Playing the Expectations Game !

What are your expectations from the trading business? It is a business where extraordinary profits are possible. (That is why we are in it.) But the question is why extraordinary profits are possible in trading. It is because it is a business where extraordinary losses are also possible.

After all, the business of trading, especially the derivative trading is a zero sum game! A trader's profits are another one's losses. If you are to consider the considerable costs of trading, which adds up to substantial sums over a period, it is actually a negative expectations game!. It is always better to have a realistic understanding of the eventualities one may encounter in the business to avoid the risk of ruin. Therefore, here are some of the pieces of advice or rules I have picked up over a period, even though the sources and the contexts have been forgotten.

You can pick any one of these rules or all of them! They are all different but they are all saying the one thing !!

• Expect the unexpected !
• If anything can go wrong, it will !!
• Hope for the best, but prepare for the worst !!!

All in a day's Trade.

We are all normal people. As we are normal, we expect a normal trading day, OK! The Nifty may trade higher, lower or do both and close higher, lower or end near the yesterday's close. As normal people our memory spans are also short. We have a tendency to forget the times on which the liquidity dried up completely on the one side of the trade and the index moved one way beyond all expectations. Therefore, let us refresh our memory or load it afresh with some real history. Here comes the Nifty history which explains why the above high sounding cliches are applicable to trading.

S&P CNX Nifty - Daily Returns in Per cent

( On a daily close to close basis )

Chart 1

The above is the graph of daily returns obtained by the S&P CNX Nifty index calculated as a percentage change over the previous days close. Here are some observations about the chart.

• Volatility increases and decreases in clusters.
• Large negative returns are accompanied by large positive returns in the cluster and vice versa.
• Most of the daily returns are confined to a +/- 5 % range.
• There are significant numbers of extraordinary returns in the data. That is, Nifty is capable of making extraordinary movements in a day's time.
• Some of these extreme movements were the result of one-off events like the general election results in 2004 and 2009.

The three extreme data points of both, the positive as well as the negative returns during the period are shown in the following chart.

S&P CNX Nifty - Highest Three Positive and Negative Daily Returns

Table 1

S&P CNX Nifty Daily Returns ( + / - Signs Removed )

Now let us see the above data from another angle by removing the positive and negative signs from the data to get an even better view of the daily movements on a close to close basis.

Chart 2

The above chart reiterates our earlier observations. So far we have examined the Nifty on a daily close to close to basis. However, such an analysis is more suitable for investors than the traders. It is seen that the close to close to analysis eliminates the intraday extremes of the index and those extremes are more pertinent to traders, especially to those who have to manage their intraday risk and use stop losses. Therefore, let us use a technical analysis tool called the True Range ( TR ).

True Range

According to the Wikipedia the True Range is a technical analysis tool developed by J. Welles Wilder. and the following is a copy of it's description from the Wikipedia.

"The range of a day's trading is simply high − low. The true range extends it to yesterday's closing price if it was outside of today's range.

Or, in plain English, true range is the largest of the

• most recent period's high less the most recent period's low
• absolute value of (the most recent period's high less the previous close) or
• absolute value of (the most recent period's low less the previous close)."

S&P CNX Nifty Daily True Range ( TR )

The following chart shows the daily true ranges of the Nifty index for the same period.

Chart 3

Here are some basic observations made after a comparison of the daily returns chart (without the + / - signs) and the true range chart :

• There are more extreme data points in the TR chart than in the daily returns chart.
• There are eight TR values which are higher than 10% in the TR chart whereas there are only three similar values in the daily returns chart.
• The TR data points are significantly higher than the daily returns chart and therefore a Nifty futures trader is susceptible to significantly higher risks.

The three extreme data points of TR both the highest as well as the lowest during the period are shown in the following chart.

S&P CNX Nifty - Highest and Lowest True Range Values

Table 2

Now, how much is the margin for the Nifty futures? On an average it is around ten percent. It doesn't require much extrapolation to find that on all days the index has returned a TR of ten percent or more , at least one side of the traders would have lost their entire margins. The brokers would start their margin calls and by the time the trader either remits the margin or the broker squares off the position the losses might have become even higher. I have seen people becoming frozen or paralyzed and incapable of taking any decisions on such days. Thankfully the broker takes the decision and squares off the positions but mostly at the worst possible prices.

As we have seen the worst let us see what is the normal or 'the new normal ' values of daily returns and the true range. The following table shows the average, median and the geometric mean of both the daily returns and the true range for the sample period.

S&P CNX Nifty - Average, Median and Geometric Mean of Daily Returns and TR

Chart 3

It is observed that the geometric mean of the daily returns and the average, median and geometric mean of TR are nearly identical at around 2.6 % of the previous day's closing value.

What are the key takeaways from the above statistics? They are very simple.

• Don't take big leveraged positions in the market. Even small positions can lead to extraordinary losses in trading.
• It is better to avoid market turmoil due to the expected event risks like election results, union budgets etc by keeping no positions or only positions of long options.
• Trading is a business in which any skills or advantages of a trader is used by him to build substantial profits over a period and not a wham bam game.
• Even if a trader is using all the risk control methods described in the page named Position Limits, the trader may be susceptible to significantly higher risks due to totally unanticipated events or any other reasons. Therefore, keeping a part of the trading capital as a reserve is a prudent option.

The Tail Piece

Is it mandatory to have tail piece towards the end of any discussion? Even if it is not mandatory or if it is totally unnecessary, I am having an inclination to add a tail piece. Because, there is a very apt tail piece available!

Here is a new job description. Measure the heights of 2775 people ( equal to the sample size of the trading days ) randomly and pass the collected data through the processes we used for analyzing the Nifty closing prices. We may find that the average, median and geometric mean of the new data may fall anywhere between five or six feet. This is comparable to similar values obtained by us with respect to the Nifty in the Chart 3.

However, the question is whether we will be able find people with heights of seven to nine times the average in the sample or anywhere else. But why? For example the true range is having an average of 2.63 ( Table 3) and an extreme value of 22.55 ( Table 2 ) and the ratio between them is 1: 8.5. Anyone knows that finding a human being with a height which is 8.5 times the average is an absolute impossibility. Statisticians say that the data like the heights of people is distributed normally. It simply means that most of the data points will be near the average and chances of finding a 45 feet human being is impossible.

Statisticians say that financial data series like equity prices or indices have long tails. This simply means that most of the data points when plotted on a graph will fall near the average but some of the data points will be very far away from the average and those points may look like long tails in the graph !!

That brings us back to question of whether the discussion needed a tail piece. And it is settled now !
Beware of long tails in trading !! And sometimes the tail may wag the dog as well !!!

SOURCE:: http://momentumsignal.blogspot.com

Love the Game

NBA champ and MVP Kobe Bryant MAKES 1,000 shots a day in practice to increase his chances of making the 20-30 shots a game he takes.

Along with team practice, Peyton Manning (NFL champ and MVP) watches hours and hours of tapes of opposing teams every day (even during the offseason) to develop his uncanny ability to read defenses and score against them in one 60-minute game a week.

Tiger Woods wins golf tournaments for a living. He has won 14 major golf tournaments and 71 PGA tour events - more than any active golfer. He practiced religiously every day for 15 years before winning his first pro event at the tender age of 18.

The obvious commonality between these champions not only do they work their butts off, but they also love with they do. They love the challenge and the competition.

Their passion for the game is so strong that it gets them through the hours upon countless hours of tedious tasks that others may not enjoy like tape watching, suicide drills, weight training, putting drills, etc.

To them, these things are fun!

Again, we're not gonna sugar coat things. You're all big boys and big girls.

There will be days when trading SUCKS!

It will get to the point where you think "Gosh darnit! &#$(*&!! I wanna quit now."

There will be days when you will be totally clueless. You won't understand why the market is not moving with the news or why your mechanical system is getting chopped up.

There will be days when you will feel extremely lazy. You won't feel like journaling. You won't feel like reviewing your trades.

Trust us, you will experience a lot of these days. Especially in the beginning.

On days like these, it's the "love of the game" will keep you doing the things you need to do to become a good trader.

Source:: http://www.babypips.com/school/love-the-game.html#ixzz1MWIUltaF

Be Patient. Stay Disciplined.

Patience.

It's a virtue...Especially in trading.

Arnold H. Glasgow, an American humorist, once said, "The key to everything is patience. You get the chicken by hatching the egg, not by smashing it."

Developing your trading plan will take time. Developing skills will take time.

Waiting for the right trades requires patience. Entering and exiting a trade at the right moment requires patience.

Discipline.

Discipline is also a virtue, and it means doing the things you need to do to progress and get better....even if you don't want do it.

This means preparing for each trading day or week with research and chart study.

If you're a mechanical or automated trader, this means back testing systems and constantly trying different settings and strategies as the environment changes.

And of course, don't forget about keeping a trade journal and reviewing every single day you trade.

Journaling is the one trading task that separates the wannabe traders from the real deal traders. Unfortunately, most newbies won't do it.

Trading concepts and techniques are simple and easy to learn. What's hard to learn is how to be patient and disciplined to do the right things and make good trading decisions. Truthfully, it will be one of the most difficult endeavors you will ever take on.

To a newbie, sitting on the sidelines and watching the markets move while you wait for your best setups means you're missing out on profits.

This way of thinking leads to a failure of patience and discipline and causes some of the most notorious trading mistakes in the book:

• Impulse trades
• Letting losers run too long
• Cutting winners too quickly
• Revenge trades

These actions will kill your account!

Remember that your job as a newbie is to learn how to make good trading decisions and SURVIVE!

Source:: http://www.babypips.com/school/be-patient-stay-disciplined.html#ixzz1MWIIPfSy

Focus on the Process. Not on the Profits. Read more: http://www.babypips.com/school/focus-on-the-process.html#ixzz1MWIBBkmf

We've made the School of Pipsology as easy and fun as we could to help you learn and understand the basic tools used by forex traders all over the world, but remember that a tool is only as good as its handler.

A painting does not become a beautiful masterpiece by the brush alone. It's the vision and skillful hand of a painter that creates a work of art.

A football doesn't find its way to the end zone by itself. It is the quarterback's ability to read a defense, position his players accordingly, and send the football to the right spot at the right time.

It's not the "ridiculously awesome" indicator, the Cowabunga system, or the "super duper" strategy that gets your account in the black at the end of the year.

It's your ability to read the market, execute the correct strategy for that particular situation, and consistently apply risk management techniques that hopefully gets you more profitable wins than losses in the long run.

Like in art, sports, or any performance endeavor, trading is a multi-faceted skill. The tools alone won't make you successful.

A dedicated effort towards education and application of what you learn, as well as the constant review of your performance is the only path to success.

In the beginning, that process of learning and deliberate practice should be your main focus, NOT the profits.

Continuing with the basketball analogy, if your goal was to reach the NBA, would you get to the level of performance you desired by playing games only?

Or would you develop faster by focusing on physical conditioning, developing different skills (a jumpshot, dribbling, footwork, passing, etc.) in practice, as well as playing games?

Probably the latter right?

If you went straight to the NBA without any training, do you think you'll score many points or win games?

Nope. We didn't think so.

Source: http://www.babypips.com/school/focus-on-the-process.html#ixzz1MWI4Jepq

Nobody can perfectly predict the market every single time. Nobody

All hope is not lost though if you decide to stubbornly not listen and continue your search for the Holy Grail.

Rumor has it that if you can find a pink unicorn standing under a rainbow, you will come across an invisible leprechaun who will give you the Holy Grail. And the iPhone 5! Good luck.

Source:: http://www.babypips.com/school/holy-grail.html#ixzz1MWGBqmSo

Holy Cow! There's No Holy Grail!

Ask any quant on Wall Street (the super geeky math and physics PhDs who create complex algorithmic trading strategies) why there is no "holy grail" indicator, method, or system to pull profits 100% of the time. He or she will give you these two reasons:

1. You can't predict the future.

Is there anyway to know what a central bank president will say during a speech? Or maybe what a super famous investor or hedge fund manager says during a random TV interview?

Do you know when the next terrorist attack will hit and cause risk aversion?

How about a natural disaster like an earthquake or tsunami?

The list of unforeseen market moving catalysts is infinite and when they happen, they can rock the markets and your system.

Understand that this is part of trading and the best you can do is be prepared.

Be ready to have your world rocked. And we don't mean that in the way you think it means.

2. Data doesn't move the market. Humans do.

There will be times when data or market themes do not mesh with price action.

Why is that?

Maybe the outcome was priced in ahead of time? Maybe traders weren't focused on the data that was released? Maybe there was an institution covering a huge position that was on the wrong side of the market?

Would all players in the market react to an unforeseen catalyst the same way?

Whatever the price behavior may be, the decisions that lead a trader to take action aren't always logical or congruent to the information out there.

When you multiply this by the millions of players with different goals/strategies and different sized trading accounts, it becomes impossible to tell where the overall market will go every single time.

Source: http://www.babypips.com/school/holy-grail.html#ixzz1MWFovKk3