mutual funds selection cover

Mutual Fund Selection – Six Key Technical Factors to Consider!

A study of Technical Factors involved during Right mutual Fund Selection: Mutual Fund as a financial product has gained a lot of dominance in recent years. With the growing education of financial products and government advertising schemes like ‘Mutual Fund Sahi hai”, people are now more aware of the various mutual fund investment avenues.

In our previous article on how to pick a mutual fund, we had given insights on the various fundamental factors, we should consider and understand before selecting a Mutual Fund to invest. Through this article, we aim to look at and explain the various technical factors that need to be considered for mutual fund selection. Thorough knowledge of both fundamental and technical factors goes a long way in picking the right funds to invest in.

Anyways, before understanding the technicalities, let us revise the concept of Mutual funds to brush up our basics. Let’s get started.

What is Mutual Fund?

mutual funds trade brains3

To put it in simple words, a Mutual fund is a pool of money which is been collected from various investors who want to invest their money in the stock market and other profitable assets but do want to go through the whole process of selecting the avenues to invest. They just park their money with a Financial Institution (in this case AMC), which in turn takes on the mantel of investing the pooled fund and generate returns for investors.

The funds are being managed by the fund managers, who use their skill and experience in generating the best possible returns for the investors. Eventually, these returns are sent back to the initial investors, after deduction of the basic costs required to run that fund.

Technical Factors to consider for Mutual Fund Selection

Here are six of the most important technical factors that the investors need to consider for mutual fund selection. Anyways, the best part about these technical factors are they are very simple to analyze. Let’s look into these technical factors:

1) Expense Ratio

This probably is one of the most important factors that is sometimes overlooked a few investors while deciding upon a mutual fund.

The expense ratio is the fee that is charged by the Asset Management Company (AMC) for managing the mutual fund. It basically includes the fee the fund manager, other operational and administrative expense which are incurred while managing the fund. Expense cost is charged on a year to year basis.

Generally, the expense ratio is also the function of the size of the fund. The type of Mutual funds (Growth and Direct) also impacts the expense ratio. The expense ratio of Direct mutual funds is lesser compared to Growth mutual funds.

In India, the expense ratio generally varies between 1% to 2.5% of the total fund value, depending on the fund house and type of fund.

2) Fund’s Portfolio

This is one very important consideration while buying a mutual fund. With the help of careful analysis and research, we can choose the fund which has a portfolio that suits our risk profile. And even the size of the portfolio makes a lot of difference in choosing a mutual fund.

Say, if we were to choose a blue-chip fund to invest. A fund that has diversified investment in 50-60 stocks, is more likely to perform in line with the performance of Nifty, and the fund which had a smaller portfolio is likely to have more volatile returns.

The quality of shares in the portfolio also makes a difference in the performance of the fund. The fund which includes sector leaders has more sable returns compared to one that is laggards of the industry.

3) Rating Agencies

The rating given by rating agencies provides valuable insight into the performance of the funds. For example, CRISIL Ratings of different mutual funds. Just to put in perspective, a rating of 5 on 5 generally means the fund has been performing better than expected in their category. They have been managing risks that are well within the acceptable limit. While rating a fund, the historical performance may be given higher weightage by different rating agencies. It a basically a consistency parameter of the mutual fund.

4) AUM (Asset Under Management)

The total value of the assets which are being managed by the fund (AUM), gives a big picture of the quality of the fund. The fund which has a large AUM has a faith of a large number of investors which in turn gives an indication that it is managed in a professional and cordial manner. And these funds are managed by professional Fund Managers. The following are some of the factors which have an impact on the AUM of the fund:

  • The Fluctuations of the market
  • The performance of the fund i.e., if the fund performs well, then the AUM of the fund increases and it attracts more investors to put money in the fund.
  • Size of the fund. If the fund is of big size, then the returns generated will be higher which in turn will increase the size of the AUM of the fund

5) Category Returns

One’s performance is always judged by how they perform compared to their peers. Similarly, in the case of mutual funds, the performance of the funds, compared to their category peers holds a lot of significance.

Again to take the example of Bluechip Funds:blue chip fund category returns

Figure : Mutual funds peer comparison (www.moneycontrol.com)

Now, if we look at the figure above, we see the performance comparison of the Blue chip funds category. And the categorical comparison helps us in understanding the fund’s performance. There are various parameters to choose from. And one can filter the funds, depending on one’s preference, and make an informed judgment while buying the fund.

6) Risk Ratios

The last on the list, but one of the most important parameters in judging the funds’ performance. The risk ratios help us in understanding the risks taken to generate returns for the investors. Through this article, we will have a look at the two risk factors: Standard deviation & Beta.

Standard Deviation (SD): This parameter judges the volatility of the fund over the last three years. If the SD value is low, it generally indicates low risk and low volatile funds and which ultimately leads to more predictable performance. Therefore, if we have two funds, Fund A and Fund B. If both the funds are giving similar returns, and if one has a lower standard deviation than others, then it is advisable to choose a fund with a lower standard deviation.

Beta: Even beta is used to understand the volatility of the fund. If the fund had a high beta, then the funds is generally more volatile. It is advised to choose funds that have low beta value.

Even while doing the risk analysis of the category of the funds, the ones which have low beta and standard deviation should always be the preferred choice.

Conclusion

In this article, we tried to cover the technical factors that you should look into during mutual fund selection for right investments. Here are the top takeaways from this article:

  • A clear understanding of both technical and fundamental factors goes a long way in choosing the right fund to invest.
  • The size of the fund along with portfolio diversification should be given due importance in choosing the fund
  • The expense ratio gives information about the cost of managing the fund. The lower the expense ratio, the higher the returns for the investors.
  • The categorical comparison helps in selecting the right fund which matches one’s risk profile
  • The risk factors that measure the volatility of the funds should be carefully analyzed and the fund with low volatility should be preferred while investing.

That’s all for this post. I hope this was helpful to you. If you’ve got any queries related to the above-discussed factors for mutual fund selection, feel free to comment below. I’ll be happy to help. Happy Investing.

September 9, 2020 Mutual Funds No comments yet
What is Open Interest(OI)? How to interpret it in Options Trading?

What is Open Interest (OI)? How to interpret it?

Understanding Open Interest: The term open interest (OI) is one of the most popular terminologies used among stock market traders. In this article, we are going to discuss what exactly is Open Interest. Here, we’ll discuss it’s definition, what does an increase or decrease in open interest implies, the difference between open interest vs volumes, and how one should interpret open interest. Let’s get started.

Open Interest Definition

Open Interest is the total number of the futures contracts (or Options) held by market participants at any given point of time. The total number of open interest contracts keeps on changing with every transaction executed. The open interest is said to be the best indicator to gauge the market sentiment and understand the reliability of the price movements.

Therefore, for an open interest to exist, there must be a buyer for every seller and vise-versa. Here, the relationship between buyer and seller creates one open interest. So, when buyers and sellers come together and initiate one new position, then open interest is increased by one unit. And when the same buyer and seller decrease their position, an open interest is reduced. But, if a buyer and seller passes their position to a new buyer and seller, then the Open interest remains unchanged, its just a transfer of position.

What does the Increase/Decrease in Open Interest Imply?

An increase in Open Interest means that new money is flowing in the market. And it generally indicates that the present trend (Bullish, Bearish, or sideways) is expected to continue.

A decline is an open interest usually implies, that the current trend is expected to halt and we could see a reversal in the market. To know the current open Interest, we just need to know the total from the buyer or seller side and not both.

Difference between Open Interest (OI) and Volumes

There is generally a common misconception that both OI and volumes mean one and the same thing. However, they are two different concepts, giving out two different sets of data. But, both the data can be used in conjuncture. Let us understand the concept of Open Interest with the help of an example.

Say, there are five traders (A, B, C, D, E) trading the Nifty futures contract. Let us understand, as to how their trading has an impact on the open interest and its calculation.

On Monday: ‘A’ buys 20 Nifty futures contract and ‘B’ also buys 10 Nifty futures contract. While ‘C’ sells 30 Nifty futures contract in the market. Therefore, we have a buying activity of 30 futures contracts and a selling activity of 30 futures contracts. Hence, the total Open Interest is 30.

TraderBuy (L = Long)Sell (S = Short)Contract held
A2020L
B1010L
C3030S
D
E
Total30

On Tuesday: C wants to get rid of half the position and ‘D’ comes into the market and takes 15 short contacts from C. Here just the mere transfer of position happened and no new contracts were added. So, the open Interest will still stand at 30.

TraderBuy (L = Long)Sell (S = Short)Contract held
A
B
C1515L
D1515S
E
Total30

On Wednesday: D wants to add 15 more short contracts. And both A & B want to add 5 long contracts each, to their existing long positions. And C wants to exit 5 more short contract position form here existing position of 15 short contracts. Therefore, 10 more long contracts (both A & B) are added in the market. And the contract between C and D would be just a mere transfer of positions. In short, the table on Wednesday would look like this:

TraderBuy (L = Long)Sell (S = Short)Contract held
A55L
B55L
C55L
D1515S
E
Total30

On Thursday: Trader E decides to enter the market. And wants to sell 50 Nifty futures contracts. Therefore, trader D decides to exit his 30 lots position and transfers his position to E. While trader A & B add position so 10 lots each to their existing positions. Overall, 20 new lots get added to the system and the final table at the end of Thursday looks like:

TraderLSContractsLSContractsLSContractsLSContracts
A2020L20L525L1035L
B1010L10L515L1025L
C3030S1515S510S10S
D1515S1530S300
E5050S

If we carefully analyze and look at the table above, it gives us a fair sense that open interest is eventually a zero-sum game. If we add all the longs and subtract them with all the shorts in the market. The end result is eventually zero.

open interest data money controlFigure 1: Open Interest data (Moneycontrol.com)

Now, if we look at the snapshot above (Fig 1), it is the data showing the shares with the highest change in the open interest for the day. With the change in the open interest, the share price has also gone up and which is usually an indication that the buying momentum is expected to continue in these ten shares.

— Open Interest and Volume interpretation

From the discussion above it is clear that OI tells us information about the contract which are open and live in the market. But, the volume gives us information about the number of trades executed in the market.

The volume data is reset at the end of the day and the new counter starts at the beginning of the next day, but the data of the OI is a continuation from the previous day. 10 lots bought and 10 lots amount to 10 volume and 10 OI for the day.

— Interpreting Open Interest

PriceOpen Interest (OI)Expectation from market
IncreaseIncreaseThe buying momentum is most likely expected to continue
DecreaseDecreaseLong unwinding can be seen i.e., buyers are exiting from the market
IncreaseDecreaseShort covering can be seen in the market.
DecreaseIncreaseWe could be a reversal in buying momentum as we can see more shorts than longs in the Market.

Conclusion

In this article, we tried to simplify the concept of open interest in share market and what it interprets. Here are a few of the top takeaways from this post:

  • Open interest gives you information about the total number of contracts which are outstanding in the market.
  • It is an excellent indicator to understand the market sentiment and expected momentum in the market.
  • When the contract switches hands, it’s just a transfer of positions and Open interest does not change.
  • The data of volume refreshes every day but Open Interest is a continuous data.

That’s all for this post. I hope it was useful for you. If you still have any queries related to open interest in the share market, please comment below. I’ll be glad to help you out. Happy trading.

September 2, 2020 Technical Analysis, Trading No comments yet
Should you Invest During COVID19 times cover(1)

Why Should You Invest During COVID19 times?

Demystifying whether you Should Invest During COVID19 times: Before we dig deeper into this topic of why investing is so important, let us try and understand as to what investment means. To put it in simple words, Investment can mean building something right now that will help your sustainability in the future. It is the stepping stone towards securing one’s future.

Moreover, investment is an ongoing and continuous process. And the worth of investing is understood more during the recessionary or pandemic e.g. COVID-19 times.

How is Investing different from Trading?

A lot of people lose money in the market because they trade in stocks confusing it as investing. There is a conceptual and structural difference between trading and investing. A few of the key ones are mentioned below:

  • Investing, in general, is targeted for a longer duration of time. However, trading is for a short duration of time (sometimes even for a few minutes).
  • While investing, the focus is to earn long term and sustainable gains, but in the case of trading, the focus is for short term gains.
  • Investors have set rules and goals for buying or selling. But, in the case of trading, the rationale behind a trade keeps changing from trade to trade.
  • The most important difference is the System. Investing is systematic by nature. The aim here is to have a gradual building of wealth over an extended period of time, by building a portfolio. It can be done via a basket of stock, mutual funds, bonds, or any other investment avenues. But trading follows only one rule i.e., the rule of short term gains.

Having understood the major difference between Investing and trading, let us understand as to why one should invest.

Should you Invest During COVID19 times? – Importance of Investing

Here are a few of the top reasons why one should invest:

  • To secure one’s Future: As we have already mentioned that investing is an ongoing and continuous process. And one does that to secure one’s own future. and we all know that the future is uncertain. But if we are able to financially plan our future, then it becomes easier to handle the tough times like the current global pandemic.
  • Investment compounds our savings: Let me explain this with the help of a simple example. Say, if we start an investment with an annual capital of Rs. 2,00,000 and if we do that for 15 years. Let’s say if the annual return on investment is 12% p.a. Here, the compounded value of the investment after 15 years would be Rs. 1,63,39,747.
  • Retirement Planning: This is one of the major reasons for investment for most people. As most of the people depend on salary for their livelihood and which is why investment becomes more pertinent. Lifestyle maintenance, when one does not have a job can only be possible with proper planning and investment
  • Planning future events: This is one of the most important benefits of investing. If we have some major expenses (children education, or marriage) a few years down the line. The expenses can be ascertained and proper financial planning can be done for them
  • Fulfilling one’s aspirations: As the good old saying goes, “If you don’t aspire, you are not living”. Therefore, to be able to fulfill one’s dreams (buying a house, international vacation, etc.) and aspirations, proper planning, and the right investment is a must. And the functionality of compounding also helps in swelling up the investment and meeting one’s goal

Why start Investing during Pandemic (COVID-19)?

As we can see the world economy has been struggling during the pandemic. And with most of the economies posting with near zero or negative GDP growth rate, the investing has become more lucrative. The following are some of the reasons to start investing right now:

  • The investment avenues are available at a cheaper cost. Say, if I have to buy shares of the blue-chip companies. They are all available at discounted prices and once when the world economy revives, they can give high returns.
  • To safeguard one’s own interest in the future. The uncertainties come without any warning. Therefore, to protect oneself against it, investing is very important.
  • Diversification into the various asset classes is of prime importance when one is looking to invest. Say, if someone is looking to invest via mutual funds, they can do so by allocating the portfolio in different funds like equity fund, debt fund, index fund, hybrid funds, gold fund, etc.

Various Investment Avenues in India:

There are various forms of investment avenues that are available in India. The investment can be in the form of stocks, mutual funds, deposits, Provident funds, Pension schemes, etc. We will be discussing here the most frequently invested upon.

  • Stocks: Stocks are basically the ownership of the company of which the stocks have been bought. These are ideal forms of long term investment if someone has a little risk appetite. This form of investment has the best return making possibility for money invested.
  • Mutual funds: These forms of investments are ideal for people who are not willing to manage their investment on their own. They rather put their money in a fund (pool of investment) and which in turn is managed by the fund manager. There are various forms of funds like the equity-linked fund, debt fund, hybrid fund, gold fund, etc. Depending on one’s risk profile, one can choose the kind of fund.
  • Fixed Deposits: Probably, the safe heaven when it comes to investing. Through Fixed deposits, one can a fixed amount of interest for a pre-decided tenure. The interest on fixed deposit keeps changing depending on the economic conditions and on banks’ discretion.
  • Recurring Deposits: Very similar to Fixed deposits except for the fact that there is a periodical investment (every month) for a pre-decided tenure. These forms of investment are best suited for smaller goals within a foreseeable future.
  • EPF (Employee Provident Fund): This is the favorite amongst the salaried class. This form of investment is exempted under section 80C. This is a fixed portion that is deducted from the salary on monthly basis and the same amount is matched by the employer as well. EPF is completely tax-free and the interest rates are decided by the government.
  • PPF (Public Provident fund): This investment instrument is a long term investment by nature. The usual duration is for 15 years. Investments in PPF can be used for tax exemption. PPF can be used as collateral if one wants to take a loan against them.

Also read: How to Invest in Share Market? A Beginner’s Guide

Conclusion

In this article, we discussed why it is so important to invest, especially amid the COVID19 pandemic. Here are a few of the key takeaways you from this post:

  • Investing is the most reliable way of securing one’s future and meeting one’s long term goals.
  • One should not confuse investing with trading, as investing is for the long term and trading is for the short term.
  • The purpose of Investing is to earn stable and long term gains. While the purpose of trading is to make quick and short term profits.
  • With the help of investing, one can plan their future goals and aspirations.
  • Lastly, the most important purpose of investing is to plan and secure one’s future.

That’s all for this post. I hope it was useful for you. If you’ve got any queries related to investing amid coronavirus times, feel free to comment below. I’ll be happy to help. Happy investing.

August 13, 2020 Investment Basics 2 comments
What Are Futures Contract meaning

What Are Futures Contract? And How are they traded in India?

Understanding Futures Contract and their importance: The Futures and Forward Contracts are a financial instrument that derives their value from the value of the underlying asset. Basically, the futures contract are contracts between buyers and sellers, where the buyer agrees to buy a fixed number of shares from the sellers, at a specified time in the future and at a pre-determined price. The futures contract derive their value directly from the value of the underlying asset. Moreover, they are one of the highest traded derivative instruments in the world.

In this article, we are going to discuss futures contract in detail including the importance of these contracts and how to trade in futures contract in India. Let’s get started.

Difference between Futures contract and Forward contract

There are two major points of difference between Futures and Forward contract. Firstly, futures are a legally binding contract to buy or sell the underlying asset or a specific date. Secondly, the futures contract are done via Futures exchange i.e., they are regulated.

A standardized contract specifies the time, quantity, value, quality, time, and location of the underlying asset. The product can be a commodity, currency, stocks, index, etc. The standardization of contract sets the same rules, specification of contract for all the participants. And because of the standardization, the ownership of the contract can be passed to any other trade by way of a trade.

As the Futures contracts are exchange-traded, it guarantees the parties involved that the contract will be honored. All the futures contracts are centrally cleared via exchanges thus eliminating the counterpart risk.

How are Futures contract traded in India?

In India, the futures contract are mainly traded in two forms – Stock Futures and the Index Futures.

— Index Futures

The index is the grouping of stocks. It simply measures the change in the prices of group stocks over time. Say, for instance, Bank Nifty represents the top 12 banks in the Indian Banking system. These banks are from both the public and private sectors. And any movement in the share price of these banks directly impacts the index. Future contracts are also available for these indexes. They directly derive their value from the value of the index. The following are some of the characteristics or traits of these indexes:

  • Size of the contract: Each and every contract in the futures contract have a specified fixed size. Anyone willing to trade will have to buy the full contract or multiples of it. Say, for instance, if I am trading Nifty 50 Index, then each lot has 75 shares in it. And in the Bank Nifty, each future lot has 25 shares in it. These are the two most actively traded Index futures in the Indian equity market.
  • Expiry: Each and every index futures have a specified date of expiry. All the Index futures are settled on the last trading Thursday of the month. If the last Thursday is a holiday, then the expiry happens on the previous working day. Since the index are the culmination of various stocks, hence there is no physical delivery of the shares on the index. Only the cash differential is to be paid.
  • Time frame: The Index futures have three contracts running simultaneously all the time i.e., the near month (1-month), the middle month (2-month), and the far month (3-month). As and when the near month contract expires, a new far month contract is added to the series.
  • Margin Required: The margin required to trade the futures contract is comparatively high, as the position are exposed to market to market (M2M) risk and the brokers and exchanges will have to safeguard their interest in case the index becomes very volatile on a particular day.

— Stock Futures

The basic premise of trading stock futures is very similar to Index futures. Stock futures are the derivative instruments, that derives their value from the value of the underlying security/stock. The contracts have a specific size, fixed price, and specified date. Once the contract is entered, it will have to be honored. Following are some of the characteristics of Stock futures:

  • The size of the contract: All the stocks trading in the futures market, have a different number of shares in each lot. We can’t trade just one share to trade futures. A minimum of one lot has to be traded. For example, one lot of futures contract of Reliance industries has 505 shares, one lot of Maruti has 100 shares, one lot of ICICI bank has 1375 shares etc.
  • Expiry: All the stock futures contract have a fixed maturity. They expire on the last trading Thursday of the month. And if the last Thursday is a holiday, then they expire on the previous trading day. The stocks have three expiring contracts – near month (1-month), middle month (2-month), and far month (3-month).
  • Margin: The margin required to trade stock futures contract is very high to cover for Mark to Market (M2M) losses. This is basically done to protect the interest brokers and the exchange.

How Are Futures contract Priced?

Futures contract derive their value from the value of the underlying assets. There is always a variation/difference in the prices of the cash segment and derivatives segment. There are basically two methods of pricing the futures contract: The Cost of Carry Method & The Expectancy Method.

— The Cost Of Carry Model

Under this method, the market is assumed to be perfectly efficient. There is no difference in the value of cash market and futures contract. So, the profit made by trading the cash segment or futures segment is same, as the movement in the prices are aligned. Following is the process of calculating the prices under the Cost of Carry model

Futures Price = Cash Price + Cost of Carry

The cost of carry here refers to the cost of holding the futures contract till maturity.

— The Expectancy Method

Under this method, the futures prices are the expected cash price of the underlying asset in the Future. So, if the market is positive/conducive for the underlying asset, then the futures price will be higher than the cash price. And if the market has a weak sentiment towards the underlying asset, then the futures price will be lower than the underlying asset.

Advantages of Trading Futures contract

Here are a few of the major advantages while trading in the futures contract:

  • Futures contract are one of the safest mode to hedge one’s exiting position in the market i.e., if I am long in shares of a particular company, I can hedge my position by taking short in futures contract of the same underlying Asset
  • The futures contract are high leverage instruments i.e., to trade futures contract we have to pay only a fraction of the total value. In general, the margin amount is just 10% if total value. This margin money acts as a collateral, in case the value of the underlying asset goes opposite to the views of the investor and he incurs losses. Say, if one futures lot of XYZ company has 1000 shares. And if the price of one share is Rs.100. So, if one were to buy 1000 shares, then the total value to be invested will be Rs. 100000 (1000*100). But, to trade futures contract, one has to keep only Rs. 10000 (10% of total value) as margin.
  • Because the futures contract are regulated by exchange, liquidity is never a factor while trading futures contract. One can exit their position anytime from the market.
  • Because of the low margin requirement, small players and speculators get to be a part of bigger game
  • Short selling becomes very easy while trading Futures contract. And one can legally short position in the shares of the company, by shorting futures contract.
  • The buying or selling pressure in on particular underlying asset can help us to gauge the future demand and supply of the shares

Key Takeaways

In this article, we tried to cover what are futures contract, how they differ from forward contracts, how are futures contract traded in India, and the advantages of trading futures contracts. Here are a few of the key points to remember from this post.

  • Futures contract derive their value from the value of the underlying assets.
  • Because of the low margin requirement, the futures trading is very popular amongst traders
  • The futures contract are exchange regulated, there is never the question of trust amongst the traders
  • One can exit their existing futures contract position anytime from the market by taking an opposite position in the futures market.
  • It is also a very popular hedging instrument for already existing long position in the cash market
  • The Index futures are cash-settled
  • There are two methods of calculating the futures contract value – The cost of carry method or the Expectancy method

That’s all for this post. I hope this article on what are futures contract is useful to you. If you’ve got any queries related to this concept, feel free to ask below in the comment section. I’ll be happy to help. Happy trading and investing.

August 10, 2020 Options Trading, Trading 2 comments
What are Forward Contracts cover

What are Forward Contracts? And How do they work!!

Understanding what are Forward Contracts along with its risks and outcomes: One of the most important key concepts to understand for a derivate trader is forward contracts.  Through this article, we aim to give a clear understanding of the Forward Market and Forward contract.

Today, we’ll cover what are forward contracts. We’ll also look into why do both the parties enter into the contract, possible outcomes, how they are settled, risks associated, and more. Let’s get started.

What are Forward Contracts?

The Forward contract, as the name suggests, is a financial derivative transaction that is settled at a specified date in the ‘future’. The forward contract derives its value from the value of the underlying asset. Therefore, in that regard, the futures and forward contracts have a lot of similarities.

The forward contract can be said to be the more ancient version of the futures contract. The basic framework of the futures contract is very similar to a forward contract. The forward contracts are still used, however, the scale and volume are very limited.

— Understanding Forward Contracts with an Example

Let us understand this concept further with the help of a simple example. Suppose, there are two parties involved. One is the manufacturer and designer of Silver jewelry. Let us call the manufacturer as “ABC Jewelers”. The other party involved is the importer of silver and he sells in bulk to jewelry shops. Let us call him “XYZ Dealer”.

Say, on 5th Aug 2020, the current price of 1 kg of silver is Rs. 65,000. ABC enters into an agreement to buy 50 kg of silver two months down the line. The agreed-upon price is the price of silver on 5th Aug 2020. Therefore, ABC has to pay Rs. 32,50,000 (65000*50) to XYX to buy 50 kg of silver on 5th Oct 2020.

In short, after two months, both the parties in the contract will have to honor their agreement irrespective of the price of silver at that time.

— Why both parties enter into the contract?

From the above context, the buyer of the silver (ABC) is of the view that the price will go up in the future and wants to lock in the prices to benefit from the increased price in the future. On the other hand, the seller of the silver (XYZ) is of the view that the price is most likely going to decline in the future and wants to benefit from the locked-in current price.

Both the parties involved in this transaction have opposing views and hence they enter into a forward contract to express their views.

— The possible outcomes of the Forward contract

Scenario 1: Either the silver price goes up

If the price of the silver goes up in the future, then ABC Jewelers stands to make a profit, and XYZ dealer is dealt loses. Say, if the price of silver goes up to Rs. 70,000 per kg after two months. So, the profit of ABC in this case will be = (70000-65000)*50 = Rs. 2,50,000. And the same is the loss for XYZ dealers.

Scenario 2: Either the silver price goes down

If the price of silver falls in the future, the XYZ dealers stand to make a profit, and ABC jewelers stand to make losses. For example, if the price of silver after 2 months falls down to Rs. 61,000 after two months. Here, the profit for XYZ dealers, in that case, will be = (65000-61000)*50 = Rs. 2,00,000. And, this will be the loss for ABC jewelers.

Scenario 3: If the price of silver remains unchanged

In that case, neither of the party (ABC or XYZ) will stand to lose or make any money from this contract.

How are forward contracts settled?

Forward contracts are settled via two ways, either cash-settled or the underlying asset is physically delivered.

1) Physical Settlement: Here, ABC jewelers pay XYZ dealers, the full agreed-upon amount (Rs. 32,50,000) of buying 50 kg of silver and in return gets the physical delivery of silver.

2) Cash Settlement: In this case, there is no actual physical delivery of silver. Just the cash differential has to be paid. Say, if the price of silver goes up, then XYZ dealers will have to give the cash differential to ABC jewelers. And if the price of silver goes down then XYZ dealers receive cash differential from ABC jewelers.

Assume, if the price of silver goes up to Rs. 67500 per kg. Then, XYZ dealer pays Rs. 1,25,000 ((67500-65000)*50) to ABC Jewelers for cash settlement.

Risks Associated while Trading Forward Contracts

Following are some of the risks associated with trading Forward contracts

  • Liquidity Risk: Theoretically, the parties with opposing views enter into a forward transaction. But, in reality, it is difficult to find two parties having an opposing view and willing to enter into the forward transaction. Therefore, the parties involved will have to approach the investment bank and who in turn scouts for willful parties willing to enter the forward contract.
  • Cost: The cost is a big factor in the forward contract. As the investment banks are involved in finding parties to enter into a forward contract, they come at a cost i.e., fee. Therefore, even if the price goes in favor of one of the parties, they make real profit only after the cost (fee to investment bank) is recovered.
  • Default Risk: The default risk is very much if losing party upon the expiry does not pay up the other party i.e., it defaults.
  • Regulation Risk: There is no regulatory framework while dealing with a forward contract. They are entered into with the mutual consent of the willing parties. Therefore, there is a situation of lawlessness and which is where the chances of default also increase.
  • Non Exit able before expiry: Say, halfway through the contact, if the view of one of the party reverses, then there is no way to exit the contract before expiry. There is no clause of foreclosure. The only option which they have is to enter into another agreement which again is a tedious and cost consuming process.

Also read- Options Trading 101: The Big Cat of Trading World

Conclusion

In this article, we tried to cover what are future contracts and how future market actually works in terms of transactions and settlement. Let us quickly conclude what we discussed here:

  • The basic premise while trading both forward and futures contracts are the same.
  • The forward contracts are contracts that are settled at a future date.
  • They are not traded via an exchange. The forward contracts are Over the counter – OTC  derivative.
  • The forward contracts are non exit-able before the expiry.
  • These contracts can be either physically delivered or it can be cash-settled.

That’s all for this post. I hope it was useful to you. If you still have any queries related to future contracts, feel free to comment below. I’ll be happy to help. Happy trading and investing.

August 7, 2020 Investment Basics, Trading No comments yet
Understanding what are Fibonacci Retracements and how to use it while trading

Fibonacci Retracements: How to use it in Technical Analysis?

Understanding what are Fibonacci Retracements and how to use it while trading: The concept of Fibonacci was introduced by Italian Mathematician called Fibonacci (also known as Leonardo Bonacci or Leonardo of Pisa). This concept was primarily introduced to solve the problem of understanding the population growth of Rabbits. And it has now become one of the most interesting and sought after concepts in Mathematics and Trading.

In this article, we’ll cover what is a Fibonacci Series, the implication of Fibonacci on trading, and how exactly to use Fibonacci while Trading. Let’s get started.

What is Fibonacci Series?

The Fibonacci is a series of numbers starting from zero and arranged in such a way that the next number is a summation of the previous two numbers.

Therefore, the Fibonacci series is as follows: 0, 1, 1, 2, 3, 5, 8, 13, 21, 34, 55, 89, 144, 233, 377………

Here are the calculation involved while finding the numbers in the Fibonacci series:

  • 0 + 1 = 1
  • 1 + 1 = 2
  • 1 + 2 = 3
  • 3 + 5 = 8
  • 5 + 8 = 13
  • 8 + 13 = 21
  • 13 + 21 = 34 and so on.

A Few Fun Facts about Fibonacci series

Before moving forward, here are a few fun facts about Fibonacci series that you should know:

  • If we divide any number by the previous number, then the ratio is always equal to 1.618 (233/144 or 144/89 or 89/55 or 55/34, etc.)
  • Second, if we divide the number by the next number, then the ratio is always equal to 0.618 (21/34 or 34/55 or 55/89 etc.)

Needless to that the number 0.618 (or 61.8%) holds a lot of significance while calculating Fibonacci.

  • If we divid any number in the series by a number which is two places higher, then the ratio is always equal to 0.382 (21/55 or 34/89 or 55/ 144, etc.)
  • And if we divide any number in the series by a number which is three places higher, then the ratio is always equal to 0.236 (21/89 or 34/144 or 55/233, etc.)

From the above facts, we get the percentage series for Fibonacci to be 61.8%, 38.2%, 23.6%

The implication of Fibonacci on trading

The Fibonacci series of 61.8%, 38.25, and 23.6% have a very impactful presence in all the charts of the share price of any company. It is applied regularly when we see movement in the prices of the shares. And it can be applied in all the time frames.

It is a known fact that the share price of the company does not move in one direction. The prices always have a zig-zag pattern. If the share price of the company has gone up from 100 to 150, then before having another leg up, it is most likely to retrace back. But to find the level of retracement, Fibonacci retracement levels come in very handy.

For example, if the share price of the company before going up = Rs. 100. In, the first leg of the move, the share price goes up to = Rs. 150

Therefore, if the share price retraces to 38.2% then it will fall to = 150 – 38% of 50 = 131. And if the share price retraces to 61%, then it will fall to = 150 – 61 % of 50 = 119 (approx.)

fibonacci retracements for Daily chart of Maruti

Fig 1: Daily chart of Maruti (www.zerodha.com)

If we look at the above figure above, Maruti looks strong in the move up from Rs. 4000 to Rs. 5500. And looks poised to go up more. But before going up, the market makes a correction and it’s till the projection range of 38.2% to 61.2%. And after consolidating in that range, it makes a fresh move up and makes new recent high.

Therefore, if someone is looking for a correction in the market, Fibonacci retracements are a very useful tool and it also helps in entering the market if someone had missed the first move in the market.

fibonacci retracement example

Fig 2: Daily chart of BajajFinsv (www.zerodha.com)

In fig 2, If we look at the figure above, the share price of BajajFinsv is on a downward trend. And looks poised to fall more.

However, before falling, the market has made a small correction rally and is consolidating around a 38% retracement level. And now we see, that the share price is making lower highs and lower lows. Therefore, we could see the bearish momentum coming back and market breaking or re-testing previous lows.

Uses of Fibonacci while Trading

Assume, if we are looking to buy the stocks of a particular company but because of the strong momentum in the price, the share price has gone up substantially and it is very expensive to buy the shares at the current price. Here, we wait for a correction in the share price of the company and wait for it to retrace around 61.8%, 38.2%, or 23.6% levels.

Anyways, before picking the right retracement levels, the following factors also need to be considered: The candlesticks formation near the retracement levels, The price action around the level, The support and resistances around it, The volume at these retracement levels, And the overall fundamental picture.

Conclusion

In this article, we tried to explain what are Fibonacci Retracements and how to use it while trading. Here are a few conclusions from this post to take away:

  • The Fibonacci should be used when one is looking to plot the retracement or projection levels.
  • Then Fibonacci is useful when one has missed the entry at first instance but is still interested in buying the shares of a particular company.
  • The important levels of Fibonacci are 61.8%, 38.2%, and 23.6%
  • Just the Retracement levels of Fibonacci should not be the only basis of entering the trade. Overall, fundamental and technical factors should also be considered.

That’s all for this article. I hope it was helpful to you. If you have any doubts related to Fibonacci Retracements, feel free to comment below. I’ll be happy to help. Happy trading.

August 4, 2020 Technical Analysis, Trading 1 comment
New Margin Trading Rules by SEBI cover

Margin Trading: The New Tighter Rule by SEBI (Dec 2020)!

New Margin Trading Rule by SEBI: Recently, SEBI published a new circular on margins that astonished the entire trading community along with the stockbrokers. Through this circular, SEBI announced tighter margin norms for the traders. In this article, we are going to discuss what exactly is this new margin rule introduced by SEBI and how it will affect the people trading in share market.

What is Margin trading?

In terms of the financial market, Margin would be a direct synonym to leveraging. It simply gives you the power to buy/trade in stocks that we can’t afford to buy. Through Margin trading, one is allowed to buy the stocks by just paying the part of the actual value of shares.

The margin can be paid either in terms of cash or in shares as security. The balance amount of shares are funded by the brokers. In other words, Margin simply refers to the amount of money borrowed from the broker to buy the shares of a company. The broker acts as the lender of money and the securities in the investor’s trading account, are kept as collateral.

The margin is settled later when the positions are squared off. We receive profit if we sell the shares at profit or we stand to lose the margin if we make losses.

— How to trade using Margin?

To trade using a margin account, one must have a separate margin account and not the standard brokerage account. A margin account is a separate trading account in which the broker lends money to the investor to buy a security which otherwise he will not be able to buy. The loan or the margin money which is borrowed from the broker comes at a cost i.e., the interest. Therefore, one should use a margin account for short term trading as the interest on the margin money keeps accruing.

Say, if you deposit Rs. 1,00,000 in your margin account and you have a 50% margin in your account, which means buying power of Rs. 2,00,000. Now, if you buy stocks of Rs. 70,000, you still have the buying power of Rs. 1,30,000. And we have enough cash in our margin account to cover for the transaction. We start borrowing only, once we have bought shares worth Rs. 1,00,000.

— Three steps in Margin trading

  1. We need to maintain the Minimum Margin (MM) throughout the trading session because volatility in the stocks can push the prices (up or down) more than one’s anticipation.
  2. The position needs to be squared off at the end of each session. If we have bought on margin, we need to sell it off before the end of the day (EOD) and vice-versa if we have sold using margin.
  3. If we want to carry the trade onto the next session, we need to convert it to the delivery trade. And for that, we need to keep the cash ready.

If any of the above three steps are missed then the broker automatically squares off the position in the market.

New Margin Trading Rule by SEBI

The Securities and Exchange Board of India (SEBI) gave out guidelines pertaining to Margin trading (which account for nearly 90% of the daily turnover of the stock market), which has not been welcomed by the brokerage firms with open arms. These rules will put an end to intraday trading and turnover generated out of it.

The brokers have been instructed to collect VaR (value at risk) and ELM (extreme loss margin) upfront from their clients. These rules will be implemented in a phased manner starting in December 2020.

  • Phase 1: From December 2020, the brokers will be penalized if the margin is more than 25% of the sum of VaR and ELM.
  • Phase 2: From March 2021 and June 21, brokers will be penalized if the margin exceeds 50% and 70% of the sum of VaR and ELM
  • Phase 3: From August 2021, brokers will be penalized if the margin exceeds VaR and ELM

Also read: What is SEBI? And What is its role in Financial Market?

Reactions from the Brokerage community

The broking community feels that this will put an end to leverage based intra-day trading. Currently, some brokers collect as low as Re. 1 for every Rs. 100 worth of trade. Here are some of the reactions from Big brokerage houses:

Nithin Kamath, CEO of Zerodha Brokerage Tweeted, “Today’s SEBI circular says that all brokerage firms have to stop intraday leverage products by August 2021 in a phased manner”. In another tweet, he added:

“While many (even we) don’t like restriction on intraday leverages by SEBI, I don’t think any regulator in the world has done so much to protect retail investors. A lot of this slows brokerage business but what is good for the client eventually is good for the business as well.”

nithin kamath on New Margin Trading Rule by SEBI

Jimeet Modi, CEO, and founder of Samco Securities said, “This was expected since last year after the December 2019 circular. Now the industry and exchanges will need to adjust to this new reality. This probably will also accelerate the market share towards discount brokers from full-service brokers. Differentiated margins was a service offering by full-service brokers which has now been arbitraged away. Our estimate is that almost 30-35 percent of the intraday turnover is based on additional leverage provided by brokers. Now assuming full margin is required, total turnover would shrink by approx 20 percent since balance part margin was still being collected from clients.”

How Market Turnover is impacted by new SEBI rule?

On July 21, SEBI gave out a circular pertaining to new rules on Margin trading. And these rules are directly going to impact the market turnover both in the cash and derivatives segment. The cash segment on NSE recorded an average daily turnover of Rs. 50,322 cr (April), Rs. 52,656 cr (May), Rs. 61,395 cr (June). And the derivatives market is nearly 18-20 times of the cash market. NSE is the largest derivatives exchange in the world with an average daily turnover of more than rupees 11 lakh crore.

Some of the brokerage houses are of the view, with the new rules if VaR+ELM, the daily turnover may shrink by almost 20-30%. The clients will also have to maintain a higher margin in their account and which will also impact their return on investment. And these changes in rules will not only impact the brokers but will also impact the government, in the form of reduced Securities Transaction Tax (STT).

July 24, 2020 Beginner's guide, News, Trading 1 comment
Understanding Volume Profile for Technical Analysis

How to use Volume Profile while Trading? – Technical Analysis Basics

Understanding Volume Profile for Technical Analysis: In today’s day and age, the success of any movie depends on the number of people viewing it. If the movie has a large audience anticipating it, then we can be assured that it will have a large audience watching it and which in turn garners success for the movie. Here, the number/volume of the audience plays a very key role in the success of the movie.

Further, if we were to take the example of television series or any online series, its success is measured by the number of viewers. Game of Thrones (GoT) is a classic example of it. It has one of the largest numbers of viewership in online content history. Therefore, eventually, it all boils down to the volume or number of people watching.

Similarly, in trading also, the volume is the number of shares traded on a day to day basis. If there is no volume, then the price of shares won’t move. In short, volume plays a key role in deciding the movement. In this article, we are going to discuss what is Volume Profile, how is volume calculated, the correlation between volume and price, and the Correlation between Candlesticks, Supports & Resistances with Volume. Let’s get started.

What is Volume Profile?

In simple terms, volume simply signifies the quantity of shares traded of a particular company within a specified time. If a move in prices of shares happens with high volume then, it is considered to be more reliable. And the move can be expected to continue. But if the move happens on low volume, then the authenticity of the move is always questionable.

To confirm any pattern or to apply any technical indicator on the market, the Volume profile plays the most critical role. It plays an important role in confirming the trends or patterns in the market. It also plays a very big role in understanding the buyers’ or the seller’s perspectives. Without sizable volume, even the strongest of technical indicator or pattern might not hold much significance.

Quick note: Market Profile or MKTP is the synonym for volume profile. They are used interchangeably.

How is Volume calculated?

From the above explanation, we understood that Volume simply signifies the number of shares bought or sold within a specified time-frame. The more active the share is, the higher the volume and vice-versa.

For example, in the case of RIL, if for the price of Rs. 1,900, a total of 50 share been bought and 50 share being sold, then the volume here is 50 (and not 100). For the correct volume calculation, there has to be a buyer for every seller to complete a transaction. We should not consider the volume to be 100 (50 buys + 50 sell). Let us understand it with the help of an example:

How is Volume calculated?

So, from the table above, we can notice different buying and selling activities for the security for the different levels of time. The buyers and sellers meet to create volume for the share. And the cumulative volume is a summation of all the volume traded for the day.

The following tables show the volume change in the market for the most active securities on NSE with a time gap of 40 minutes.

The following tables show the volume change in the market for the most active securities on NSE with a time gap of 40 minutes.

Figure 1: Most active share at 11.42 am (21/07/2020, NSE India)

Figure 2: Most active share at 12.22 pm (21/07/2020, NSE India)

Now, if we were to compare to the tables above, we can see the volume table of most active security and the change in them with a gap of 40 minutes.

If we take the example of Bajaj Finance from Table, we see the change in price by Rs 8 (reduced) and the volume has increased by nearly 50% in 40 minutes. So, the move with this volume can be said to be genuine and not artificial. Any move with sizable volume helps the technical charts and indicators to take shape.

Correlation between Volume and Price

While trading with keeping volume in mind, the prior price and volume trend is of high significance. If the move happens, with the volume near its average volume or more than average volume, then that move holds more significance, than the move with thin or low volume.

Now, let us understand the correlation between volume and price with the help of the following table:

Correlation between Volume and Price

If the price increases with an increase in volume, then the expectation from the market is that the bullishness or strength is expected to continue. And if the same move were to happen with low volume, we can say that one needs to be cautious and be careful about forecasting the next move.

Similarly, if the price of the share reduces, with increased volume, we can expect the bearishness to sustain and continue. And if the same move happens on less volume, we need to be careful with the next leg of this move. And similar interpretation can be done for Rangy markets.

Participants on Low and High Volume days

If the market is trading with low volume, we can say that there is a lot of retail player’s participation in the market.

However, if the market is trading on high volume, we can say that there is a lot of institutional buying and selling in the market. Higher volume moves have better conviction and a higher chance of a continuation of the move, in the near future.

Correlation between Candlesticks, S&R and Volume

If the candlestick pattern gives certain trade patterns and if the signal were to come near the supports and Resistances and to top it off if the volume profile were aligned with the technical signals, then the trade can be said to have a very high probability of being successful.

In other words, a marriage of technical factors along with volume goes a long way in generating strong trading signals. Traders can benefit significantly from it if spotted at the right time.

Also read: Introduction to Candlesticks – Single Candlestick Patterns

Conclusion

Let us quickly conclude what we discussed in this article:

  • Volume is one of the most important indicators in understanding the trend of the market.
  • It provides a very strong impetus to our technical view on the market.
  • If the market is trading on low volume, we can say that retail traders are participating in the move.
  • If the price increases with an increase in volume, we can expect the bullishness or strength to continue (and vice versa).
  • And, if the market trades on high volume, it generally is a signal that institutional players are participating in the market

That’s all for this post on Volume Profile. I hope it was useful for you. If you have any doubts regarding volume while trading in stocks, feel free to comment below. I’ll be happy to help. Happy trading.

July 22, 2020 Investment Basics, Stocks, Technical Analysis, Trading 2 comments
technical analysis Cup and Handle Pattern

Cup and Handle Pattern: Technical Analysis

Understanding Cup and Handle Pattern: Technical Analysis can be used by both traders and investors for entering into any trade. It provides a means to have a stronger conviction about the trade. Candlesticks are the most common form of Technical analysis tool used by the traders globally.

We have several types of candlestick patterns that are used by traders in their day to day trading. One such form of candlestick pattern, that gives trades with a high level of conviction is the “CUP AND HANDLE FORMATION”. In this article, we are going to cover what is a Cup and Handle Pattern and how to use them for your trades.

What is a Cup and Handle Pattern?

cup pattern

A cup and handle pattern is a formation that resembles the cup. The main body of the formation is like a “U shape” and further, we have a small body or a downward drift, which resembles a handle attached to the cup. This pattern is generally a bullish pattern as it follows a series of bearish sessions.

From the perspective of the long term, this formation pattern may take from a few weeks to a year. And for a short term view, we can see this formation in a minute, hourly, etc., time frame.

How is Cup and Handle Formed?

The market trend is generally bearish at the start of formation. We see new lows being formed, followed by a period of consolidation/stabilization, and then we have a move up, similar to initial move down. Therefore, the chart formation is like a cup. Afterward, the price then moves sideways or comes down within a channel, forming the handle for the cup.

The handle can have the shape of “Reverse C” or “A Triangle” or “A sideways zone”. Ideally, for a valid Cup and Handle formation, the handle should not have a depth of more than 50% of the size of the cup. Let us understand the formation with the help of a few examples.

— Cup and handle formation on DMart

Cup and handle formation on DMart

Figure 1: D’mart Chart (Source: www.zerodha.com)

In Figure 1, we see a formation of Cup and Handle and the formation, which took nearly four months to complete. The first phase is a part where the market sees bearish momentum. Then, in the 2nd phase, we see consolidation at the bottom of the cup.

Next, in the third phase, we see buying momentum coming back and market-moving back up to the high of the first phase. And in the final phase, we see a formation of the handle.

— Cup and handle formation on TATA Motors

Cup and handle formation on TATA Motors

Figure 2: TATA Motors’s Chart (Source: www.zerodha.com)

In Figure 2, the pattern formation is very similar to the pattern formation on the D’MART chart. There are four phases of fall, consolidation, rise, and the handle formation. The trade for TATA Motors after the formation gave a very decent return of nearly 90%.

Also read:

When to Enter the Trade using Cup and Handle Pattern?

Before entering the trade, one has to wait for the formation of the handle. During the formation of the handle, the market is often in a sideways trading mode. But when then market breaks the top of the sideways channel, the Cup and handle formation is complete and the market is expected to rise from there.

There is no guarantee of the trade making money after the completion of the formation. The market could again come back in the sideways zone and the pattern might fail. And that is why, we should always have a stop loss for the trade, entered by using this pattern.

— How to set a Stop Loss for the Trade?

Stop-loss while trading is a point beyond which the trader does not want to lose money. It is a point to exit the existing trade. So, while trading using this formation, the stop loss for the trade is the low of the handle.

This low point is chosen because the price might again comeback in the sideways territory and then make a move up. And in case the market starts to go in favor, one can keep on trailing the stop loss and rise the move.

— What is the Exit Point for the trade?

As a rule, the height of the cup should be the profit target for the trade, from the point of breakout.

Say, for example, the price at the bottom of the candle is Rs. 100 and the height of the candle is 10 units. Therefore, Rs. 110 is the breakout point for the trade. The target for this trade should be Rs.120 (Breakout price = 110 + the depth of cup = 10). The other way to keep a target for the trade would be using Fibonacci Projections.

The stabilization period at the bottom of the cup is very important for this formation, as it forms a base for the cup. The stronger the base, the better the quality of the trade. The volume at the formation of the pattern also plays a very important role in the authenticity of the trade. If formed on low volume, the pattern might not be as reliable as the one formed with higher volumes.

Quick Note: If you new to stock trading and want to learn how to read charts, candlesticks, and technical indicators, you can enroll in our “Technical Analysis Course” for beginners. Click here to check out this course! Happy learning.

Conclusion

The Cup and handle formation takes some time to spot and trade upon. Constant practice is the best way to spot this pattern. But once if we get a hang of the pattern, it provides trades with very good risk-reward.

One should ideally enter the trade at the confirmation of the pattern as it provides trades with better conviction. And always have a stop loss for every trade which we enter in the market. Happy trading and Money making.

July 20, 2020 Technical Analysis, Trading No comments yet
What are Moving Averages And how to use them

What are Moving Averages (MA)? How to Use Them?

Simplifying what are Moving Averages – SMA & EMA: Moving averages are one of the simplest yet most frequently used technical analysis tools by traders. Every time you read any technical or research report, on any Index or shares of a particular company, you must have come across terminologies like the Simple Moving Average (SMA) or Exponential Moving Average (EMA). These are the two types of Moving Averages.

In this post, we discussed the basics of Moving Averages in the technical analysis of stocks. Here, we covered what are Simple Moving Averages (SMA) and Exponential Moving Averages (EMA) and how to use them correctly. Let’s get started.

An Example to Understand Moving Averages

In mathematics (or statistics), a moving average creates a series of averages of different subsets of the full data set in order to analyze data points.

For example, imagine in a game of Cricket, we want to analyze the performance of a bowler. Here, the parameter that we can use for our judgment is the number of runs conceded against every wicket picked. Let’s assume that we have the following data available for the bowler:

InningsRuns ConcededWickets
1452
2393
3602
4481
5504
6381
7405
8750
9502
Total44520

From the table above, the total runs conceded by the bowler over 9 innings is 445. Further, he has got 20 wickets against his name.  Therefore, the average number of runs conceded per wicket will be equal to 445/20 = 22.25 runs conceded per wicket This is the simplest method that we can use for calculating the average.

A similar concept can be used while looking at the price movements of the shares. Through this article, we will try to understand the concept of the moving average and its implication while trading.

What are Moving Averages?

Moving averages are the most common and sought after form of technical analysis tools used while trading. These indicators are said to be lagging indicators, as is it is constructed with the help of the data presented as the end of day prices.

In order to understand this concept easily, let us take another example. Consider the following closing prices for the shares of Reliance Industries limited:

DateClosing Prices
03/07/201788
06/07/201852
07/07/201823
08/07/201798
09/07/201824
Total9085

Now, a simple moving average (SMA) is a calculation that considers the average or arithmetic mean of a given set of prices over a specific time period. For example, the SMA or average price of shares of RIL over these five days will be equal to 9085/5 = Rs. 1,817

Next, imagine if the share price of RIL at close on 10/07/2020 is 1,800. Now, if the calculate the moving average again for the last five days, its value will change as the average price changes after accounting for new data. In other words, the average price changes as and when the value of underlying asset changes on day to day basis.

Further, the moving averages can be calculated for any time frame. It could be 5 minutes, 15 minutes, hours, days, weeks, and so on. Depending on one’s trading style and trading objective, one can choose the Moving Average charting pattern. If we are using 5 observations within the selected time frame, it is called 5 SMA, and if we are using 9 observations within the selected time frame, it is called 9 SMA and so on.

Now, the chart below is the daily chart of Airtel Limited. And we have plotted 50 Day Simple Moving Average on it.

Fig: 50 DMA of Airtel Limited (Source: www.kite.zerodha.com)Fig: 50 DMA of Airtel Limited (Source: www.kite.zerodha.com)

Now, if you carefully analyze, the 50 SMA clearly bifurcates the chart in two halves. When the market is trading over 50 SMA, we see continuous buying momentum in the market and the bulls are having a tight grip on the market. And as and when the market comes below 50 SMA, we see selling pressure in the market and the bears are having higher say in the market. Overall, in simple words, it can be said that prices above SMA are considered to be bullish and below it are bearish.

Exponential Moving Average (EMA)

Exponential Moving Average (EMA) are slightly advanced and more trusted form of moving average. The main difference between EMA and SMA is the weightage given to each and every value under consideration.

Under EMA, the more recent values are given higher weightage, but in SMA, all the values are given equal weightage. For this simple reason, EMA is sometimes said to be a better parameter for trading than SMA. We will not be going to explain the calculation methodology of EMA in this article.

The chart below is the daily chart for HDFC Bank and the yellow line plotted is the 50 EMA

Fig: 50 EMA of HDFC Bank (source: www.kite.zerodha.com)Fig: 50 EMA of HDFC Bank (source: www.kite.zerodha.com)

Now, before explaining the chart, the following rule has been set for the entry and exit of the trade. A position is entered when the current price crosses over 50 EMA and the position is held till the share price down not crossover or come below 50 EMA.

If we look at the chart, the 50 EMA in the chart above has given multiple entry and exit signals based on EMA. For example, if we look at Trade 1, the chart gave a long trade as the market came close to the EMA and it bounced back and gave a return of about 15% (not bad by any standards). And similarly, Trade 2 gave an entry near EMA and upon exit, it gave a return of near 7%.

Also read: What are Supports and Resistances? And How to identify them?

Moving Averages: Key understandings 

In this post, we tried to simplify the concept of moving averages. Let’s quickly summarize what we discussed here:

  • Moving Average gives us simple and traceable buying and selling signals
  • When the price is trading above a certain MA, it usually signals strength in the market and buyers are having more say
  • When the price is trading below a certain MA, it usually signals weakness in the market and sellers are dictating in the Market

Moving averages are considered to be a reliable indicator while understanding the trend and market sentiment. One has to continuously keep using them go get a better hang of them and find a moving average that suits their trading style. One Golden rule which every trader must follow: “Always have a stop loss for your trades” Happy trading and Happy Learning!

July 15, 2020 Technical Analysis, Trading 1 comment
What are Supports and Resistances? And How to identify them cover

What are Supports and Resistances? And How to identify them?

Understanding what are Supports and Resistances: One of the most elementary concepts while trading in stocks that every trader should know is, “Supports and Resistances”. If you’re already involved in the market, you might have heard or read terms like “Nifty50 has got a big resistance at 10,800 points” or “Stock XYZ has a support line at Rs 105”. So, what exactly do the traders mean by these terms in their analysis? We are going to discuss that through this article.

In this article, we are going to discuss what are supports and resistance, their characteristics, and how exactly to use them. By the end of this article, you will have a good idea about these concepts and use them in your trading. Let’s get started.

What are Supports and Resistances?

The Synonym for the word support is “Reinforce”.  Basically, support can be said to be a point of reinforcement. In other words, supports are those points which act as a barrier for the prices, when they start to come down. They can also be said as points, where the downtrend is expected to be paused. And we should see a new surge in buying and demand. In short, supports are those points, where buyers are more forceful than sellers.

support-resistance-basics

On the other hand, Resistances are said to be the point where the supply increases or the longs start getting out of their positions from the market. Therefore, if we were to carefully analyze, supports and resistances can be said as the point of friction or tussle between buyers and sellers. And Resistances, are those points where sellers have higher say than buyers.

Now, once the level of Supports and Resistances (S&R) are identified, they become the point of entry or exit for the trade. The prices either bounce back or correct back, from S&R level or breach these levels and go to the next S&R.

Characteristics of Supports

Here are the key characteristics of Supports while looking into the charts:

  • Supports are those points or levels, below which the market finds difficult to fall. They can also be said as a point of infliction between buyers and sellers.
  • Supports are also the point of Maximum demand from buyers, and even the sellers exit their selling positions from the market.
  • The buyers have a higher say in deciding the levels of support in the market. These levels can also be said to be the mainstay for buyers.
  • Supports, if breached, sees a quick sell-off in the market, and then the next level of support becomes a point of contention.
  • If the levels of support hold in the market, then fresh longs can be initiated, and generally, these trades have good risk to reward ratios.

— Understanding Supports with an Example

The figure below shows the daily chart of HDFC Bank. Through this chart, we get a clear illustration of the concept of supports and the impact on the market, if the supports are respected or breached.

Characteristics of Supports

Figure 1: Daily HDFC Bank chart (Source- Kite Zerodha)

Now, if we carefully look, the market finds very strong support in the range between Rs. 1030 and 1075. The sellers continuously try to breach these levels but to no avail. And after forming a base at these levels, the market starts going up.

And, we see continuous buying momentum in the share price of HDFC Bank. Trend line support is formed in the market by joining three points from where the market is bouncing. In this rally, the share price of HDFC bank moved up from 1030 levels to almost 1250 levels (a near 20 % gain).

And the moment, the price of the shares of HDFC bank breaks the Trend line support, we see an increased selling pressure and the longs unwind from the market. Following this, the share price reaches the initial support levels near dotted lines (Figure 1). And after finding support at these levels, the market starts to rally back and we see continuous buying in the market and it nearly makes a move of 25% from there.

So, if we were to just use simple supports patters while trading the above chart, we would have got a minimum of three trades with a minimum of 15% returns

Characteristics of Resistances

Here are the key characteristics of Resistances while looking into the charts:

  • Resistances are the levels that are defended by sellers. And the market finds it difficult to go beyond that level. It is a tussle point between buyers and sellers.
  • Maximum selling pressure comes from sellers at this point and even the buyers start to exit their long positions at these levels
  • If the levels of Resistance are breached in the market, we could see a massive short covering in the market, up to next resistance levels.
  • Resistances can also be called as points where fresh short positions can be initiated in the market, with good risk to reward ratio.

— Understanding Resistances with an Example

The figure above is a weekly chart of Airtel Limited. Through this chart, we get a clear illustration of the concept of Resistances, and the impact on the market if the resistances are breached.

Understanding Resistances with an Example

Figure 2: Weekly Airtel chart (Source- Kite Zerodha)

The Share price of Airtel Limited had made a new high in the year 2007 and after that, the market had corrected nearly 50% from its highs. And then again, the market made a move up and went up till near 500 levels and started correcting again. And by joining these two points, of the initial high and the recent high, we could form a trend line.

So, now this trend line forms an important resistance in the market. As and when the market made a move up, this trend line acted as an important barrier and the market started to correct back. And the market was able to breach this resistance in Mid-2014 and the share price had a massive short covering. And the market made a move till the initial swing highs of 570 levels. Therefore, this is the power of Resistances, when an important level is breached.

Now, let us understand the concept of swing trades. If we look at Figure 2, we have marked swing trade. Swing trades are those trades that we hold for a longer duration of time, usually for the completion of one full cycle. These are the trades that have a longer holding period. And we generally don’t have a profit target in place, we just keep trailing the Stop losses and ride the wave.

Watch this video to understand the concept of Supports and Resistances better:

Also read:

Closing Thoughts

In this article, we tried to simplify the concept of Supports and Resistances while looking into the charts. Let’s quickly conclude what we discussed today.

Supports and Resistances are important points of significance on charts as we get good entry or exit points for our trades. On one hand, Supports are defended by bulls/buyers and on the other hand, Resistances are defended by bears/sellers. These levels of Supports and Resistances can be used to identify targets for the trade and also for keeping Stop losses for existing trades. As a thumb rule, for a longer trade, look for the immediate resistance level as the target. On the contrary, for a short trade, look for the immediate support level as the target.

July 10, 2020 Technical Analysis, Trading 2 comments
Bank Nifty and Other Scrips Lot Size Changed (After July 30, 2020 Expiry) cover

Bank Nifty and Other Shares Lot Size Changed (After July 30, 2020 Expiry)!

The lot size of all the Bank Nifty Contracts expiring on or after 30th July 2020 has been changed from 20 contracts to 25 contracts. In other words, this means that the lot of Bank Nifty has increased by 25% after July 2020. (Source: NSE Circular)

Let us understand what it means with an example. Assume, if a particular strike Price of Bank Nifty Option was Price at 50 units of Premium. Here, the margin required under the old format was = 50 * 20 = Rs. 1,000. However, under the new contract size, the margin required will be = 50 * 25 = Rs. 1,250

Along with the change in lot size for Bank Nifty, the lot size for 78 other stock F&O contracts has also been revised. The list is as follows:

SymbolPresent lot sizeRevised lot size
ACC400500
ADANIPOWER1000015000
AMARAJABAT8001000
AMBUJACEM25003000
APOLLOTYRE30005000
ASHOKLEY80009000
AUROPHARMA10001300
BANDHANBNK12001800
BANKBARODA54008200
BEL60007600
BHARATFORG13001500
BHEL1040021000
INFRATEL20002800
BOSCHLTD4050
CANBK26005000
CENTURYTEX6001400
CIPLA11501300
COALINDIA27003700
CUMMINSIND9001200
EICHERMOT3035
EQUITAS49007600
EXIDEIND29003600
GAIL53346100
GLENMARK14002300
GODREJCP8001000
GRASIM750950
HDFCBANK500550
HDFCLIFE9001100
HEROMOTOCO200300
HINDALCO35004300
HINDPETRO21002700
HDFC250300
IDFCFIRSTB1200019000
IBULHSGFIN12003100
IOC40005700
INDUSINDBK400800
NAUKRI200250
INDIGO300500
ITC24003200
JSWSTEEL23002700
L&TFH56006800
LT375550
LICHSGFIN13002000
LUPIN700850
M&MFIN16002100
M&M10001400
MARICO13002000
MOTHERSUMI50007000
NATIONALUM1170017000
NCC900021000
NMDC60006700
NTPC48005700
ONGC41007700
PAGEIND2530
PEL309550
PNB830014000
RBLBANK15002600
SRTRANSFIN600650
SAIL1570019000
SUNPHARMA12501400
SUNTV12001500
TATACHEM9002000
TCS250300
TATAMOTORS43005700
TATAPOWER900013500
TATASTEEL15001700
FEDERALBNK70008500
RAMCOCEM800850
TVSMOTOR13501400
UJJIVAN17002200
UPL9001300
VEDL35006200
IDEA98000140000
ZEEL17003000

Source: NSE Circular dated March 31, 2020 on Revision in Market Lot of Derivative Contracts on Individual Stocks (zip)

Implications of Increased Lot Size:

  1. The trading activity on these scrips might take a little hit as the cost of Trading will increase
  2. The Pricing of these contracts will be fair as the Market manipulation will reduce
  3. The Value of Premiums on Options will also reduce to compensate for increased Lot Size

What do you think about this update in the lot size of Bank Nifty and Other Scrips After July 30, 2020 Expiry?  Share your views in the comment section below.

June 26, 2020 News, Trading 2 comments
INDIA VIX MEANING

What is India VIX? Meaning, Range, Implications & More!

Understanding what is India Vix, meaning & its importance: Ever heard of India Vix? If you’re involved in the market for some time and particularly active in the share market in March-April 2020, then I’m sure that you would definitely have come up with this term “India Vix” at least a couple of times mentioned on different financial websites and channels.

In this post, we are going to discuss, what exactly is India Vix, it’s meaning and how exactly it is important for the traders and investors to understand this term. Let’s get started.

What is India Vix?

India VIX is a short form for India Volatility Index. It is the volatility index that measures the market’s expectation of volatility over the near term. In other words, it explains the annual volatility that the traders expect over the next 30 days in the Nifty50 Index.

The India VIX value is derived by using the Black & Scholes (B&S) Model. The B&S Model uses five important variables like strike price, the market price of the stock, time to expiry, the risk-free rate, and the volatility. India VIX was introduced by NSE in the year 2008, but the concept of VIX is a trademark of CBOE (Chicago Board Options Exchange).

One simple way of understanding India VIX is that it is the expected annual change in the NIFTY50 index over a period of 30 days. For example, if the India VIX is currently at 11, this simply means that the traders expect 11% volatility for the next 30 days. Further, say, if the current index is trading at 9,000 and India VIX trading at 20. So, expected volatility over next year over 30 days will be:

  • Index spot: 9000
  • India Vix: 20
  • The expected downside for the year = 9000 – 20% of 9000 = 7200
  • The expected upside for the year = 9000+ 20% of 9000 = 10,800

Here, the expected range for the year is between 7200 and 10, 800

Anyways, before moving further, let me mention that one should not confuse India VIX with Market Index. Market Index gives information about the direction of the market but on the other hand VIX measures the volatility of the market.

Quick Note: Originally, VIX is a trademark of the Chicago Board Options Trade (CBOE).

Why is India VIX so important?

All the major directional moves in the market are usually preceded by a lot of choppiness or a lot of range play in the market. India VIX plays a very major role in understanding the confidence or fear factor amongst traders.

A lower VIX level usually implies that the market is confident about the movement and is expecting lower volatility and stable range. A higher VIX level usually signals high volatility and lower trader confidence about the current range of the market. A major directional move can be expected in the market and a quick broadening of range can be expected.

For example, during the sub-prime crisis, India VIX was trading at 55-60 (high of 90) levels and the market was in a state of panic and indecisiveness and hence the moves were erratic and hostile. Volatility and India VIX have a positive correlation. High volatility indicated high India VIX and vice-versa.

Similarly before COVID-19. India VIX had stayed below 30 (Since 2014). But since the epidemic disease broke out, the VIX has crossed the 30 level and is trading near 50 levels (trading above 80 for few days) and we have seen Indian equity Index losing nearly 40 percent of its value and is trading near 8000 levels.

So, India VIX plays a major role in understanding the sentiment of the market. But be aware of the fact, India VIX does not give any indication of the directional move in the market, it simply indicates the volatility in the market. So, anyone with a huge investment in Equities should keep a close eye on the movement of India VIX coz a similar movement in the shares of his portfolio cannot be ruled out.

Is there an ideal range for India VIX?

Theoretically speaking, VIX ranges between 15-35. But there have been outliers case of as low as 8(very tight range) and as high as 90 (extreme volatility). If VIX moves close to Zero, then theoretically either the index can double or come to 0. However, usually, VIX has a tendency to revert back to mean.

indiavix chart 2020

The figure above is India Vix chart for the last 10 years. With the current global crisis of COVID-19, the global markets have faced a lot of heat and extreme volatility and all the major global indices have lost nearly 40% from their recent highs and Indian equity market is no exception. With this current level of volatility, India VIX had climbed up to all time high levels of 90 for a couple of days.

And it seemed to be stabilizing near 50 levels about a month ago. The Vix range is still on the higher side, to attain some stability in the market. For stability to return, the global factors will have to improve and the India Vix level should ideally come around 20 levels.

The Current VIX level is 30 (June 2020) and the market seems to be stabilizing for now. But for the long term stability of the market, sub 20 levels of VIX is desired.

What do these extreme Vix levels mean for Options Writers?

India VIX also plays a very major role in the pricing of Options. A higher India Vix levels usually signal more volatile prices for options and a stable range would mean that the options are priced reasonably cheaper.

Simply put, high VIX levels expose option writers to unlimited risk with limited rewards (Premium). A deep in out of money Put/Call option can become at the money or even In the money option in a matter of a couple of trading sessions.

Also read: Options Trading 101: The Big Cat of Trading World

For Example, the stock price of XYZ shares is Rs. 300, and a trader has sold 280 put option contract (2,000 shares) for a premium of Rs. 10 and the contract has still 7 days to expiry. So, with current volatility, the share price can come to Rs. 240 in 2 trading sessions. So the loss for option writer with still 5 days to expiry will be:

  • Strike price: Rs. 280
  • Spot price: Rs. 240
  • Premium Earned: Rs. 10

Here, the loss for option writer: Rs. (240+10-280) i.e., Rs. 30 loss per lot, which is a loss of Rs. 60,000 (2000*30) per lot. Therefore, ideally, the option writer should avoid writing contacts and even if they do, the premium charged should also be higher.

Summary

To summarize, it can be said that India Vix is a silent yet very effective indicator to gauge the range play for Index, which in turn gives us a clear view of the expected movement of the share price.

Historically, large Vix levels have always been followed by a large movement in the indexes and share prices. And even the option pricing, the premiums charged also increase or decrease because of the Vix level changes.

June 19, 2020 Options Trading, Technical Analysis, Trading 7 comments
Trading Psychology - Tensions and Emotions in trading cover

Trading Psychology: Tensions and Emotions While Trading

An overview of Trading Psychology to understand what goes inside the mind of a trader: Trading psychology is the most important aspect of trading even more important than the technical and fundamental aspects of making trades. To be able to control one’s emotion, to be able to think fast on one’s feet and being disciplined, are some of the very key features of this trading psychology that every trader needs to learn eventually.

“I don’t want to be at the mercy of my emotions. I want to use them, to enjoy them, and to dominate them.” ― Oscar Wilde

Taking quick decisions, avoiding panicking, and sticking to one’s informed resolution in times of crisis is what sets a good trader apart from an average one or should I say, the winning one from the losing ones.

Biggest Psychological Tension While Trading

Not maximizing and holding on to a trade for too long, are two sides of the same coin. When I am saying, not maximizing, all I am saying is that when a trade goes in favor, we tend to book our profits too quickly and not maximize the potential. And this is critical because, with the technical and fundamental view remaining the same, there is no reason to book just because something is making money. We should try and squeeze the maximum possible juice out of fruit i.e., the trade.

Similarly holding on too long on to a position and not booking substantial margins even though the market is showing a change in momentum, is another psychological issue with trading. We are always of the viewpoint, what if I book too early. But one should understand that “Profit in hand, is better than profit in books”.

Staying flexible and being open to opportunities around to better the trade price or hedging is an important psychological aspect of trading. As the saying goes in the market, “Bulls Make Money, Bears Make Money, Pigs Get Slaughtered.”

the cycle of market emotions graph

Trading Psychology – Few Important Points to Know

— Avoid Over-Analysis Paralysis

This is the most common psychological trait associated with trading. We tend to over-analyze and over research the trades, before executing them. And which sometimes leads to trade been missed or we don’t take that trade, because some of our technical or fundamental parameters didn’t signal the trade. Too much information sometimes overcomplicates trading.

— The Randomness of Market

We have to accept the fact that markets are random to a large extent. This statement might come as a surprise to many. But we have to understand that our technical and fundamental analysis only works to an extent in the market. And if markets were not random, the technical and fundamental parameters working so far should always be able to predict the market future.

But, that’s never the case. So as long as we are in sync, with the randomness in the market, we should maximize the possibility. Because sooner or later, the randomness will take over and we have to change the parameters.

— Knowing When to Exit

what is factor investing meaning concept more

This skill is as important, as the art of knowing when to enter. Having a firm plan of when to exit is an important ability that every trader should develop. Having the mastery of this skill goes a long way in making the most of the profitable trades and exiting the wrong trades with minimum damage.

The best way to go about this strategy is to exit a part of your position when it makes to a decent profit. Doing this, locks in some profit and it also gives an opportunity to enter again if the markets correct again. And most importantly it gives confidence about one’s trading skills.

— Accepting when you are wrong

To accept when one is wrong is the most difficult art in humans. Similarly, in trading too, if we are able to accept that we have gone wrong in taking a trade, it goes a long way in prolonging one’s trading career. Its a proven fact, accepting a wrong trade, avoids the chain of wrong trades and which goes a long way in preserving one’s trading account.

Also read: 5 Common Behavioral Biases That Every Investor Should Know

— No more FREE internet tips

There are many fraudsters in the market who simply circulate a message (via SMS/email/any other social medium) spreading positive/negative rumors depending on whether they want to sell or buy. One should completely avoid falling for this honey trap, as people might lose a large chunk of their capital by trading this penny or rumor based tips. Traders should always use their informed judgment before entering any potions in the market.

— Have a Winning Attitude

Futures vs Options Trading What is More Profitable

This is an acquired trait over time. The winning attitude develops over time. What we need to understand here is that no trader has a 100% success rate with their trades. It’s our attitude, to do our background research (could be technical or fundamental) on each and every position/trade we take, makes a difference. Lack of discipline while trading, leads to disaster. The positivity with which we enter a trade makes a world of difference in the outcome of the trade.

— No Revenge against the Universe

The Universe here is the universe of trading. An individual trader is like grain of sand on a beach. He/she is simply not big enough to take revenge from the market. Therefore, we should never get into the mentality of taking revenge against the market. One always needs to remember, we are a part of the market and we cannot trade without the market. Moreover, it would not make any difference to the market, if a small trader like you or me is not there in it.

Closing Thoughts

“Every trader has strengths and weakness. Some are good holders of winners, but may hold their losers a little too long. Others may cut their winners a little short, but are quick to take their losses. As long as you stick to your own style, you get the good and bad in your own approach.” – Michael Marcus

Trading psychology is the most important aspect of trading that every trader needs to learn. In conclusion, we can say that the whole psychological warfare of trading, is the sole pillar on which the world of trading runs. Mastery of one emotional quotient goes a long way in having a long and rewarding trading career.

June 9, 2020 Investing Psychology, Trading No comments yet
How Crude Oil Prices Impact Indian Market & Economy cover

How Crude Oil Prices Impact Indian Market & Economy?

Understanding how crude oil prices impact Indian market & Indian economy:  The Liquid Gold, as the name goes, is the most important factor in understanding Global economic health. We have seen a 150% fall in the prices of WTI crude oil over a period of the last four months (Feb-May 2020) and a bounce-back of nearly 75%. Therefore, this year has been a year of massive swings in the prices of crude oil.

The price at the beginning of the year was above $60 per barrel and we saw the price of negative (-) $30 per barrel on around 20th April 2020. Hence, in all practical sense, one was paid to buy a barrel of oil. The current price of WTI crude is $35.46 per barrel (1st June 2020). This has caused a crisis in OPEC nations and other countries like Russia, which are dependent on oil exports.

The current price of WTI crude is $35.46 per barrel (1st June 2020)
(Source: www.Bloomberg.com)

How Crude Oil Prices Impact Indian Market?

Let us now understand how crude oil prices impact Indian market and its effect on different segments of the economy like current account balance, fiscal deficit, stock market, and more.

1. Impact on Current Account Balance

India imports nearly 84% of its domestic demand and it is one of the largest importers of oil in the world. Indian Oil imports account for nearly 27% of its total imports. Therefore, a fall in the prices of oil will reduce the cost of importing oil from other countries. And this in turn has a direct impact on the current account deficit (the amount that India owes in foreign currency).

Therefore, in the current crisis time (COVID-19 pandemic and economic slowdown), reduced crude oil prices have been a blessing in disguise to the Indian economy. In general, a 5 % increase in oil prices will impact the trade deficit by nearly $4 billion.

2. Impact on Fiscal Deficit

The price of the oil is fixed by the government and it is at a subsidized rate. And then the government compensates the companies for selling the oil at lower prices. These losses are also called under-recoveries. Therefore, the losses incurred because of compensating the companies losses, adds to the Fiscal deficit of India. But with the reduced oil prices, the compensation to be paid to these companies also reduces and which in turn helps in narrowing the fiscal deficit.

3. Impact on Stock Market

Now, if research and history are to be believed, then there is an inverse relationship between the oil price and the Indian equity market. This is because the Indian oil industry is majorly an importer of oil. Therefore, industries like tyre, lubricants, logistics, refinery, airlines, paints, etc are directly affected by a change in oil prices.

Further, as we are aware, energy stocks have nearly 12.5% weightage in Nifty 50 and nearly 15% weightage in Sensex. So, strength in crude oil prices adversely affects these oil-dependent industries and weakness in oil prices, usually signals strength in these companies’ stock prices. If we were to take an example of the paint industry, companies like Asian paints, Kansai Nerolac, etc use oil as a major ingredient in their paint. So, any movement in oil prices directly impacts their performance in the stock market.

Crude Oil Prices Impact on energy index

(Fig: Nifty Energy Index – 10 Yrs Chart)

Crude Oil Prices Impact on energy index (Fig: Crude Oil WTI Futures – 10 Yrs Chart)

Now, if we were to look at the two charts above. The one on the top shows the line graph of the Nifty Energy index for the last ten years and the one at the bottom shows the performance of WTI crude over the period of the last ten years.

At first glance, it may be very clear that there is an evident negative correlation between the performance of two. During 2011-12, when oil was trading near its peak of $140 per barrel, the Nifty energy index was trading near its low. And, when the Nifty energy index was nearing its peaking in early 2019, the per-barrel cost of crude oil was hovering around $55.

Now, we all must be wondering, that our equity market should have really outperformed when the oil prices crashed to sub-zero levels. But the global pandemic (COVID-19) has slowed down all global economies and we are no exception to it.

4. Impact on Exchange Rate

Rupee, being a free currency (value of rupee depends on the demand in the currency market), its value depends on the current account deficit. Therefore, if the oil prices are high, then the country will have to sell rupees and buy dollars to pay for oil bills. Similarly, if the price of the oil is low, then the current account deficit is low and the amount of dollars required to pay for oil bills are also low.

5. Impact on Inflation

India, being a vast country, the goods need to be transported from one place to another. And oil is a very important catalyst in the movement of vehicles from one place to another. A rise in oil prices leads to a direct increase in the price of goods and services. And it has a direct bearing on the prices of petrol and diesel. And hence it contributes to the rise in inflation in the country.

Therefore, a reduced price of oil comes as a boon to the economy of India. Reports published by Moneycontrol.com and State Bank of India(SBI) suggest that a $10 change in the oil price, impacts inflation by 0.3%.

Closing Thoughts

In conclusion, we can say that weak or reduced oil prices have a major positive impact on the Indian economy. India being an importer of crude oil, so higher oil prices imply, more payment needs to be made in foreign currency. And oil prices have a major say in the financial markets of our country. A weak oil price usually signals strength in the performance of the stock market. And a strong oil price has a negative impact on the performance of the stock market.

And similarly, if we were to take the example of oil-exporting nations, strong oil prices have a very positive effect on their incomes, balance of payments, and their financial markets.

June 2, 2020 Economics, Investment Basics 4 comments
SGX Nifty meaning what is it

SGX Nifty Explained – How it affects Indian Share Market?

Understanding SXG Nifty meaning & its impact on Indian share market: If you are an active stock market trader in India, I’m sure that you would have definitely have heard of the term ‘SGX Nifty’. If you open any business news channel, then before the opening of the Indian equity market, all you will see is an hour-long discussion on the SGX Nifty and its implications on the opening of the Nifty for that day.

The importance of understanding this terminology can be seen from the fact that it is one of the most popular hashtags followed or searched over different social media platforms like Twitter, if one wants to have a better picture of the Indian Equity market. In this post, we are going to discuss what exactly is SGX nifty and how it affects Indian share market.

What is SGX Nifty?

The word SGX is an acronym for the Singapore Stock Exchange. Besides, Nifty is the benchmark index of the National Stock Exchange (NSE) of India and it is comprised of the top 50 companies listed on NSE. So, if we were to add these two constituents, we can say that SGX Nifty is the Indian Nifty trading on the Singapore Stock Exchange. It is an actively traded futures contract on Singapore Exchange.

SGX Nifty Chart

Who is allowed to trade SGX Nifty?

Any investor who is interested in trading Nifty, but is not able to access Indian Markets, finds trading SGX Nifty very good alternative to trade. Even the big hedge funds who have big exposure in the Indian market find SGX Nifty as a good alternative to hedge their positions.

Further, an Indian citizen is not allowed to trade SGX Nifty contracts. For that matter, Indian citizens are not allowed to trade derivatives in any other country.

Difference between Nifty and SGX Nifty?

1. SGX nifty is Nifty futures contract trading in Singapore Stock Exchange and in India, Nifty contract trades on NSE.

2. The contract size of SGX Nifty is different compared to Nifty. In India, we have 75 shares in every Nifty contract Lot whereas the SGX nifty does not have a contract with shares in it. SGX Nifty is denominated in terms of US dollars. Say, if Nifty is trading at 9500, then the contract size of SGX Nifty will be 9500*(2 USD) i.e., 19000 USD.

For example, if the Nifty moves up by 100 points for the day, then make a profit of 100 rupees per share.  So, total profit in case of Nifty will be 100*75 = Rs 7,500. But in the case of SGX Nifty, we will be making a profit of 100*2 = 200 USD per contract.

3. Now, In India, in the case of Nifty, we see Open Interest as the ‘number of shares’ outstanding. But in the case of SGX Nifty the Open Interest shows the ‘number of contracts’ outstanding. Both Nifty and SGX Nifty are highly liquid and a very high volume of trading happens in that.

Also read: What is India VIX? Meaning, Range, Implications & More!

Trading Hours of SGX Nifty

SGX Nifty Futures

(Source: SGX Nifty)

The above figure is the value of SGX Nifty from the website on the Singapore Stock Exchange. It shows the value of SGX Nifty futures traded on SGX. In Singapore Nifty trades in two tranches. One part during the day time and it is denoted by ‘T’ (as seen in the picture above). The other half during the evening time and it is denoted by ‘T+1’. The trades happening in the evening will be considered in the next day settlement prices.

SGX Nifty Trading Timings

(Source: SGX Nifty)

Now, the above picture gives you details about the trading hours of SGX Nifty. The Trading hours mentioned here are Singapore time and the difference between Indian Standard Time and Singapore time is 2 hr 30 minutes. Therefore, we can see that in the Morning (T) session, it trades from 9 am to 6:10 pm Singapore Standard time.

So, in Indian Standard time, the trading happens at SG Nifty from 6:30 AM to 3:40 PM. And the Evening (T+1) session, it trades from 6:40 pm to 5:15 am Singapore Standard Time, which if converted to Indian Standard time will have timings of 4.10 pm to 2:45 am.

Contract Settlements in SGX Nifty

SGX Nifty has two serial monthly contracts and it has Quarterly contracts. The contract expires on the last Thursday of Every expiring month and if the last Thursday is an Indian holiday, then it expires the preceding business day. The SGX Nifty contracts are cash-settled and the final settlement price is derived from the official closing of S&P CNX Nifty.

How SGX Nifty Impacts Indian Equity Market?

Looking at the current global scenario, with the continuous onslaught of COVID-19 pandemic or the rising tensions between US-China over trade deal, we see a continuous inflow of information and news. And these inflow of information has a direct impact on the Global Financial markets.

SGX Nifty still trading way after the closure of the Indian Nifty market, we see an impact of these global news on the SGX Nifty price movement. This further directly impacts the opening pricing of Nifty, the very next day. And that is one of the reasons we see the Indian Nifty market opening at a premium or discount over the previous day’s close.

Note: Most analysts use SGX Nifty as one of the factors to predict whether the market will open higher or lower on a trading session.

Closing Thoughts

The SGX Nifty is a perfect substitute for investors and traders looking to trade in the Indian equity market but are not able to do so. It is a perfect hedging instrument if you are already exposed to the Indian equity market. One unique advantage that SGX Nifty has the longer trading hours compared to the Indian Equity market. And all these points make it a lucrative investment and trading avenue.

May 27, 2020 Market, Options Trading, Trading 13 comments
Option Greeks Basics - The Gods In Option Trading

Option Greeks Basics: The Gods In Option Trading

Introduction to Option Greeks Basics: What are the makings of a great cricket match? Is it just that brilliant hundred by a batsman, or one 5 wicket haul by a bowler or is it that sparkling catch or run-out by the fielder. Or is a combination of all of these along with some crucial moments in the game.

Let us take the example of the inaugural World T20 final 2007. The biggest match of the tournament. The Arch rivals, “India Vs Pakistan”. No bigger setup in the world of cricket. But what made this match memorable was the quality of cricket played. India did eventually win the world cup final by 5 runs.

But what made this match unforgettable? Was it the innings by Gautam Gambhir (75 off 54 deliveries), was it the dash by Rohit Sharma (30 off 16 deliveries) that propelled India to a competitive score, was it the genius of Robin Uthappa to get a direct hit run-out of rampaging Imran Nazir, was it the onslaught by Misbah-ul-Haq or was it the masterstroke by none other, but M S Dhoni, to give last over to Joginder Sharma and seal the deal. I guess it was a mix of everything that made it an event to remember.

What are Greek Options?

Similarly, the Option Greeks are the ingredients of the recipe which eventually helps in pricing the options. Option Greeks are various factors which help option trader in trading options. With the help of these Greeks, one is able to price the options premium, understand volatility, manage risk, etc. These Greeks also have a major impact on each other.

There are majorly four different types of option Greeks – Delta, Gamma, Theta, Vega, and Rho. We will be discussing all of them in this post.

Quick Note: If you’re new to options trading, you can read our series of articles on options here.

Delta of an Option

In simple terms, Delta measures the change in the value of premium with respect to change in the value of underlying. For a call option, the value of Delta varies between 0 and 1 and for a Put option, the value of Delta varies between -1 and 0.greek options basics Delta of an Option

The above Option chain is for Nifty at 09:57 am. Nifty spot is trading at 9320.

delta of an option nifty option greeks

The above Option chain is for Nifty at 10:07 am. Nifty spot is trading at 9316.

Now, form the above two tables, it is clear that with a small change in the value of Nifty, the premium for the option changes. The premium for 9100 CE in the first option chain is 291.65 and in the second option chain is 289.40.

Now, say if I were bullish on the market, so how would I find the premium for all the strike price if I were to expect the Nifty spot to be trading at 9400 by End of Day. So, this is where Delta comes into the picture.

For a call option, assume the delta for a strike price is 0.40. So for every 1 point change in the value of underlying, the value of premium will change by .40 points. Say, if I had bought 9350 CE at a premium of 142.70. The Nifty spot price is 9316 and the Delta for this option is .40. And if by the End of the day, the spot price of Nifty jumps to 9350.

So the change in the Premium will be = (9350-9316)*0.40 = 14.4 points. So the new Premium will be = 157.1. Similarly, if the spot price were to come down to 9250, then the change in the Premium will be = (9250-9316)*0.40 = 26.4 points. So the new premium in this case will be = 142.7-26.4 = 116.3.

Delta value dependency on the Moneyness of an Option

The value of the Delta is derived using the Black & Scholes model. Delta is one of the output form this model. The Moneyness of the contract helps in deciding the value of Delta:

MoneynessDelta Value (Call Option)Delta Value (Put Option)
In the Money0.6 to 1-0.6 to -1
At the Money0.45 to 0.55-0.45 to -0.55
Out of Money0 to 0.450 to -0.45

Delta of a Put Option: The delta of a Put option is always negative. The value ranges between -1 to 0. Let us understand it with the help of a situation. Say the spot price of Nifty 9450. And the strike price in consideration is 9500 PE (Put option). The Delta for this option is (-) 0.6 and the premium is 110.

Now, in Scenario 1, if the spot price of Nifty goes up by 80 points, then

New Spot price = 9530

Change in Premium = 80*(-.6) = -48 points

So the New Premium = 110-48 = 62. In case of Put options if the spot price of underlying asset goes up, then the premium is reduced (the premium and spot price of Put option are negatively co-related)

In Scenario 2, if the Spot price goes down by 90 points, then

New Spot price = 9360

Change in Premium = 90*(-.6) = 54 points

The New premium = 110+54 = 164 points

Risk profiling for choosing Delta

The risk taking ability of a trader has an impact in choosing the right strike price. It is always advisable to avoid trading in Deep out of Money Options as the chances of those options expiring In the money is like their Delta (5% to 10%). For a Risk Taker trader, a slight out of Money or At the Money contracts are the best strategy. A Risk Averse trader should always avoid trading Out of Money contracts. They should always trade At the Money or In the Money contracts as the chances of trade expiring in their favour is significantly higher than Out of Money contracts.

Gamma of an Option

As we have seen, the Delta of an option measures the change in the value of premium with respect to change in the value of underlying. The value of delta also changes with the change in the value of underlying. But how does one measure the change in the value of delta? We introduce you to ‘GAMMA’.

Gamma measures the change in the value of Delta with respect to change in the value of underlying. Gamma calculates the Delta gained or lost for a one-point change in the value of underlying. One important thing to remember here is that Gamma for both Call and Put option is positive. Let’s understand:

Spot price of Nifty: 10000

Strike price: 10100 CE

Call Premium: 25

Delta of option: .30

Gamma of option: .0025.

Now if Nifty goes up by 100 points, then

New Premium = 25 + 100(.3) = 55

Change in Delta will be = Change in Spot price * Gamma = 100*.0025 = .25

New Delta will be = .30+.25 = .55 (Option is now an At the Money contract)

Similarly if Nifty goes down by 70 points, then

New premium = 25 – 70(0.3) = 4

Change in Delta will be = Change in Spot Price * Gamma = 70*.0025 = 0.175

New Delta Will be = .30-.175 = 0.125 (Option is now a Deep Out of Money contract)

Gamma Movement

The movement of the gamma changes and varies with the change in the Moneyness of a contract. Just like Delta, the movement in Gamma is the highest for At the Money contracts and it is least for Out of Money contracts. So, one should ideally avoid selling/writing At the Money contracts. Out of money contracts are the best ones to write as they have a very good chance of expiring worthless for option buyer and the seller can pocket the premium.

Also read: Introduction to Candlesticks – Single Candlestick Patterns

Theta of an Option

Theta is an important factor in deciding option pricing. They uses time as an ingredient in deciding the premium for a particular strike price. Time decay eats into the option Premium as it nears expiry. Theta is the time decay factor i.e., the rate at which option premium loses value with the passage of time as we near expiry.  If we could recall, Premium is simply the summation of Time Premium and Intrinsic value.

Premium = Time premium + Intrinsic value.

Say, The Nifty spot is trading at 9450 and the strike taken into consideration is 9500 CE (call option). So the option is currently out of Money. There are 15 days to expiry and the premium charged for this option is 110. Now, the Intrinsic Value (IV) of this option = 9450-9500 = -50 = 0 (Since IV cannot be negative)

Now, Premium = Time value + IV

=> 110 = Time value + 0, hence the time value for this Out of Money option is 110 i.e., the buyer is willing to pay a premium for an Out of Money option. So, the analogy “TIME IS MONEY” holds true in case of options pricing.

Let’s take another example:

  1. Say, Time to expiry = 15 days, Spot price of share of XYZ company = Rs. 95, Strike price = 100 CE, Premium = 5.5
  2. Now, if the spot price of XYZ = 96.5, time to expiry = 7 days, then for the same strike the Premium reduces to 3
  3. Again if the share price increases to 98.5, for same strike price and with just 2 days to expiry, the premium reduces to 1.75
  4. Therefore, from the above example it is clear that even though the spot price is moving towards the strike price, the premium is reduced as the time remaining to make a substantial move above strike price is reduced. The option has less chances of expiring In the Money. The Greek Theta is a friend to Option writers. It is advisable for option writers to write/sell the option at the starting of contract as they will be able rise the premium erosion with passage of time.

So from the above example, it is clear that the value of Premium is Depreciating with the passage of time.

Vega of an Option

Vega as a Greek is sensitive to the current volatility. It is one of the most important factors in determining the option pricing. Volatility is simple terms is the rate of change. Vega simply signifies the change in the value of an option for 1% change in the price of underlying asset. Higher the volatility of underlying asset, the more expensive it is to buy the option and vice versa for lower volatility.

Say the spot price of XYZ Company is Rs. 250 on 5th May and the 270 call option is trading at a premium of 8.

Let’s assume that the Vega of the option is 0.15. And the volatility of the XYZ Company is 20%.

If the volatility increases from 20 % to 21%, then the price of the option will be 8+0.15 = 8.15

And similarly, if the volatility goes down to 18%, then the price of the option will drop to 8 – 2(0.15) = 7.7

Key Takeaways

If options is a team, then it has various players are Option Greeks like Delta, Gamma, Theta, Vega, volatility, etc. Each and every Greek has its own pivotal role in finding the exact pricing of the option. They play a pivotal role in deciding the Moneyness of the option.

A simple and clear understanding of all the Greeks goes a long way in deciding the right strike price and right option strategy. Risk Management both for option writers can be handled with a better understanding of the Greeks. Option buyers should ideally avoid trading Out of Money options and Option sellers should ideally write/sell Out of Money Options.

May 11, 2020 Options Trading, Trading 1 comment
Right time to invest or is it

The Right time to invest, or is it?

“Imagine, always wanting to own something but not being able to, because that something was too expensive, maybe not worth the price tag or maybe it was the right price but your pockets were not deep enough to buy it”

The above thoughts must be crossing every investor’s or trader’s mind right now. The stocks which were expensive in January 2020 are right now available at a discount rate of 30%-50% in May 2020. So what led to this sudden decline in prices or undervaluation or availability at a sale? Is it just an impact of Global pandemic (COVID-19), or Is it the global uncertainties. Are we heading towards a bigger recession? Or Were these share prices simply too overvalued and had just the right trigger to correct them, which in this case was COVID- 19.

To get a little deeper into the discussion, let’s take an example of a few sectors. The auto sector, the health of which usually defines the ‘luxury health’ of a nation. But over some time we have seen a continuous decline in the Nifty Auto Index, which tells us a lot about the depleting health of the sector.

The Auto index which was trading near all-time highs of 11900 in January 2018 is right now trading near lows of 5000. As we can see that this decline in the sector started long before COVID-19 was born. This also tells us a lot about the consumer’s reluctance to spend less on luxury items and save more for future uncertainties. In the current scenario, most of the Auto sectors company shares are trading at almost half the price compared to early 2019 levels. The image below is the Auto Index for the last three years.

Nifty Auto Bloombergquint (Source: Nifty Auto –BloombergQuint)

So, it is still the right time to buy or are these companies still overvalued, especially knowing that consumer demand for luxury goods will still take quite some time to bounce back. But, seeing the lucrativeness of the prices of various stocks (as they are trading at a discount of 30%-50% from top), one can start investing a portion of his desired investment now. But, it is advised to not to empty the full clip right now, as we could see some more correction in the market. So investing parts of portfolio over time is the best way ahead. And as the saying goes, “it is never a wrong time, to do the right thing”

Similarly, if we were to take the example of the Nifty Pharma index, this index was at peak during March 2015 (13,300 levels) and at its low during March 2020 (6700 levels). The figure below shows the Nifty Pharma Index Now, in this case, one can say that this might be the right time to start investing in this sector as the pharma products will have higher demand during this global pandemic and we can already start seeing pharma companies doing well over last two months.

The index has almost recovered to 9000 levels. So one can start building their portfolio have some portion dedicated to the pharma sector. Again SIP is the best strategy.

nifty pharma bloombergquint

(Source: Nifty Pharma BloombergQuint)

From the above discussion it very difficult to say that the recovery mode for the market has started or we have seen the bottom. One can never be sure. But one thing is for sure, that the market will recover sooner rather than later. One has to be very prudent and use his/her bias-free judgment to pick his or her investment strategy and timing.

One best way to do it by having a systematic Investment plan (SIP) and diversify his/her risk across sectors. It is near impossible for anyone to pick the top or bottom for any indices or sector. So it is advised to invest a portion of total desired investment and keep investing at systematic intervals of time. This way the investor will be able to average his price and a major movement in one sector or indices would not dent his portfolio significantly.

May 6, 2020 Market, News 2 comments
Futures vs Options Trading What is More Profitable

Futures vs Options Trading: Which is More Profitable?

Futures vs Options Trading – before we dwell deeper into this debate, let us first understand what each of these financial instruments implies. However, before that, it is important that you understand what does owning an equity share implies –

“Owning an Equity is like owning an ownership stake in the company. The holders of Equity shares have voting rights and have ownership say in the management and working of the company. Equity shareholders are partners in the growth and tough times of the company. They are entitled to receive dividends”

Now that you know the meaning of owning equity, let me define the basics definition of futures vs options trading:

“Futures are like a forward contract whose value is derived from the value of the underlying asset. In the case of companies, the underlying asset is equity share values and in the case of Index, the spot price of Index. The futures contract owners don’t have an ownership right on the asset they are underlined with”

“Options, as the name suggests, gives an option to the buyer, if wants to buy (Call option) or sell (Put option) on or before the expiry of the contract. He buys this right from the option seller by paying a fee (Premium) and the seller is obligated to honor his promise”

Read more: Options Trading 101: The Big Cat of Trading World

Benefits of Futures Contract

Here are a few key benefits of future contracts:

  1. Since Futures derive its value directly from an underlying asset, so any movement in the underlying price has equally proportionate movement in the value futures contract.
  2. The futures contract can be rolled over to next month contract at the same price as the expired contract expiry price.
  3. Futures contract do not face time decay problems as the value is direct proportional to the value of underlying and expiry does not affect its pricing.
  4. Liquidity is one of the most important factor in futures trading. The standing bids and offers make it easier for interested parties to exit and enter positions.
  5. The margin required for trading via futures haven’t changed much in years. They are changed a little bit when the market becomes volatile. So, a trader is always aware of the margin required before taking positions.
  6. The pricing is easier to understand as the values are based on Cost to carry model i.e., the futures price should be the same as the current spot price plus the cost of carry.

Benefits of Options Contract

Here are a few key benefits of Options contracts:

  1. As the name would suggest, the Options contract gives the right to option buyer to exercise his contract if he wishes to. If the Spot price doesn’t go in favor of the buyer of the contract he does not have to exercise his right, he stands to lose just the premium.
  2. One time premium is the only fee that option buyer has to pay to ride the momentum of underlying price and be a part of a bigger game.
  3. If an option seller is of the opposite view to that of option buyer, he can just sell the option contract and pocket premium income.
  4. The options are less risky than equities. Say for example if a trader wants to buy 1000 shares of Reliance, then at CMP (Rs 1400 per share), one has to shed out Rs 14,00,000 (fourteen lakhs). But one can express the same view by buying 2 Call option contracts (500 shares each). Say if he buys At the Money contract of 1410 CE by paying a premium of 35 per lot. Then, his total cost would be = (500*35*2)= Rs. 35000 only. So, now If option were to expire Out of Money for option buyer, he just stands to lose premium only. But, if the share price of Reliance Industries comes down to Rs. 1300, then total loss of equity shareholders will be Rs. 1,00,000 (1000*100).
  5. Return on investment for an option buyer is very high because the cost paid is just the premium and the potential return is unlimited.

Also read: Options Trading Definitions – Must Know Terms for Beginners

Futures vs Options Trading: Which strategy is better?

There is no right answer as to which instrument is better. It all depends on one’s risk appetite, and view on the market. However, here are a few key points to compare which strategy is better:

  1. Options are optional financial derivatives whereas Futures are compulsory derivatives instruments.
  2. The seller of an option is exposed to unlimited risk but the buyer’s risk is limited to the premium paid. But in the case of Futures, both buyer and seller have equal risk associated with their trades.
  3. The options although they can be rolled but have a different premium for different expiry, but in case of futures, they are rolled over at the same price in the next contract.

For example, if someone has bought the Future contract of XYZ Company at Rs. 110 and if upon expiry the price of XYZ is Rs. 105, he can simply roll over the position to next expiry at Rs. 105 and his entry price is not changed. But in case of Option, if an investor bought 110 call options of XYZ Company by paying a premium of Rs. 5 and it expires worthless, then he again has to buy next expiry contract by paying a fresh premium (Say Rs. 7). So to reach the breakeven, the spot price of XYZ Company has to go above Rs. 122(110+5+7).

From the discussion above it is clear that both financial derivatives instruments, Futures vs Options Trading, have their own advantages and disadvantages. One has to be rational, bias-free, use his/her judgment, and have proper risk management to survive long in the trading World. Happy Investing and Happy Money making.

May 1, 2020 Options Trading, Technical Analysis, Trading 2 comments
Multi Candlesticks Patterns cover

Understanding Candlesticks – Multi Candle Patterns

Multi Candlesticks Patterns: Hi traders! In the previous article, we discussed the various single candlestick patterns and their importance in understanding the pricing patterns. Here, in this article, we will be talking about various multi candlesticks patterns.

These are patterns generated by a series of prior candles. Single candlesticks patterns along with multiple candlestick study goes a long way in understanding and giving better trade signals in the market.

Here is a list of Multi candlesticks patterns we will be having a discussion on in this chapter: The Engulfing Patterns (Bullish Engulfing pattern and Bearish Engulfing patterns), The Piercing pattern, The Dark cloud cover, The Harami Pattern (Bullish Harami & Bearish Harami), The Candles Gaps, The Morning star, The Evening star, Three White soldiers & Three Black crows.

The Engulfing Pattern

The Engulfing pattern is the most basic two candlestick pattern. The first candle is a relatively small one and the second candle is a bigger one as it engulfs the first candle. If this pattern happens at the bottom of a trend, then it’s called bullish engulfing and if this happens at the top of a trend then it’s called bearish engulfing.

— Bullish Engulfing

Here are a few characteristics

  1. The Bullish engulfing pattern shows Long (buy) trade
  2. The prior trend should be bearish.
  3. The prior candle should be Red.
  4. The engulfing candle should be bigger than previous and covering the whole body of a red candle and should be green.

bullish engulfing - Multi Candlesticks Patterns

In the figure above we see bearish trend prior to the engulfing green candle. Once the engulfing pattern took over, we saw a long bullish trend. One important point to observe here is that the engulfing candle attempts to continue bearish pattern but constant buying and rejection at lows brings in more buyers and ultimately the candle closes green.

The trades to be taken here depends on one’s risk appetite. A risk-taker will execute the trade on the day the trend is made but the risk-averse will wait for confirmation and execute his trade the next day. The Stop loss for this trade has to be below the body of the engulfing candle. In the figure above, the trader with both kinds of a risk appetite would have made a substantial profit.

— Bearish Engulfing

bearish engulfings - Multi Candlesticks Patterns

As the name suggests, the bearish engulfing pattern gives an opportunity for short trades. The prior pattern here has to be a bullish one and the engulfing pattern candle should also give an indication of continuing bullish pattern but due to constant selling pressure, the sellers eventually take over and the candle closes red. The engulfing red candle has to bigger than the prior green candle.

The buying pressure gets exhausted by constant selling. It is advisable to exit long trades when this pattern happens and enter fresh short trades. The risk-taking trader enters short trade on the same day while the risk-averse trade waits for the pattern confirmation and enters into trade the next day. The figure shown below is a classic example of Bearish Engulfment with the engulfing body bigger than previous green candle and substantial bearish trend post that.

The Piercing Pattern

The Piercing pattern is very similar to a bullish pattern with a minor difference. In the case of the piercing pattern, the size of the green candle should be between 50-100 % of the red candle. Say if the size of the red candle is of 100 points, then the piercing candle length should be more than 50 points but less than 100 points. This candlestick pattern has a similar characteristics like Bullish engulfing but the confidence level on trades via piercing pattern is little lesser compared to bullish engulfing.

The Dark Cloud Cover

A mini version of the Bearish Engulfing pattern. A bearish pattern indicator and uptrend halter. Here, unlike the bearish engulfing pattern, the red candle size should be between 50-100 % of the previous green candle. Say, if the size of the green candle is 150 points, then the dark cloud candle should be anywhere between 75-150 points.

The Harami Pattern

I know what comes to mind when you hear the word ‘Harami”. But Harami here is a Japanese word meaning Pregnant. This is generally a trend reversal pattern. The first candle is a big one followed by a candle with a small body. And the color of the second candle is generally different from the first candle. If the second candle turns out to be a Doji candle, the chances of reversal increases.

— The Bullish Harami

the bullish harami - Multi Candlesticks Patterns

In the figure above, we see a bullish Harami encircled. It is a two-day pattern. Following are some of its characteristics:

  1. The prior trend of the market is bearish and on the previous day, the market has made a new low.
  2. On the next day, the candle opens in green as against the expected red candle and hence the panic and shorts start to get covered and the day ends with a green or a Doji candle.
  3. The idea here is to go long at the formation of this pattern.
  4. The risk-taking trader can go long near the close of the day and the risk-averse trader can wait for pattern confirmation and go long the next day.
  5.  The Stop Loss for the trade is below the low of blue or Doji candle.
  6. In an ideal scenario, it is always best to keep trailing stop loss and ride the reversal move.

— The Bearish Harami

the bearish harami - Multi Candlesticks Patterns

In the figure above, we can notice that the bearish Harami in a squared box. It is a trend reverser. The strong bullish trend is halted and a new bearish trend starts. Few characteristics of this pattern:

  1. The prior trend is a strong bullish trend.
  2. The prior candle makes a new high and the next candle opens low against an expectation of new high and hence the panic selling.
  3. One should look to exit his existing longs and enter fresh short trades.
  4. The risk-taker will execute the trade close to the end of the day and the risk-averse trader will wait for the confirmation and enter a trade on the next day.
  5. The stop loss for the trade will be the high of the first red candle.
  6. Here also one should keep trailing the stop losses and ride the full move.

The Candle Gaps

The Gaps are formed when the candle for the next day opens significantly opens up or below the previous day closing.

the candle gap - Multi Candlesticks Patterns

If the market gap ups, it shows buyers enthusiasm. They are willing to pay a higher price. The Image above shows Nifty gaps up and buyers are willing to pay a higher price and the momentum continues. This pattern emerges when we see some overnight positive news and the markets react with a gap up. If the share price of some company gap ups, it usually means some positive management news or good quarterly results or firm receiving some substantial orders, etc.

Similarly, in the case of a Bearish Gap down, we see the market opening below the previous day’s close and selling pressure. In the figure above we see a bearish gap down in nifty index and continued negative momentum post that.

One important thing to keep in mind is that candle gaps are more news-driven or event-based but it has a strong bearing on changing the technical set up of the market.

The Morning Star

The Morning star is a bullish candlestick pattern. It’s a three candlestick pattern. This pattern usually indicates a trend reversal. A sustainable bullish trend is on cards.

the morning star - Multi Candlesticks Patterns

Following is the pattern setup:

  1. The market is in a bearish trend and it’s continuously making new lows.
  2. In the image above, we can see the first candle in the circle is a red candle and a new low is formed.
  3. The next candle starts by making new lows and looks set to go down. But with regular buying, the candle closes by making Doji. It starts to set panic amongst the bears.
  4. The next candle starts above the close of the Doji candle (Gap up opening) and shorts start to exit their position and fresh long positions re-initiated in the market.
  5. The best way to trade this pattern is by entering the market near the close of the third day and by then the trend reversal confirmation is also given by the market. The Stop Loss for this trade is the low of the third candle. Trailing Stop losses is the best strategy to ride this move.

The Evening Star

The evening star is the exact opposite of Morning star. It’s a strong bearish reversal pattern. Similar to the morning star, evening star is also a three candlestick pattern.

the evening star - Multi Candlesticks Patterns

  1. The market is in a bullish trend and it’s continuously making new highs.
  2. In the image above, we can see the first candle in the circle is a green candle and a new high is made.
  3. The next candle starts by making new high and looks set to go higher. But with regular selling, the candle closes by making Doji. It starts to set panic amongst the bulls.
  4. The next candle starts below the close of the Doji candle (Gap down opening) and longs start to exit their position and fresh short positions are initiated in the market.
  5. The best way to trade this pattern is by entering the market near the close of the third day and by then the trend reversal confirmation is also given by the market. The Stop Loss for this trade is the high of the third candle. Trailing Stop losses is the best strategy to ride this move.

Three White Soldiers

The three white soldiers is a bullish reversal candle. The trend prior to the formation of this pattern is bearish. This trend has three green candles formed. The opening of every candle is slightly below the previous days close and it closed above the previous day’s high. One can exit their existing short positions and enter fresh longs to initiate a new trade.

A risk-taking trader can execute trade before the close of the third candle and a risk-averse can execute his trade after the confirmation of the trend. The stop loss for this trade is the low of the first candle.

three white solders - Multi Candlesticks Patterns

Three Black Crows

Three black crows is a bearish reversal pattern. The prior trend is a bullish trend with new highs been made every day. The opening of the candle is slightly above the previous day but the closes is lower than the previous day low. Fresh shorts can be initiated with stop loss over the high of the first candle. One should keep trailing his stop losses as the trade starts to move in their favor.

Also read:

Conclusion

From the discussion above, we see various multi candlesticks patterns which can be useful barometers in the trade execution. There are some patterns that are frequent and followed more regularly and other not so frequent but very reliable patterns.

But by no means, these technical indicators to be followed blindly. One should see the technical factors going around and use informed judgment in executing their trade. “Happy Trading and Money Making!”

April 28, 2020 Options Trading, Technical Analysis, Trading 2 comments
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