Module V
Introduction
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Module V
In this module we will focus on How Higher timeframe can help us to identify the
bullishness or bearishness of the stock before Market starts. So that when can have the
highest probability stock in our watchlist for tomorrow.
Let’s start….
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1.Only Trade Stocks with High Volume
It is often said that liquidity is like oxygen to traders; without it, they are dead. Thus
liquidity is the first and most important rule while selecting a stock for day trading.
A liquid stock is one, which has a high average trading volumes, so that it can be bought or
sold in sufficient quantities without causing much impact on the prices.
It is advisable to day trade strictly in liquid shares less liquid stocks helps a trader buy or sell
large quantities of shares without any problem of there being no buyers or sellers. While it
could be argued that illiquid volatility also creates opportunity through rapid price change,
statistics prove that volatile shares move the most in the least amount of time. Therefore,
most opportunity dissipates while downside risk looms.
However, this is not a hard and fast rule, as the amount of liquidity depends on the quality
of your trade.
Suppose you buy few shares, say 50 to 100 shares, then shares with average trading
volume of 50,000 to 75, 000 will suffice, whereas if you buy few hundred or thousand
shares then you need a stock with average trading volume of few lakh shares.
Some of the examples most liquid stocks include Reliance Industries, SBI, Infosys, ONGC
etc.
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What is Liquidity after all
Basically, it is the ability of an asset to be converted into cash quickly (sold) without
significant loss of value.
For instance, a real estate asset (plot of land) is not as liquid as an equity asset (shares).
When the stock market is said to be liquid, it indicates that there is a lot of cash in the
economy that is finding its way to the stock market.
A stock is said to be liquid when the shares are actively traded and are available in large
volume. So the stock price will not be dramatically moved by a few buy or sell orders.
However, shares in small companies with much fewer shares are generally considered
illiquid. Because one or two big orders can move the price up or down sharply.
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What is Volatility?
This refers to the degree of price fluctuation.
An investment is said to be volatile if it is susceptible to varying price fluctuations over
short periods of time.
The greater the volatility, the wider the fluctuations between its high and low prices.
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2. Avoid unpredictable (chaotic) stocks
Generally it is seen that stocks that are trading with low average daily volumes or stocks
where some big news is soon expected, tend to trade in a highly unpredictable manner.
Sometimes even after an important announcement -- which may be either good or bad
(like big order, good results, bad results, plant shutdown etc) -- the stock may trade in a
chaotic manner. So it is advisable to avoid such chaotic stocks.
Some of the mid caps, and most of the small caps especially those in S, T and Z group are
chaotic stocks; better not to trade them from intraday point of view. They also have very
low volume thereby increasing their unpredictability.
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3. Trade stocks with good correlation
It is advisable to trade in stocks that have more in correlation with major indices and
sectors. That is if the index or a sector moves up the stocks belonging to that index or
sector also moves up and vice versa.
Stocks that track and trade in correlation with the group (sector) to which they belong are
more readable & reliable, so that if any good/bad news comes in, affecting the sector as a
whole, then you can depend on the stock to move in the manner as the overall sector is
expected to move.
For instance, if the Indian rupee strengthens against the US dollar then all IT companies
depending on US markets get adversely affected.
A stronger rupee means these IT companies will earn less from their exports. Conversely
rupee weakening against the dollar leads to increase in their export earnings.
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4. Move with the trend
It is always easier to swim along the river rather than across it. Always remember
this thing while day trading.
If we are in a secular bull run, then it is advisable to find stocks (sectors) that are
going to rise, rather than finding stocks (sectors) that are going to fall.
Similarly if we are in a bearish phase, then it is advisable to find stocks (sectors)
that are going to fall, rather than finding stocks (sectors) that are likely to move
up.
We will discuss more about it in later part of this module.
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Searching for trading set ups
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Lets begin
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The Bull and the Bear
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Searching for trading set ups
As a Trend trader basically what we will be searching for in the chart are, presence of a good
TREND and good buying opportunity, that will hold the highest probability of winning.
1> SMA TREND FILTER
2> STOCHASTICS OVERSOLD/OVERBOUGHT
3> MOVING AVERAGES CORELATION
These are “must have” criteria's for valid Trending set ups. Without having them we
cannot proceed and straight led us to cancel the set ups.
If done correctly, this system is incredibly simple and extremely effective and it always keeps
your risks low because you are looking for low, risk high probability trades with very little
drawdown in case things do go the wrong way. There are times when they will. But there will
always be very little at risk.
Lets study them in details…
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100 SMA Primary Trend Filter
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The 100 SMA Trend Filter
So, this is a Day trading system, right?
Nice, nice, but… how exactly do we determine whether we are in a trending market or not?
Well. Some people rely on Bollinger Bands, some other look at the ADX, etc. Every trader has
his bullet. I personally use what I call as 100 Simple Moving Average Trend Filter, which is fairly
pretty simple: grab a plain chart without any indicator , trendline or anything else and plot
100 Simple Moving Average. That’s all I use to determine trends.
Timeframe is 30 minutes or 60 minutes. then,
UP Trend : Price above 100 SMA.
DOWN Trend: Price below 100 SMA.
NO-Trend: prices swing up and down considerably around 100 SMA.
if and only if Price is above 100 SMA, I will look for buying opportunity.
if and only if Price is below 100 SMA, I will look for Short selling opportunity.
If prices swing up and down considerably around 100 SMA but with no resulting overall
price movement in either direction, then I don’t look that stock till Prices get one direction.
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The 100 SMA Trend Filter
CHART - I
Market is in Up-Trend (Bullish)
100 Simple Moving Average
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The 100 SMA Trend Filter
CHART - II Market is in Down-Trend (Bearish)
100 Simple Moving Average
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The 100 SMA Trend Filter
CHART - III 100 Simple Moving Average
There is NO-Trend in the Market (Choppy Market or Sideways Market)
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Stochastic
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Trading Bias
Indicators are used to define the path of least resistance, which becomes the trading bias.
We look for bullish setups when the bias is bullish and bearish setups when the bias is
bearish. Trading in the direction of this bias is like riding a bike with the wind at your back.
The chances of success are higher when the bigger trend is in your favor.
We will use a Stochastic Oscillator on the chart with the setting of (70,3,3) on 30 minute or 6
minute chart.
This timeframe is simply five times the 14-day timeframe.
The trading bias will be considered bullish when above 50 and rising Upwards.
The trading bias will be considered bearish when below 50 and falling Downwards.
The chart below shows 70-period Stochastic Oscillator defining the bullish and bearish
periods.
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Stochastic (70,3,3)
Bullish trading bias Bullish trading bias
100 Simple Moving Average
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Stochastic (70,3,3)
Bearish trading bias Bearish trading bias
100 Simple Moving Average
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Moving Averages Co-relation
(An Optional Filter)
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Until now, we were looking for the Set ups on Higher timeframes chart.
I mean we use 100 SMA and Stochastic for finding Trending Stock (prior to actual trading
day) with 30 minute or 60 minute charts.
Now, for our next filter which is 50 and 100 simple moving average co-relation, we will
Focus on 5 minute chart on the day of Trading itself.
(It’s an optional Filter I mean its not mandatory)
What we look for:
We open our Stock in 5 minute chart and within Opening Range Period i.e. for first 30
minutes,
we will like to see 50 SMA above 100 SMA in case we are looking to BUY first
and SELL after. (LONG TRADE)
Similarly
we will like to see 50 SMA below 100 SMA in case we are looking to SELL first
and BUY after. (SHORT TRADE).
Example on next page will illustrate this concept.
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50 SMA
100 SMA
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As we see in above example, Market opened at 09:15 AM and we open our Stock in 5
minute chart and within Opening Range Period i.e. for first 30 minutes,
we will like to see 50 SMA above 100 SMA.
As day Proceeds the difference between 50 SMA and 100 SMA goes on increasing which
indicate us that Momentum in the Stock is rising.
Let’s take another Example.
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50 SMA
100 SMA
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Summary
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To summarize all,
Prior day Scanning, will be done with our 2 Primary Filters on 30 minute or 60 minute charts,
1> 100 SMA TREND FILTER
2> STOCHASTIC
On Actual day, after market opens we will look for SMA Co-relation for TREND STRENGTH.
Though it’s an optional filter and not at all a “must have criteria”, it provides us some
valuable information.
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Thank You !
End of Module V
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Disclaimer
These educational recommendations are based on author’s
personal observations & on the study of technical analysis
and hence, do not reflect the fundamental validity of the
script. Due care has been taken by the author while
preparing these comments & outcomes, But still no
responsibility will be assumed by the author for the
consequences whatsoever resulting out of acting on these
recommendations. You are advised to take your position
with your best sense and judgment. This document does not
claim for profits/Losses. Some Information, here with
provided is obtained from the sources deemed to be reliable
but is not guaranteed as to accuracy and completeness.
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