The big problem with gaps for trading systems is that they simply massacre your volatility-based stoplosses. Imagine a gap of 100 points. The range the expands to 100 for a specific bar and hence the simple average of this range, goes up roughly by a factor of 5 (if you took the standard 20-bar as the range).

Now multiply it with the factor of 2 or 2.5, it becomes very large. If you are subtracting it from the extremes (hoping to avoid losing a trend, which you could if you subtract from close or mean, then the range - and hence the stoploss - really expands indeed. Due to simple averaging used, the adverse effect stays for 19 more bars during which the trend could change and you would have lost out on a good part of the gain. This was common in 2008.

Alternatively, after a gap, the price action could remain narrow for over an hour or two, which is not uncommon and towards the end of which your stoploss would have come to very close to the price action. Then the price action may enlarge into a (even) a slightly a larger trading range triggering your stoploss.

The problem is because of the narrow range after a steep gap-up/gap-down and simple averaging, the discussed enlargement of the trading range would not be large enough to cause a moving average convergence (Maco), but would have put you out of market - that is no Maco if you had adopted larger parameters for your MAs (and smaller parameters will by themselves whipsaw any number of times and throw up so many trades that you would have become the loverboy of your broker and the villain of your dealer).

What Should be Your Favorite Mutual Fund

2010-09-05T09:47:00.007+05:30

An investment in a Nifty Junior ETF would have returned far better than an investment in all the mid-cap mutual funds in the country. Nothing more to be said.

The Drawdown - Prashanth K

2010-08-28T13:23:00.005+05:30

Drawdown is a statistical function that is missed by many and worse mis-interpreted by many others. Every system builder always has one eye on the CAGR and another on drawdown. It is a balance that is often unstated but has to remain rational for any system that has been developed after much effort to become operational.

A 1000 percent return with a 90-percent drawdown is a lot worse than a 100 percent return with 9 percent drawdown, although mathematically both are similar. The reason I say that the second is more important is because there is something we call: "Your worst Drawdown is yet to come", which in efffect means that no matter what percentage your system backtest would show, the chance is greater that a drawdown greater than this would arise in real trading.

Secondly, the system does not consider the psychological profile of the trader. It is tough to live with a trade where you have lost nearly 10 percent of the capital as against living in a trade where you have lost nearly all of the equity.

So, lets look at what a drawdown is and why, in my opinion, it is one of the most important figures to see in any backtest.

An Amibroker Backtest report provides two drawdown figures. They are (copy-pasted from AB Help),

Max. trade drawdown - The largest peak-to-valley decline experienced in any single trade.

As explained, it is the drawdown an open trade experiences. For example, assume your system has gone long in ABC at Rs 100 and the stock, after moving to 102, has moved to 96 without there being any additional signal.

The Trade drawdown in this case will be 6 * Qty (102 - 96 = 6).

Max trade % drawdown - The largest peak to valley percentage decline experienced in any single trade .

The above example expressed in percentage terms.

Max system drawdown - The largest peak to valley decline experienced in portfolio equity

This statisic is bit different, in the sense instead of taking a single ticker, it takes the equity as the ticker and provides the drawdown static.

Max system % drawdown - The largest peak to valley percentage decline experienced in portfolio equity.

Same as above expressed in percentage terms.

System Drawdown is useful to know since sometimes systems go into multuiple losses and the equity line plunges dramatically. For example, a system equity after reaching say 10,000 starts having loss trades (consecutively) and reaches 8000, this change would be shown here.

The system drawdown is a important factor to consider when deciding the capital requirement for the system, since if you are using leverage, a large system drawdown can ensure that you no longer can trade with the amount you have in hand and hence all permutations and calculations can go awry.

Benchmarking and Leverage - Prashanth K

2010-08-28T11:38:00.005+05:30

A friend of mine was recently suggesting to a group, where I was part of, that the easiest way to pick stocks was to get MetaStock, run its indicators and select a list of stocks based on discretion.

I generally argue against such BS, but did not have the mood to do so and let it pass. But the information he sought to convey is that all you needed is MS and a data provider and well, you could well be on the way to riches and glory.

Just yesterday I was discussing with a friend (who is also a client of mine) about the importance of 'Benchmarking'. I believe if a system is not able to generate at the minimum twice the return of a said benchmark (after deducting all expenses incurred in regard to trading that system), it may be wiser to be a Buy and Hold (or shall I say Buy and Hope) investor - since one can spend the same time doing some other profitable work.

Generally when computing returns, people forget the risk they take (leverage) and instead calculate directly the net profit or loss. A friend of mine recently showed me a list showing the returns generated by him for his clients. He has over nine months averaged around 5 percent per month, net of brokerage and taxes.

While on the face of it, it's a commendable performance, what one misses is the fact that he uses nearly 5 times leverage to achieve such returns. The question that one should then ask is whether the risk is worth the reward. Five times the capital is no small leverage and one bad move can wipe out returns generated over months together. Hence once should carefully evaluate risk rewards before entering any kind of trade.

The author is a member of Bangalore Stock Exchange.

Anxiety

2009-04-30T21:24:00.003+05:30

All instinctive behavior concerns survival: feeding, mating, fighting or fleeing. Strong emotions focus and lock our attention ...everything is simplified to a black-or-white choice. It is either safe or it isn't. The amygdala (the primitive mamallian brain in all humans) is so powerful that it can shut off the neo-cortex (higher intelligence) completely. High emotional arousal makes us temporarily stupid.

Most situations we deal with today are not life-and-death situations, which the amygdala is designed to operate under. If a car comes crashing toward us, it is the amygdala that propels us in to darting sideways and escaping injury. Thus, the role of the amygdala is survival. Once the life-threatening situation is averted, the feelings aroused out of fear are dealt with, the amygdala switches off.

Now, if the amygdala is operated under less than life-or-death situations, and the arousal is not dealt with, then the amygdala remains switched on, removing all access to higher intelligence. Thus, in a partially aroused state, we are partially stupid. Anxiety denies full access to the thinking brain.

Beta - Market Risk of a Stock

2009-04-24T19:23:00.007+05:30

An important criteria when choosing what stock to trade is Beta. Sounds like Greek? Beta is indeed the second letter of the Greek alphabet, but, as a statistical tool, it holds great relevance in stock market investing.

Simply put, beta is a statistical tool that quantifies the degree of correlation of a stock to a benchmark share index, like the NSE Nifty or BSE Sensex. In other words, it measures the market risk of a stock.

A stock index is said to have a beta of 1, and stocks are measured against it. A stock with a beta greater than 1 is said to be more volatile than the market. So, for every 10 percent fall (or rise) in the Nifty, a stock with a beta of 1.5 will generally fall (or rise) 15 percent.

On the other hand, a stock with a beta of less than 1 is said to be less volatile than the market. So, for every 10 percent fall (or rise) in the Sensex, a stock with a beta of 0.5 will generally fall (or rise) 5 percent. In other words, the higher a stock’s beta, the more it is likely to fluctuate higher than the broader market.

Risk is an important consideration in holding any portfolio. The risk in holding securities is generally associated with the possibility that realized returns will be less than the returns expected.

Risks can be classified as Systematic risks and Unsystematic risks.

Unsystematic risks:
These are risks that are unique to a firm or industry. Factors such as management capability, consumer preferences, labor, etc contribute to unsystematic risks. Unsystematic risks are controllable by nature and can be considerably reduced by sufficiently diversifying one's portfolio.

Systematic risks:
These are risks associated with the economic, political, sociological and other macro-level changes. They affect the entire market as a whole and cannot be controlled or eliminated merely by diversifying one's portfolio.

The degree to which different portfolios are affected by these systematic risks as compared to the effect on the market as a whole, is different and is measured by Beta. To put it differently, the systematic risks of various securities differ due to their relationships with the market. The Beta factor describes the movement in a stock's or a portfolio's returns in relation to that of the market returns. For all practical purposes, the market returns are measured by the returns on the index (Nifty, Midcap, etc), since the index is a good reflector of the market.

Methodology/Formula

Beta is calculated as :

where,

Y is the returns on your portfolio or stock - DEPENDENT VARIABLE
X is the market returns or index - INDEPENDENT VARIABLE
Variance is the square of standard deviation.
Covariance is a statistic that measures how two variables co-vary, and is given by:

Where, N denotes the total number of observations, and and respectively represent the arithmetic averages of x and y.

In order to calculate the beta of a portfolio, multiply the weightage of each stock in the portfolio with its beta value to arrive at the weighted average beta of the portfolio.

Standard Deviation

Standard Deviation is a statistical tool, which measures the variability of returns from the expected value, or volatility. It is denoted by sigma(s) . It is calculated using the formula mentioned below:

Where, is the sample mean, xi’s are the observations (returns), and N is the total number of observations or the sample size.

Beta is an indicator of a stock’s historical volatility. There’s no saying that the stock will show identical volatility in the future too. Having said that, most actively-traded stocks tend to do justice to their beta values.

Read the entire article here and here

Gaps!!!

2009-03-21T20:20:00.002+05:30

These are just a few examples of gaps and how we can play these gaps. The charts below are self explanatory. These are not exactly how the gaps would play themselves out, but would give you an idea, if such a situation occurs then these might be the possibilities. This is in keeping with the theory of KISS. By the way the conservative trades mentioned in the pictures below are nothing but the Dow Theory in action!!!!

First The Gap Ups;

Now The Gap Downs;

"If you are aware of your weaknesses and are constantly learning, your potential is virtually limitless." Jay Sidhu

Trend Following ! Simpler The Better!!!

2009-03-21T20:15:00.002+05:30

Today I had a nice discussion with a few friends and it all veered down to identifying the trend and its reversal. Well we discussed everything from trend lines, moving averages, to indicators and oscillators. Everyone had their own personal choices; like I always say different strokes for different folks! I personally find the good old Dow Theory the best for this. The good old higher highs and higher lows or the lower highs and lower lows sequence the best way to identify the trends. It sounds too simple but then I guess in TA simpler is what works! The element of KISS rulez!!! Please do take a look at the chart below and try to see if watching this action makes a difference to your trading. What I am talking about? Just look at the chart below and maybe you can see your MONA LISA!!!

Chart courtesy of Trading Strategies.

"I am great believer in luck and I find that the harder I work the more I have of it."

Thomas Jefferson

A Guru Or A Mentor???

2009-03-21T20:02:00.002+05:30

This post got me into a bit of thinking (gray cells put to work!). I am not sure weather I will be able to express myself clearly, nevertheless I will give it a shot. When I started of two years back on this treacherous road to trading, I was desperately looking for helping hands that would pull me out from the precipice I had fallen into. There were a few hands (the world is still a good place to be in!). What I found later was that among these hands there were some who genuinely extended support (what ever knowledge they could offer they did…God bless them). Yet the other variety wanted me to keep on holding to their hand (they wanted to me to subscribe to their newsletters and call services …the prize??? they promised The Garden Of Eden!!!).

There were a whole lot of Gurus that came by, and very few Mentors. A lil bit of thinking got me to this conclusion. You see Gurus seek Disciples (meek) and Mentors seek Character (leaders). A guru needs these disciples, and they need them in hoards (this is provided by flush of new uninformed entrants to the market everyday). In the case of a Mentor, it’s the other way around. He shuns the hoards, and seeks out a few pieces of uncut rough rocks. A Guru will always give you sermons on what’s wrong with your life whereas the Mentor will show you how to put your life right. A guru will provide you with a sense of calm (his services, which he makes sure that you cant do without). A Mentor on the other hand will take away your calm make you sweat and toil. A Guru will never let you leave him (you are his milking cow!!!). A Mentor will not let you to stick to him (he has made a gem out of that rough uncut rock… his work done…and now he goes ahead to seek more such rough rocks).

The road to successful trading is not a smooth one. The treacherous journey has consumed many a souls. It’s long and a tiring journey and many of us give up mid way and seek solace in the arms of a Guru. What we need is a Mentor who teaches us to conquer the road ahead.

Don’t give up… see what lays ahead!!!!!!

The choice is yours… you need a Guru or a Mentor??? While you still ponder on, I suggest you read what Alexander Elder has to say about Gurus here. As for me.., I will be tryin2find a mentor!!!

Divergence - Manoj Bhagra

2009-03-20T07:40:00.010+05:30

DIVERGENCE is a favorite trade setup of many traders. As Pring states, when the momentum and price are moving in tandem, there isn’t much to read other than assuming we have a healthy trend. It is when the momentum and price get out of sync that we have a divergence in hand.

There are 2 basic types of Divergence.

Regular Divergence

1-Price is making higher highs while the indicator is not: Bearish

2-Price is making lower lows while the indicator is not: Bullish

Hidden/Reverse Divergence

3-Indicator is making higher highs while price is not: Bearish

4-Indicator is making lower lows while the price is not: Bullish

Divergences test patience; one has to let them develop and then get ready to put in a trade. One of the mistakes novices make is to jump the gun too soon when a divergence is spotted. It should be remembered that divergences in themselves do not signify a reversal or a trend change; they merely gives us an advanced warning of the underlying strength or weakness in the prevalent trend. The real confirmation comes from the Price action itself.

There is a lot one needs to understand about divergence than these simple interpretations. The significance of Divergence, the Divergence Trap and Complex Divergence (will add these later). I reiterate again that one should read Pring’s book on Momentum to get better hang of things. Divergences if traded right, can give phenomenal trades, but then you need to spot them, and wait patiently to let them develop, and finally pull the trigger when the price gives the signal!

Rogue Trader (1999) - The Movie

2009-03-15T10:41:00.006+05:30

This movie is a must for all traders. It's basic message is this: no matter who you are and no matter how much you know, do not f**k with the market. Another key view that comes across is that it is erroneous to assume that the big institutions know everything. Of course, in the face of the 2008 subprime and financial crisis, this message may not have as much impact, but in 1999, when this movie was released, it would have been apt. Although we have moved on to bigger cycles, for those who are starting out as traders, this is a must-watch movie.

Rogue Trader is a 1999 drama film directed by James Dearden about Nick Leeson and the 1995 collapse of Barings Bank. Based on Leeson's book of the same name it stars Ewan McGregor and Anna Friel.

Rogue Trader tells the true story of Nick Leeson, an employee of Barings Bank who after a successful spell working for the firm's office in Indonesia is sent to Singapore as General Manager of the Trading Floor on the SIMEX exchange. The movie follows Leeson's rise as he soon becomes one of Barings' key traders. However, everything isn't as it appears - through the 88888 error account, Nick is hiding huge losses as he gambles away Baring's money with little more than the bat of an eyelid from the powers-that-be back in London.

Eventually the losses mount up to well over £800 million and Nick, along with his wife Lisa, decide to leave Singapore and escape to Indonesia. Nick doesn't realise the severity of his losses until he reads in the newspaper that Barings has gone bankrupt. They then decide to return to London but Nick is arrested en route in Frankfurt. Nick is extradited to Singapore where he is sentenced to six and a half years in jail (but stays in jail for four years, because he was diagnosed with colon cancer). The film is based on Leeson's real life book, Rogue Trader.

Download the torrent here.

Boiler Room (2000) - The Movie - Must-see for Traders

2009-03-12T22:34:00.011+05:30

This is a must-see movie for all those stepping in to the world of trading and investing or dealing with a relationship manager at a broker firm. This movie will open your eyes so wide that you will never ever keep your eyes closed when talking to a representative of a broking firm.

It proves why trusting brokers, for stock tips and trades is the biggest risk one can take in the business. You can trade without technical analysis and still succeed but trusting a broker is the highest form of risk ever. As a senior writer with a leading analyst house said: All brokers around the world are boiler rooms.

The term boiler room in business refers to a centre of criminal activity where financial products, particularly stock, are sold by telephone. The targets of organisations using boiler rooms are often subject to unfair, pressured, and dishonest sales tactics. Whilst some boiler rooms specialise in stock fraud, most sell penny stock or shares in companies which have yet to float on a stock exchange, misrepresenting it as more valuable than it actually is.

Boiler Room is a 2000 US drama, written and directed by Ben Younger, and starring Giovanni Ribisi, Vin Diesel and Nia Long. Other characters in the film were played by Ben Affleck, Nicky Katt, Scott Caan, Tom Everett Scott (who also starred in That Thing You Do! with Ribisi), Ron Rifkin and Jamie Kennedy.

The film takes a look at the world of "boiler room" (seedy, dishonorable, and often fraudulent) brokerage firms. The film centers around college dropout Seth Davis (Ribisi), a budding underground casino owner from Queens, New York who gets a job at J.T. Marlin, a less-than-reputable brokerage firm. However at the time, Seth is totally unaware of the firm's criminal reputation. Davis' opposition to his disapproving federal judge father drives the plot as Davis goes deeper into the operation at J.T. Marlin than he'd like, learning how the firm scams its clients. The company is a chop shop brokerage firm that runs a "pump and dump", using its brokers to create artificial demand in the stock of defunct companies by cold calling investors and selling them shares at prices set by the brokerage firm, which include a large commission to the brokers (up to three dollars a share for a penny stock). When the firm is done pumping the stock, the investors then have no one to sell their shares to in the market, and the price of the stock plummets. As Seth learns more about the firm, he realizes he needs to get out. When the FBI confronts him, he agrees to help them bring down the firm. Although he feels bad about the many affluent investors (whales) that he lied to and scammed, he only tries to help one client who could not afford to be scammed in the first place.

Get the torrent here

Street Smarts - Linda Rashke

2009-03-10T14:00:00.005+05:30

Traders talk amongst themselves, not necessarily to discuss bullish or bearish market opinions, but rather to share insights into the nature and quirkiness of this business.

The mental toll trading exacts definitely forms bonds. When we open up it is always surprising to discover the similarity of lessons learned, experiences shared, and how we all independently arrive at the same conclusions. Often in talking with each other we're really looking for clues into our own heads, hoping to understand ourselves a little better.

Despite our constant pursuit of knowledge, the market itself assures there is no shortcut to obtaining our final degree. In the end, it is experience which is our ultimate teacher and there is no substitute. We can only choose the attitude with which we approach this process of learning to trade. We can accept the inevitable setbacks and learn from them, or we can yield to our natural human stubbornness and be forced to repeat the same lessons over and over again. The single most important secret is this: learn to listen to the markets and do not impose your own will upon them.

Every successful trader we have known has also discovered the necessity for consistency. It is the key to everything - you must trade with a coherent methodology. You must follow a specific trading strategy. The essential starting point is: minimizing risk first, looking to maximize gains only after risk has been defined and controlled. Our number one guiding belief is that you must, above all, find setups and entries which minimize exposure. The profits come on their own terms.

You only need ONE strategy to be prosperous. Some of the best traders are successful because they trade only one strategy.

Seventy Thousand to 55 Lakh - The Chaoist

2008-07-25T10:41:00.002+05:30

It was August 2007 and I had been trading for 2 years by then, working hard, learning everything I found on the markets, but I had still had no rewards. In fact, I had just Rs 70,000 left in my trading account. I could do all kinds of technical analysis, build trading systems, etc., but it was not leading me to profits and success in trading.

I had sacrificed my college education, so that I could be successful trading, but here I was, down to my last few thousands. I decided that if I lost this Rs 70,000, I would try and make a living selling trading systems and by giving tips to other traders.

However, come August 2007, everything changed. I suddenly started to make money. The Rs 70,000 I was down to, now started growing exponentially, until it reached what is now Rs 55 lakh - yes Rs 55 lakh!

So, what had changed suddenly?

I have no precise answer. I even wondered how a 21-year old like me, without college education, and who was perhaps in the middle of the trading curve, was able to make so much money, while there were so many more people with much more knowledge, still struggling in the market? My young mind was suddenly filled with many questions?

Was trading a game of technicals? What separates a winning trader from a losing trader? Was my journey from Rs 70,000 to Rs 55 lakh merely a product of luck? There are many questions to which I need to find the answers, but I decided to share the few reasons that I think lead to my success in trading in last one year:

1. I cannot deny the fact that I was lucky. Life is unfair - this is a fact. When I had Rs 70,000 at the beginning of August 2007, a few losing trades could have wiped out all my money. So at that time I was lucky enough to survive despite being undercapitalized. However, I think later on, after these 1-2 months it was not just pure luck that brought me to Rs 55 lakh.

2. I am believer of the Van Tharpe trading model trading, which says: Trading is 10 percent technicals, 40 percent psychology and 50 percent risk management. I concentrated on the last two things and it paid off. To manage risk, I was trading only intraday, and I never traded overnight positions. This may sound contradictory to the many sermons one receives on how it is so terrible to being an intraday trader.

3. My sole policy was to survive first and then make money. If you are surviving in markets and losing small, you will have time when you are favored by luck and you will make it big.

4. A trader without risk management is like a nude girl in a boy's hostel. If you are using leverage, you should either be hedging your positions or you should not carry overnight positions. Otherwise it is just a matter of time when a big gapup or gapdown will wipe you out.

5. The old classical things we need to fight are fear, greed, hope and bias. Bias is ignored by many but it can cause serious problems.

6. Becoming successful trader is a process. It is like any sport, which you learn the basic rules but then develop your own style. Let us say cricket - each batsman (or bowler) has his own style, which is unique to him. You cannot fully copy anyone, but you can learn from others and develop your own technique of playing in markets, based on your strengths.

7. There are unlimited number of ways you can make money in the markets and unlimited number of ways you can lose.

8. Supports and resistances are for making bulls and bears hope. If you use technicals and want to become a sound technical trader, then I would advise to go for automatic system trading. For others always remember not to use supports and resistances for hoping in the markets.

9. Trading is very simple but it is not easy.

10. Keep your losses small and let your profits run. You have read that in many places but this holds true, so implement it practically.

11. Remember the worst mistakes are made at the best times and best of the trades are made at the worst times.

11. Feel free to short sell. Short selling is a great way to make fast money.

12. Always be prepared for the worst, and and when you are feeling stuck, remember these lines: "The further you run from your sins, the more exhausted you are when they catch up to you. And they do".

13. There are no shortcuts. You have to go through learning the process of trading.

14. If you did well paper trading, it is not necessary you will do well in real-time trading. It has the same difference as in batting at Net practice and batting under pressure on the field.