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
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
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
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
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
Introduction to Candlesticks - Single Candlestick Patterns cover

Introduction to Candlesticks – Single Candlestick Patterns

A Guide to Single Candlestick Patterns: If you want to become a successful stock market trader, it is very important that you learn to read and understand candlesticks or candles. These candlesticks are basically a style of technical chart used to describe price movements of a stock, derivative, or currency. Understanding candlesticks and their patterns can help you to decide the entry and exit points for your trades.

“I just wait until there is money lying in the corner, and all I have to do is go over there and pick it up. I do nothing in the meantime.” – Jim Rogers

In this article, we are going to discuss what are candlesticks and then look into the popular single candlestick patterns that every trader should know. Let’s get started.

What are Candlesticks or Candles?

Candlesticks are the most common form to gauge the market trends, historical analysis, forecasting future. They are the most potent form of technical indicators. Just like a burning candle throws light to present and future, candlesticks with their patterns throw light on the present and goes a long way in understanding the future trends.

A simple candlestick shows the events which transpired within the selected timeframe. It shows us the open, high, low, close of the day (within the timeframe selected). The length of the candle helps us in understanding the volatility of the day. The longer the length of the candle, the more volatile the day and shorter the candle, the less volatile the day.

candlestick high low open close

The candlestick can be said to be a historical indicator as the candlesticks are formed on the already happened market action. But the candlesticks formed goes a long way in understanding the future trends and price patterns.

Before we start understanding the various candlesticks patters, I would recommend keeping the following factors in mind:

  1. “Trend is your friend.” Avoid going against the trend.
  2. One should be very flexible with his views. Stubbornness generally leads to disasters.
  3. Historical data analysis goes a long way in understanding future price patterns.
  4. Avoid taking directional trades on small size candles. Generally, trends are formed after substantially long sized candles.

Single Candlestick Patterns

In simple words, a single candlestick pattern is formed by just one candle. Here, we do not look into multiple or group of candles and the trading signal is generated based on a single day’s trading action. The following are some of the popular Single candlestick patterns we would be discussing in this article: The Spinning top, The Marubuzo, The Doji, The Hammer, The Hanging Man, The Shooting Star.

— The Spinning Top

The Spinning Top unlike any other candlestick formation does not give any clear direction of the trend but has a lot of price action associated with it. A Spinning candle looks like the candle shown below:

the spinning top candlestick

Following are the initial observation looking at the candle:

  1. The body of the candle is very small compared to upper and lower wicks.
  2. The wicks on both sides are generally of similar size.

The spinning although looks like a plain candle but has a lot of price action associated with it. The small main body would imply that the open and close of the candle are very close to each other. Because the open and close are so close to each other, the colour of the candle usually does not signal any trend.

The upper body shows the high for the day. This simply signifies that the bulls did make an attempt to go up but to no avail.

The lower body has similar characteristics like the upper body. This simply signifies that the bears tried to push the market down but were not successful in doing it.

— The Marubuzo

The Marubuzo is again a single candlestick pattern. It is probably the only candlestick pattern in which the prior trend is not given much importance. Only the last candle is given importance.

the marubuzo candlestick

The green line above explains Bullish Marubuzo and the red line represents Bearish Marubuzo.

— Bullish Marubuzo

In Bullish Marubuzo, the open of the candle is low for the day and the close of the candle is high for the day. There are no wicks in this candlestick pattern. This candlestick can also be said to be a trend changing one. The intensity of the buying is so high that the traders are willing to buy the stock at the high of the day. This candlestick patterns simply implies that the buying will continue for the days to come. The recommended buying price is the closing price of the Marubuzo candle.

Theoretically, the open should be low and the close should be high. But in reality, a little bit of variation is allowed.

Let us understand it with the help of a hypothetical example: The XYZ company share price has formed a Marubuzo candle with: Open = 403, High = 450, Low = 400, Close = 449.

Now the trader’s risk profile defines the time of execution of the trade. A Risk-taker would be taking the trade on the day the Marubuzo is formed. So how does this Risk-taking trader gets confirmation about the formation of Marubuzo? The trader basically does that by taking the trade very close to the end of the day.

On the other hand, a Risk-averse trader would be taking the trade the next day once the trend is confirmed. So, a risk-averse trader entry price might be higher than the risk-taking trader but has a better assurance about the pattern formation.

One very important thing to be kept in mind is that one has to be very mindful of the fact that the trade has to be executed with a stop loss in mind. Stop loss helps the trader to minimize the losses because of the inherent risks associated with the trade.

— Bearish Marubuzo

In a Bearish Marubuzo, the open of the candle is high for the day and the low of the candle is close for the day. A bearish Marubuzo indicates that the selling pressure is so high that the trader is willing to sell the share at the lows of the day expecting more negativity in the price of the share. This candle indicates a change in momentum and this changed momentum is set to last over some time.

One should bear in mind that this kind of trades are generally not meant for scalping purposes, they are to held until the trade reaches its desired price. Trailing stop losses is the best strategy.

— The Doji

The Doji is a candle formation that does not have a real body. It just has wicks on either side. So, the opening and closing price of the candles are one and same.

the doji candlestick - Single Candlestick Patterns

The Doji pattern can sometimes be similar to a spinning top except for the fact that Doji does not have any real body. Dojis are generally momentum changer or momentum halter. These candles clearly show the indecisiveness amongst the traders about the momentum and the direction of the market. Let’s examine it with the help of the following situation.

Say the market is in a bullish momentum and has had green candles over a series of days. So, if a Doji candle is formed, it could simply imply the dwindling momentum in the market or could mean an end in current momentum and signal trend reversal. Therefore, it is advisable in this scenario to be cautious and exit the long position or at least one should have stop losses in place. This is generally a time to wait and watch before entering new trades.

Also read: Options Buying vs Selling: Which Strategy to Use?

— The Hammer

The Hammer pattern is one of the most convincing trading patterns simply because of its formation pattern.

the hammer candlestick

The hammer pattern occurs when the candle opens at high but is not able to sustain there and it falls considerably but with continuous buying interest is able to recover and the candle closes in green and near the opening price. The length of the wick here has to be at least twice the size of the body.

In the diagram above, a bullish hammer has formed at the bottom of the bearish trend and the momentum changes significantly after the hammer formation. One Important thing to be kept in mind is that the hammer can be of any colour (green to red) as long as it meets the body to wick ratio. Few characteristics of hammer trade:

  1. The hammer formation generally gives a bullish or a long trade.
  2. The execution time of trade depends on the risk appetite. A risk-taker would execute the trade on the same day and a risk-averse will wait for the confirmation of the trade.
  3. The Stop loss for this trade is generally below the low of the hammer candle.

— The Hanging Man

According to Investopedia, “A hanging man uptrend and warns that prices may start falling. The candle is composed of a small real body, a long lower shadow, and little or no upper shadow. The hanging man shows that selling pressure is starting to increase”.

One important criterion for a candle to be called as a hanging man is that the market has to be in a bullish trend. Just like Hammer, a Hanging man can be of any colour as long as it meets the body to wick criteria. The Stop Loss for the short trades executed via hanging man pattern is the high of the candle.

the hanging man candlestick - Single Candlestick Patterns

— The Shooting Star

As the saying goes, save the best for the last. Probably the most influencing of the single candlestick pattern. The shooting star just looks like an inverted hammer or hanging man. It gives very strong trend reversal signals.

shooting star candlestick

The basic characteristics of the Shooting star are:

  1. The shooting star candle has a long upper wick. Generally, the size of the wick is twice the size of the candle body. The longer the wick, the stronger the pattern.
  2. The shooting star is a bearish reversal pattern, so the preceding trend is bullish.
  3. In general, the shooting star happens on the day when the existing bullish trend is expected to continue.
  4. Once a shooting star candle is formed, it is advisable to exit the long trades or at least put a stop loss and if possible reverse the long positions.
  5. One has to be bias-free when trading this type of formation.

Closing Thoughts

In conclusion, the above discussion should give us a clear picture of the various single candlestick patterns. All the patterns have their individual strengths. One has to be very aware of the basic mantra in the market: “Trend is your friend, always trade bias-free and always trade with a proper stop loss to be a long survivor in this marathon of trading”.

In the next article, we will be talking about Multi candlesticks patterns along with examples. “Happy Trading and Money Making”

April 27, 2020 Options Trading, Technical Analysis, Trading No comments yet
algorithm trading cover 3

What is Algorithmic Trading (Algo Trading)? And how it works?

Technological developments help define the future and we tend to rely on them more and more everyday. Investors are no exception to this rule as they use of technology to take advantage of optimal market conditions and earn high returns.

One such technology is algo trading or algorithmic trading which is a type of stock trading that uses statistical models and equations to run trades on a program designed by the user. Algo trading has become more popular in the last few years as it has been made more accessible to investors. It currently comprises of 35-40 per cent of turnover in Indian Stock Exchanges.

What is algorithmic trading?

An Algorithm is a code that is designed to carry out a certain process. Algorithmic trading uses computer programs to initiate trades at high speeds based on preset conditions such as the stock prices or the current market conditions.

The algorithms can include a level of manual intervention or can be fully electronic also known as zero-touch algos. The trades are initiated based on pre-set quantitative factors, arbitrage opportunities and the client’s preference. In India, the most commonly used algo is the Application Program Interface (API) that lets investors choose their strategy and enter in their requirements. The trades are then executed by the brokers.

For instance, algorithmic trading can be used by a trader who might want to implement trades when the stock price reaches a certain point or falls below a certain level. Based on the current market conditions, the algorithm can recommend how many shares to buy or sell. Once the trader enters the program requirements, they can sit back and relax as the trades automatically take place based on the preset conditions.

What are the benefits of algorithmic trading?

Algorithmic trading automates the trading function which is incredibly advantageous to traders. This makes sure that the trades are carried out at the right time during optimal market conditions which increases the chances of high returns. The traders does not face the risk of missing out on important opportunities in the market.

Another key advantage of algorithmic trading is that it removes human emotion from the trading equation as the trades are defined by preset conditions. This is advantageous because human emotions can cause investors to make irrational decisions based on fear and greed.

Algorithmic trading also allows you to backtest. This essentially means that the algorithms can be tested on past data to see if they have worked in the past or not. This is helpful because it lets the user identify any flaws in the trading system before they run the algorithm on live data.

In addition to this, algo trading reduces the time spent analyzing markets and lowers the associated transaction costs. The numerous benefits have made it a popular tool among investors in many stock exchanges today. 

Strategies used in algorithmic trading

Although the computer initiates the trades, the user still has the ability to input the strategy they wish to use. They can decide the volume, the price and at what time the trade should happen. Therefore the algo strategies used by the investors can have a large impact on their earnings. Here are the most common strategies used in algorithmic trading:

Trend based strategies:

One of the most commonly used algo strategies used is trend-based strategies. The involves following the current trends in the market and executing trades based on that. The trader uses technical indicators such as the moving average and the price level of the stock to assess the market and the system generated recommendations to buy or sell required to fulfill the conditions entered by the trader. This is one of the easiest strategies to implement as the figures are based on historical and current trends with no requirement for complex predictions.

Arbitrage strategy:

An arbitrage opportunity exists in the market when there is a difference in the price of securities on two stock exchanges which can result in a risk-free profit. In algo trading, the arbitrage strategy algorithm is used by the computer program to identify the differences in prices and make use of the opportunity in an efficient way.

The speed and accuracy of algo trading comes into play here because the price difference in the stock may not be high but the high volume of trade can lead to a considerable amount of profit. This arbitrage strategy is most commonly used in forex trading.

arbitrage trading

(Image credits: Corporatefinanceinstitute)

Trading Range or Mean Reversion strategy:

Also known as the counter-trend or reversal, this strategy is based on the principle that although prices go up or down, it is only temporary and they eventually come back to their average price. In this strategy, the program identifies the upper and lower limit of the stock and carries out trades when the price goes above or below this range. The algorithm calculates the mean price of the stock based on historical data and when the price goes out of bounds the trade is executed with the expectation that the stock will come back to its average price.

However, this strategy may not always work as the price may not come back to its average price as quick as expected and the moving average can catch up to the price leading to a lower risk to reward ratio.

Also read: How to read stock charts for beginners?

Conclusion

Algorithmic trading was introduced in India in around 2009 and has been growing in popularity due to its low cost and the availability of skilled resources, especially with traders who trade on proprietary books. SEBI (Securities and Exchange Board of India) has also played a positive role in the adoption of algorithmic trading in India which will help further its acceptance and incorporate the trading on a larger scale in stock markets.

Although algorithmic trading is automated, the user still has the authority to choose which strategy to follow depending on various factors. It is especially beneficial for small-time investors who want to increase liquidity in the market making it easy to enter and exit the market while decreasing price inefficiencies in trading stocks.

January 28, 2019 Technical Analysis 1 comment
How to read stock charts for beginners cover

How to read stock charts for beginners?

For anyone looking to actively trade in the stock market, it is essential to know how to read stock charts. A stock chart is a chart that shows the price of a stock plotted on a time-frame that can range from minutes to many years. It serves as an important tool for picking the right stocks and easy to find on websites such as Yahoo Finance or Google Finance.

The ticker symbol of a company can help you find its stock chart. The ticker is a series of letters found in a company’s name (Apple= AAPL). Stock charts can help you identify stock price movements and make decisions on whether to enter, buy, sell or exit the trade.

When you first look at the chart

Stock charts come in various forms, they can be candle charts, bar charts or line charts.

In addition to the view of a stock chart, you also get to pick the time frame. The most commonly used ones are intraday, weekly, monthly, year-to-date (YTD), 5 years, 10 years or even a complete history of the stock.

how to read chart 1-min

(Stocktrader.com)

Once you have picked the chart view and time-frame, it is now time to understand the various features of a chart. For demonstration purposes, we can look at a candlestick chart.

On a candlestick chart, the red candles show downward price movement, while the white (or green) candles show an upward price movement. The chart has numerous technical indicators such as the moving average index (MA), the relative strength index (RSI) and the moving average convergence divergence index (MACD). These technical indicators are used to analyze future price movements.

Support and Resistance lines

how to read chart support and resistance

(Image credits: BabyPips)

The next step is to look for the support and resistance lines. As the name suggests, the resistance line indicates a point which resists the price from rising further. It shows the maximum supply for a stock where the level is always above the current market price. There is a great probability that the stock would rise up to the resistance level, absorb the supply and then decline. For traders, the resistance line is an indicator to sell.

Alternatively, the support line indicates a point that stops a price from falling lower. It shows the maximum demand for a stock in the market. There is a high chance that a stock price will reach the support line, absorb all the demand and then bounce back. The support line is a signal to buy stock.

Below the stock chart is a window that shows the trading volume of the stock. The volume shows how much of the stock has been traded over a period of time. The green bars show the greater buying volume days and the red bar shows the greater selling volume days.

how to read chart

(Image credits: Investors Underground)

Why is the volume important?

The volume of a stock is an important indicator of whether or not to invest in a stock. This is because the trading volume is influenced by the buying and selling of stocks done by big traders, large investment banks, mutual funds or exchange-traded funds (ETFs). It can be the high-value trading done by these large firms that causes the price of a stock to go up or down.

An individual investor can use the volume as an indicator of buying or selling stock, forecasting future price trends and identifying the support and resistance level. When there is a bullish market- that is investors are optimistic and expect the prices to rise- there is high volume trading on up days and low volume trading on low days. However, during a bear market- when investors are less optimistic- there is high volume trading on down days and low volume trading on up days.

how to read chart

(Investopedia)

Other technical indicators

In order to better understand the price movements and trends in a stock chart, investors use a variety of technical indicators. One such indicator is the 200-day moving average which is a stock’s average closing price in the last 200 days. A high 200-day average signifies a bullish market while a low 200-day average shows a bearish market. In reality, however, when the 200-day average is extremely high it is a sign that the market may soon go down and that investors are far too optimistic and when the 200-day average is low it signifies the reverse. The shorter the moving average, the greater the change in the market.

The 200-day average indicates whether a stock is healthy or not and is often compared to the 50-day moving average. When a stock in the 50 day moving average crosses the 200-day moving average, it achieves the ‘golden cross’ status. That is the stock may go up to a much higher price. On the flip-side, if a stock in 50-day moving average goes below the 200-day moving average, it is known as the ‘death cross’. This means there is a good chance the price of the stock will go down in the future. Technical indicators are used in conjunction with momentum indicators to analyze the direction and strength of a stock’s price movement.

Understand the overall trend of the stock

When looking at a stock chart it is important to understand the upward and downward trend of a stock but you also need to analyze the background of the stock as well. This involves understanding how a particular stock usually trends- does it have low price movements or is it constantly volatile?

Another factor to consider is the possibility of the trends reversing. Momentum indicators such as Relative Strength Index (RSI) or MACD can help identify if a stock has reached its peak giving investors the opportunity to exit the market. Understanding these trends can help you make better decisions about what stocks to purchase.

Also read: Fundamental vs Technical Analysis of Stocks

Conclusion

Knowing how to read stock charts is important for any trader. It provides perspective on the price movements of stocks and will help you make better decisions to improve profitability. Hopefully, this guide gives you a better understanding of how to read stock charts before you start trading. Always remember, by failing to prepare, you are preparing to fail.

January 25, 2019 Technical Analysis 2 comments
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