There is nothing more frustrating than getting stopped out of a trade only to watch the price go back to the initial direction you were trading in the first place.
It’s grating, I know.
Assets, like animals, have different types of characteristics. Some are fast, some are slow, some jump high, some jump low. Understanding the behaviours and patterns of your chosen assets will help you set your stops at reasonable levels.
With this post, I’ll share a simple method of placing your stops in a way that is realistic and decreases the chances of getting hit every single time.
The Concept of Stopping Distances
If you are driving at 50 km/h (~31 mph), do you know how much safety distance you have to maintain between you and the vehicle in front of you ?
What about when you’re cruising at 120kmh (~75mph), will you still be keeping the same distance?
“Well, duh!” I hear you say.
The typical stopping distances chart below is a case in point:
Your stopping distance should be adjusted to your vehicle’s size and driving speed. For example, larger vehicles weighing 40 tonnes need a greater stopping distance than a compact car that is significantly smaller in weight and size.
A similar concept can be applied in trading.
Basing your stop loss solely on a hard and fixed number (e.g. x number of pips / x number of points) is like using the same stopping distance FOR EVERY SINGLE VEHICLE. There is a smarter way to calculate your stop loss and the first step is to know the range of your asset.
This is akin to knowing the size of the vehicle you’re driving – it makes it easier for you to get a good idea of what a reasonable stopping distance would be. Knowing the trading range of your asset, or the “average true range” (ATR) as we call it, also helps you select a sensible stop level which can decrease the chances of your trade being stopped out, provided that your bias was set in the right direction.
How to Calculate the Average True Range
So here is a simple step-by-step guide on how to calculate the average true range of any asset (be it stocks, commodities, currencies, etc)
- Get the historical data for your asset. You will need the data of the open, high, and low numbers .This data set usually always comes as a package called open, high, low, and close (OHLC). You can download these numbers from the following free resources:
- Subtract the low price of the day from the high price of the same day. The result you get is what you call a “True Range”. This tells you how much the asset moved in a day.
- To get the average true range (ATR) for a certain period, you just repeat step number 2 for the number of days you want to calculate the range for. Then you get the average number of the true ranges within your specified period. Below is an example for a 20-day ATR, which is equivalent to a whole trading month:
Calculating the average true range of an asset tells you how much the asset has moved within a particular period
- You can then calculate the daily ATR in form of a percentage as follows:a. You add the true range of the latest closed trading day and the trading day priorb. You divide the result by 2c. Then you divide the number by the open level of the latest trading day
The result you get tells you how much the asset is expected to move on an average day. For example, if your calculated ATR is 1.37 %, that means that the asset is expected to move by 1.37% from the opening price. This is how it would look like on a spreadsheet format:
Calculating the average true range of an asset expressed in percentage
- Once you have the percentage worked out for the different time frames you need (e.g. 3 days, 10 days, 20 days, 1 year, 10 years etc), you can use this % as a stop loss level.In the above example, if we are entering a trade say, at $985 (the numbers on the spreadsheet are expressed in cents), and we have calculated a 20-day ATR of 2.15 %, then we can set our stop level at $964 (2.15% of $985 is $21, so we subtract $21 from our entry level to calculate the stop level based on the ATR).
You can apply this technique in many different variations. For example, you can use a 3x ATR as a stop level if you know that your asset is a “wild” one, i.e. extremely volatile. Or you can round up the calculated ATR to the nearest 5 for good measure. Or you can even use the ATR to target a profit level.
Voilá. Now you know how to calculate your “stopping distance”.
Will this guarantee that your stop levels won’t get hit?
There are no guarantees for anything and there is certainly no one way of setting the right stop level and nailing it every single time. But I would think of it like this:
Most trades almost always start off with a loss, so when you enter a trade, what you’re essentially doing is you give your position some space to prove itself. This “space” is predetermined by the stop loss you set. Once your position exceeds this “space”, that’s when you know you need to cut it as you will be damaging your trading account or portfolio otherwise.
Giving your trades the appropriate amount of “space” is key as you will otherwise be depriving it of the chance to prove itself. This is where knowing how to calculate your asset’s average true range can help you.
And remember to always trade responsibly.
The original post appears on 5to9trader.com and is available here.
Loss Aversion – Cut Losses Short & Let Winners Run
If you’ve been trading for a while, you’ve probably heard the following ubiquitous mantra of trading: “Cut Your Losses Short & Let Your Winners Run”.
Why Should You?
Stocks can literally go to zero. It happened many times before and will happen in the future, regardless of how big the company is.
MANY oil and coal companies recently filed for chapter 11 bankruptcy and their stocks got delisted. You may also remember Lehman Brother and General Motors. What happens when your stock falls off a cliff and gets delisted? You simply lose all the money you invested in that stock.
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If as a TRADER you want to have disciplined and profitable trading, The Core Concept you need to Understand is
As a Trader, you do not have any control on the market.
Nil Control on Market
You’ve either figured out or you will figure out the fact that not much at all remains under your control as a trader. Dealing with an endless set of variables using a mind that’s geared by nature to defining constants is a tough task. Most of traders focus on returns and not focusing on the process of trading.
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Maybe you also followed this story. Or maybe not. But basically a really big hedge fund manager, one of those guys who people quote and probably talk about at Harvard Business School, placed a super big bet on this company called Valeant.
Valeant is a pharmaceutical company trying to cure problems with skin and infectious diseases. They actually also own Bausch Lomb so that means they have a giant eye care business.
This hedge fund manager made a bet that Valeant would keep growing their business, diversifying, and acquiring. He once even called them the next “Berkshire Hathaway.”
This thesis turned out to be wrong. Like really wrong. The company crashed. People started to call Valeant out for jacking up the prices of their drugs. They also were apparently doing some dicey bookkeeping things. Just Google “Philidor Valeant scandal” if you want to learn more about that.
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Derivatives or Futures and Options are leveraged instruments to trade in the stock market. There are broadly 3 groups of people who use derivatives-
- Short term traders for making quick buck– most of them want to make a quick buck. Leveraged trading means, you can potentially make 100% returns from a 10% movement in the stock. 100% returns from a 10% move looks lucrative! The only issue is you can lose bigger amount if stock moves in opposite direction
- Long term stock investors for hedging portfolio- these category of people may use derivatives for long term hedging of their portfolio or making some extra return on their stock holdings. They mainly use options. And, the idea is to hedge the portfolio, and not make great returns from short term trading
- Long term investors who buy special long term options with a long term view- These include big investors including Warren Buffett and many others buying warrants, convertible debentures, long term calls etc.
Majority of people who trade in derivatives come in the first category. More than 95% of traders lose money. Mostly these are young people who get job in corporate companies, open a new demat account and want to make some quick money. They are replaced by new traders (as new graduates complete college and get job). The cycle repeats.
Here is an interview of Nithin Kamath where he mentions –
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Howard Fischer, wearing a white shirt and khakis, leans back into a window seat at a juice bar in Greenwich, Connecticut, sips a cold-brewed Mexican mocha and shares his angst.
“It’s miserable, miserable,” the 57-year-old manager of $1.1 billion Basso Capital Management says of hedge fund returns over the past few years. “If that’s the normal expectation, I don’t have a business.”
Fischer’s lament and ones like it are echoing through the industry. It’s an existential crisis for former masters of the universe who once prided themselves on their trading prowess. Now they’re questioning their wisdom and their ability to generate profits that made them among the richest in finance.
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The original article is written by Steve of Trading Method, Trading Plan and can be found here.
Most new traders think their win rate is the most important math in their trading. It is not, your risk / reward ratio will determine your profitability more than a win rate.
Chart Courtesy of Tradeciety.com
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The original article is written by Mastermind, Deepak Shenoy and is available here.
After Bharat Forge was caught having reduced its ownership in its key defence subsidiary, Kalyani Strategic Systems Limited (KSSL), from 100% to 51%, the question is: how did the stake reduce?
We’ve found the answer for you. Wading through MCA documents, we found that:
- KSSL had about Rs. 500,000 in capital (5 lakh)
- Bharat forge put in about 1.39 cr. in November 2015 at Rs. 10 per share (par). This took the total capital to about Rs. 1.44 cr.
- In March 2016, Three promoter companies put in about Rs. 1.38 cr. as capital into KSSL. This increased the total capital to about Rs. 2.83 cr. and gave the promoter companies 49% of KSSL.
Here are the three promoter group companies that bought into KSSL:
Sundaram Trading and Investment Private Limited is on the list of promoter companies of Bharat Forge. (BSE) Kalyani Global Engineering (see Tofler) has a common director with Kalyani Technoforge, a Shrinivas Kanade, who’s also on the board of other Bharat Forge promoter companies, such as Ajinkya Investment and Trading Company, KSL Holdings etc.
This is pretty simple to see – the promoters of Bharat Forge have been issued fresh shares of KSSL.
Why is this a problem?
The issue is: the shares have been issued at par, i.e. Rs. 10 per share. Why are promoter companies getting to buy shares at Rs. 10 per share, when Bharat Forge has done all the hard work of setting up Joint Ventures etc. through KSSL?
KSSL is their defence arm, and was owned 100% by Bharat Forge. It never was in the need of money – and if it needed Rs. 1.38 crores, this is so small an amount that Bharat Forge could sneeze and that much would be magically available. No, this is rotten because the amount was tiny and that the shares were sold at par.
Remember, the shares were issued to promoter companies in March 2016.
KSSL had a joint venture with SAAB in Feb 2016. Was that worth nothing? Even after that, no premium was paid by promoters.
In May 2016, the conf call transcript of Bharat Forge even says that they fielded a gun program (in response to a question about artillery) in KSSL, and they were looking to bag orders.
The fear is that promoters will try to take part of what should entirely be the property of Bharat Forge shareholders. In such instances, one does not get the confidence that the promoters will allow profits to continue to flow through the listed company. This should be addressed by Bharat Forge immediately, and in the longer term, SEBI should increase disclosure norms when subsidiaries issue shares and dilute parents.
Disclosure: No positions.
The original post is by Mastermind, Sana Securities, authored by Rajat Sharma and appears here.
I wasn’t really sure of the title to this post but the idea stemmed out of a question that I received from a subscriber.
Instead of repeating the exact question, I will break it up into 2:
- Can you earn fixed interest income on the spare cash lying in your trading account?
- Should you transfer spare cash into your bank account where you can earn up to 4% – 6% interest (savings account rate for Yes Bank and Kotak Mahindra Bank) or can you earn higher?
Cash Position: The best cash position is naturally the one that earns the highest possible ‘fixed income rate’ in the market. Fixed interest income can be earned on – money lying in savings/ current account, money market and liquid funds, ultra-short and short term funds and medium and long term funds.
As a trader or as a short term investor, you will require the money that you keep in your trading account at a short notice. For this reason, many short term investors believe that the best thing to do is to transfer funds from trading account to your savings bank account, perhaps at the end of the trading day (i.e. at 3.30 pm) and allocate them back to your trading account terminal when needed. It’s all in real time with internet banking these days. This is not the best thing to do.
How much are you going to earn by doing this?
Savings bank interest: In the most aggressive (bank) scenario you will earn ~ 0.06% on a weekly basis (i.e. ~ half of 6% divided by 52 weeks; considering that you transfer it exactly at 3.30 pm each day for until when the market opens on the next day).
Now consider a Liquid fund on the Mutual Fund Segment within your trading terminal.
Liquid and money market fund interest: Typically, these funds earn between 7.8% – 7.9% annual interest but that’s not all. You can actually stay invested in these funds unless you need to settle a trade (see example below). Here you will earn ~ 0.15% on a weekly basis (i.e. 5.8% divided by 52 weeks; see example below).
Example: You have Rs. 2,00,000 lying unutilised in your trading account and do not want to buy anything or make any position. You can either transfer this money to your bank account or buy a money market or liquid fund which typically earns 7.8 % return with very little volatility.
If you have stocks lying in your demat account, you will typically get 4 times their market price as margin to trade / invest (i.e. if you have stocks with current market value of Rs. 2,50,000 in your demat account, you will be allowed to buy/sell for up to Rs. 10,00,000/-). No interest will be charged on such buying and selling for up to 3 days**. Even on the 3 rd day, all you have to do is sell your liquid fund and your account is settled immediately. So practically, you may never have to sell your cash position. All you have to do is to define how much of your capital would you want to keep in cash at any point, based on market factors.
** These margins and limits may vary. The above is based on the limits we provide to all our clients.
Now consider this:
If you choose an ultra-short to short term fund where interest rates are 8.9% – 9.6%, and can stay invested for up to 15 days, then you earn ~0.18 % on a weekly basis (provided that instead of 2-3 days, as above, you can plan your buying and selling for up to 15 days).
Depending on market factors you do get opportunities to invest in even higher interest bearing instruments. For now, if you are still worried about losing out on basic interest income in trading account and are constantly transferring money back and forth between your accounts, STOP. There are easier solutions in life and better things to do after 3.30 pm.