An underlying theme of much of Gann's work is in determining trends. Whether a Gann fan line of 1 x 1 works or not is due to other considerations. It is generally accepted that Gann was open to any ideas, some of which still seem esoteric to me. However, I am not in a position to discount them since whenever I ask people whether they trade them, the answer is "yes." Putting aside the reasons why Gann seems to work at times, the other question is can you trade Gann?
For this you need to consider that there are generally three types of markets to trade: trending, choppy, and volatile. Trading a trending market means going long on uptrends and short on downtrends. A choppy market moves sideways and you attempt to pick highs and lows as best you can, and buy on the bottom and sell at the top - support and resistance play a major role as well as indicators. Trading a volatile market means trading prices only and not indicators. The best example is looking for patterns and then for breakouts, gaps, dead-cat bounces, etc. (a volatility trader might even boast that they don't use indicators).
Trending market traders loathe chop. The reason is that to trade trending markets you usually use moving averages. Try as you might, moving averages always lag. Which means in a choppy market -- one that moves up and down -- you are late getting in and when the market reverses you are late getting out. To be successful as a trending market trader you need to find a market that trends - some stocks and especially some commodities tend to trend. There are also helpful money management schemes that can be employed in a trending market but would have problems in other markets. So Gann didn't just come up with Gann fans, he also had to be concerned about determining if the trend changed and if prices are moving up or down while in trend. Gann is best used in conjunction with trend-trading systems. Gann's rules of trading also contain advice that fits a trend trader.
An approach attributed to Gann for determining whether a trend changes is the use of swing points: peaks or valleys. To visualize a swing peak or valley think of price action in a trend channel. Swing peaks occur when prices touch the upper channel line and valleys are the points where prices touch the lower channel line. A swing point marks the point at which a trend could change direction. More generally, swing peaks form intermediate peaks (valleys) when subsequent price changes fail to rise above a previous peak or fall below a previous valley. If a subsequent price move rises above a previous peak, the trend is up. If price falls below a previous valley the trend is down.
Arnold (see "Gann" by Curtis Arnold, Stocks & Commodities Magazine, March 1983) defines swing points by saying that in a downtrend a swing occurs when there are three days of higher highs, and for an uptrend when there are three days of lower lows, except for reversal days. A reversal is a temporary retracement and has not created a swing point. The giveaway to a reversal is the reversal day. In the context of a downtrend Curtis states, "a reversal day top occurs when prices move higher but then close near the lows of the day, usually below their opening and below the midpoint of the day's range. An even stronger reversal is indicated if the close is below yesterday's close." (See Figure 1 for an example). Just the opposite is true for uptrends.
Figure 1: Trends and reversal days.
Graphic provided by: Technical Analysis Inc..
Arnold trades Gann by going "short on a close below the 1 x 1 from a previous swing bottom." If you go back to Figure 1 in Part II of this series, and examine grid line G1, you will see a low on October 30, 2000. This is a swing valley. The grid line G1 forms resistance/support for the upswing which ends on Novmber 3, 2000. Using Arnold's rule, since you are still in a downtrend, you would short when the close drops below G1 (a 1 x 1 line since I made the grid using a 32 x 32 rise over run) which is around November 3, 2000.
Robert Krausz in his article "The New Gann Swing Chartist" (Stocks & Commodities Magazine, March 1998) writes about this subject as well. He was fortunate to have bought a copy of Gann's course from someone who had purchased the course from Gann. There is a notation on one of Gann's charts that says, "Use 2 day charts and rules better than 3 day." What is the implication? Krausz explains the use of a HiLo activator, which is a three-day average of highs along with a three-day average of lows. Using the HiLo activator looks a little like envelopes that move along with the price. It is used as a filter to test the validity of the swing. Krausz makes an important distinction between swing direction and trend direction. Currently the Nasdaq is in an overall downtrend, but has swings that temporarily carry prices higher.To be technically correct when I discussed manually creating G4, the Gann fan line whose origin is O3 (see Figure 1 in "Gann and Fibonacci Part II of III"), went through the upswing not the uptrend, of prices. It also suggests that Arnold's article may want to change, except Arnold still would give you a strong signal, although maybe not quite as fast.
Arthur A. Merrill in the article "Swing Expectations", (Stocks & Commodities Magazine, December 1988) makes an extremely valuable observation. He asks: if the price has already gone up by X%, how likely is it that it will go up Y% more? The idea is to make a distinction between noise and something significant happening. To determine trend change, Krausz uses swing points and asks is the price higher than the nearest swing peak or vice versa. Merrill has a different slant that I like even more, because using ZigZag (an indicator that filters out changes less than a chosen percentage) allows me to see the volatility it took to create a trend with a bunch of swing points defined by percentage change. This also gives me a chance to change the percentage when a downtrend is established so I can take advantage of the fact that stocks come down faster than they go up. For example using a 5% change on the Nasdaq Zig Zag shows five swing points in the uptrend going from October 1999 to the peak in March 2000, while the downtrend from September 2000 to the present shows 19 swing points (so shorting on a downtrend requires more margin - cash flow).
J.R. Davis ("Swing Charts", Stocks & Commodities, August 1998) writes that Gann did not use daily charts and suggests the creation of swing charts by counting up days and down days - a bit of a simplification of Arnolds' approach.
So how do the pieces fit together? David Lammar ("Trading with Elliott Wave and Gann", Stocks & Commodities, June 1988) writes that Elliott waves provide price targets based on the ratios of .618, .5, .382, and 23.6, which you will recognize as Fibonacci numbers. Lammar writes that he was able to significantly improve his performance using Gann in connection with Elliott wave determination. So there appears to be a connection between Gann and Fibonacci numbers. Gann would have been very familiar with point and figure charts, which require that you write a new X or O on your chart only if the price change is significant enough, so for Gann it looks like the determining factor was also two or three days in time.
Warning and Disclaimer:
Trading involves risk of loss and may not be suitable for you.
Past performance is no guarantee or reliable indication of future results.
This message is of the nature of general information only and must not in
any way be construed or relied upon as legal, financial or professional advice.
No consideration has been given or will be given to the individual investment
objectives, financial situation or needs of any particular person,
The decision to invest or trade and the method selected is a personal decision
and involves an inherent level of risk, and you must undertake your own investigations.
W.D. Gann used charting paper that lent itself to use equal rise and run when charting price and time. The alternative to this is to create a grid superimposed on a computer software generated price/time chart, which is sized to fill the window you have created on your screen. The superimposed grid, as you might expect, will not be square if the visual picture you start with is not square (equal rise and run). Following the rule of attaching a fan to a major or intermediate top or bottom I attached the grid origin, labeled as point O1 on Figure 1, to the September 1, 2000 peak.
From practice I have found that stocks with a 100-point range seem to work best on my 17-inch screen. Figure 1 shows a Gann grid (green) superimposed on a standard arithmetic price/time chart. The grid size is 32 x 32.
Figure 1: QQQ (AMEX: Nasdaq top 100 stocks) price annotated with Gann grid (green), Gann lines (blue).
Graphic provided by: MetaStock.
Graphic provided by: Data vendor: eSignal<.
Points A and B happen to coincide with grid intersections. Point C almost does as well. The coinciding of A, B, and C with grid intersections are a result of picking a cycle of 32. The fact that at points A, B, and C the grid lines form trend support and resistance is due to making the rise equal to the run, or due to a Gann approach.
If you attach a Gann fan from the September 1, 2000 peak you will have the Gann fan lines of resistance and support for downtrends. You can't see any uptrend resistance or support unless you find a bottom to attach Gann fan angles -- or use an alternative. The alternative is to draw a vertical line through the peak at September and then find an intersection of a major uptrend, using Gann angles, and the vertical line. Hopefully that line is the Gann 1 x 1. Grid line G1 seems to be a candidate, although a weak one, since there is so little uptrend to match (not much of a surprise in this bear market). I next attach a single Gann fan line at O2. O2 is the point of intersection of the vertical line with a Gann angle line (which happens, in this case, to be grid line G1 as well that shows resistance support to an uptrend).
The math I am using for Gann uptrends is the lower Gann angles of 45, 26.25, 18.75, 15, and 7.5 degrees. I take the tangent of each angle and multiply by 32 to get rise. Rise values for a run of 32 are therefore 1, 15.78, 10.86, 8.75, and 4.21.
I now manually attach and draw two Gann angle lines. By coincidence the downtrend comes to a momentary retracement at point D, which is on the 16.75 degree Gann angle line (Figure 1: Gann angle line G3) and then meets resistance at point E, which is on the 26.25 degree Gann angle line (Figure 1: Gann angle line G2).
G1 is a weak choice because the uptrend is so short. Line G4 is a stronger candidate since there are more price tags of resistance for this longer uptrend. Line G5 is drawn from origin O3, which is the intersection of G4 with the vertical line going through the September peak. This predicts that around March 26 or so that QQQ will hit 40 or so and then meet some support.
Warning and Disclaimer:
Trading involves risk of loss and may not be suitable for you.
Past performance is no guarantee or reliable indication of future results.
This message is of the nature of general information only and must not in
any way be construed or relied upon as legal, financial or professional advice.
No consideration has been given or will be given to the individual investment
objectives, financial situation or needs of any particular person,
The decision to invest or trade and the method selected is a personal decision
and involves an inherent level of risk, and you must undertake your own investigations.
Trader William Delaware Gann (1878-1955) reportedly had trading successes that would be the envy of anyone. Perhaps his observations are a by-product of point and figure charting back when charting techniques were most easily accomplished with charting paper. Gann fans, one of the techniques employed by Gann, use a predetermined set of angles and can be easily seen when using charting paper. They are used on charts where one unit of price equals one unit of time. Like Gann, Fibonacci numbers are also predetermined but their use does not require special charting techniques. Gann himself seems to have favored the use of Fibonacci numbers to find retracement levels.
Progressive Ohio [PGR], (top chart Figure 1) is representative of the charts I happen to pick at random (including Microsoft, QQQ, and AOL). The distinguishing features of PGR are an intermediate high followed by a gap down and then a downtrend to a low. There is an uptrend followed by downtrend, a gap up and then a peak in January 2000. The trends (Figure 1-top chart: U1 vs U2 and D1 vs D2) are somewhat parallel at times but in general if there is a pattern it's difficult to see.
Figure 1: PGR (NYSE) price chart without Gann and Fibonacci annotations (upper chart), and PGR with Gann and Fibonacci annotations (lower chart).
Graphic provided by: MetaStock.
Graphic provided by: Data vendor: eSignal<.
Now examine the bottom chart for the same time period. I have attached three Gann fans (Figure 1-bottom chart: red and green lines) to highs and lows. The fans have an equal rise and run. My choice was 32 x 32, because of work done by J. M. Hurst - and will be more evident in Part II. Gann fans provide trend resistance and support. The red Gann fan attached to the peak on the left, July 1999, shows resistance and support to downtrends. The coincidence of the price downtrend with one of the Gann fan lines is not unique to PGR; it happens on a number of charts. I have labeled the matching downtrend and fan line as A.
Gann fans use the angles of 82.5, 75, 71.25, 63.75, 45, 26.25, 18.75, 15, and 7.5 degrees using a grid that has equal rise and run. Each grid unit of the x-axis is equal to a unit of the y-axis. In order to see these angles, take a piece of graph paper and mark off a section that is eight units high by eight units long. Let the lower left hand corner be the origin. Drawing a line from the origin to the upper right hand corner makes a 45-degree angle with the horizontal.
Gann considered this the most important angle in terms of trend resistance and support. Forty-five degrees is alternatively referred to as the 1 x 1 and corresponds to the point that is eight units from the origin to the right (run) and eight units up (rise). Starting at the origin, 2 x 1 is eight squares to the right and four squares up (26.25 degrees), and 1 x 2 is eight squares up and four units to the right (63.75 degrees). Get the 3 x 1, and 1 x 3, lines by going just 1/3 of the way up or 1/3 of the way to the right. They (1 x 3 and 3 x 1) are the exception in drawing the lines from the origin to a grid coordinate along either the top or right edge of the eight by eight square.
The next event is that the downtrend remains in tact and when it reverses it does so with a gap up. By coincidence, a Gann fan line marks the break in downtrend resistance. I call that event B. Now the price action is in the adjacent fan wedge to the right of the one where I started. It is a broad fan wedge. There are not many options at this point to see how uptrend U1 (see upper chart for label) will progress and end. You can attach a fan at the low point and the prices do trend up along the fan lines.
By mid-September 1999 it's probably fair to say that PGR had hit a low at the beginning of September. Suppose at mid-September you were to attach Fibonacci retracement lines to the peak in July and the low in the beginning of September. The result is a series of horizontal lines showing levels of retracement starting with 0% at the peak in July and going to 100% at the low in the beginning of September. The significant levels of Fibonacci retracement are 23.6%, 38.2%, 50%, 61.8%, and 100%. Now notice that the point where price deviates from the Gann fan line coincides with the 61.8% Fibonacci retracement level. I label this as event A1.
Using Fibonacci time zones (corresponding to 1, 2, 3, 5, 8, 13, etc. trading days), which start at the PGR peak in July 1999, there is coincidentally a match with the September intermediate peak and the Fibonacci retracement at 61.8%. I call that event C. Now PGR retraces back down to the 100% Fibonacci retracement line. I call that event D.
As it turns out, PGR is going through a double bottom. As price rises from the October low it takes an enormous gap up and lands close to the intersection of the Fibonacci 61.8% level and one of the Gann fan lines. I label this as event E. Attaching a Gann fan at the second double bottom, again using 32 x 32 for rise and run, one of the Gann fan lines acts as resistance, event F, and then moves sideways to the adjacent fan line and continues on up, all of which I call event G. Price moves sideways using the Fibonacci retracement level of 23.6% as support, which I call event H (which also has two retracement lows at the intersection of two Gann lines). Finally, in February 1999 five events coincide: a Fibonacci time zone line, a Fibonacci 61.8% retracement level, a fan line from the peak in July, a fan line from the low in October, and a turning point in price, which I call event I.
Are events A, A1, B, C, D, E, F, G, H and I all just coincidences? You could say that with enough lines you could hit a barn. But I always use 32 x 32 or 16 x 16 and see similar results. I always attach the fan origins to an intermediate or major high or low. You could say that you don't know ahead of time which fan line to choose. No, but it's clear that a fan line can "accidentally" act as a resistance or support line for a price trend. Or is "accidentally" just a little too patronizing when it's a price trend that's being followed? Clearly there are lines that don't count, so does that mean you would expect an event for every line? In other words, if you argue that there are some lines that don't come into play, then you are essentially saying every line and intersection has to have a significant event; that seems extreme in the other direction. I think the compromise lies in realizing if Gann fan lines work as support and resistance trend lines then some fan lines will offer little support/resistance while others offer more.
You can't dismiss all the events as just coincidences because using the same rules give similar results. The issue is reliability. The fact that some events don't take place would make a trading system based on Gann and Fibonacci alone difficult to trade. So perhaps the answer is to use Fibonacci and Gann in conjunction with other indicators.
One factor worth mentioning is that one of the Fibonacci time zone lines (12/6/2000 line) for the Fibonacci time zone started with the July 1999 peak happens to nearly hit a peak (12/11/2000) for PGR in December 2000. Also a Fibonacci time line (4/4/2000) for a time zone started at the low in October 1999 exactly hits an intermediate high (4/4/2000). Given that Fibonacci time zone lines get more spread out as time moves out and therefore the number of lines gets less and less, the chance of coinciding with a significant event becomes less and less.
For Part II, I'll go through QQQ and show another option in attaching fans. Elliott waves anyone?
Warning and Disclaimer:
Trading involves risk of loss and may not be suitable for you.
Past performance is no guarantee or reliable indication of future results.
This message is of the nature of general information only and must not in
any way be construed or relied upon as legal, financial or professional advice.
No consideration has been given or will be given to the individual investment
objectives, financial situation or needs of any particular person,
The decision to invest or trade and the method selected is a personal decision
and involves an inherent level of risk, and you must undertake your own investigations.
As you examine articles that attribute their approach to Gann, common themes recur: retracement zones and trends. Retracement zones are characterized by price swings, and trend changes are initiated with price swings. When will the trend turn direction or when will the price go into a continuation pattern and then resume its current trend?
What is the most common continuation pattern encountered while in a trend? The answer is a wedge. The top chart of Figure 1 shows an idealized price history going through a peak followed by a downtrend. Given that you want to characterize a wedge continuation pattern, what will you use? As the top chart shows, you will use a pair of lines that slant upwards (to form a rising wedge). In order to create the pair of lines that show the uptrend resistance, which will form the wedge, you have to move the origin of the Gann angle down the vertical line because you need two lines, each with a different origin. By sliding the origin for the Gann angle down the vertical line, you are doing nothing more than saying this equity is still going down, but that's exactly what a wedge is saying; the trend is still down.
The general rule is that a rising wedge (formation shown in Figure 1) is bearish and a falling wedge is bullish. A succession of falling wedges are created by Gann angles created at successively higher origins, implying rising price, and a succession of rising wedges are created by successively lower origins, implying falling price.
The other theme that recurs is 50% retracement. Gann is reported to have said that 45 degrees was the most important angle. Recall that Gann used square grids. Suppose you create a square grid of 8 x 8. Now draw a line from the lower left corner to the upper right corner. The line is at 45 degrees. Next draw a line between the other two corners, upper left down to lower right. Another 45 degree line. Where do they intersect? In the middle, at 50%.
Figure 1: Idealized downtrend price behavior (top chart) with wedge continuation patterns, QQQ (weekly data) analyzed in a similar fashion (middle chart) and QQQ (daily data) analyzed using a 50% retracement (bottom chart).
Graphic provided by: MetaStock.
Graphic provided by: Data vendor: eSignal<.
To create the bottom chart I have not shown the Gann angles, but have attempted to analyze QQQ using Gann-like techniques. I have noticed for some time now the daily downtrend price behavior of QQQ contained wedges. In view of the way that Gann might have approached the problem, this means creating a series of Gann angle origins, with the origins sliding down a vertical bar going through the September 1 peak. What I have noticed is a downtrend, interrupted by a series of wedge continuation patterns, and then a downtrend that is still continuing.
The start and end of each wedge could be confirmed by using swing points. I used ZigZag with an 8% filter (recall that Gann preferred two-day changes - which is a way of filtering out noisy little dips, not unlike point and figure techniques to only plot Xs and Os after a predetermined amount of change). ZigZag is a technique that allows you to filter a change in direction based on either percentage or point change.
At 5% I was seeing every little up and down in price, as well as those in the bottom chart of Figure 1. Much to my comfort the way I had hand drawn the wedges matched with the swing points --- so you don't need ZigZag --- although I admit it's a handy little tool. By the way 5% ZigZag shows only five downswings in the uptrend from October 1999 to the March 2000 peak, and shows 14 upswings when applied to the downtrend from September 1, 2000 to the current date. The fact that an 8% filter still shows significant price patterns for a downtrend, while 5% is needed for an uptrend only confirms that prices move faster for a downtrend than for an uptrend.
Next I drew support and resistance lines to match the tops and bottoms and of the wedges - seen as blue dashed lines on the bottom chart. I wanted to see the bottom of the wedge above act as resistance to the uptrend of the wedge below - and it did. I wanted to confirm that price was in fact going through zones of resistance and support, but maybe a more appropriate phrase would be zones of distribution. Each wedge is characterized by buying on decreasing volume - in other words, a weak accumulation. The downtrend is resumed with selling on heavier volume - distribution. I checked the volume at the swing points that are the wedge "ends" and they are marked by lowered volume.
What to do now? I don't try to pick downtrend bottoms because I think it's guesswork. Gann also didn't try to find bottoms either, so it is not surprising his techniques didn't either. If Gann couldn't, or didn't want to, figure out a way why should any of us? But curiosity has gotten the better of me. What did they say about curiosity and the cat? So for what it's worth, and this is a bit scary, looking at the area where the wedges occurred was definitely a period where the market was trying, without much enthusiasm, to just say no to more downtrend. It failed. So I went through the drill. I declared a large area as a distribution zone. It marks the 50% point. So is the bottom at QQQ=36? If it is, this is not going to be pretty.
To see if I could confirm this bottom I brought up the QQQ weekly data, which resulted in the middle chart. To create the middle chart I use Gann angles to define a rising wedge. I used swing points defined by ZigZag with a 5% filter to help see the wedge. The bottom of the wedge suggests an origin point on a vertical line drawn through the peak on September 1, 2000. Drawing a 1x1 from that same origin point suggests support at QQQ=31.5. Almost the same story, only worse.
Gann was an impressive trader. Even if I only understand some of his techniques, I can certainly agree with his trading rules. If you have been trading for a while, these rules will jump out at you - they are that good. If you are just starting, do your best to incorporate them. I have incorporated my comments in parenthesis.
GANN'S 28 TRADING RULES
(Sidebar - "The Gann Method", John J. Blasic, Technical Analysis of Stocks and Commodities, June 1992)
1. Never risk more than 10% of your trading capital in a single trade. (Good risk management rule.)
2. Always use stop-loss orders. (Good risk management rule.)
3. Never overtrade. (Avoid getting whipsawed - don't try to catch up.)
4. Never let a profit run into a loss. (Don't try to hit the top if long, or the bottom if short.)
5. Don't enter a trade if you are unsure of the trend. (Never buck the trend. If a trend has developed and you are trading trends then make sure through setup and entry the trend is established. Going long in a downtrend or bear market is a way to see your capital get eaten away. Conversely going short in an uptrend or bull market will also see your capital get eaten away.)
6. When in doubt, get out, and don't get in when in doubt. (Patience, patience, patience - it will pay to be patient and sure. I have learned this the hard way.)
7. Only trade active markets. (Never short a dull market, and pile of other rules come from this.)
8. Distribute your risk equally among different markets. (Asset allocation still works.)
9. Never limit your orders. Trade at the market. (In a trend trading system, limit orders do not confirm the direction of the market for entry - they are countertrend because they want a better price, which would be against the trend. If you are trading support and resistance in a trading channel, then give this a shot.)
10. Don't close trades without a good reason. (Know your exit criteria. Exit because your trading systems says you should and not your intuition. Non-professionals often get out too early because their intuition says to get out.)
11. Extra monies from successful trades should be placed in a separate account. (Don't expose your profits to the same winner of the moment.)
12. Never trade to scalp a profit. (Scalpers can to do this through Nasdaq, but at Gann's time this was not available. You also have to worry about slippage in a big way.)
13. Never average a loss. (Your biggest drawdown is your biggest worry.)
14. Never get out of the market because you have lost patience or get in because you are anxious from waiting. (Gee - does he have to tell me twice? Hmmmm.)
15. Avoid taking small profits and large losses. (Know your risk- to-reward ratio and use stop-loss orders. For a trend trading system stop limit orders are a way to enter with a confirmation of trend direction.)
16. Never cancel a stop-loss after you have placed the trade. (One in the hand is worth two in the bush. Always have a stop-loss in place. Don't remove a stop-loss before you place another.)
17. Avoid getting in and out of the market too often. (Hmmmm - this is the second time you've told me. I wonder if you are hitting me up again about being patient, in which case this makes the fourth time.)
18. Be willing to make money from both sides of the market. (Learn how to short.)
19. Never buy or sell just because the price is low or high. (Fundamentalists eat your heart out - sorry, I just couldn't resist - probably goes to my problem with being patient.)
20. Pyramiding should be accomplished once it has crossed resistance levels and broken zones of distribution. (Gann recognized that price swings seen in trend channels are a series of accumulation and distribution zones - they are most easily seen as patterns, such as wedges. "Trend changes most often occur outside the retracement zone after the initial support resistance levels are tested" ("The Gann Method", John J. Blasic). Retracement zone and consolidation zone are used interchangeably in this article. It would appear that QQQ has passed through its retracement zone and now we are waiting for the bottom.)
21. Pyramid issues that have a strong trend. (Pyramiding uses the unrealized profits in your margin account to buy even more - thus leveraging yourself while riding the trend.)
22. Never hedge a losing position. (For example - trying to trade long in a bear market is a good way to see your money slowly but surely eaten away by hedging via protective stops and buying options - the better choices for a bear market are (1) buying bonds - Greenspan must really like the bond traders- (2) selling calls (3) buying puts (4) shorting.)
23. Never change your position without a good reason. (Watch out for three-day reversals - use swing points to assure that the trend has changed - in other words, don't switch from long to short unless you have backtested data that says you should switch.)
24. Avoid trading after long periods of success or failure. (Successes can make you overconfident and stop using a system, while losses can make you hesitant to pull the trigger when you should.)
25. Don't try to guess tops or bottoms. (Guessing is gambling - Vegas will pay better than the market. Gann's techniques were aimed at support and resistance relative to trends, not sideways trading channels with chop where support and resistance pick the tops and bottoms of the chop within the channel.)
26. Don't follow a blind man's advice. (If someone tells you about a good trade opportunity - ask them why it's good - those who see, usually have a number of reasons - as part of seeing is seeing a lot; ask them what the setup and entry is for example.)
27. Reduce trading after the first loss; never increase. (If you have a trend trading system that contains setup and entry conditions and you take a loss, it could be that market is going into chop. A trend trading system will lag price moves and your losses will grow faster if you don't pull back on the amount you trade or the number of times you trade. Since Gann didn't use daily charts he avoided buying on dips and thus reduced the number of trades by avoiding trading on dips.)
28. Avoid getting in wrong and out wrong; or getting in right and out wrong. This is making a double mistake. (Did you notice he didn't say that getting in wrong and getting out right was a double mistake - paying too much for something can be corrected by waiting for the price to return higher - and selling too low can be corrected by waiting for the price to go lower - still each is a mistake just not as bad as the first pair.)
Professional traders are following the above rules. If you aren't, then you need to consider more of an investment slant versus trading for a living. If you are going to have an edge you need to do or at least understand all of the above and then some more.
Warning and Disclaimer:
Trading involves risk of loss and may not be suitable for you.
Past performance is no guarantee or reliable indication of future results.
This message is of the nature of general information only and must not in
any way be construed or relied upon as legal, financial or professional advice.
No consideration has been given or will be given to the individual investment
objectives, financial situation or needs of any particular person,
The decision to invest or trade and the method selected is a personal decision
and involves an inherent level of risk, and you must undertake your own investigations.
1) Amount of capital to use: Divide your capital into 10 equal parts and never risk more than one-tenth of your capital on any one trade.
2) Use stop loss orders. Always protect a trade when you make it with a stop loss order.
3) Never overtrade. This would be violating your capital rules.
4) Never let a profit run into a loss. After you once have a profit (...), raise your stop loss so that you will have no loss of capital.
5) Do not buck the trend. Never buy or sell if you are not sure of the trend according to your charts and rules.
6) When in doubt, get out, and don't get in when in doubt.
7) Trade only in active markets. Keep out of slow, dead ones.
8) Equal distribution of risk. Trade in 2 or 3 different commodities, if possible. Avoid tying up all your capital in any one commodity.
9) Never limit your orders or fix a buying or selling price. Trade at the market.
10) Don't close your trades without a good reason. Follow up with a stop loss order to protect your profits.
11) Accumulate a surplus. After you have made a series of successful trades put some money into a surplus account to be used only in emergency or in time of panic.
12) Never buy or sell just to get a scalping profit.
13) Never average a loss. This is one of the worst mistakes a trader can make.
14) Never get out of the market just because you have lost patience or get into the market because you are anxious from waiting
15) Avoid taking small profits and big losses.
16) Never cancel a stop loss order after you have placed it at the time you make a trade.
17) Avoid getting in and out of the market too often.
18) Be just as willing to sell short as you are to buy. Let your object be to keep with the trend and make money.
19) Never buy just because the price of a commodity is low or sell short because the price is high.
20) Be careful about pyramiding at the wrong time. Wait until the commodity is very active and has crossed resistance levels before buying more and until it has broken out the zone of distribution before selling more.
21) Select the commodities that show strong uptrend to pyramid on the buying side and the ones that shows definite downtrend to sell short.
22) Never hedge. If you are long of one commodity and it starts to go down, do not sell another commodity short to hedge it. Get out of the market; take your losses and wait for another opportunity.
23) Never change your position in the market without a good reason. When you make a trade, let it be for some good reason or according to some definite rule; then do not get out without a definite indication of a change in trend.
24) Avoid increasing your trading after a long period of success or a period of profitable trades
25) Don't guess when the market is top. Let the market prove it is top. Don't guess when market is bottom. Let the market prove it is bottom. By following definite rules, you can do this.
26) Do not follow another man's advice unless you know that he knows more than you do.
27) Reduce trading after the first loss; never increase.
28) Avoid getting in wrong and out wrong; getting in right and out wrong; this is making double mistakes.
When you decide to make a trade be sure that you are not violating any of these 28 rules which are vital and important to your success. When you close a trade with a loss, go over these rules and see which rule you have violated; then do not make the same mistake the second time. Experience and investigation will convince you of the value of these rules, and observation and study will lead you to a correct and practical theory for successful Trading in Commodities.
1. Emotional control is at the heart of good trading. Controlling yourself allows the ability to think clearly at each moment, resulting in success as a trader.
2. Cut losses with the most strict discipline. We must preserve capital at all times. Losing is part of trading, but opportunity cost is to be considered when hoping for a losing position to reverse course. If your trade reverses and violates the trend line, get out and be willing to re-enter. Do not take home an overnight trade unless it shows you a profit by the close on the day you entered the trade. This will save you from big losses and you can always re-enter if the stock crosses the entry price again.
3. Make good decisions and winning will take care of itself. Focus on how you play the game and not on the scoreboard. Trade with discipline and follow your game plan.
4. When you lose, don't lose the lesson! Forget the names but remember the events. Those who don't remember the past are doomed to repeat it. Make mistakes with composure and character, without blaming others, and don't dwell on mistakes.
5. When in doubt, get out. Scrutinize your positions at all times, each day, and you will not be left holding a stock without reason. Be willing to change direction at any time.
6. Keep your risk/reward profile in check. Profits can exceed losses even if the number of losing trades is greater than the number of winning trades. Always properly manage money, size positions accordingly, obey stops, and protect profits.
7. Avoid scheduled news. We are unable to foresee breaking news, but scheduled news we can step aside from. Scheduled news includes interest rate announcements, corporate earnings announcements, and various daily economic releases. Remember to trade only when you've got the best of conditions.
8. Consider your account size for appropriate trading. An account that is too small magnifies each trade, which keeps us from thinking rationally. Trade with the attitude that the next trade will simply be 1 of the next 1000 trades you will make.
9. Get a charting program that allows you to build watch lists, sort stocks, and draw trendlines. This is essential to learning. Price action and volume are vitally important in finding good chart patterns.
10. Scale out of winning positions as they work for you. This achieves two goals: taking some off the table and keeping you in the game. If your trade reverses, you took some profit at good spots. If the move continues, you are still on board for the ride.
11. Don't dig yourself into a hole early in the day or in your career. Be willing to observe the market and make an informed decision. Missed money is better than lost money.
12. Trade with a blend of anticipation and confirmation. Balancing these two will mean that you adopt a system of "if this happens, I will do that." Wait for your pitch!
13. Beware of your trading process following a winning streak. After a win streak, be extra disciplined! Many will make money in the market, but discipline is required to KEEP it. Stay on your guard at all times!
14. Evaluate your results at least monthly. Monitor your P&L, your win/loss ratio, and the relationship between your biggest wins and worst losses. Reviewing these results helps you continually improve your understanding of the markets and yourself.
15. Finally (perhaps most important), always be patient. Long-term patience will keep your confidence and optimism high, and short-term patience will help you wait for the best trades. Success doesn't come easy, and rarely are fortunes made overnight. Be willing to pay your dues and put in the work in order to achieve your goals.
1. Adopt a definite trading plan. Because of the emotional stress that is inherent in any speculative situation, you must have a predetermined method of operation, which includes a set of rules by which you operate and adhere to, thus protecting you from yourself. Very often, your emotions will tell you to do something totally foreign or negative to what your market trading plan should be. It is only by adhering to a preconceived formula that you can resist the emotional temptations and stresses that are constantly present in a speculative situation.
2. If you're not sure, don't trade. If you're in a trade and feel unsure of yourself, take your loss or protect your profit with a stop. If you are unsure of a position, you will be influenced by a multitude of extraneous and unimportant details and will probably end up taking a loss.
3. You should be able to be right 40% of the time and still show handsome profits. In speculating, it would be folly to expect to be right every time. An individual with the proper trading techniques should be able to cut his losses short and let his profits run so that even being right less than half the time will show excellent profits. This point is re-emphasized in Rule Four.
4. Cut your losses and let your profits ride. The basic failing of most speculators is that they put a limit on their profits and no limit on their losses. A man hates to admit he's wrong. Therefore, an individual will often let his loss ride, becoming larger and larger in hopes that eventually the market will turn around and prove him correct. Then after a while, he begins hoping for a small loss and gives up hoping for a profit. Human nature also dictates that an individual wants to take his profit right away and thus prove himself correct. There is an old saying, "You never go broke taking a small profit." But you'll certainly never get rich that way. Being satisfied with small profits is the wrong mental approach for making money in speculation. If you are correct when entering a speculative situation, you will know it almost immediately and will show a profit quickly. However, if you are wrong, you will show a loss and you should remove yourself from the situation quickly. Taking a small loss does not necessarily mean you were wrong in your thinking. It simply means that your timing was perhaps incorrect and that you should wait for the correct timing and situation to allow you to reenter the market. Remember, in any speculative situation, the market is the final judge. An individual must let the market tell him when he is wrong and when he is right. If you show a profit, ride it until the market turns around and tells you that you are no longer right, and, at that time, you should get out...but not before! On the other hand, the market will also tell you if you are wrong and it would be a serious mistake to argue with what it is saying.
5. If you cannot afford to lose, you cannot afford to win. As we have stated in Rule Four, losing is a natural part of trading. If you are not in a position to accept losses, either psychologically or financially, you have no business trading. In addition, trading should be done only with surplus funds that are not vital to daily expenses.
6. Don't trade too many markets. It is difficult to successfully trade and understand a specific market. It is next to impossible for an individual, especially a beginner, to be successful in several markets at the same time. The fundamental, technical, and psychological information necessary to trade successfully in more than a few markets is more than the individual has either the time or ability to accumulate.
7. Don't trade in a market that is too thin. A lack of public participation in a market will make it difficult, if not impossible, to liquidate a position at anywhere near the price you want.
8. Be aware of the trend. ("The Trend is your friend") It is vitally important that a trader be aware of a strong force in the market, either bullish or bearish. When this force is at its height, it would be folly to attempt to buck it. However, one must learn to recognize when a trend is about to run its course or is near a period of exhaustion. By an ability to recognize the early signs of exhaustion, the trader will protect himself from staying in the market too long and will be able to change direction when the trend changes.
9. Don't attempt to buy the bottom or sell the top. It simply can't be done unless you have the aid of a crystal ball or some other tool which could be peculiar to the mystic. Be content to wait for the trend to develop and then take advantage of it once it has been established.
10. Never answer a margin call. This rule acts as a stop loss when your position has weakened considerably. By dogmatically and arbitrarily adhering to this rule, you will be forced to get out of the market before disaster sets it. It is often difficult to admit you're wrong and get out of the market (which you probably should have done well before you received a margin call). However, the presence of a margin call should act as a final warning that you have let your position go as far as you conceivably can (unless the initial margin is out of line with the volatility of the contract).
11. You can usually sell the first rally or buy the first break. Generally, a market which has just established a trend either up or down will have a reaction and good interim profits can be made by recognizing this reaction and taking advantage of it. For example, in a bull market, the first reaction will generally be met by investors waiting to buy the break. This support generally causes the market to rally. The reverse is true of a bear market.
12. Never straddle a loss. A loss by itself is difficult enough to accept. However, to lock in this loss, thus making it necessary for you to be right twice rather than the once (which you previously found impossible) is sheer absurdity.
Entry rules
1. Get in on a 20-bar breakout
2. Before reversing the trend using the 20-bar breakout, there must be a losing trade in the opposite direction.
3. Always enter on a 55 bar breakout
4. (subjective) If the market is sideways, use a 55 bar breakout
5. Once there is a profit in one direction, you can continue to trade in that direction, but to trade in the opposite direction, there must first be a loss.
Stop rules
1. On the day of entry, use a 1/2 (Average True Range) ATR stop. If the trade gets stopped out during the intraday trading, then get back in if the intraday market gives a new signal (makes new lows or highs).
2. Use a 10 day trailing stop
3. The day after the entry, use a 2 ATR protective stop. Sometimes the 10 day trailing stop is too far away. The 10 day trailing stop assures you will not be risking more than 2-ATR on a trade (except when there is a gap open against your trade).
4. When the trade is at a 2.5 ATR profit, move the protective stop to breakeven.
5. Once the 10 day trailing stop or the 2.5 ATR rule moves the stop to breakeven, start using a wider trailing stop of 20 bars.
6. Once you are ahead by 10 ATR, use a 3 bar pivot as a trailing stop and the 20 bar breakout as a trailing stop.
Additional Techniques
1. Enter additional positions at a 55 day breakout, provided the protective stop on the first positions have been moved to breakeven.
2. After a big profit of 10 ATR or more, do not trade in the opposite direction for 45 bars using the 20 bar breakout method. Use the 55 bar breakout instead.
3. Wait for a sideways market to start trading and get in on a 55 bar breakout.
Money Management Rules
1. Do not risk more than 1% of your account per trade.
2. Do not expose your account to more than a 2 ATR risk at any time.
3. Use fractional entry technique
4. If in one trade, wait for that trade to be moved to breakeven before adding any new trades.
5. Trade the strongest commodity within a complex, such as grains and currencies.
6. Trade when the volatility shrinks. When the volatility shrinks by 50%, it allows more contracts to be used for the same dollar risk.
Frequently Asked Questions
Q. How many periods for ATR?
A. The ATR is based on a 10 day average of the ATR
Q. Explain fractional entry technique.
A. Enter 1/2 to 1/3 of all contracts initially. Once the trade moves to breakeven, buy/sell the next 1/2 or 1/3 of the contracts. Most losing trades are losers from the start. This method reduces risk and allows for maximum profits in a long term trade.
The Obvious Rules
Always do your homework. Have a position (bullish, bearish, or neutral) before you take a position.
Anticipate and plan rather than react; think of all the "what-ifs".
Be disciplined and rational. Work hard.
Make your own luck through hard work and perseverance.
Risk < 5% (1 to 2 %) of your capital on a single trade.
Ride winners; cut losses; trade small.
Pay attention to what other markets are doing.
Don’t be concerned about where you got into a position. The only relevant question is whether you are bullish or bearish on the position that day.
Don’t trade until an opportunity presents itself. Wait for a trade you feel most confident about.
Be patient. Avoid impulses. (There is nothing wrong with doing nothing. Wait for your number.)
Scale in and scale out of positions to spread risk.
The Not-So-Obvious Rules
Identify and commit to an exit point before every trade.
Don’t trade too much or trade to play. This detracts from finding real winners.
Never add to a losing position.
Don’t get complacent with profits. The toughest thing to do is hold on to them.
Place your stop at a point that is difficult to reach (above resistance, below support). If this implies an uncomfortably large loss, trade smaller. Scale the stop.
Never play macho man. Never over-trade. (Organizations need to guard against trading "junkies".)
Don’t cast too wide a net. There isn’t a "best" commodity or stock to trade. Narrow your scope to commodities or stocks you are comfortable with and you will have more time to focus on good trades.
Follow your ideas, but be flexible enough to recognize when you have made a mistake.
Adopt the key characteristics of successful traders: discipline, patience to wait for the right trade and stick with a winner, adequate capitalization, a strong desire to win, and a noble goal.
Guard against making the worst mistake. The worst mistake is to miss a major profit opportunity.
Separate your ego from trading. Making money is most important. Learn to accept mistakes and limit losses --- quickly.
Moderate your emotions. Don’t try too hard, and don’t be arrogant. When you get arrogant, you forsake risk control.
Don’t place blind trust in anyone; be self-reliant. "Experts" are not traders. More money is lost listening to brokers than any other way.
Be strong and independent. Think against the herd.
Be a good risk manager, be a successful trader.
1. The first and most important rule is - in bull markets, one is supposed to be long. This may sound obvious, but how many of us have sold the first rally in every bull market, saying that the market has moved too far, too fast. I have before, and I suspect I'll do it again at some point in the future. Thus, we've not enjoyed the profits that should have accrued to us for our initial bullish outlook, but have actually lost money while being short. In a bull market, one can only be long or on the sidelines. Remember, not having a position is a position.
2. Buy that which is showing strength - sell that which is showing weakness. The public continues to buy when prices have fallen. The professional buys because prices have rallied. This difference may not sound logical, but buying strength works. The rule of survival is not to "buy low, sell high", but to "buy higher and sell higher". Furthermore, when comparing various stocks within a group, buy only the strongest and sell the weakest.
3. When putting on a trade, enter it as if it has the potential to be the biggest trade of the year. Don't enter a trade until it has been well thought out, a campaign has been devised for adding to the trade, and contingency plans set for exiting the trade.
4. On minor corrections against the major trend, add to trades. In bull markets, add to the trade on minor corrections back into support levels. In bear markets, add on corrections into resistance. Use the 33-50% corrections level of the previous movement or the proper moving average as a first point in which to add.
5. Be patient. If a trade is missed, wait for a correction to occur before putting the trade on.
6. Be patient. Once a trade is put on, allow it time to develop and give it time to create the profits you expected.
7. Be patient. The old adage that "you never go broke taking a profit" is maybe the most worthless piece of advice ever given. Taking small profits is the surest way to ultimate loss I can think of, for small profits are never allowed to develop into enormous profits. The real money in trading is made from the one, two or three large trades that develop each year. You must develop the ability to patiently stay with winning trades to allow them to develop into that sort of trade.
8. Be patient. Once a trade is put on, give it time to work; give it time to insulate itself from random noise; give it time for others to see the merit of what you saw earlier than they.
9. Be impatient. As always, small loses and quick losses are the best losses. It is not the loss of money that is important. Rather, it is the mental capital that is used up when you sit with a losing trade that is important.
10. Never, ever under any condition, add to a losing trade, or "average" into a position. If you are buying, then each new buy price must be higher than the previous buy price. If you are selling, then each new selling price must be lower. This rule is to be adhered to without question.
11. Do more of what is working for you, and less of what's not. Each day, look at the various positions you are holding, and try to add to the trade that has the most profit while subtracting from that trade that is either unprofitable or is showing the smallest profit. This is the basis of the old adage, "let your profits run."
12. Don't trade until the technicals and the fundamentals both agree. This rule makes pure technicians cringe. I don't care! I will not trade until I am sure that the simple technical rules I follow, and my fundamental analysis, are running in tandem. Then I can act with authority, and with certainty, and patiently sit tight.
13. When sharp losses in equity are experienced, take time off. Close all trades and stop trading for several days. The mind can play games with itself following sharp, quick losses. The urge "to get the money back" is extreme, and should not be given in to.
14. When trading well, trade somewhat larger. We all experience those incredible periods of time when all of our trades are profitable. When that happens, trade aggressively and trade larger. We must make our proverbial "hay" when the sun does shine.
15. When adding to a trade, add only 1/4 to 1/2 as much as currently held. That is, if you are holding 400 shares of a stock, at the next point at which to add, add no more than 100 or 200 shares. That moves the average price of your holdings less than half of the distance moved, thus allowing you to sit through 50% corrections without touching your average price.
16. Think like a guerrilla warrior. We wish to fight on the side of the market that is winning, not wasting our time and capital on futile efforts to gain fame by buying the lows or selling the highs of some market movement. Our duty is to earn profits by fighting alongside the winning forces. If neither side is winning, then we don't need to fight at all.
17. Markets form their tops in violence; markets form their lows in quiet conditions.
18. The final 10% of the time of a bull run will usually encompass 50% or more of the price movement. Thus, the first 50% of the price movement will take 90% of the time and will require the most backing and filling and will be far more difficult to trade than the last 50%.
1. Don't trust others opinions -
It's your money at stake, not theirs. Do your own analysis, regardless of the information source.
2. Don't believe in a company -
Trading is not investment. Remember the numbers and forget the press releases. Leave the American Dream to Peter Lynch.
3. Don't break your rules -
You made them for tough situations, just like the one you're probably in right now.
4. Don't try to get even -
Trading is never a game of catch-up. Every position must stand on its merits. Take your loss with composure, and take the next trade with absolute discipline.
5. Don't trade over your head -
If your last name isn't Buffett or Cramer, don't trade like them. Concentrate on playing the game well, and don't worry about making money.
6. Don't seek the Holy Grail -
There is no secret trading formula, other than solid risk management. So stop looking for it.
7. Don't forget your discipline -
Learning the basics is easy. Most traders fail due to a lack of discipline, not a lack of knowledge.
8. Don't chase the crowd -
Listen to the beat of your own drummer. By the time the crowd acts, you're probably too late…or too early.
9. Don't trade the obvious -
The prettiest patterns set up the most painful losses. If it looks too good to be true, it probably is.
10. Don't ignore the warning signs -
Big losses rarely come without warning. Don't wait for a lifeboat to abandon a sinking ship.
11. Don't count your chickens -
Profits aren't booked until the trade is closed. The market gives and the market takes away with great fury.
12. Don't forget the plan -
Remember the reasons you took the trade in the first place, and don't get blinded by volatility.
13. Don't have a paycheck mentality -
You don't deserve anything for all of your hard work. The market only pays off when you're right, and your timing is really, really good.
14. Don't join a group -
Trading is not a team sport. Avoid stock boards, chatrooms and financial TV. You want the truth, not blind support from others with your point of view.
15. Don't ignore your intuition -
Respect the little voice that tells you what to do, and what to avoid. That's the voice of the winner trying to get into your thick head.
16. Don't hate losing -
Expect to win and lose with great regularity. Expect the losing to teach you more about winning, than the winning itself.
17. Don't fall into the complexity trap -
A well-trained eye is more effective than a stack of indicators. Common sense is more valuable than a backtested system.
18. Don't confuse execution with opportunity -
Overpriced software won't help you trade like a pro. Pretty colors and flashing lights make you a faster trader, not a better one.
19. Don't project your personal life -
Trading gives you the perfect opportunity to discover just how screwed up your life really is. Get your own house in order before playing the markets.
20. Don't think its entertainment -
Trading should be boring most of the time, just like the real job you have right now.
Option premium in relation to the Current Market Price (CMP) is always higher, at the beginning of the new month (after previous month’s option expiry on the last Thursday). Again in relation to the CMP, option premium of Next Month Option (August here) is higher than the current or Near Month Option (July here). Still higher would be the Far Month Option Premium (September here). As we approach the expiry date, the premium in relation to CMP starts falling until a day or two before expiry, the premium would be almost zero. This difference is because the buyer of the option for farther off periods stands a greater chance of making profits if given more time to hold the option. The seller therefore deserves to get a higher premium. This intrinsic quality of any option to fall in value with time in relation to the CMP is called the TIME DECAY.
For example, let us imagine at Nifty value of 4500 (CMP), the 4500 Call option at the beginning of the current month (July) was trading at Rs 50/-. A day before expiry, if Nifty is still at 4500, the Call premium would be close to Rs 4/- or Rs 5/-. If Nifty closes at 4500, the value of the call premium would be zero. If Nifty closes at 4510, the call will close at Rs 10/-which is again zero premium in relation to CMP.
The significance of Time Decay
Most retail investors are buyers of options. What one should realize is that due to the inevitable time decay, a buyer has the dice loaded against him, right from the time he enters into the contract. He has to depend on the volatility of the scrip to book his profits along the down-hill journey of the option premium. He, of course, has the advantage that his loss is limited and he has to pay no deposit apart from the actual amount of transaction.
The option writer on the other hand, has the dice loaded in his favor from the time he sells the option (as a primary seller, without having bought the option first). The time decay works to his advantage on a daily basis. As long as the scrip remains stagnant, the premium continues to fall, adding to his gains. He pays the price by the mandatory deposit into the stock exchange and also by accepting the possibility of unlimited loss (but writers usually exit with a small profits and do not hold on to their positions too long to avoid undue risks).
By definition, open interest (OI) means the total number of open contracts on a security or index (NIFTY) , that is, the number of future or options contracts that have not been exercised or expired. Hence, we can say that the open interest position at the end of each day represents the net increase or decrease in the number of contracts for that day.
For example, If A and B buy two Reliance options each today, the open interest at the end of the day is FOUR. On day 2, if A sells one of his options to C (who is a fresh buyer), at the end of the day 2, the OI will remain FOUR (since one buy by C has been compensated by one sale by B). But consider the situation where, A and B have retained their options and C has bought a newly written option (by an initial seller or the so called writer of options).The OI at the end of day 2 will be FIVE. In other words, increase in OI is a reflection of new contracts coming into the market. What then would be the significance of OI variations vis-à-vis market trend ?
If market is on an uptrend and OI is rising :Bullish signal for the index/stock derivative (more calls being written).
If market is on an downtrend and OI is rising :Bearish signal for the index/stock derivative (more puts being written).
If market is on an uptrend and OI is falling :Bearish signal signifying a decreased interest for buying fresh calls. This may precede a trend reversal.
If market is on a downtrend and OI is falling :Bullish signal signifying a squaring off of existing positions in anticipation of a trend reversal.
If the market movement is sideways and OI is rising :This suggests that a trend in either direction is likely soon.
If the market movement is sideways and OI is falling :This suggests that the trend less movement will continue.
Thus open interest is just one of the indicators among many that help us to take a call on the likely direction of the market. It has to be considered along with other technical indicators before taking any decision.
One of the most potent tools in the inventory of option traders are free Calls. How do we get them ? Quite simple in fact. Please note the following example (reference Reliance, any strike level, lot size 150) :
Premium Lots Price Action
40 50 3,00,000 Buy
50 40 3,00,000 Sell
So, the above transaction earns you as many as TEN FREE lots of Reliance Calls in just one day ! If you get an opportunity, you can repeat the operative the same day again. Repeating the process just FIVE times will get you as many as 50 FREE lots. You can sure have many more, depending upon how many times you repeat the operative. We suggest you begin small and increase the stakes gradually as you gain more experience & confidence.
Each and every penny earned on these FREE lots will be your profit.
20 x 150 x 50 = 1,50,000 rupees(selling at a reasonable 20 premium) 50% return10 x 150 x 50 = 0,75,000 rupees(selling at a mere 10 premium) 25% return05 x 150 x 50 = 0,37,500 rupees(selling at a rock-bottom 05 premiun) 12.5% return
All the percentage returns shown above are merely single-transaction returns. One can easily repeat the process over and over again, at least on certain definitely bullish days.
Good assured (almost) monthly income ??Unleashing the power of OPTIONS as we said !!
50% monthly return, 600% annualised !!! Any takers ???
No other trade operative makes this even remotely possible !
The beauty of these free calls is that you’ll never be in a hurry to square them off, so you can easily wait for your expected premium value. Even if some of these calls expire worthless, you don’t lose a penny as the calls were already free to you !
Please note that to be on the conservative side, we have suggested selling the initial 40 lots only at a premium of 10 (easily attainable for Reliance). You can always sell these at higher premium, thus earning yourself proportionately higher number of FREE Call lots. If you can’t sell off these initial 40 the same day, you can always wait for a day or two. Do make the usual allowance for brokerage payment please.
CAUTION : If you propose to buy/sell as many as 50 to 100 lots in a day, first please assure from the NSE web site (or through your own trading software) that there is sufficient volume available in the strike level of your choice. Even if you need to transact a costly Call, it really doesn’t matter much (beyond the higher initial investment), as you will get your entire investment back the moment you sell off the stipulated no. of Calls.
Our attempt is to provide you a basic understanding of what stock and index options are all about without confusing you with any unnecessary and avoidable details. Though there indeed are lots of online resources on options, hardly any of them deal with the typical Indian equity market scenario - we bring you one right here - perhaps the first Indian OPTIONS BLOG.
New to OPTIONS ? It is so very easy. Just follow these basics for a quick launch into the wonderful world of OPTIONS trading :The equity market permits you to either purchase/sell shares (called CASH segment), or trade in FUTURES and/or OPTIONS (called the DERIVATIVES segment). FUTURES and OPTIONS segment in popularly referred to as FnO. However, here we talk only about OPTIONS and not about FUTURES at all. Why ? Because in OPTIONS the possible extent of loss is very limited, whereas in FUTURES loss can be potentially unlimited !
Basic Call Options
Buying a call option gives you the right to purchase a given number of shares of a company’s stock at a certain price (called the strike price) from the date of purchase until the last Thursday of a specific month (called the expiration date). You can just as easily sell (square off) your purchased Call options, without necessarily having to exercise them to procure a company’s shares prior to the stipulated expiry date. That is why it is usually said that buying a Call options gives you a right, though not necessarily an obligation.
People buy calls because they hope the stock will go up, and they will make a profit, either by selling the calls at a higher price, or by exercising their option (i.e., buy the shares at the strike price at a point when the market price is higher).
Basic Put Options
Buying a put option gives you the right (though not the obligation) to sell a specified number of shares of a company’s stock at a certain price (called the strike price) from the date of purchase until the last Thursday of a specific month (called the expiration date). You can just as easily sell (square off) your purchased Put options, without necessarily having to exercise them to sell a company’s shares prior to the stipulated expiry date. That is why it is usually said that buying Put options gives you a right, though not necessarily an obligation.
People buy puts, because they hope the stock will go down, and they will make a profit, either by selling the Puts at a higher price, or by exercising their option (i.e., forcing the seller of the Put to buy the stock at the strike price at a time when the market price is lower).
So, as we have explained above, OPTIONS trading has two basic transactional instruments, called Calls & Puts. You can buy and sell both or either. Calls increase in their value as the cash scrip goes up, Puts decrease at the same time. Conversely, as the cash scrip goes down Calls decrease in value and Puts gain at the same time.
For sake of convenience, let us take Reliance as an example. Suppose the cash share of this company is currently trading at 1700. If you wish to purchase Reliance Calls, your broker or your online trading agency will tell you that Reliance Calls are available at different levels. These levels can be below, at or above the currently trading price of Reliance share. For example, Reliance Calls for the month of July are available at 1440, 1470, 1500, 1530, 1560, 1590, 1620, 1650, 1680, 1710, 1740, 1770, 1800, 1830, 1860 levels. These levels are called as Strike levels, Strike price, or simply Strikes for Reliance Calls available in the market. I have shown 1710 in bold as it is closest to the current market price (CMP) of a Reliance share. Such a level would be called as ‘At Money’ or ‘At the Money Level’. All levels below the CMP will be termed as ‘In Money’ or ‘In the Money’ levels (here 1440 till 1680), and, of course, all levels above the CMP will be termed as ‘Out of Money” levels (here 1740 till 1860).
Don’t attempt starting trading right-away. OPTIONS are time-sensitive, scheduled financial contracts. Learn the basic OPTIONS terminology and their basic calendar prior to beginning your first trade.
1. Don’t start trading in options until you are absolutely sure of the terms - ‘Buying a put’ or ‘buying a call’ and ’selling a put’ or ’selling a call’ (Look up in Terminology category). The IMPLICATIONS are different and so are your LIABILITIES .
2. Don’t start trading in options until you are reasonably well versed with short-term movements of the market as a whole (NIFTY, SENSEX), as well as in the stock you select.
3. Don’t become an initial SELLER of options - that is, selling options without having bought them first. This makes you an OPTION WRITER, and you have to pay heavy margins to the stock exchanges. Your losses can be unlimited as well.
4. Don’t select a trend less stock with narrow price movements. You will neither gain on the calls nor the puts and you will lose due to the inevitable time decay.
5. Don’t buy a put option on rising stocks.
6. Don’t buy a call option on declining stocks.
7. Don’t buy a stock where trading volumes are obviously very low.
8. Don’t get into several stock options at the same time. You may find it difficult to follow-up. Limit to two, or at most three.
9. Don’t get into buying an option until you have calculated the actual outflow per option. It may be low for Nifty (lot size merely 50) but extremely high for stocks like GMRINFRA (lot size 1000).
10. Don’t go for extreme ‘out of the money’ or extreme ‘in the money’ options. For call options, ‘in the money’ would mean strike lower than Current Market Price ( CMP ), and for put options, ‘in the money’ would imply a strike higher than CMP (and vice-versa).
11. Don’t place ‘market orders’ for any option. You may end up paying absurdly high rates placed by sellers. These becomes astronomically high when you consider stocks where the number of units per option is large like 7875 per option for IFCI.
12. Don’t buy an option closer than 7 to 10 days prior to expiry date - unless you’re trading intraday where you would be squaring up the same day, or at the most during the next 1 or 2 days.
13. Don’t hold all the options for maximum gains. Start selling a percentage of them at each significant rise. Hold, say 20% towards expiry if you expect further rise in the cash market price. Make sure that the cash market price is already well above your strike plus premium in call options that you are holding to expiry. Reverse for puts of course
14. Don’t shift to higher options in equal numbers as the scrip is rising. Speaking of call options, if you wish to shift, remove part of profits and take lesser number of options at higher strikes and lower premium. Do the reverse for put options.
15. Don’t keep a stop loss in options on the trading screen. It can easily get triggered and then reverse, since options are volatile. Keep a mental stop loss if necessary and exercise the stop loss at will.
16. Don’t utilize 100% of your capital in options. The very advantage of options is lost. If you have Rs 5 lakhs as capital, you can take exposure to the same number of shares with Rs 50000/- worth options. Limit yourself to this 10% percentage of the available capital. As you earn profits with options, you can keep back your entire capital of Rs 5 lakhs, or keep it invested in a stable blue-chip cash scrip like L&T or Reliance and continue playing in options with the profits alone.
17. Don’t play on borrowed money. Once you gain experience, you may get margin funding on your cash shares from your brokerage. Take care not to over leverage. It is quite easy to fall prey to greed in the market, more so with options since investment required is substantially less.
18. Don’t average options during a fall as in long term investment for cash market shares. You may lose big time.
19. Don’t panic seeing intra day volatility in options. It is a natural phenomenon with options.
20. Don’t buy at the opening price since the demands from sellers are often absurdly high on opening. Watch the trend before taking a position.
21. Don’t hesitate to get advice from someone you trust in case of doubt.
Wish to begin your first OPTIONS play just tomorrow ? No problem.
1. Please read this entire blog from A to Z, and in case you have any queries, ask them in the appropriate blog section(s). Don’t begin before you’re 101% sure of what you’re doing. Please note that reading (just quickly going through and making some jottings !) may take only about an hour or so (as of today), but it may result in substantial and far more complete information gain for you before you begin you options foray.
2. We suggest that you begin your OPTIONS practical training lessons with Reliance Calls as they are well traded and less volatile. Such a characteristic takes one important negative variable away - letting you begin your options play on a more positive note. You may either place your buy Call order telephonically with your broker, or, if you’re confident enough with your trading software, you may execute it yourself. PLEASE ALWAYS PLACE A LIMIT ORDER. In case you definitely want to buy at the visible price, just place your order quoting an additional 0.10, and confirm your order execution immediately thereafter. THIS CONFIRMATION OF THE EXECUTED TRADE IS VERY IMPORTANT, and cannot simply be over emphasized.
3. While buying Reliance Calls, regardless of the current price of the cash scrip (say 1900), you will find Calls available at different numerical levels (called strike levels), some less than 1900, others more than 1900. The farther away the Call’s strike level from the CMP, the more inexpensive (carrying less premium) it will be. On the contrary, if the strike level is closer to 1900, exactly at 1900 (if any), or even less than 1900 - it will be relatively more expensive (carrying higher premium). When the cash scrip price moves just a bit, Calls nearer to 1900 (or less) are likely to show much quicker movement (negative or positive), than those further away from 1900. So which strike level do we select for buying. Please see the following point.
4. You may be buying options in either a) a relative bullish scenario, b) an extreme bullish scenario, c) a bearish scenario, d) an extreme bearish scenario, or e) when the market is not showing much movement. Use the following general guidelines for a newbie options player :
Situation label >> recommended option action(example Reliance CMP 1900) :
a) Bullish scenario >>Buy & sell Calls about 1 or 2 notches above 1900 (strikes 1920, 1950)
b) Extreme bullish >>Buy & sell Calls even most distant from 1900 (Puts available very cheap)
c) Bearish scenario >>Just sit back, watch the movements and relax
d) Extreme bearish scenario >>Sell any Puts that you may have bought earlier (Calls available very cheap).
e) Range-bound market (limited, predictable movement) >>Just sit back, watch the movements and relax
Buy Calls at strike levels less than 1900 only if your budget permit. Such Calls carry higher premium. Calls & Puts are REVERSE instruments. -1900 Calls carry heavier premium, and +1900 Puts carry heavier premium too. The deeper inside 1900 the Calls, the heavier the premium, and the farther outside 1900 the Puts, the heavier the premium. For a more professional & safe approach, it pays to be armed with cheaply procured Calls & Puts - as father away from expiry as possible.
5. Don’t just proceed on a Call-buying spree straightaway. Study the Call pricing pattern (rise & decline vis-a-vis the level of indices, NIFTY, SENSEX) at least for a couple of days.
6. For a newbie, it would be safer to buy current month’s Calls any time between the 5th & 10th of the month. Any earlier, and you’ll find the Calls more expensive, and, any later, and you will find yourself perilously close to the month-end expiry (last Thursday of the month, by which date all Calls must be squared up, or, else, they expire automatically).
7. The day you proposed to buy Calls, try buying when the indices and the cash scrip CMP is closest to the lowest for the day. You will sure gain this proficiency by watching the Call/cash pattern for a couple of days.
8. VERY IMPORTANT : Never sell a Call, without having bought it first. Usually your trading software won’t permit you to sell a Call first, but, in case you have sufficient trading balance in your account, it may permit you to. So, please do guard against that. Selling Calls first makes you an option writer (see Terminology category). It may have grave implications if you become an option writer unintentionally.
9. Once you have bought your Calls, double-check the transaction in your trading account. Do ensure the chosen strike level, purchase price, the fact that the Call has indeed been bought and NOT sold first, as also the chosen validity month for the Call of your choice.
10. Don’t panic and sell your Call if you find its premium declining after your purchase. You still have about 10-15 days to exercise your selling OPTION !
11. Sell the Call(s) whenever you realize that the premium you’re getting is good enough for your liking. Don’t be too greedy. If you have purchased more than one Calls, it is usually better to sell in bits, rather than in one go.
12. Please note this VERY IMPORTANT point. If you bought Reliance 1920 strike level Calls at a premium of 30 when Reliance cash share price was just 1900, your total investment was 30 x 150 (shares per lot) x no. of lots purchased. You NEED NOT square off (sell your Calls) at or around expiry if the expected or real cash share price at that time is 1950 or more. Because this increase of 30 in the cash price now equals (and covers) your expenditure. Any more increase will be your profit. If by any chance the premium on your calls exceeds 50 (unlikely), do sell them off. Otherwise, just let your Calls expire, and you will automatically get Rs.50/- (new price 1950 minus old price 1900) x 150 x no. of lots purchased. However, if the cash share price at or around expiry is less than 1950, say 1935, then you need to weigh this against the prevalent premium of your Calls and act accordingly.
13. We strongly recommend that as a newbie you begin slowly, and play it small, safe and secure. Be happy with small & consistent profits. As you gain more exposure and begin to understand and appreciate the complex operatives of options, you will surely have your moments of BIG PROFITS … if, and only if, you carry a balanced head over your shoulders.
It is of utmost importance to know the intrinsic difference between ‘Buying of options‘ and ‘Selling of options‘.
Buying an option
When you buy a Call option or buy a Put option, your commitment to the contract is limited to the premium you pay. For example, if A buys a Call option of Nifty for Rs 50/-, and Nifty falls, the premium on the option will start falling in value , thereby resulting in a loss to A. Even if the Nifty falls by 100, the premium on the option cannot go below zero on to the negative side. Therefore, the loss incurred by A cannot be more than Rs 50/- (i.e.the initial premium paid). But if Nifty rises, the profits can be unlimited - as much as Nifty rises. For example, this month (June) we have seen Nifty Call 4500 rising from about Rs.40/- to about Rs.145/- in just about 7-10 days’ time.
Similarly when you buy a Put option, your commitment is limited to the initial premium paid. Taking a similar example, if A buys a Put option of Nifty for Rs 50/-, and Nifty rises, the value of the Put can decrease to zero but not into negative territory. The maximum loss incurred by A will be Rs 50/- (i.e.the initial premium paid). But if Nifty falls significantly, the profits can be unlimited - proportionately just as much as Nifty rises.
Selling an option
a) You can sell an option you have already bought to square up at a profit or loss. Your contract ends with no further liability.
b) You can be an initial seller of options. This is called short-selling or specifically as OPTION WRITING. This is almost like short-selling in intraday cash share trade, with the difference that you are not necessarily required to square off the transaction (by buying the Call back) during the same trading session. In fact you can square off the transaction any time up to the expiry date - depending upon as to when you’re able to realise your optimum profit.
What are the liabilities of an option writer ?
The option writer who sells Calls or Puts without having initially bought them faces a possibility of unlimited gains or unlimited loss depending on which way the index or scrip moves. When he sells an option, (Call or Put), the premium collected gets credited into his account. But, he has a responsibility to compensate the buyer of the option against any movement in favor of the buyer. For example, if he sells a Call option to A, and if the call premium moves up along with upward movement of the index or scrip, the benefit to A will be provided from the premium collected by the Option Writer. If he sells a Put option to B, and if the call premium moves up along with downward movement of the index or scrip, the benefit to B will be provided from the premium collected by the Option Writer. His liability exists till he squares up his position by buying back the Call or the Put.
To protect the buyer against default by the Option Writer, the latter has to pay a deposit to the Exchange for each option sold. This amounts to about 10% of the total value of the option (not just the premium, but the strike value x units per lot) for Nifty (about Rs 20000/- presently), but is considerably higher for individual scrips. The actual percentage is calculated depending on volatility and open interest position in the derivative. This may vary from day to day or week to week. The deposit is returned to the Option Writer once he has squared up his option (after adjustments for any loss or gain).
How does an option writer make money ?
The gains follow this formula : Selling premium minus buy back premium x units per lot x number of options.
This could be possible in any of the following situations :
a) By buying back if the option premium falls due to volatility of the scrip.b) If the scrip price remains stagnant, the option writer would gain by the inevitable time decay (see under Terminology category) that occurs as the expiry date approaches.
Usually option writers concentrate on large volumes and low profits per option, thereby ensuring consistent profits. Option writing using time-decay is a method of generating a monthly income from the markets as against investing or speculating - that is dependent only on scrip movements.
Plan your trades. Trade your plan.
Keep records of your trading results.
Keep a positive attitude, no matter how much you lose.
Don't take the market home.
Forget your College degree and trust your instincts.
Successful traders buy into bad news and sell into good news.
Successful traders are not afraid to buy high and sell low.
Continually strive for patience, perseverance, determination, and rational action.
Limit your losses - use stops!
Never cancel a stop loss order after you have placed it!
Place the stop at the time you make your trade.
Never get into the market because you are anxious because of waiting.
Avoid getting in or out of the market too often.
The most difficult task in speculation is not prediction but self-control. Successful trading is difficult and frustrating. You are the most important element in the equation for success.
Always discipline you by following a pre-determined set of rules.
Remember that a bear market will give back in one month what a bull market has taken three months to build.
Don't ever allow a big winning trade to turn into a loser. Stop yourself out if the market moves against you 20% from your peak profit point.
Expect and accept losses gracefully. Those who brood over losses always miss the next opportunity, which more than likely will be profitable.
Split your profits right down the middle and never risk more than 50% of them again in the market. The key to successful trading knows yourself and your stress point.
The difference between winners and losers isn't so much native ability as it is discipline exercised in avoiding mistakes.
Speech may be silver but silence is golden. Traders with the golden touch do not talk about their success.
Dream big dreams and think tall. Very few people set goals too high. A man becomes what he thinks about all day long.
Accept failure as a step towards victory.
Have you taken a loss? Forget it quickly. Have you taken a profit? Forget it even quicker!