Making Money In Short Term

The Indian equity market has been one of the finest performing equity markets this year with the BSE Benchmark Index Sensex rallying about 25 per cent so far, compared with a 5 per cent increase in the MSCI Emerging Market Index. Most of the analysts on the street remained pessimistic about the Indian equity market and termed this rally as short-lived with the expectation of a razor-sharp correction in the market post the election results. This is because they termed this rally as an “expectation rally” or “NAMO rally”. However the markets continued to inch higher and touched sky-high level post the election verdict.

At Dalal Street Investment Journal we continuously track the markets and guide our readers on the mid to long-terms trends. However, there is another volume-driven activity that investors keep getting into with little or no knowledge. We are referring to short-term trading, a space that has lot of opportunities to increase wealth but as much to destroy as well. We will refer to the short-term investors as ‘traders’. The psychology of retail traders is known as “fear and greed” psychology i.e. when the market runs up quickly, the unprepared trader falls in a trap of greed and in fear of missing out on the next big move chases the market. After the dust settles, the trader finds himself holding a long position at the high of a market poised to fall. This psychology of market participants leads to capital destruction and they end up blaming the market as “satta bazaar”.

Agrees Siddharth Bhamre, Head-Equity Derivatives & Technicals, Angel Broking: “It may sound cliched but this is due to a greed and fear issue. My suggestion would be not to get carried away by news or stocks which are in the limelight.” Hence this article will address this misconception and present various ways in which wealth can be created in the short term, albeit with a disclaimer that these approaches tend to have higher risks and no approach is a guarantee.

What is Short-Term Trading?

In general, short-term trading means holding an asset for a short period of time. From an investing perspective, it is a security that matures in one year or less. Short-term trading involves the opening and closing of positions in as little as five minutes, at the most 12 months. In many cases, technical analysis is an ace tool used in short-term trading by the trader. It takes a considerable time to analyse fundamental studies and as such fundamental tools have little value in evaluating short-term events. Technical analysis however is the ultimate for trading in volatile and changeable market conditions.

Short-term trading helps a trader to define his risk and reward and it also helps a trader to encash on short-term trading opportunities with limited exposure of capital. However the above sentence would be hard to digest for some of the traders as statistics say that most of the traders end up on the losing side. However, if proper discipline is exercised and the art of choosing the right stocks is followed, this could be a fruitful journey.

The short-term trading style can be categorised into four main categories:

• Scalpers (quick in and out trading)
• Day traders (intraday trading, no overnight positions)
• Swing traders (short-term trend momentum trading)
• Position traders (buy and hold trading)

Day Trading: Day trading is the buying and selling of various financial securities such as stocks, future, options, commodities and currencies with the goal of making a profit from the difference between the buying price and the selling price. Day trading as a style is more suitable for traders that prefer starting and completing a task in the same day. Many day traders would not consider making swing or position trades because they would not be able to sleep at night knowing that they had an active trade that could be affected by global events or the impact of some economic event. Day trading gained popularity in the last Bull Run.

Swing Trading: Among short-term strategies, swing trading is perhaps one of the most comfortable and promising trading styles for short-term traders. In this trading style positions are opened and closed in the course of a few days or weeks; position size is defined as per risk –reward. Swing traders have clear limits in mind when it comes to volatility and ranges and will refuse to get sucked into market mayhem if events move against what was being anticipated by a trader. Swing trading strategies don’t normally appeal to many short-term traders on first impression. They look too boring to most new traders as the frequency of trading is not so high.

Position Trading: Position trading is a buy and hold style of trading where trades are held for anywhere between a few weeks to several months. This style of trading is suitable for office-going professionals who don’t have time for day trading and this style of trading suits most of the traders as it eliminates intraday noise. Agrees Bhamre: “I have strong belief that a positional trader can make decent money in this market if he uses a combination of delivery base trading and options’ segment.”Positional trading uses long-time frame charts, including daily, weekly and monthly charts.

How to Manage Capital Efficiently and Effectively in Short-Term Trading?

Money management has many names such as asset allocation, position sizing, bet size, portfolio allocation or capital management. Money management or capital management strategy is one of the most vital variables that will give a retail trader the edge in short-term trading. A retail trader cannot control the volatility or price fluctuation of the market but he can control his money and risk on each and every trade that he executes. Comments Bhamre, “Follow proper money management i.e. if one loses X per cent in trade he moves out and this X is determined by the risk appetite of the trader.”

William O’Neill, founder of Investor’s Business Daily, has said that “the whole secret to winning in the stock market is to lose the least amount possible when you are not right.” Money management is a defensive concept. It keeps you in the game to play or trade another day. For example, money management tells you whether you have enough new money to trade additional positions.

Why Exactly is Money Management so Important?

Determining your bet size in trading is crucial in short-term trading. If a trader is not aware how much to buy or sell at all times than he is in trouble. If you start with Rs 1,00,000, is your first trade 10 per cent of that or 5 per cent? What is the number? A trader should be aware about the bet size. Below is an illustration which helps you to understand why position sizing or money management is important in trading.

There are two traders named Trader A and Trader B. Both these traders trade in Nifty future and have a starting capital of Rs 1,00,000 for trading. They trade in Nifty contracts daily and each contract size is of 50. Both the traders follow similar analysis and enter the Nifty contact at a similar price and exit similarly as well. However the only difference is that Trader A has kept his position sizing constant with two contracts daily and on other hand Trader B picks up a random number of contracts. Let us see which trader enjoys the fruits of profit?

In above example, Trader A has kept his position sizing to two contracts and he maintains this position sizing consistently. At the end of five trading days he manages to earn Rs 2,000 through a systematic position sizing approach.

In above example, Trader B picks up a random number of contracts as he has not planned his position sizing. At the end he suffers loss of Rs 6,000. Both the traders follow a similar trading pattern but the only difference is in position sizing. So it gives us a clear idea that along with analysis, position sizing (money management) plays an important role in successful trading. What are some of the issues addressed by money management or position sizing?

• How much capital do you place on each trade?
• What is the frequency of your trading?
• When must you take a loss to avoid larger draw-down?
• If you are on a losing streak do you continue to trade in similar manner?
• How is your trading adjusted with accumulated new profits?
• How must you prepare if trading both long and short positions?
• How is volatility handled?
• How do you prepare yourself psychologically?

Psychology is the study of human behaviour and thinking. It is important because it helps you to understand yourself better. It also helps you to understand other people. If you understand psychology, you can change your own behaviour and help other people to change theirs. You can also predict how other people are going to react to things. There are a number of characteristics and skill-sets required by a trader in order for him or her to be successful and consistent in the game of trading. These characteristics include the ability to determine the direction of the trend; identifying proper chart pattern; and selecting the right stock. However, not one of these is as important as the ability to contain emotions and maintain discipline. Most of the successful traders believe that trading is 75 per cent psychological and 25 per cent analysis. However, measuring the percentile is a bit difficult but it’s true that trading is more of psychological work.

The psychological part of trading is particularly important and the rationale for that is fairly straightforward since a trader is often darting in and out of stocks on short notice, and in this process a trader is forced to make rapid decisions. To accomplish this, a trader needs a certain level of presence of mind. Traders also need discipline so that they bond with previously established trading plans and know when to book profit and when to get out of trade.

Here are some common reasons why traders lose money in a stock market:

When traders lose money, they often say it’s not my day or luck is not favouring me today. Such a lack of consistency, however, is actually the result of lack of discipline or some psychological error. Traders lose discipline with trading for the same reasons that dieters lose discipline with dieting or people getting in shape lose discipline with exercise. Quite simply, our mood, needs, and mind tends to avoid short-term discomfort at the expense of our final goal.

Not having a clearly defined trading plan or strategy in the first place:

In the ‘Mahabharata’ Abhinmanyu knew how to enter the Chakravyuh but didn’t know the way out, thereby losing his life. The same goes with traders. Most of the traders are aware of entry points but very few follow a proper exit strategy when they suffer a loss. It was this situation in 2008 when many traders entered into the trending mid-cap stocks at higher rate in anticipation of making quick money but were forced to maintain a lifelong relationship with some stocks because of the lack of a proper exit plan.

Environmental distractions and boredom cause lack of focus:

All of us have limits to our attention duration and when the market is quiet we shift our focus from the market to some other stuff like news channels or mobile games, etc. This leads to lack of focus and can cause serious problems for a trader.

Unwillingness to accept losses:

This leads traders to amend their trade plans after trades have gone into the red, turning what were meant to be short-term trades into longer-term trades and transforming trades with small size into large trades by adding losers. As Bhamre puts it, “When trades go against the traders most of them get adamant and hold on to their positions in anticipation that sooner or later their underlying would move in a favourable direction. If one can adapt discipline to follow this they can see their other positive trades making good money for them so as to be overall positive. Also one should move out of positive trade when the stock is reaching its resistance or desired percentage returns have been obtained or by revising stop loss to higher levels.”

Overconfidence follows a series of successes:

It is common for a trader to attribute success to skills and failure to situations. As a result, a series of even random or unintentional wins can lead traders to become overconfident and bend from trading plans.

Inconsistency: Most traders disobey trading signals as they don’t trade on every signal generated by the trading system. You can’t tell ahead of time which trade will be a winner and which won’t. Thus as a trader you need to obey every trading signal that a system gives you.

Situational performance pressures:

This includes financial pressure and stress outside of trading. Sometimes trading does not go according to the plan or you get a period of draw-down that might be extended in time or deep in cost. Likewise, sometimes life outside of trading presents challenges that can have an impact on you. When such incidences take place, your mindset can often be affected and as a result your behaviour can become less disciplined. A typical example is where traders have financial difficulties either in their trading or personal life and thus start to get into a mode of desperation. Their sole goal then is to make money in quick time and this moves them away from the discipline of sticking to their plan.

Taking on too much risk: High risk creates higher stress, and higher stress creates stronger anxiety and worry so that all this weighs down badly on a trader’s decision-making ability. This leads to huge painful losses that no one wants to take.

A simple piece of advice to most of the traders who are struggling with their trading would be to trade tested systems or patterns and trade them systematically. If you look at highly successful business organisations such as McDonald’s, Dell or Wal-Mart, you will find them doing the same thing, the same way, every day with high degree of consistency and discipline. They have come up with a winning formula, which is half the battle won, but they execute that formula with high degree of faithfulness, and regularly. That is how a trader should go on in trading as well.

Identifying the Trend

In short-term trading it’s important to identify the trend. There is a famous saying on the street – “trend is friend”. It means a trader needs to make trend his friend and with this he can maximise wealth. A million dollar question that arises here is: How do you spot a trend? It’s difficult, as the market never moves in a straight line.

Following are some of the methods followed by professional technical analysts and traders to identify trends:

Moving averages:

A moving average is the average price of stock over specific period of time. The most common time frames are 15, 20, 30, 50, 100 and 200 days. The overall idea is to see whether a stock is trending upward or downward. A good long candidate stock will have an increasing moving average that is moving upward. If you are looking for a good short candidate you need to find a stock with flattening out or declining moving average. One of the widely used tools is the 200-day moving average. You need to simply plot the 200-day moving average on the price chart. When the price of stock moves above the 200-day moving average line it indicates uptrend and when the stock price falls below its 200-day moving average line it’s in a downtrend. One can also look at the 50-day moving average or 20-day moving average for short-term trades.

Below is a chart of JP Associates wherein we have plotted 50-day simple moving average. One can see in the chart that as soon as the stock price sustains below the 50-day simple moving average, the stock enters into deep correction from levels of 70-odd levels to 32-odd levels and this gives us a clear idea about the trend of the stock.

Moving average convergence divergence (MACD):

This is a very important tool used by short- term traders. You just have to select the MACD and plot it on a chart. The MACD comprises two lines, fast and slow. The fast line is the difference between the 26-day exponential moving average and the 12-day exponential moving average. The slow line, also called as the signal line, is the nine-day moving average. When the fast line crosses above the slow line, it’s a buy signal, and when the slow line crosses the fast line it’s a sell signal.

Trend lines:

Trend lines are the simplest form of technical analysis; it’s one of the essential tools used by all the technical analysts for their studies. A trend line is a line drawn between at least two points on a stock chart where the price has previously found support or resistance. The more the point touches a trend line, higher is the importance of that trend line.

Below is the example of how to use a trend line to define the trend. We have plotted a simple rising trend line on the stock of ITC. The trend line support was best to buy this stock and the stock kept moving higher as the stock never breached its upward trend line support. 

Ichimoku:

Ichimoku is a technical or chart indicator that is also a trend trading system in and of itself. The creator of the indicator, Goichi Hosada, introduced Ichimoku as a “one glance” indicator so that in a few seconds you are able to determine whether the trend is up, down, or sideways. In Ichimoku the cloud help us to find the trend. The trend is upward when the price is above the cloud. The trend is downward when the price is below the cloud and the trend is sideways or flat when price is in the cloud.

Below is the chart of Lupin wherein it is evident that once the stock has moved above the cloud at around the level of Rs 978-981 it is trended one way up to the levels of Rs 1,400. Such trending stocks can be identified with the help of Ichimoku.

There are number of studies and tools available in technical analysis which help to identify a trend, but we have handpicked some of the best studies and tools which will help you to identify the trend. These are some of the tools and studies used by the DSIJ research team for its ‘POP Traders Pack’ recommendation.

Insight of Best Trading Set-Ups for Short-Term Trading

Box Trade:

For short-term trading this is one of the most valuable set-up. We have seen technical analysts place undue emphasis on some complex trading set-ups, which of course sounds good, but such highly complex patterns create confusion and too many questions in novice traders’ minds. However, if we practice simple things with conviction and proper money management it will give optimum results in trading. This trading set-up is helpful for new traders or traders who have been trading over many years.

To fully understand the methodology behind the set-up, we need to first understand how the markets work and what I am sharing with you is true for all the markets. Markets trend and they consolidate; they expand and contract. It’s usual nature of all the markets, and it has been as long as man began trading goods. When a market is trending or expanding it makes higher highs and higher lows. It’s during such a period that traders make chunks of money because the moves are big. However, trending markets only occur during a small percentage of the time. The rest of the time the markets consolidate and it’s during this consolidation time that traders must be prepared to catch the next big move. This trading set-up is suitable for momentum traders or traders who want to make quick money. 

Below is an example of box trade:

The above chart is of Mastek. The stock had witness strong consolidation for more than two months and was trading in a box and once the stock moved out of the box range it had a decent rally of Rs 100; in percentage terms 45 per cent in no time.

Andrew’s Pitchfork:

This technical tool was invented by and named after renowned educator Dr. Alan H. Andrews. Andrew’s Pitchfork, otherwise known as median line, studies or utilises the concepts of support, resistance and retracements. It consists of:

• Handle.
• Resistance trend line.
• Median line.
• Support trend line.

The above chart is of Bajaj Auto and on this chart we have applied Andrew’s Pitchfork wherein you can see the stock has moved about 250-280 points from point C i.e. Andrew’s Pitchfork’s lower line support. This trading set-up is suitable for swing traders and traders who prefer better risk-reward ration i.e low risk and high returns.

NR4 and NR 7:

This trading set-up is quite popular with short-term traders. An NR4 pattern would be the narrowest range in four days, while an NR7 would be narrowest range in seven days. The philosophy behind the pattern is similar to the Bollinger Band Squeeze; a volatility contraction is often followed by a volatility expansion. Narrow range days mark price contractions that often precede price expansions.

Bull Set-Up:

• Identify NR4 i.e. the narrowest range of four trading sessions or NR7 i.e. the narrowest range of seven trading sessions.
• Buy if the price of stock moves above the high of narrow range day high i.e. high of the fourth trading session in case of NR4 and high of the seventh trading session in case of NR7.

Bear Set-Up:

• Identify NR4 i.e. the narrowest range of four trading sessions or NR7 i.e. the narrowest range of seven trading sessions.
• Sell if the price of stock moves below the low of narrow range day low i.e low of the fourth trading session in case of NR4 and low of the seventh trading session in case of NR7.

The above chart is of Reliance Industries. The last candlestick which is marked in the red circle indicates narrow range of four trading sessions. The next day, as soon as the stock price moved below the low of NR4, the candlestick stock saw good correction.

Itinerary to Learn Stock Trading as a New Trader

New traders taking their first baby steps towards learning the essentials of this game called trading should have access to several resources of excellence education. So for a new trader wanting to take his or her first steps towards trading, here is the answer to a simple question, “How do I get started?”

Open a stock broker account:

Find a good online stock broker and open an account. Become familiar with the online trading portal layout offered by the broker. Trading online is the best thing to do when you have large capital exposure for trading because you need to have right information which is required by a trader in order to execute to trade. In online trading you are the sailor of your own ship; your orders are directly sent to stock exchanges rather than stock broker. This makes the execution of a trade prompt. Some of the brokers even offer virtual trading which is extremely beneficial because you can trade with virtual money. There are some financial portals offering free virtual games and one of them is dsij.in.

Consider paid subscription:

A full time trader can allocate his whole time to the process of trading that involves tracking stock prices, chart patterns and entry-exit prices, but traders who don’t have the time to track market movement need professional guidance to trade. Therefore, they can opt for paid subscription. Paying for research and analysis can be both educational and useful for maximising wealth. Traders may find watching or observing market professionals to be more beneficial than trying to apply newly learned lessons themselves.

Market timing is most crucial in short-term trading and paid subscription helps traders to identify proper entry timing and exit points. There are a number of services offered by advisory firms like Intraday, Positional, Swing and BTST/ STBT. One can select the product which suits your trading style.

The advantages of paid subscription are:

• It helps you to identify the right stock for trading 
• All the recommendations are sent on a real time basis via SMS, instant messengers and mobile applications. This means no time lags and no delays. 
• Precise and easy to understand trading messages with follow-up updates: Sample of a trading message: BUY RELIANCE above 990 TGT 1005-1020 SL 982.  Follow-up messages like buy price triggered, book profit, stop loss hit and call are discarded. This help traders to trade hassle-free. 
• No personal bias.
• Customer support in case of any confusion.

Seminars are one of the best ways of learning as they offer first-hand source of information. Seminars provide valuable insights into the overall market scenario and specific investment types. In a seminar speakers will discuss how they have found success utilising their own strategies over the years.

Read financial magazines:

Financial magazines provide a wealth of information and are usually easy to understand and follow. In a magazine you get an update of current economic environment, in-depth stock analysis, expert interviews, and advice.

“DO YOUR HOMEWORK WELL”

As this dialogue between a professor who teaches the art of stock market trading and a keen student shows, short-term trading can be an exciting and rewarding occupation if you get the fundamentals right.

“Professor, why is it that people say that trading on a short time frame—the short-term as they call it—is riskier than trading on a longer time frame?”

“Robin, the risk difference as they see it lies in the time component alone. In the longer time format the trader gets more breathing (time) space—some more time over which he feels the desired results should set in. The assumption here is that time should cure, if trading ills did creep in.” 

“Professor, you mean to say the research work and the ground work apart, the long-term trader uses the time component as a walking stick?” 

“Not so, Robin! Events that could cause a price change in the trader’s favour could take time to present themselves. Traders look for a price advantage while locating their trades in a longer time frame and in the process wait for a price-time-opportunity scenario as Prof. Schieldmeier terms it.” 

“Tell me, Professor, if profitable trades are possible on a shorter time frame as well?”

“Of course, yes! You need to do your homework well.”

“What does that translate to specifically, Sir? Do give me a broad framework of the technical part of trading in a short time frame.”

“Well, Robin, price is a vector with two dimensions—direction and magnitude. All your research work and analyses on the fundamental and technical fronts strive to uncover just these two truths! And, here again, the trader needs to have a reference point from which he looks at the direction component, especially when he trades on an absolutely short time frame—the day! Day traders treat the opening rate for the day - which is usually a weighted average rate of the orders matched as the market opens — as sacrosanct.”

“Why so, Professor?”

“Look Robin, a trader who opens the market is generally not the one who keys in his order without a thought. He has time - from the previous evening when the market closed through the morning when it opens – to regurgitate the sanctity of the information that would have come in his grasp and decide the price at which he should place his trade and the quantum of opportunity he should seize in the process. The others who create the high and the low get lesser time to think while creating. Robin, here I keep out those who toss coins for placing their trades—very few, if at all, do it and this category is well kept out of our discussions.”

“But Professor, those who create the open would include those who hold the asset traded and want to dispose them the first thing in the morning as also those who hold bull or bear positions and like to square them at the first opportunity in the morning, right?”

“Oh yes, Robin, all I am trying to say here is that all these traders who create the open, no matter their time frame, have a ‘thought advantage’ compared to those other traders who trade after the market opens! Accepted?”

“No, dispute!” 

“Now a clear violation of the open should create counter moves right? I mean moves that could change the initial direction from the open?

“Professor, you mean even a single tick off the open could cause a change in direction?

I don’t think so.” “Good thinking! A rocket takes off from Ground Zero getting out of the grip that the earth has on it only after it has attained what they call ‘escape velocity’. Similarly the markets will have to create that escape velocity from the open (Ground Zero in this case) to get out of the grip the bulls have on them (falling markets) or the bears could have on them (rising markets) and the escape velocity is different for different financial assets almost always.”

“Sometimes a rocket can fall back to the ground. Does that happen here as well after moves from the open have helped the asset get past its escape velocity?”

“Unfortunately, yes, that can happen too.”

“Well then, if the initial move off the open could be negated by a reversal in direction even after the escape velocity has been attained, how sacrosanct is this escape velocity or the open in this case?”

“My answer would be that this escape velocity is a condition that is necessary but not sufficient. By this I mean an inability to attain the escape velocity would have clear results for the bulls and bears.” 

“Superb, Professor, I have got it now! You are trying to tell me that one could use this escape velocity factor as a reversal indicator, isn’t it?”

“You couldn’t be more correct, Robin. And I hold Ground Zero to be hugely sacrosanct. This is because a reversal in the initial direction off the open would mean a flow of new information that rejects the thought processes that have gone into creating the open. Isn’t it, Robin?”

“No dispute here again! But I have a major issue after I have located my trade.”

“The usual moves counter to the direction in which you placed your trade isn’t it?”

“You hit the nail on the head, Professor.”

“Well, direction tracking can be done by segment studies. Here we create segments in such a way that sustained movements from one segment to another, lower down or higher up as the case may be, would indicate a change in direction. We could locate our trades on a retracement and very profitably so using these segments.” 
“That’s not all. We could take the help of these segments while assessing the magnitude—price objective—as well, Robin.”

“Why do markets move effortlessly on some days while becoming range-bound on other days, Sir?”

“It is the traffic in some places compared to traffic elsewhere. Too many open trades make the traffic heavy and slow moving.”

“Agreed Professor, but can we figure out the trade areas where the traffic could move slow and the areas where they could move with speed?”

“To a great extent, yes. We use a little of our knowledge of statistics to figure this out, I am referring to distributions.”

“Complicated theory?”

“Not at all. They are simple and can be understood easily. We figure out the boundaries of the thickly traded areas and see where the market opens and trades vis-a -is those areas. I repeat that the open of the day and the market moves thereafter have to be juxtaposed against these areas to gauge the prospects for the day, Robin.”
“Interesting, but do they work?”

“Of course they do, and almost always with religious fervour.”

“Great to hear that, Sir.”

“I can go on Robin, but the stuff might hereafter bounce off. Suffice to say that good market studies in so far as its foundation and structures are concerned can be very rewarding. There is an issue on behaviour alright – the fear, the greed, the anxiety, the laidback attitudes, and what not. I will not discuss them here and now. But short term trades are based on techno fundamentals.”

“What is that, Sir?”

“It refers to the foundation and supporting structures that ‘house’ the markets. Using that along with some indicators largely developed heuristically, one could trade on a short-time basis. And successfully so! For the not so short term also one could design –heuristically again—systems that help judge the direction of a positional trade.”

“Sir, does one have to take the help of technical software as also look at the news that flow in that day?” 

“Not at all. Traders run the risk of wrong interpretation for one, if they did it. Besides, traders follow the leader –remember they don’t open trades—and direction is something they have to read well. I tell my students to desist from prejudgments of all kinds. After all, prices reflect fundamentals that are both known and unknown. Information and the so called news have no place here.”

“Great, Professor. I was speculating all these days.”

“You don’t have to speculate, Robin. The truth lies before your eyes. Do your homework and that will remove the haze that lies before it.”