How and why vs what I do and why I do Segment:
How to choose the segment of trading/investment?
Segment here refers to Cash/ Futures/ Options/ Commodities. The risk of each segment varies and is increasing in the order of Cash<Futures<Options (Commodities is a different sphere altogether, so leaving it out of scope for now). The risk of a few illiquid stocks is more than the rest; as at any given point buyers or sellers are less than liquid stocks. Sometimes even buying just 100 stocks, may take a whole trading session. So in order to choose a segment one has to understand risk appetite. Risk appetite is not what one feels is the risk they can take but the risk tolerance which can be derived after understanding the amount which is free to use, not a liability or loan from anyone including a parent, and something that can be written off till a system is back tested and improved (even if a system is developed there can be % of write off, but how to manage that will form part of evolution as a successful trader/investor).
Why should one choose a segment and not trade in all when developing and fine-tuning a trading system?
Everyone graduates over a period of time. A strategy that can be valid for the cash segment and trying to apply the same in futures and options may not work. For example: if a person’s trading system issues a sell for stock trading at 110, and as per the trader’s guesstimate the stock has to come down to 90, considering this analysis, the trader either shorts the stock in futures or takes put options of the strike 105. But the stock trades flat and mostly above 110 till the expiry day and falls the next day way below 90. In this scenario, a trader will be booking loss in the FnO segment as expiry, and time decay would have worked against the FnO trade. However, if the trader was holding the said stock and sold at 110 and re-entered at 90, then in the bargain he would have managed to buy more stocks than suffer a mark to market or M2M loss. So choosing a segment to trade and developing one’s understanding of the product is important. Futures and options are used by traders and fund houses to hedge their positions. Many traders make this niche area of expertise. However in the learning phase at least it is not required for a person to try and incorporate all segments of the trade.
What I do and Why I do?
What: I trade in cash stocks and index futures only. 99.99% of the time I avoid options.
Why: I understand the dynamics of stocks and choose them on various parameters that I have either skill or knowledge about. For years I stuck to only cash segment trades. I trade index futures on most days for limited points and do not wait for big targets. This ensures that on days and weeks together when the stocks in my trading list are moving in a flat range, I can clock some profits at least and maintain consistency in my trading account P/L statement. If I depend only on the cash stock segment, then often weeks can pass without a trade. During such phases, out of frustration entering into a trade which hitherto my system may not warrant is possible. There are days when both cash and index may not move much or not offer a trade as per my system. These days are my self-proclaimed trading holidays.
And I love such breaks.
Holding period — How to choose?
Holding period of trading or investing can be
- Buy and Hold strategy for the long or medium term
- Swing Trading
- Intraday Trading
For the same stock as the cash segment, the risk increases with a decrease in the holding period. However, this is not true for all stocks.
If one holds the stock for a longer time frame, the risk is mitigated. But the argument that time-diversification reduces risk is flawed but it is useful in bolstering self-control and mitigating fear. So the risk of the portfolio depends on what you hold and is not just mitigated because it has been held for a long time.
How and Why to choose a holding period to develop your trading system?
How- The amount of time one can spend for their investment/trading and the risk appetite should be the basis initially to choose a holding period.
- Can’t spare time at all — Ideally, take the advice of a professional fee-only planner and invest through a well-managed mutual fund.
- Can spare time once every 6 months — Review and develop a system to hold stocks for the long term. Use market conditions to buy in dips. The holding period is ideally more than 3 years.
- Can spare time once a month — Develop a system, review, and improve for medium-term stocks. The holding period is more than 3 months and up to 3years.
- Can spare 1–2 hours during trading days — Develop a swing trading system that focuses on using the swing lows and highs of stock to book quick profits. Review every week to see if you can wait for the entire expected target or need to book out quickly. The idea of swing trading is to make consistent profits using momentum stocks that are in range and have been testing the same support and resistance zones over a period.
- Full-time trader — Develop a system that can suit any holding period strategy. You can be even an intraday trader provided your system can handle the risk and you limit it through position management and stop loss.
Why should a trader develop a trading system based on the holding period?
The holding period for which one intends to trade or invest will be the basis on which the entire strategy is developed, improved, or revamped. A stock can be more volatile in 6 months but less volatile in a longer time frame. Likewise, another stock can do nothing for months together and cover the entire trajectory of the upswing in one month. So the holding period will decide what type of stocks can be picked for trading or investing.
What do I do and why?
I started out as an intraday trader under the guidance of my mentor. I still remember I ran out of the room after looking at the flicker of the changing prices of stocks. Starting out as an intraday trader perhaps suited my psyche but I will not ask anyone to go straight for it. In my case, I was quick to learn and at least had fundamentals about company law, issued capital, free float, etc clear. I could read any company’s financials and understand the basics because of my educational background. Over a period because of lack of time I stopped intraday trading and concentrated on building a medium-term and long-term portfolio. As time progressed, with turn-in events, a market-related post-graduation followed by a job in capital markets helped me understand my basics in fundamentals to a point where I wanted to take it up as a whole-time profession. But before leaving the cushion of a well-paying job, I had to tick off a few aspects like; Need close to enough stock accumulated as per target requirement in my long-term portfolio; My medium-term portfolio returns at that time should at least be good enough to supplement my then bonus amount if not on yearly basis, once in two years basis. Post this I had to allocate capital for a swing trading portfolio and start trading while I still had a job to test the waters. Once everything was in place, I quit my job to take up trading and investments to support my living and secure even my future.
Initially, I made the typical mistake of buying the right stock but not at the right time. My technical analysis back then was limited to pivot calculators (today I can trade even with a pivot calculator). Though I was aware of most of the indicators everything seemed fuzzy. This was the time when I dug back into post-graduation books and fished out the only TA book I ever read- TA and Stock Trends by Edwards and Maggie. Honestly, it did not help. This is when I sought help from like-minded people and established traders. Most of them helped when approached (99% without any expectations). They asked me to start applying indicators and question the logic behind an indicator. I went a step ahead and tried to understand the statistics behind an indicator. To date this is the basis when I learn something new, what is the formula, and how can it improve my existing system. There was a stage when I improvised my system with a hybrid system of price action and indicators. I understand the need to keep updating and yet keep the system as simple as possible
Stock selection
How to choose a stock that suits your trading or investment strategy.
Pick or eliminate your stocks not just on the basis of ROE, beta sensitivity, momentum, and ability to deliver X returns in Y period but also on the basis of corporate governance and their operating cash flow. Unless one is picking stocks based on value, too much emphasis on the Free cash flow and Capital Asset Pricing Model can be avoided. If one likes the story that the company has to offer in terms of futuristic growth but has red flags during financial statement analysis like fluctuating cash flows, decreasing revenues, and an increase in the debt-equity ratio, then read the footnotes and find out what the company is doing as corrective for future. If the stock is important, and information is insufficient, you can even write to the company secretary seeking information. Most of the time it may be a template answer, but sometimes you will be surprised. Rejecting a well-performing company based on an increase in debt-equity may not be a good idea, specifically if the debt is taken as the interest rates are reducing and is an efficient way of raising capital at lower cost and the said debt is utilized to fund Capex plans of the company. As a beginner, it is better to avoid penny stocks and illiquid stocks as they are often used in circular trading which by itself is fraudulent activity. Even if you are not good at spotting the next Infosys, MRF, or Wipro, it’s ok. You don’t need to ace it. As long as you can learn to use the equity in building a portfolio by picking a strategy based on the time you can allocate, risk tolerance, and the strategy that you would like to stick to, you will be fine.
Above screeners can help in choosing your stocks based on financials, effective management, volume, and momentum. One can also check the company website for financials or exchange-related corporate announcements for a particular company.
Why should one choose a stock that suits one investment strategy?
All stocks will not suit all investment strategies. If a person is choosing to develop a strategy around swing trading, then stocks with momentum and decent price ranges with good fundamentals are better choices over low momentum and less volatile stocks. This is because a good swing trading system helps the trader use volatility to their advantage. The reverse is also true and can lead to losses, if the trader misses in developing a good system, learn the importance of back-testing it and improvise it over time. One should not invest with a trader’s system/mindset or trade with an investor’s system.
How do I choose stocks?
First, let me speak about what I will avoid
I avoid stocks with corporate governance issues. I avoid stocks that have been in the limelight for the wrong reasons. For eg — Never traded in yes bank to date because it was one stock that changed the way IPO markets operate but not for the right reasons.
https://www.business-standard.com/article/markets/the-scam-that-changed-india-s-primar y-market-116080101718_1.html
I avoid penny stocks — There are better stocks that aid my purpose and don’t need to be penny stocks unless I am committing an insignificant amount based on fundamental factors that I might have liked.
I don’t pick stocks with heavy promoter pledging specifically with low cash from operations and weak past performance. A simple Google search will throw up the list of stocks with high promoter pledged stocks. Screeners can also be used for this purpose.
What I do?
The basics of fundamental analysis that I apply are already explained in a detailed article by
Zerodha Varsity:- https://zerodha.com/varsity/module/fundamental-analysis/
I give more importance to profit and loss and cash flow statements and due diligence in comparison to other parameters already explained in the Zerodha link. I understand DCF because that’s what I did for 7 straight years of my life. However, there are many online tools these days that are close to a fair analysis. https://tradebrains.in/dcf-calculator/
I also check Economic Micro and Macro Trends, sectoral trends, Industry-related news, and policy changes every week. However, I cannot trade with constant news channels blabbering, not even on a budget day.
Lastly, not all companies that I trade need to have consistent profits, however, the stocks that I invest in for a medium or long-term buy-and-hold portfolio cannot have red flags in financial statement analysis or governance issues.
Long-Term Stocks –
I prefer global diversification in the businesses of the companies that I intend to hold for a long. Foreign companies with a global presence or Indian companies that are expanding to different continents made this list on the basis of being a world leader in their core products. I prefer the manufacturing and pharma companies on this list.
The companies held in this list also have been able to grow organically and inorganically thus rising up the ladder to becoming the best in their sector. Driven management and capital budgeting decisions have been the reasons for the choice. I keep my long-term portfolio list very minimal. There are only 9 stocks on this list. I avoid cyclical stocks in my long-only portfolio.
Medium Term Stocks-
I prefer stocks with sound businesses, which have visionary leadership looking to scale up their operations while keeping costs down. This is the portfolio where I am willing to take cyclical bets and also foray into spaces that I don’t understand very well yet are important industries per se. For example, unlike my choice of only manufacturing and pharma stocks in my long-term portfolio, stocks from the IT space that too the ones who are establishing their presence in IoT or Internet of Things interests me. I also like holding and investment, trading companies, cement, sugar, fertilizers, NBFC, and banking stocks for this range of investments. I don’t like OMC stocks, textile, toys, and jewelry stocks. OMC stocks can be good for trade but the extra need to keep checking crude charts deters me from keeping this for longer time frames investment stocks; however, they are ideal for the swing when nothing else is working. Textiles, toys, and jewelry are need and trend-driven. I personally like stocks of companies that are either leaders in the manufacturing or service industry, specifically companies who have established businesses across different markets. I don’t have a separate value portfolio but at times like to search for stocks whose ratio of Market Cap to 3 years operating cash flow is in the range of 3–5. I like to research these stocks further for a medium-term position. Yet times these stocks become the best picks.
Swing Trading
I like to swing anything and don’t mind trading stocks that have loss-making quarters in this category. However, the ground rule of staying away from any company without transparency and being caught up in news for the wrong reasons remains. Such stocks are definitely not making even to this list (not even for the adrenaline rush). The reason I buy and sell stocks at a particular price for swing trading is purely based on technical reasons.
How to develop trading techniques based on Technical Analysis and what I use regularly in my system.
Technical analysis can range from simplest to complex predictions based on the past performance of a stock. Given are types of TA tools I know, listed based in ascending order of their complex calculation. Each of these points can and should be researched, back tested, and used over a period of time frames and varied stocks before designing a traders system. Note: I don’t use all of them though I have a fair idea of all the under-mentioned tools. I keep my charts as clean as possible
Pivot calculator — Depending upon the open, high, low, and close price of the pivot point, resistance and support prices are formed. Apart from classics, there are variations. They can be plotted on a chart or used separately. One can even make their own excel and update their stock list on a daily basis with pivots for the next day. This is the first step I learned in my TA journey and I still do it religiously. https://in.investing.com/tools/pivot-point-calculator
Candlestick analysis — A candlestick’s shape specifically after a continuous bullish or bearish trend, can be used as an aid to predict reversals. However many reversals and continuation signals can be either weak or not understood in totality leading to more errors. But its study helps understand trends, patterns, support and resistance zones, and possible breakouts that are the crux of price action. The book Beyond Candlesticks by Steve Nison is a classic and there are other good read links that can help one get a better idea. https://www.elearnmarkets.com/blog/35-candlestick-patterns-in-stock-market/
Price Actions — Trend lines, patterns of shapes of cup and handle, necklines. Head and shoulder, reverse H&S, and channels are a few basics of price action. Pure price action goes just by the direction of the price of the security. To develop a strategy with pure price action is like charting the course in darkness on an unknown road; only reliance is on your understanding of the vehicle, the headlight source, and your own driving skills. It is a highly skilled job. However, when used in tandem with one or two indicators it can spin magic. As more indicators are tested with simple price action patterns, a simpler and more reliable trading system can be developed is an example where the price action of downward channel breakout in a daily time frame was bought with Fibonacci retracement as a target, and RSI is considered as a confirmation to close this trade which will be in a new few days when RSI in Daily charts moves closer towards 70.
Indicators — Indicators can be divided into upper chart overlays and sub chart overlays.
Most go with a broader classification of indicators based on Trend, Oscillators, Volatility, and Support & Resistance. If one understands the basic formula behind an indicator, then whether to use two indicators together or not to eliminate conflicting results becomes an easier choice. For example, the MACD measures the relationship between two EMAs, while the RSI measures price change in relation to recent price highs and lows. So one trend and one oscillator can give better confirmation to traders. A simple article that can help one expound further
https://www.dailyfx.com/education/technical-analysis-tools/technical-indicators.html Fibonacci Retracements — This helps as a predictive tool for likely price retracements at the initial stages of a trend reversal. Thus a trader can take a position and trail it with a stop loss for a target indicated by Fibonacci ratios. There are seasoned traders who trade momentum stocks based just on the Fibonacci series without the help of any chart. Even I follow this setup for a few stocks. A simple article is already published in Zerodha https://zerodha.com/varsity/chapter/fibonacci-retracements/
Gann/Elliott Waves/Harmonic and Financial astrology — All these four topics need a space of their own. It’s more complex for my understanding and beats my purpose of keeping the trading system as simple as possible. However, to my understanding, those who are purists in the said fields are able to predict the trend way ahead. Financial Astrology and its derivative developed by Gann can even predict the dates way ahead. I do not use any of these studies for my own trades; however, do keep reading articles of practitioners.
Open Interest and Vix- Fno Indicators are not exactly Technical analysis but do give the perspective of where buyers and sellers are unwinding the positions.
What do I use?
Time Frames and technical tools used
Long Term -: Chart Time Frames — Weekly and Monthly; Price action confirmation for continuation patterns.
Medium Term -: Chart Time Frames — Weekly and Daily; Price Action for trend reversal, Indicators, and Fibo retracements.
Swing Trading -: Chart Time Frames — Hourly and 2H (few stocks give better confirmation in 2H), and daily; Indicators and Fibo retracements for a swing low and high.
Index Future: Chart Time Frames — 5 Minutes, Hourly, Daily; Price action, classic pivots, VWAP. Refer to VIX and OI on and off.
How I choose or modify the indicators for my set-up?
All tools of technical analysis are based on price and volume. So it was important for me to understand my indicators. I can do this by understanding their formula. This helps in improving my system in multiple ways. For example, I have my own set of excels that can be run on a daily basis to give results that form the basis for my decisions. I have close to 30 stocks that form the basis of my swing trading setup. This stock list is revamped from time to time. By just updating the open, high low, and close of all stocks, the entire lists of pivot points and their supports and resistances are plotted instead of doing it individually in a calculator or charts. There are days when I just want to trade without charts and rely on this information only.
Understanding formulas of the indicators also eliminates the overuse of indicators and helps me understand which are laggards over others but can give better confirmation in longer time frames.
For Trend — I use 89 MA, 233 EMA and MACD, and ADX in daily TF, and Higher Highs, Higher Lows for bullish trend and Lower Highs and Lower Lows for bearish setup.
For the Oscillator- I use RSI in hourly and daily TF
For Volatility — I don’t use volatility indicators beyond checking VIX for Index future trading
For Support and Resistance — I use classic pivots for stocks and Classic pivots + VWAP for Nifty and Bank Nifty Futures trading.
Note: What indicators I use may not be part of my system in the future as the structure of the market, my risk appetite, and the time that I can actively spend will change. Besides, my setup is limited to my knowledge and skill. I will sincerely request anybody to use this broader framework as a generic write-up and not copy it straight. My system works for my choice of stocks. I know to tweak them if there is a need. Most topics are easy to understand; I tried to give as many reference links and charts as possible; they can also be Googled and there is no need to buy any reference material at a beginner’s level. However, enough time and practice are required to apply them over a series of times. Developing, back-testing and fine-tuning a trading system will take considerable time and effort. Unless one genuinely spares both, they will not remain in the 1% of successful traders often given as reference by most as Nikhil Kamath’s quote based on data.
