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How to Trade with No Confusion?

According to Pareto principle, 2 indicators out of 10 will give right signal. So it is better to exclude those eight indicators that has high degree of power to create a confusion in your mind.

In the previous article I have discussed how to choose a stock to make long term investment. But these stocks can also be used for short and medium term investment.

For a beginners it would be wise to invest in long term rather than short term. Learning is the key that will determine weather one will make profit in share market or not. Learn technical analysis and all the terminology related to a company’s growth before making any decision to buy or sell. Following the news and knowing the company’s net profit, assets and liabilities is not enough to know the future direction of price movement. One should also have a sound knowledge of technical analysis to make profit in the volatile share market.

First of all one has to understand that more the number of indicators employed in the analysis of share price, more you will be confused. You can’t reach to a right decision by using too many indicators and criteria to buy or sell a share. There are thousands of indicators and oscillators in the vast ocean of technical analysis topic. It is purely a research work that will include or exclude the indicators for reaching a correct decision. Also, according to Pareto principle, 2 indicators out of 10 will give right signal. So it is better to exclude those eight indicators that has high degree of power to create a confusion in your mind.

My extensive research has included only two indicators to determine the future direction of price movement of a stock. These indicators are

1. Trend line

2. 14 Period Stochastic oscillator

Drawing a trendline requires  experience but  it is not so difficult to learn and it gives right signal with 95% accuracy. My analysis of 14 period stochastics oscillator is somewhat different from the inventor of this oscillator that again makes this indicator to give 95% correct indication.

In this article, I am going to use some of the terminology that are unfamiliar for those who rarely read articles of technical analysis of stock market. But I will try to keep it as simple as possible. Before going to the actual analysis, I will like to share about the basic knowledge of trend, especially with beginners.

What is a trend?

The ultimate direction of price movement of a share in a specified time period is called a Trend.

Classification of trend

Classification on the basis of direction of price movement

Share prices move in 3 directions, so it can be classified according to the direction of trend.

1. Uptrend

Whatever may be the fluctuations in the share price, ultimately the price of share rises.

Monthly chart of nifty 50 showing up Trend
Monthly chart of Nifty 50 index, source Economic Times of India
2. Down trend

Whatever may be the fluctuations in the share price, ultimately the price of share falls.

Weekly chart of Coal India Limited showing down Trend
Weekly chart of Coal India Limited, source Economic Times of India
3. Sideways Trend

Whatever may be the fluctuation in the share price, ultimately the price remains in a horizontal narrow region.

Daily chart of Steel Authority of India Limited, showing sideways trends
Daily chart of Steel Authority of India Limited, source Economic Times of India

Classification on the basis of time

Another type of classification of a trend is on the basis of time.

1. Long term trend – When a trend lasts for a very long period of time

2. Medium term Trend – When a trend lasts for medium period of time

3. Short term trend – When a trend last for a short period of time.

4. Very short term trend – When a trend last for a Very short period of time.

Strength of a trend

Long term trend is more powerful than medium term trend and medium term trend it is more powerful than short term trend.

If long term trend is showing an upward movement but medium term and short term Trend is showing downward movement, then the medium and short term Trend is ultimately going to reverse from downward movement to upward movement. This is because long term trend is more powerful than medium and short term trend.

Classification of charts with respect to time

Now, Charts can be classified in the following groups

1. Long term chart (say, monthly chart)

2. Medium term chart (say, weekly chart)

3. Short term chart (say, daily chart)

4. Very short term charts (say, hourly, half hourly, 15 minute, 5 minute, 2 minute, 1 minute charts) These charts are generally used by intraday traders.

How to know the direction a trend

There are many methods to know the direction of the current trend. But here I will suggest an easy method to know the direction of the trend.

Determining the direction of long term Trend

To know the direction of long term trend plot monthly chart over your screen. Just below the monthly chart plot 14 period monthly stochastics. Also plot a horizontal line over stochastics chart at the level of 50.

Analysis

1. If the fast stochastics line is above 50, then the long term trend is upward.

2. If the fast stochastics line is below 50, then the long term trend is downward.

Determining the direction of medium term Trend

To know the direction of medium term trend plot weekly chart over your screen. Just below the weekly chart plot 14 period weekly stochastics. Also plot a horizontal line over stochastics chart at the level of 50.

Analysis

1. If the fast stochastics line is above 50, then the medium term trend is upward.

2. If the fast stochastics line is below 50, then the medium term trend is downward.

Determining the direction of short term Trend

To know the direction of short term trend plot daily chart over your screen. Just below the daily chart plot 14 period daily stochastics. Also plot a horizontal line over stochastics chart at the level of 50.

Analysis

1. If the fast stochastics line is above 50, then the short term trend is upward.

2. If the fast stochastics line is below 50, then the short term trend is downward.

Determining the direction of very short term trend (used by intraday traders)

To know the direction of very short term trend plot hourly chart over your screen. Just below the hourly chart plot 14 period hourly stochastics. Also plot a horizontal line over stochastics chart at the level of 50.

Analysis

1. If the fast stochastics line is above 50, then the very short term trend is upward.

2. If the fast stochastics line is below 50, then the very short term trend is downward.

When to buy a call option

When the below mentioned conditions are fulfilled by a stock, one can execute order to buy

1. Long-term trend should be up – In monthly chart, 14 period stochastics should be above 50

2. Medium term trend should be up – In weekly chart, 14 periods stochastics should be above 50

3. Short term trend should be up – In daily chart, 14 periods to stochastics should be above 50

4. 1 hour chart is one of the strongest chart for intraday trading. Next we will watch movement of stochastics in one hour chart.

Buy signal

When 14 period stochastics of hourly chart moves from below 50 to just above 50, execute trade order to buy.

Sell signal and / or Stop loss signal

When 14 period stochastics of hourly chart moves from above 50 to just below 50, execute trade order to sell or stop loss.

A word of caution

Don’t worry or make drastic change in decisions, if stochastics oscillator moves above 80 (ie overbought territory) or fall below 20 (ie oversold territory). If you watch closely maximum price movement occurs in overbought or oversold territory. Also neglect the crossover of fast and slow stochastics (ie K% and smooth D% crossovers) as it shows numerous false signals.

Basic disciplines to be maintained for option trading

1. Strike price selection : The strike price should be close to the actual share price and it should have high open interest with high number of contracts traded. In technical terms, select at the money contracts with high open interest.

2. No trading should be done in the last week of expiry date of that option.

3. No reversing of trade immediately after suffering a small loss.

4. Before ordering a new trade, plan where to make a stop loss. Always remain strict with yourself to order stop loss according to your plan.

4. Never trade against the direction of long-term or medium term trend as prices will ultimately and suddenly start following medium and long term trend.

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