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No matter how much net practice (paper trading) one does, the true test of a trader (in the stock market) comes only on the real pitch and in playing with the big boys.
Trade execution is very important to ensure that you do not end up buying tops and selling bottoms although that too will sometimes happen. The goal of good trade execution is to get into low risk situations which give you a wide stop loss and the trade gets enough room to gyrate before moving on and you need to actually be wrong for the stop loss to be hit.
Buying oversold situations in an uptrend and overbought situations in a downtrend should be the goal of trade execution:
a. The best entries are achieved in the latter half of the day. I avoid all trade execution in the market's first hour. The advantage of entering trades late, and particularly in the last hour, is that by then the market has had all its intraday swings and is moving in the direction it finally wants to take.
b. The one exception to the above rule is that if the market gaps down and the main trend is up; I like to buy when the market opens. This generally provides an excellent breakeven level and is usually a very high percentage trade.
Once you get a trade that immediately moves about one average true range into the money, you just need to trail stops and let the profits roll in. The same applies to sell side trades.
c. I have access to 5- and 30-minute data as well as I like to take trades when some kind of a breakout happens on a pattern on any of these charts; 30-minute charts for daily entries and 5-minute chart for intraday entries, provided the main trend is in place on the higher time frame.
d. If a trade on, say, the Nifty is executed on the long side and the stop loss of one average true range is hit, I would like to see the breadth of the market and see if the market is making lower tops. If so, I reverse the trade. So I take a stop loss getting hit as a signal for a trade possibility on the opposite side. These trades are often big trades since, like me, other traders could also be trapped.
e. I take profits on overnight positions at the opening if the market opens with a favourable gap, but new positions should not be initiated.
f. Gap openings in the direction of the main trend should be dealt with very carefully. Personally, I like to wait a while till the market makes some kind of trading range beyond the gap, or the gap gets filled after the opening and takes support at some point before taking action. As risk free as the gaps in the opposite direction are, I have found gaps in the direction of the trend to be extremely risky. Keeping patience in the case of such gaps is the best strategy.
Trade management
Contrary to what most people think, the part of trading that makes you the most money is trade management. Trade management is the part that happens once a trade has been taken on. Many traders do not get far enough to critically review their trade management skills, since most trading careers end while learning the mumbo jumbo of technical analysis.
Once a trade is on, three things can happen:
1. Trade moves deep in the money quickly
This is the situation all of us hope for. I start the trade with a one average true range stop. As the market moves into the money by one average true range, I move the stop to breakeven. This means I give the market room for at least one average true range to go through its intraday gyrations. Intraday pivots can be used as the stops for intraday charts.
I just let the trade reach its logical targets which have been identified in my trading plan. I will hold on to the trade as long as the market keeps acting right. This means unless there is overwhelming evidence of trend change, I would not get out of the trade.
This might take away some profits from you if the markets turn exactly from the targets identified earlier but the tendency to stay longer with the trade will help in the long-term because the market operates on excesses. As the targets approach, however, stops can be tightened or partial profits booked but keeping some of your position will keep you in the trade till the end.
Always, try to trade with the trend unless there is overwhelming evidence of a trend reversal. In counter-trend trades it's important to remember that technical targets may not be met and you should be prepared to book profits at the first sign of reversal.
2. The trade does nothing for an entire session
This can happen in choppy markets where the index and stocks can stay in a narrow range for many days. The index or the stock may meander around the breakeven level, neither hitting the stop loss nor advancing any further.
In such situations it's best to get out of the trade and make a fresh entry another day. Alternately, you could consider selling straddles or covered calls. But a trade that does not immediately move into profit seldom turns out to be a winner in the end.
3. The trade immediately goes and hits your stop
There are two reasons why the stop loss might be hit:
It was placed too close and got hit by the noise in the market. To check this out, observe the market for a while and try to enter the next breakout and also keep a wider breakout.
If a stop loss of one average true range gets hit, then you can be sure it probably was not noise. You should then consider the breadth of the market, look at intraday patterns on the index as well as key stocks, and consider selling on the next rally. The best moves occur when the market initially changes direction because a number of traders do not take timely action when the market is not acting in their direction.
Finally, remember the following thumb rules in all types of markets.
Extraordinary market volatility indicates an impending decline and is a sign of distribution, particularly at the top of the market.
If the volume drops in an upmove and the market goes extremely quiet, it means that the fuel needed to keep the market is running out and it would soon go into correction, or will reverse trends.
If the volume drops in a downmove, and the market becomes quiet it means a slow accumulation might be taking place. Look to trade the first breakout from a consolidation pattern.
If a market is dropping on heavy volume, it means there is more downside yet to come and people are getting out in a hurry.
Indians love speculation. They love taking risks with whatever they have. Often they are cheated by lottery owners and casino owners into thinking that huge riches await them. At other times they lose their shirts to frivolous ventures such as plantation companies. but derivative trading is different, it is a game of skill where the best man wins. It cannot be manipulated to give an unfair advantage to anyone.
Excerpt from:
How to Make Money Trading Derivatives: An Insider's Guide
by Ashwani Gujral
Price: Rs 395
Ashwani Gujral trades derivatives for a living and is a featured expert on CNBC. He also writes regularly for the leading US specialist magazines and journals on trading and technical analysis.
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