Beyond The Technical Analysis. An Exclusive Indian Stock Market Technical Analysis Tutorial Blog

Basic knowledge of risk management

noreply@blogger.com (Pareesh Ratan Kundu) — Tue, 25 Mar 2014 05:22:00 +0000

Basic knowledge of risk management

Every investment is subject to risk due to potential unfavorable price changes. As the financial markets constitute a complex system with many factors influencing the demand and supply at the same time, it is important to know that the result of practically any given transaction is uncertain.

Risk management depends very much on the types of assets the trader is interested in. In this text we would like to discuss the tools that can be used in order to minimize potential losses resulting from adverse price changes:

study the different types of assets
plan your strategy
establish the maximum acceptable risk
use the different order types.

Study the different types of assets

It is crucial to first understand the liquidity.

Depending on the type of asset you are interested in, there may be more or less volatility related. The higher the volatility, the higher the financial risk associated with the given market. This means that operating on a such market involves potentially higher profits and losses than in the case of markets with lower volatility. There are markets where there is not much movement, while others change very often and the price changes may be quite significant.

Another important issue is the spread - i.e. the difference between the ask price and bid price. Different assets have different spreads, as the spread size depends on such factors as liquidity of the market, its volatility or time of the day. As the spread represents an indirect cost of the transaction for a trader, it can be related to the volatility in order to compare the cost of transaction between the given markets. For example, the cost of operating on a market where the spread is 4 points and the difference between daily maximum and minimum is equal to 60 points, can be considered to be more attractive than in the case of a market where the spread is 2 points, but the daily price range is just 20 points.

Plan your strategy

It is imperative to decide what type of investment strategy is to be implemented

The strategy shall define the key aspects of the trades, including their time horizon. There are assets where it is difficult to trade in the short term, as the cost of transaction is relatively high in relation to the size of typical price movements. However, it is still possible to consider such markets for the purposes of investment in the longer term, cost carry transactions or possible arbitrage. On the other hand, assets that change very often could provide a good possibility for transactions in the short and ultra short term.

Establish the maximum acceptable risk for an investment or trade

Important step that many investors seem to ignore

It may be a good idea to establish a maximum amount of money that he/she is willing to risk in any given transaction. Such an amount can be defined as a percentage of the available capital. Considering an example where the trader is willing to risk no more than 3% of the portfolio, 3% of that amount would mean that the investor is willing to “risk” no more than $300 USD in a trade.

The limit calculated as shown above, or using any other method, can be taken into account when considering where to set the stop loss or close the transaction by any other means. In order to do that, one should also consider a value of pips. Assuming that for a specific asset the pips value is equal to $10 USD, and the acceptable risk is $300 USD, then a trader may consider placing a stop-loss with a value of 300/10 = 30 pips from the level where the transaction was opened.

Use the different orders.

Understanding the possibilities behind the pending orders of the trading platform may contribute to more efficient trading plan

There are many different orders available at the MT5, which can potentially help to realise profits or limit the losses during the investment process:

Market orders - buy/sell
Stop loss
Take profit

Market orders (or instant execution orders): these are simply orders (buy or sell) that are executed instantly at the time they are placed.

Stop-loss: stop-loss orders are additional orders available for both pending orders and market orders. They can also be attached to already opened positions on a given market. These types of orders are the most basic orders designated for limiting the potential losses, for example when an investor is not able to follow prices all the time. A trader establishes stop-loss levels by either specifying the level in points from the current price or by specifying an exact price level. For long positions, the stop-loss value must be lower than the current price. For short positions, the stop-loss value must be higher than the current price.

Take-profit: Take profit is an additional order available for both pending orders and market orders. They can also be attached to already opened positions on a given market. The difference between this order and the stop-loss order is that in the take-profit order, a trader will fix the exact profit he wants to realise. Sometimes, investors are not actually sure how much a price will continue its direction, so they fix a value for which a profit is guaranteed if the price reaches that level. For long positions, the take-profit level must be above the current price. For short positions, the take-profit level must be lower than the current price.

Pending orders: Pending orders will be placed immediately but executed only when the price has reached a previously determined price. There are six types of
orders available as pending orders:

Buy limit
Sell limit
Buy stop
Sell stop
Buy stop limit
Sell stop limit

Buy limit: an investor is willing to buy an asset when the price has reached a certain level. At the time of placing of an order the market price must be higher than the one specified as the buy limit price. In this situation, investors believe that prices will fall to a certain level and will later rise.

Sell limit: an investor in this case is willing to sell an asset when the price has reached a specified level. At the time of placing an order, the market price must be lower than the one specified by the investor (sell limit price). This approach reflects the belief of the trader that prices will reach a certain level (the sell limit price level) and then start falling.

Buy stop: by placing a buy stop order an investor expects that if prices reach a certain level (buy stop price), they will keep on rising. The price at which the transaction is concluded will be less favourable than the current market price. However , the fact of reaching that level could be interpreted as a confirmation signal. Once executed, this order will buy an asset after reaching a level defined by the investor. The market price at the time of placing the order must be lower than the defined buy stop level.

Sell stop: by placing a sell stop order a trader expects the prices to keep on falling, once a certain level (sell stop price) below the current market price is reached. Reaching this level can also be interpreted as a confirmation order of the investor’s prediction. Once executed, this order will sell an asset after reaching a level previously established by the trader. The market price at the time of placing the order must be higher than the defined sell stop level.

Buy stop limit: It is combines both buy stop and buy limit features. This order will place a pending order (buy limit order) only if the price previously reaches a defined price by the investor. One may say that this is a conditional pending order, that will only be executed when the price reaches a certain level. To place this order the current price must be lower than the conditional price level - i.e. the price which activates the pending order.

Sell stop limit: This is a conditional pending order. An order will be placed if and only if a price reaches a price level previously defined by the investor. To place this conditional order, the current market price level must be higher than the conditional price. Once prices start falling and reach the conditional price level a new sell limit order will be placed.

Harmonic Pattern

noreply@blogger.com (Pareesh Ratan Kundu) — Wed, 19 Mar 2014 17:30:00 +0000

HARMONIC PATTERNS

Harmonic price patterns take geometric price patterns to the next level by using Fibonacci numbers to define precise turning points. Unlike other trading methods, Harmonic trading attempts to predict future movements. This is in vast contrast to common methods that are reactionary and not predictive. Let's look at some examples of how harmonic price patterns are used to trade on the market. (Extensions, clusters, channels and more! Discover new ways to put the "golden ratio" to work.

Combine Geometry and Fibonacci Numbers

Harmonic trading combines patterns and math into a trading method that is precise and based on the premise that patterns repeat themselves. At the root of the methodology is the primary ratio, or some derivative of it (0.618 or 1.618). Complementing ratios include: 0.382, 0.50, 1.41, 2.0, 2.24, 2.618, 3.14 and 3.618. The primary ratio is found in almost all natural and environmental structures and events; it is also found in man-made structures. Since the pattern repeats throughout nature and within society, the ratio is also seen in the financial markets, which are affected by the environments and societies in which they trade. (Don't make these common errors when working with Fibonacci numbers - check out Top Fibonacci Retracement Mistakes To Avoid) By finding patterns of varying lengths and magnitudes, the trader can then apply Fibonacci ratios to the patterns and try to predict future movements. The trading method is largely attributed to Scott Carney, although others have contributed or found patterns and levels that enhance performance.

Issues with Harmonics

Harmonic price patterns are extremely precise, requiring the pattern to show movements of a particular magnitude in order for the unfolding of the pattern to provide an accurate reversal point. A trader may often see a pattern that looks like a harmonic pattern, but the Fibonacci levels will not align in the pattern, thus rendering the pattern unreliable in terms of the Harmonic approach. This can be an advantage, as it requires the trader to be patient and wait for ideal set-ups. Harmonic patterns can gauge how long current moves will last, but they can also be used to isolate reversal points. The danger occurs when a trader takes a position in the reversal area and the pattern fails. When this happens, the trader can be caught in a trade where the trend rapidly extends against them. Therefore, as with all trading strategies, risk must be controlled. It is important to note that patterns may exist within other patterns, and it is also possible that non-harmonic patterns may (and likely will) exist within the context of harmonic patterns. These can be used to aid in the effectiveness of the harmonic pattern and enhance entry and exit performance. Several price waves may also exist within a single harmonic wave (for instance a CD wave or AB wave). Prices are constantly gyrating; therefore, it is important to focus on the bigger picture of the time frame being traded. The fractal nature of the markets allows the theory to be applied from the smallest to largest time frames. To use the method, a trader will benefit from a chart platform that allows the trader to plot multiple Fibonacci retracements to measure each wave.

The Visual Patterns and How to Trade Them

There is quite an assortment of harmonic patterns, although there are four that seem most popular. These are the Gartley, butterfly, bat and crab patterns.

GARTLEY PATTERN

The Gartley was originally published by H.M. Gartley in his book Profits in the Stock Market and the Fibonacci levels were later added by Scott Carney in his book The Harmonic Trader.

Figure 1: The Gartley Pattern.

The bullish pattern is often seen early in a trend, and it is a sign the corrective waves are ending and an upward move will ensue at point D. All patterns may be within the context of a broader trend or range and traders must be aware of that (see Elliott Wave Theory). Point D is a 0.786 correction of the XA wave, and it is a 1.27 or 1.618 extension of the BC wave. The area at D is known as the potential reversal zone (PRZ). This is where long positions could be entered, as some price confirmation of reversal is encouraged. A stop is placed just below the PRZ.

More About Bullish / Bearish Gartley Pattern.

Bearish Gartley

The bearish gartley pattern formation is similar to head and shoulders pattern, but as you can see the point C is below the point A, hence it is not head and shoulder pattern.

Formation and trading strategy of Bearish Gartley pattern:

Point B must retrace 61.8% of AX movement.

Point C must retrace anywhere from 38.2% to 88.6% of BA movement.

Point D must be 138.2% or 161.8% extension of the BC movement.

Point D must retrace 76.8% of AX movement. This is our selling area.

Bullish Gartley

The bullish pattern is as seen below, its formation is quite similar to inverse head and shoulders pattern, but as you can see below point C is not on the same level as point A.

Formation of Bullish Gartley pattern and trading strategy:

Point B can retrace 61.8% of XA movement.
Point C can retrace anywhere from 38.2% to 88.6% of AB movement.
Point D can be 138.2% or 161.8% extension of the CD move.
Point D can retrace 76.8% of XA movement. Point D is our buying area.

Stop loss in this is always very strict and hence we get very cool risk reward ratio, many times around 1:5 or more. The very important reason for trading this pattern is that it is based on uncertain places where traders are most afraid to take positions, hence giving better meaning for risk.

Butterfly Pattern

Figure 2: The Butterfly Pattern

The butterfly pattern is different than the Gartley in that it focuses on finding reversals at new lows (bullish) or new highs (bearish). D is a new low and a potential reversal point if the Fibonacci figures align with the structure. D would need to be an extension of BC in the magnitude of 1.618 or 2.618. This should align with an extension of XA in the magnitude of a 1.27 or 1.618. Entry is taken near D with price confirmation of the reversal encouraged. Stops are placed slightly below the potential reversal area (bullish).

Bat Pattern

Figure 3: The Bat Pattern

The bat pattern is similar to Gartley in appearance, but not in measurement. Point B has a smaller retracement of XA of 0.382 or 0.50 (less than 0.618), but the extension of the BC wave into D is at minimum 1.618 and potentially 2.618. Therefore, D will be a 0.886 retracement of the original XA wave. This is the PRZ: when selling has stopped and buying enters the market, enter a long position and take advantage of the bullish pattern. Place a stop just below the PRZ.

Crab Pattern

Figure 4: The Crab Pattern

The crab is considered by Carney to be one of the most precise of the patterns, providing reversals in extremely close proximity to what the Fibonacci numbers indicate. This pattern, similar to the butterfly, looks to capture a high probability reversal at a new (recent) low or high (bullish or bearish respectively). In a bullish pattern, point B will pullback 0.618 or less of XA. The extension of BC into D is quite large, from 2.24 to 3.618. D (the PRZ) is a 1.618 extension of XA. Entries are made near D with a stop-loss order just outside the PRZ.

Fine-Tuning Entries and Stops

Each pattern provides a PRZ. This is not an exact level, as two measurements - extension or retracement of XA - creates one level at D and the extension of BC creates another level at D. This actually makes D a zone where reversals are likely. Traders will also notice that BC can have differing extension lengths. Therefore, traders must be aware of how far a BC extension may go. If all projected levels are within close proximity, the trader can enter a position at any area. If the zone is spread out, such as on longer-term charts where the levels may be 50 pips or more apart, it is important to wait to see if the price reaches further extension levels of BC before entering a trade. Stops can be placed outside the largest potential extension of BC. In the crab pattern, for example, this would be 3.618. If the rate reversed before 3.618 was hit, the stop would be moved to just outside the closed Fibonacci level to the rate low (bullish pattern) or rate high (bearish pattern) in the PRZ. Figure 5 is an intra-day example of a butterfly pattern from May 3, 2011.

Figure 5. Bearish Butterfly Pattern - EUR/USD, 15 Minute

The price touches almost exactly the 1.618 extension level of XA at 1.4892 and the extension of BC to 2.618 is very close at 1.4887 (there are two Fibonacci tools used, one for each wave). This creates a very small PRZ, but it may not always be the case. Entry is taken after the rate enters the zone and then begins to retreat. The stop is placed just outside the most significant level that was not reached by the rate, in this case a few pips above the 1.618 XA extension. Targets can be based on support levels within the pattern; therefore, an initial profit target would be just above point B.

The Bottom Line

Harmonic trading is a precise and mathematical way to trade, but it requires patience, practice and a lot of study to master the patterns. Movements that do not align with proper pattern measurements invalidate a pattern and can lead traders astray. The Gartley, butterfly, bat and crab are the better-known patterns that traders can watch for. Entries are made in the potential reversal zone when price confirmation indicates a reversal, and stops are placed outside the nearest significant (for the pattern) Fibonacci level that was not hit by the BC or XA extensions/retracements into the D (PRZ) area.

Top Fibonacci Retracement Mistakes To Avoid

noreply@blogger.com (Pareesh Ratan Kundu) — Wed, 19 Mar 2014 16:01:00 +0000

Top Fibonacci Retracement Mistakes To Avoid

Every trader will use Fibonacci retracements at some point in their trading career. Some will use it just some of the time, while others will apply it regularly. But no matter how often you use this tool, what's most important is that you use it correctly each and every time. (For background reading on Fibonacci, see Fibonacci And The Golden Ratio.)

Improperly applying technical analysis methods will lead to disastrous results, such as bad entry points and mounting losses on currency positions. Here we'll examine how not to apply Fibonacci retracements to the foreign exchange markets. Get to know these common mistakes and chances are you'll be able to avoid making them - and suffering the consequences - in your trading.

1. Don't mix Fibonacci reference points.

When fitting Fibonacci retracements to price action, it's always good to keep your reference points consistent. So, if you are referencing the lowest price of a trend through the close of a session or the body of the candle, the best high price should be available within the body of a candle at the top of a trend: candle body to candle body; wick to wick.

Misanalysis and mistakes are created once the reference points are mixed - going from a candle wick to the body of a candle. Let's take a look at an example in the euro/Canadian dollar currency pair. Figure 1 shows consistency. Fibonacci retracements are applied on a wick-to-wick basis, from a high of 1.3777 to the low of 1.3344. This creates a clear-cut resistance level at 1.3511, which is tested and then broken.

Figure 1: A Fibonacci retracement applied to price action in the euro/Canadian dollar currency pair.

Figure 2, on the other hand, shows inconsistency. Fibonacci retracements are applied from the high close of 1.3742 (35 pips below the wick high). This causes the resistance level to cut through several candles (between February 3 and February 7), which is not a great reference level.

Figure 2: A Fibonacci retracement applied incorrectly.

By keeping it consistent, support and resistance levels will become more apparent to the naked eye, speeding up analysis and leading to quicker trades.

2. Don't ignore long-term trends.

New traders often try to measure significant moves and pullbacks in the short term - without keeping the bigger picture in mind. This narrow perspective makes short-term trades more than a bit misguided. By keeping tabs on the long-term trend, the trader is able to apply Fibonacci retracements in the correct direction of momentum and set themselves up for great opportunities. In Figure 3, below, we establish that the long-term trend in the British pound/New Zealand dollar currency pair is upward. We apply Fibonacci to see that our first level of support is at 2.1015, or the 38.2% Fibonacci level from 2.0648 to 2.1235. This is a perfect spot to go long in the currency pair.

Figure 3: A Fibonacci retracement applied to the British pound/New Zealand dollar currency pair establishes a long-term trend.

But, if we take a look at the short term, the picture looks much different.

Figure 4: A Fibonacci retracement applied on a short-term time frame can give the trader a false impression.

After a run-up in the currency pair, we can see a potential short opportunity in the five-minute time frame (Figure 4). This is the trap. By not keeping to the longer term view, the short seller applies Fibonacci from the 2.1215 spike high to the 2.1024 spike low (February 11), leading to a short position at 2.1097, or the 38% Fibonacci level. This short trade does net the trader a handsome 50-pip profit, but it comes at the expense of the 400-pip advance that follows. The better plan would have been to enter a long position in the GBP/NZD pair at the short-term support of 2.1050. Keeping in mind the bigger picture will not only help you pick your trade opportunities, but will also prevent the trade from fighting the trend.

3. Don't rely on Fibonacci alone.

Fibonacci can provide reliable trade setups, but not without confirmation. Applying additional technical tools like MACD or stochastic oscillators will support the trade opportunity and increase the likelihood of a good trade. Without these methods to act as confirmation, a trader will be left with little more than hope of a positive outcome. Taking a look at Figure 5, we see a retracement off of a medium-term move higher in the euro/Japanese yen currency pair. Beginning on January 10, 2011, the EUR/JPY exchange rate rose to a high of 113.94 over the course of almost two weeks. Applying our Fibonacci retracement sequence, we arrive at a 38.2% retracement level of 111.42 (from the 113.94 top). Following the retracement lower, we notice that the stochastic oscillator is also confirming the momentum lower.

Figure 5: The stochastic oscillator confirms a trend in the EUR/JPY pair.

Now the opportunity comes alive as the price action tests our Fibonacci retracement level at 111.40 on January 30. Seeing this as an opportunity to go long, we confirm the price point with stochastic - which shows an oversold signal. A trader taking this position would have profited by almost 1.4%, or 160 pips, as the price bounced off the 111.40 and traded as high as 113 over the next couple of days.

4. Don't use Fibonacci over short intervals.

Day trading the foreign exchange market is exciting but there is a lot of volatility. For this reason, applying Fibonacci retracements over a short time frame is ineffective. The shorter the time frame, the less reliable the retracements levels. Volatility can, and will, skew support and resistance levels, making it very difficult for the trader to really pick and choose what levels can be traded. Not to mention the fact that in the short term, spikes and whipsaws are very common. These dynamics can make it especially difficult to place stops or take profit points as retracements can create narrow and tight confluences. Just check out the Canadian dollar/Japanese yen example below.

Figure 6: Fibonacci is applied to an intraday move in the CAD/JPY pair over a three-minute time frame.

In Figure 6, we attempt to apply Fibonacci to an intraday move in the CAD/JPY exchange rate chart (over a three-minute time frame). Here, volatility is high. This causes longer wicks in the price action, creating the potential for misanalysis of certain support levels. It also doesn't help that our Fibonacci levels are separated by a mere six pips on average - increasing the likelihood of being stopped out. Remember, as with any other statistical study, the more data that is used, the stronger the analysis. Sticking to longer time frames when applying Fibonacci sequences can improve the reliability of each price level.

The Bottom Line

As with any specialty, it takes time and practice to become better at using Fibonacci retracements in forex trading. Don't allow yourself to become frustrated; the long-term rewards definitely outweigh the costs. Follow the simple rules of applying Fibonacci retracements and learn from these common mistakes to help you analyze profitable opportunities in the currency markets.

Gann Theory - Gann analysis

noreply@blogger.com (Pareesh Ratan Kundu) — Mon, 17 Mar 2014 05:53:00 +0000

Gann Theory

Investment strategy developed by W D Gann, a successful twentieth century Wall Street trader, using continuous detailed analysis of the rate of change of stockmarket prices and applying strict trading rules, especially stop-loss levels. The Gann analysis is based on Natural Law, geometrical proportions, and the Gann’s law of vibration, where every asset has its own vibration according to its individual energy.

Gann analysis

William Delbert Gann, was the creator of the very popular Gann analysis, which includes such tools as the Gann Fan, Gann Trend and Gann Grid. Gann used Natural Law (the usage of reason to analyse human nature and its moral acts) and geometric proportions based on the circle, square and triangle, to forecast prices and to provide a base for his theories. His analyses were based only on the relationship between time and price.

Another theory which the general Gann analysis is based on is the Law of Vibration. The principles of Gann’s Law of Vibration, applied to the capital markets, were first presented to the public in his interview in 1909 to the “Ticker and investment digest”, and may be summarised as follows:

Each stock has its own distinctive path and range of activities based on trade volume, direction and others. All of them move according to their individual patterns or as defined by Gann “Vibrations”. Gann also compared the stocks to atoms by stating that the first are also a kind of centre of energy which may also be defined mathematically. Another interesting statement from Gann is the opinion that stocks possess powers just as magnets do - they can attract and repel - meaning that sometimes they may be leaders in a market for a moment, and in the next, just stagnate.

Together with the above theories, Gann concepts were mostly based on mathematics, and its numbers retrieved from ancient history, like egyptology or even the bible. Some numbers had special meaning in his concepts of price forecasting, the most significant being 16, 25, 36, 49, 64, 121 and 144. According to Gann, these numbers together with geometry and natural law have provided the proposed tools with a very significant forecasting ability.

Rule of thumb
Gann's theoretical approach may seem to be rather enigmatic, however its practical application on financial markets comes down to usage of a number of tools
The most important are described within this section, and it can be quite simple

Gann Line

Gann Line is a simple tool indicating the direction of a current market tendency and its possible points of reversal.
The Gann Line is the most basic tool among the array of forecasting instruments based upon the theory created by W.D. Gann. The method is constituted by a line, drawn at an angle of 45 degrees, either ascending or descending. According to Gann’s theory, the trendline at 45 degrees represents a long-term trendline.

In the case of an ascending line, as long as prices remain above the trendline, the market is considered to be bullish. A fall of a price below that level may indicate a discontinuation of a rising trend. On the other hand, prices below the descending line signal a significant downward market trend.

Rule of thumb

The Gann Line is based on the theory that the long-term trends follow a 45 degree line
As long as the prices remain above this line, the market tendency is considered to be bullish

Gann Grid

The Gann Grid may appear to be chaotic at first glance, however once properly set, it may provide insight into the development of the situation on the market.

Gan Grid is a variation of the 45 degrees Gann’s Line.

The 45 degree trendline is considered a long term trend, and prices above that line are considered to be bullish. A situation when the market prices remain under the 45 degree line is considered to be bearish. Instead of having only one 45 degree trendline, the grid compiles a set of 45 degree lines plotted over a price chart. Whenever the price stays above one of the ascending lines, the asset is considered to be in a bullish movement.

On the other hand, whenever the price stays below one of the descending lines, the asset is considered to be in a bearish movement.

Rule of thumb

Gann Grids implement the Gann’s theory, where a grid of lines at 45 degrees indicates possible market patterns.

Gann Fan

Gann Fan is based on the theory that the relationship between time and prices follows certain patterns, and the tool is aimed at the separation of bullish from bearish prices.

The Gann Fan is one of the many techniques W.D. Gann developed to study price movements.

For the Gann Fan, it is required for charts to be drawn with equal time and price intervals, so that a price movement for each time interval equals a 45 degree angle. Gann believed that the ideal balance between time and price exists when prices move at a 45 degree angle, relative to the time axis.

Based on Gann theories, the Gann Fan is made up of 9 trendlines, which function as support and resistance lines. When a price breaks one line, it should move to another line. The most important line in the Gann Fan is the 1x1 trendline (based on the 45 degree Gann line). Depending on the price being above or below this line, it will indicate a bull or bear market. Besides this major trendline, Gann indicates 8 other minor trendlines, with angles greater/less than 45 degrees (4 greater and 4 less than 45 degrees). These minor trendlines are 1x2, 1x3, 1x4, and 1x8.

Rule of thumb

The Gann Fan is generally used to determine trends - general market directions and potential support and resistance lines.

Mistakes of stock Investment.

noreply@blogger.com (Pareesh Ratan Kundu) — Thu, 13 Mar 2014 17:14:00 +0000

5 mistakes of my first stock Investment

Do you remember your first stock market trade and how you behaved at the time? Just like you, even I, have made some really stupid mistakes while investing. Today, I would like to share some mistakes (only the big ones :)) which I made during my first trade in stock markets. Its worth discussing, how I could have avoided those mistakes. You can learn from them too!

Mistake 1 : Buying on Others Recommendation.

27th Nov 2007 : I had just got my spanking new trading account and I was so eager to trade and make lots of money(How to start in Stock Market) . I saw an Orkut community recommending GTC India – a “Buy” Recommendation. There were several good reasons discussed there, and an extrapolation on how it can reach from current price of 600 to 2000 in some months. It looked like a “don’t-miss” trade. I bought 10 shares @ 560/-.
Mistake : Buying only on recommendation and not analysing the opportunity well, over relying on others recommendation, buying a company which I do not understand enough .
Learning : Never buy, just on recommendation! Do your own study and analysis. When you buy on others recommendation, you don’t take responsibility if there is any loss, which is dangerous in markets. Hear others but listen to your self. See other factors like market trends, sector view, global markets, future prospects et al. Once you are fully confident that its a good trade and you feel comfortable with it… go for it.

Mistake 2 : Being too greedy

After 3 days : Just after I bought the shares, it went up from 560 to 800 in 3-4 days. I thought that its moving as expected, and bought 10 more shares at 800. Within another week, it went up more to 950! Now, I was flying! I bought 10 more shares @955 again, to reach the target of 1500+ . My average buy price was now 772 . I was feeling little bad for not buying 30 shares directly @560 in the start .
Mistake : Greed! Pure & simple… This is a very common mistake, a big mistake at that – so big that it will be among the top mistakes investor and traders do. Buying more wasn’t wrong. It was the intention behind the buy. There is nothing wrong in increasing the position once it moves to your target, but it has to be backed up with strong reasons and study. It should be a trade with high probability of success. In my case, it was not. It was just a recommendation from someone in an orkut community, with a couple of lines, explaining, why it will go up .
Learning : There was no need to buy more shares that point in time. I should have just sat back and watched. The Stock market is just like our life, you need to have a level of satisfaction in your life and stock markets. If you want more and more and more, you might not get anything. In fact, you can lose heavily. Because of greed, I invested more than I could afford to lose. I took an unwanted and unaffordable risk, because I only saw profits and never the potential losses.

Mistake 3 : No profit booking on Time

After 1 week : The prices were not moving now. It was going up a bit then coming down again and was stuck in a range of 900-1000. It went up to 990 once. For a time being there was doubt in my mind if it will not move up to 2000 and will return back to my buy price levels.
Mistake : No profit booking. There was a sharp rise in shares price from 550 to 900 in just 2-3 weeks and that is rare. It doesn’t happen to every stock, it was an excellent return, but i did not book profits. Instead of making the best of the situation and taking the (not so bad) profits, the market was offering me, I wanted more and more and lost even what I was getting. The reason was Greed, again.
Learning : The better thing to have done, was to book profits, at least partially… Situations change in markets, I never checked on any news regarding the company after i bought the shares, and I was never updated about it. Every time you get some good profit, its a wise idea to at least book some partial profits out of it (Unless you have really strong reasons to hold it for long) .

Mistake 4 : Having Ego

In next 1 week : Prices now started coming down. It came to 900 first, I was scared and told myself that I will book profits once it goes back to levels of 950+. It never did! Then it came back to 800 and I regretted not booking a profit at 900 and said to myself again “I will book it for sure when it comes to 850.” Guess what? It never did! Then it went up a bit again and went up to 850 . I forgot my promise to myself & allowed my greed to take over my promise. It went down again after that and now it was near my average buy price. This was the time I was feeling, “What a big fool am I, for not booking Great profits!” I could have sold it at 0% profit, & yet I didn’t, because I would look a fool in my own eyes. Why Stock Markets Attract and Look Easy
Mistake : Ego ! Fear of losing part of profits, another mistake was the fear of not making any profits and fear of losing some money . Fear! Fear! Fear!
Learning : “When your boat starts sinking, you don’t pray… just jump” Once you are doubtful, surrender to markets wish. See what markets are showing you, not what you wanted to see. Markets are supreme and no one can be smarter than the markets. Leave your ego at your home, when you go in front of Markets. The markets tell you what’s going to happen, not vice versa. Accept that you are wrong and you made a mistake. Then move on.

Mistake 5 : No Patience

After few days : Then the prices started falling and plummeted to 600 (my original buy price). Now I was in loss. I was proven wrong, but I just couldn’t accept it. I kept trying to prove myself right by holding it and hoping it would come back up. Yea, you know… It never did . It went lower and lower and lower and I was just praying & hoping that it’d return back to a level where I’d be happy to sell it. It never did! It went up to 300 and I sold it all in frustration. Then, I saw it go down to 250 and bounce back to 500! Now, I was feeling like I was cheated by the market for not giving me the right opportunity to exit.
Mistake : Impatience, Fear and not cutting my losses short. I exited at a very bad time, at almost the lowest price then. There was an opportunity for me to exit at small loss, but taking a loss hurts the ego and it did. Not cutting my loss in time was the result, of my not defining my loss early enough. I should have had thought of it earlier. Then, I’d just pull a trigger, when it reached that level, without emotions. Fear overtook common sense, Fear overtook logic .
Learning : I should have defined my Target and Losses before taking the trade. I should have been realistic and logical. I should have waited little more time and then exited at a better price. I should have consulted someone, better than me (At that time though, even a street dog could have given a better advice than me :))

Price of GTC INDIA after this Incident : It never went above price levels after that and went to Rs 55 after couple of months , even (Nov , 2010) , its hovering below Rs 65 only .

Conclusion and Summary

My first trade was not at all planned and “no plan” is “a plan to fail” . Fear! Greed! Emotion! Ego! Impatience! . These are the elements of Failure in Stock markets. Manage them well and you’ll do better!

5 difference between stock & mutual funds Investing

noreply@blogger.com (Pareesh Ratan Kundu) — Thu, 13 Mar 2014 17:05:00 +0000

5 difference between stock & mutual funds Investing

When we say Equity, what comes to your mind – Stock or Equity Mutual Fund? While a single stock or a mutual fund both comes under the category of Equity and they are good option for long-term investment and needs periodic review. There are some differences between stock investing and mutual fund investing that is done by a common man. It’s a good idea to know where they differ and in which situation they differ, so that one can take better investing decisions. Let’s look at the main differences.

Volatility

When you invest in a single stock or bunch of stocks (3-5 scrips), the change in it’s value is very high. On a given day it can be extremely volatile. It can give you 20% return and sometimes -10% loss also depending on the environment. This can be very exciting and at the same time very disheartening and gives you a feeling that you need to “act fast”.

Mutual fund on the other hand is not that much volatile by nature, as the diversification is very large and at a time 50-100 stocks are covered. Different kinds of stocks from different sectors and market capitalization are involved in mutual fund and the over all change in value is thus less volatile (other than extreme days).

Return Potential

This is very much in line with the above point but still let’s look at it separately. There are lot of success stories where someone got quick rich by investing in equities directly and it can happen, but those are rare happenings and require lot of work and analysis, patience and belief in what you have picked. If you want superb returns in short time and you believe you can research well, you can go for stock investing directly but then risk is also more.

Mutual funds are known to deliver good returns (not in line with stocks, but still very good). So you can expect handsome returns from mutual funds but not unbelievable like stocks return. This is mainly because the money is diversified across different stocks (read ideas) and chances of all of them becoming a super success in short time is impossible.

Monitoring Required

Stock investing is a personal affair and you are doing it on your own the decision of what to sell and what to buy is on you. Even in case of long-term investing, you might have to keep an eye every quarter or yearly unless you have really spent some good time in picking the good stock. You need to also keep an eye on news and sector specific developments.

Monitoring in mutual funds is relatively low because the job of monitoring is anyways done by the fund manager who is paid SALARY to filter through the fluctuations. He constantly adds and removes the stocks from the portfolio. This can be a positive point, but sometimes it can be a negative point also if there is too much of churning.

SIP Investment

Mutual funds are known for possibility of SIP (monthly investment). SIP in mutual fund works and is recommended as a great way for a salaried person to invest in equity markets for long-term basis without understanding the working of equity markets.

However SIP in stocks do not work. Yes, some companies provide you the facility of SIP in stocks, but it’s a terrible concept. There is no diversification and SIP in a particular stock does not make sense because the risk is with single stock. A stock can be in a bad phase for years and decades, whereas in a mutual fund the bad performing stock is weeded out.

Asset Class Restriction

Stocks investing is restricted to Stocks only. You can choose a large cap stock, mid cap stock or small cap stock, but finally it will be equity asset class. However, mutual funds can invest in mix of asset classes. There are equity funds, debt funds, gold funds, Mix of Equity and debt also. To top up, even balanced funds are there which can adjust the asset allocation on its own, so in a way mutual funds are more superior in terms of features compared to a single or bunch or stocks.

Conclusion

Mutual Funds are actually collection of stocks only but just because it’s a group of stocks the characteristics are not very similar to that of stocks. You should be clear about all the points of difference and only after that you should decide whether to invest in Stocks directly or take the Mutual Fund route.

5 major changes in life insurance policies

noreply@blogger.com (Pareesh Ratan Kundu) — Thu, 13 Mar 2014 16:50:00 +0000

5 major changes in life insurance policies from Jan 1, 2014 – How it affects you ?

Some major changes are going to happen in life insurance industry from Jan 1, 2014, especially in traditional policies like Endowment Plans, money-back plans and even ULIP’s. You will surely have a LIC policy or any other private sector traditional plans or might buy them in coming times. Here are 5 major changes which you should be aware about and they will come into effect from Jan 1, 2014.

1. Service Tax introduced in LIC Policy Premium

Till now LIC was not charging the service tax of 3% from the customers and paying it to govt from the pool of money collected itself, but now the service tax will have to be charged separately from policy holders. Which means that if your LIC premium was Rs 50,000 per annum, now it will be 3.09% higher in first year, which is Rs 51,500 and after 1st year, it will be 1.545% as per moneylife article.

While customers see it as additional burden, note that its not the case exactly, Earlier – LIC was paying the service tax from the pool of money collected from investors only, which reduced the bonus amount given back to them. But now because it will not be taken out from the funds, that means the bonus declared each year will go up by that much margin and will come back to investors only. Note that Pvt companies were charging the service tax already, so nothing changes on their side. Only LIC was not charging it separately, which they will have to do from Jan 1, 2014 deadline.

2. Increase in Surrender Value

One of the major changes which has happened, is the change in surrender value for policy holders. The rules of surrender value depends on the premium paying term of the policy. If the premium paying term for policy is less than 10 yrs. Then the policy will acquire the surrender value after paying premium for 2 yrs (earliar it was 3 yrs), however if the premium paying tenure is more than 10 yrs , then the surrender value will be acquired only after paying 3 yrs premium.

In both the cases, the minimum surrender value would be 30% of the premiums paid without excluding the first year premium. Note that earlier, if you used to surrender after paying 3 premiums, you got 30% of premiums paid MINUS first year premium, but now as per new rules, the first year premium will not be deducted. Learn everything about LIC policies working before Oct 1

Another good change is that, from 4th-7th year, the minimum surrender value would be 50% of the premiums paid, and has to reach 90% of premiums paid in last 2 yrs of policy paying tenure.

3. Possible Decrease in Premium on LIC Policies

There is a great possibility that the premiums on LIC policies will come down by some margin, because the mortality rates will now be revised by LIC in calculating the premiums.

Mortality rates are the rates at which the insurance company deducts the fees for insuring you based on your age. LIC had been using old mortality rates till now, but now they will have to use new mortality rates . Just to give you an idea on reduction of premium, when I check the mortality rate for a 40 yrs old person in old table, its 0.001803 . But in new rates its 0.002053 . Which is approx 10% better. Lets not go into detailed calculation at the moment, but your risk premium part should go down by 10% (not the full premium, because only some part of whole premium in traditional policies are risk premium and rest is investment part) .

4. Higher Death Benefit

If the policy holder is above 45 yrs of age, then the Sum Assured has to be more than 10 times the annual premium, and for those who are less than 45 yrs old, it can be minimum 7 times the premiums. Note that for claiming the tax exemptions, your sum assured has to be 10 times the base yearly premium. So when you buy the policy in-case, you need to keep it in mind. BasuNivesh has done a great point by point notes on each aspect of regulation, in-case you want to go into details.

5. Agents’ incentives have now been linked to the premium paying term

Now agents commissions is linked to the premium paying tenure. Earlier a lot of agents used to sell the policies which had higher maturity tenure, but limited premium paying tenure (like 30 yrs policy with 10 yrs premium payment) . Here is the new commission structure taken from Moneylife article

In case of regular premium insurance policies, a policy with a premium paying term (PPT) of five years will not pay more than 15% in the first year. Products with PPT of 12 years or more will have first year commissions up to 35% in case the company has completed 10 years of existence and 40% for the company in business for less than 10 years.

The funny aspect is that a lot of LIC agents tried to mislead many new investors by projecting date Jan 1, as the deadline when a lot of LIC products will stop giving good features using the official notification. LiveMint has even captured it in this image.

What should you do ?

The insurers have to refile all their products to IRDA and already lots of products have been approved and many are still waiting for approvals. So if you have a insurance policy, then you will get the communication from your insurer about any changes if any. Right now, for sure the traditional plans have got better, compared to their past avatars.

If you are adamant on buying endowment plan, better wait for some time and let things get more clear. Let me know about your thoughts on this change ?

Transfer PPF account from Post Office to Bank

noreply@blogger.com (Pareesh Ratan Kundu) — Thu, 13 Mar 2014 16:39:00 +0000

Transfer PPF account from Post Office to Bank

How do you transfer PPF account from Post Office to SBI Bank? This has been a big question mark for all the PPF account holders who opened their PPF account in Post Office and now want to transfer PPF account to SBI Bank or other banks so that they can take benefits of online money transfer to their PPF accounts. Also it becomes easy for them to do other kind of activities if PPF account is in some bank.

So, in this article we will see the steps required to transfer PPF account from Post office to any Bank. In this example we will use SBI as the example. But you can use the same procedure for any SBI Bank or its subsidiaries or even ICICI Bank which has recently started providing PPF accounts.

Steps required to Transfer PPF account from Post Office to SBI Bank

Step 1	First step is to make sure your PPF Passbook is updated with all the interest credited till date. You need to go to Post Office and get it updated.
Step 2	Fill up following documents PPF Transfer Form SB-10(b) . Download Form to transfer PPF Account here An application on plain paper requesting PPF Account transfer from Post Office to SBI Bank Incase you already have a SBI Account, then SBI passbook (Will fasten the process) PAN/Address Proof (Can be confirmed at Post Office)
Step 3	Submit the form to Post Office Head PostMaster, He will verify your signature with the records at Post Office and verification will be completed.
Step 4	The balance in your PPF account in Post Office will be taken out and your PPF account will be closed by Head Post Master and he will note the remark of Transfer of PPF Account to SBI Bank on all the relevant documents.
Step 5	The balance amount in your PPF account will then be remitted back to State Bank of India through Cheque or Demand Draft along with other relevant documents.
Step 6	Your PPF account will then be opened (transferred) at SBI Branch and you will be notified on this. It would be better to not wait for it and you yourself keep track of the progress.

Go to SBI bank after all these steps are done and collect your new PPF Passbook. Note that all the previous entries of your Interest payments etc will not be present in the new PPF Passbook. It will only have the new and current entries now. So in-case you needed the previous information for claiming tax deductions, better take the printout of the previous PPF Passbook and keep photocopies of all the documents you filled and submitted for PPF Account Transfer.

What about interest part when you Transfer PPF account from Post Office?

Do you know How PPF interest is calculated ? Its only monthly basis , but credited yearly. Now as per PPF Rules, the bank or the post office transferring the account will add interest up-to the preceding 31st March in the account before the it is transferred. The interest from 1st April onwards will be added by the transferee office after the close of the year. As per rule 8 of the scheme the interest in the account has to be added at the end of the year and not in the middle of the year in any case. So make sure to ask and confirm from Post Office Postmaster if he will do this step or not. And once the PPF Account is transferred, at the end of the year, make sure you get the total interest in your account. Just verify it at the end of the year.

What Problems you are can face while Transfer of PPF Account?

Problem 1 : The biggest problem you will face is the ignorance SBI & Post office employees have about this whole process. I think Post Office Employee has more information (and less ego) than SBI Employees. They might reject the whole idea and say “Its not possible to transfer”.

In that case, take the print out of Rule 153 of this document which is at Post Office website and clearly defines the rules to Transfer PPF Account from Post Office to SBI Bank. Another thing you can do is very humanly and in a soft voice, tell them you will file an RTI to know the process of PPF Transfer from Post Office to SBI Bank and would come back with that RTI query (Post Office and SBI comes under RTI incase you didn’t know). I am sure this will be enough to speed up the whole process.

Problem 2 : Another problem you may face is documentations, I am not very sure if PAN card/Address proof is required or not and what other documents, but in that case again take help of your Post Office Head Post Master, he will surely help you. If you are stuck at any points, use sentences like “I will file an RTI and … ” . That might help you.

Public Provident Fund (India)

noreply@blogger.com (Pareesh Ratan Kundu) — Thu, 13 Mar 2014 16:28:00 +0000

Have a PPF Account? Read This

Till date, the Public Provident Fund (PPF) scheme is the most popular investment in India. If you’re looking for an exemption on the money you invest, interest that is non-taxable and a maturity amount that is exempt from tax as well, this is the instrument for you.

So it’s no surprise that with these 3 very prominent benefits, almost every individual in the country has a PPF account and contributes to it religiously every year.

But do you really have total PPF knowledge? Are you aware of interest rate changes in the PPF over time? Do you know that this money can never be attached to any debt or liability i.e. it is yours forever? There are many ways in which you can derive the maximum benefit from your PPF account. Let’s see if you know everything you need to know about this incredible investment instrument.

Let’s get straight to the facts...

1. PPF stands for Public Provident Fund - a government backed, long term, retirement savings instrument.

With a 15 year lock in, this is the longest horizon for an investment that exists in India. If you are keen on a safe investment, a decent rate of return, tax benefits (deduction and tax free interest) and have a long term investment horizon, then the PPF is for you. It is a disciplined investment avenue as your money is blocked for 15 years. PPF also offers loan against the account which can help you during occasions like a wedding in the family, further studies of your children, etc.

2. The main features are:

the 15 year lock in,
the E-E-E status (tax exemption on investment, interest and maturity) under Section 80C,
the minimum investment of Rs. 500 p.a. and maximum of Rs. 1 lakh p.a. (w.e.f 01-Dec-2011)
and the interest rate which currently stands at 8.8% for this fiscal year. The interest rate will be announced annually, it is no longer fixed at 8% p.a.

In fact, the PPF interest rate has steadily dropped over the years, and can be expected to slowly fall as the years proceed. Here’s a look at what rates used to be in the hey-days of the PPF account:

Period	Interest Rate p.a.
01 April 1986 - 14 Jan 2000	12%
15 Jan 2000 - 28 Feb 2001	11%
01 March 2001 - 28 Feb 2002	9.50%
01 March 2002 - 28 Feb 2003	9.00%
01 March 2003 - 30 Nov 2011	8.00%
01 Dec 2011 - 31 March 2012	8.60%
01 April 2012 till date	8.80%

01.04.2014	Present	8.7%

3. An NRI can’t open a PPF account.

The rule of 25th July, 2003 states that ‘Non Resident Indians are not eligible to open an account under the PPF Scheme’. However ‘Provided that if a resident who subsequently becomes a Non Resident during the currency of the maturity period prescribed under the PPF scheme may continue to subscribe to the Fund till its maturity, on a Non Repatriation Basis.’

So if you open it as an RI, and during the 15 year tenure become an NRI, you can continue to invest, but on a non-repatriable basis.

4. You can make up to 12 investments in a year into your PPF account, in multiples of Rs. 5.

5. You can transfer your account from one ‘Account Office’ to another for example for convenience if you shift home.

6. The best time to invest is between the 1st and the 5th of any month, preferably April each year. Interest is calculated for the calendar month on the lowest balance at credit of your account, between the close of the 5th day and the end of the month, and is credited at the end of every year.

7. Regarding withdrawals from your PPF account, there are 3 things you need to know:

a) Any time after the expiry of the 5th year from the date that the initial subscription is made, you become eligible to withdraw an amount of not more than 50% of the previous year’s balance or of the 4th year immediately preceding the year of withdrawal, whichever is less. If you have taken any loan on your PPF, this also gets factored in and reduces your balance.

b) You cannot make more than a single withdrawal in the year. you need to apply with Form C for any withdrawals.

c) Our PPF Calculator helps you see exactly how much you can withdraw from your PPF account and also how much loan you are eligible to avail, and in which years.

8. You can close your account or continue your account without deposits after maturity...

Any time after your account matures i.e. after the 15 year tenure is over, you can withdraw the entire balance using Form C. Interest will continue to be paid on your account and you will receive the total amount including interest up to the last month preceding the month in which you apply for a withdrawal.

9. You can even continue your account with deposits after maturity...

Few people know this, but the PPF account is indefinitely extendable. It has a 15 year lock in, but then you can extend it for periods of 5 years at a time, indefinitely. Your account continues to operate normally i.e. you make deposits of up to Rs. 1 lakh, earn interest and renew after 5 years if you wish. Everything remains E-E-E. To extend by a block of 5 years, use Form H.

10. You can withdraw, even if you choose to extend...

If you choose to extend by subscribing for a 5 year block, you can make partial withdrawals (using Form C again) of up to 60% of the amount standing at your credit at the beginning of this 5 year block period.

11. At any point in your life, you are allowed to have only 1 PPF account in your name.

You can also have an account in the name of a minor child of whom you are the parent / guardian. However that will be the child’s account, you will simply be the guardian.

If at any time it is seen that you have more than 1 account in your own name, the second account will be deactivated, and only your principal will be returned to you.

12. If you choose to take a loan against your PPF account, you can repay it within 36 months from the 1st day of the month following the month in which the loan was sanctioned. So if your loan is sanctioned in June, 2012, the following month is July 2012, and you have until end July 2015 to repay your loan. The interest rate charged is 2% p.a. over the prevailing PPF interest rate.

Conclusion

There’s a lot to know that can help you make the most of your PPF account. And if past rate changes are anything to go by, you can expect 8.80% interest to not last forever. As it stands today, the PPF remains E-E-E, so make the most of it to add to your retirement corpus. Feel free to use the PPF Calculator.

10 points you must know while investing in Mutual Funds

noreply@blogger.com (Pareesh Ratan Kundu) — Thu, 13 Mar 2014 16:09:00 +0000

10 points you must know while investing in Mutual Funds

Today, with over 3,500 mutual schemes available in the market the task of picking the right mutual fund can be rather mind boggling. Moreover with a tendency amongst investors to fall for the "Rs 10" investment proposition - offered by New Fund Offerings (NFOs), the task of picking the right ones can be even more daunting. While many investors also do feel that 'any' mutual fund can help them achieve their desired goals, let us apprise you that each mutual fund scheme is unique and caters to a certain risk profile. Moreover, selecting winning mutual funds involves a rigorous process, where both quantitative and qualitative parameters are considered, as it is imperative to have consistent performers in your portfolio; those who can stand by you in sickness and health.

Thus while there are host of factors to be studied, while picking a good mutual fund (which may not be everyone’s cup of tea to evaluate), we recommend that one can broadly look at the following 10 points, which can enable in selecting the right one:

A fund sponsor with integrity

Fund sponsor are individuals who think of starting a mutual fund house. They approach the capital market regulator - Securities and Exchange Board of India (SEBI), who then provide them approval to enter the mutual fund business (after having ascertained their credentials). After having given the approval by SEBI, the sponsors then establish a Trust under the Indian Trust Act, 1882, and the trustees of which appoint an Asset Management Company (AMC), who then manages investors’ money.

It is vital for you investors to recognise this 3-tier structure of a mutual fund house, as the linkage of the same will help you understand who the promoters are, their record in the financial services domain and the experience which carry along with them. While SEBI would grant a permission to start a mutual fund only to a person of integrity, with significant experience in the financial sector and a certain minimum net worth; it imperative for you to be satisfied (by your own judgement) on these aspects. We believe these background checks are necessary be it sponsors from India or abroad.
Experience of the fund management team

While the trustees assign the job of managing investors’ money to the Asset Management Company (AMC), a check over the experience of the fund management team may ensure that you give your hard earned money in competent and deserving hands.

While many investors’ often get impressed seeing more number of schemes managed by the fund manager (of a respective fund houses); in our view this is rather worrisome since it reflects transcending pressure on the fund manager while managing investors’ hard earned money. It may so happen that he may simply replicate the portfolio, and in the bargain defeat the unique mandate of each scheme managed by him. In our view, ideally, a fund manager should not be managing more than 5 schemes; as such a "funds-to-fund manager ratio" can help in bringing in efficiency while managing your hard earned money.

Also we think that one should not merely invest in a respective mutual fund scheme of a fund house, just because it is managed by a star fund manager. Many mutual fund distributors / agents / relationship managers may persuade you to invest in mutual fund scheme managed by a star fund manager; but then you need to ask relevant questions on track record of performance of all the mutual fund schemes managed by the star fund manager (which your mutual fund distributor / agent / relationship manager has high regards), where you need to check the following:
- Returns of the respective mutual fund schemes
- Risk investors are exposed to (as revealed by the Standard Deviation)
- Risk- adjusted returns achieved by the fund (as revealed by the Sharpe Ratio)
- Portfolio churning (as revealed by the Portfolio Turnover Ratio)
Moreover, as a litmus test you also need to ascertain how the respective mutual fund schemes managed by the star fund manager has sailed during various market cycles (i.e. during bull and bear phases of the markets). Mind you, while your mutual fund distributor / agent / relationship manager may have everything to boast about the star fund manager during the bull phases, the true test of the fund manager (he's promoting) lies during the bear phase. This is because the respective mutual fund schemes managed by the star fund manager must display limited downside risk during the turbulence of the equity markets, thereby attempting to protect wealth erosion. And indeed if the fund manager has delivered a luring performance, then you got to ponder over the question of what should you do if the fund manager leaves the organisation (for better career prospects, or even when he retires). While this may sound a bit too much of long- term thinking, in our opinion it is imperative if the mutual fund house is not process and systems driven, whereby the fund manager has been given the leeway to manage a mutual fund scheme based on his individual fund management traits.
Investment philosophy, processes and systems followed at the fund house

After having done an evaluation on the fund manager and his team’s experience, what is the broader investment philosophy at the fund house should be well recognised. Moreover, you also need to assess whether investment processes and systems have been well laid down by the respective mutual fund house. It is noteworthy that prudent investment processes and systems have a major impact of individual mutual fund schemes perform, and moreover tend to sail well during the turbulence of the equity markets and also when the fund manager quits or retires from his job. This is because everything is well-defined through an investment process and system (along with a mandate which a respective fund follows), and is not left to the fund manager’s whims and fancies. It is noteworthy that getting a fund house following strong investment processes and systems is the first, right and very important step in making a prudent investment decision in mutual fund investing. Hence it is important for you as investors to delve a little deeper in understanding all these aspects before entrusting your hard earned money to a respective fund house.
Investment objective

Every mutual fund scheme, irrespective of the category - whether equity or debt has an investment objective. It is this investment objective which entails them to invest in various asset classes in defined proportions. As investors it is imperative to check the investment objective of the respective mutual fund scheme, and thereby see whether it suits your objective of investing as well. For example, if you have an objective of capital appreciation with a long-term investment horizon in mind and is willing to take high risk, then you should be looking at equity oriented mutual funds. Similarly if you are a risk averse investor, you should be looking at suitable debt mutual fund schemes (depending upon your investment time horizon).
Investment style

Further depending upon your risk appetite, you can also structure your mutual fund portfolio as per market capitalisation bias (i.e. large cap, mid cap, small & micro-cap, mutli cap and flexi cap) and fund management style (i.e. opportunities style, value style, growth style and blend style). While one may argue over how the layman can judge which market cap bias and investment style the mutual fund scheme follows; we would like to apprise you that it’s all there in the mutual fund scheme’s offer document, which you ought to read well before parking your hard earned money.
Fund performance

The past performance of a mutual fund scheme is important in analysing a mutual fund. But remember that, past performance is not everything, as it may or may not be sustained in future and therefore should not be used as the only parameter to select winning mutual funds. While during good times your mutual fund distributor in pomp, may exhibit you performance charts and tables, you also need to evaluate them in context to:
- Risk they have exposed you to
- Risk-adjusted returns clocked
- Portfolio which they held (and its characteristics)
- How often the fund has churned its portfolio
Moreover, merely studying these numbers in isolation can do no good to you. On the contrary a comparative study on these, along with analysing performance across market cycles can help you in picking the good ones.

While one may say why not invest in star rated funds if such vigorous process has to be followed, we would like to acquaint you that merely relying on star ratings (which are illustrated taking into account only quantitative parameters) may not enable you to have rock stars or winning mutual fund schemes in your portfolio. This is because when quantitative parameters (on which they are rated) undergo a change, mutual fund schemes would also play musical chairs. A fund which is "5 star" rated today, may become "3 star" in the ensuing year. The financial crisis of 2008 has shown that credit rating agencies were happy to sell their star system to those who offered them money. The saddest part is that, this completely misled the investors.

Mind you, at PersonalFN we have never followed an "issuer pays" rating model. Our rankings are completely unbiased and independent, taking into account both quantitative as well as qualitative parameters. We never, put anything before the interest of our investors'. And that makes us unique.
Expense ratio

Like any other organisation, a mutual fund house also incurs annual expenses (such as administrative costs, management fees, etc.) to run it business. Expense Ratio is the percentage of assets that go towards these expenses. Every time the fund manager churns his portfolio, he pays a brokerage fee, which is ultimately borne by investors in the form of an Expense Ratio. It is noteworthy that, higher churning not only leads to higher risk, but also higher cost to the investor for all the brokerage charges and taxes incurred on every trade. Costs are always there and are deducted immediately, but the returns and a higher NAV are a hope for all investors. Hence it is always recommend to select a mutual fund scheme, which has got a low expense ratio as compared to its peers.
Exit load

Likewise, you should also be checking the exit load which a respective mutual fund scheme would charge. An exit load is levied when you sell your units of a mutual fund within a particular tenure; most funds charge if the units are sold within a year from date of purchase. As exit load is a fraction of the NAV, it eats into your investment value. Thus it is imperative that you invest in a fund with a low exit load, and more importantly stay invested for the long-term.
Investor service and transparency

Services offered by mutual fund houses may vary across funds. Some fund houses are more investor friendly than others, and offer information at regular intervals. For instance, fact sheets of some mutual fund schemes are not disclosed in entirety, where the undisclosed portfolio holds a large composition, thus making one wonder in which securities is the money parked by the fund house.

Thus while investing, it important to delve a little detail and assess whether the fund house and the respective mutual fund scheme adopts good disclosure norms, thus making you exude confidence in them and take a prudent investment decision.
The tax implications

Many a times investors go by the word of their mutual fund distributor / agent / relationship manager and invest in mutual funds. While we aren’t debating about quality of the advice they provide (on a respective mutual fund scheme per se), we think that it is necessary for you to be aware of the tax implications of a respective mutual fund schemes.

Apart from being aware of tax status for Equity Linked Savings Schemes (ELSS) - where you are entitled to a deduction under section 80C of the Income Tax Act, 1961 for the investment made upto a sum of Rs 1 lakh; through experience we can say that many investors aren’t aware of the other tax implications of investing in equity and debt mutual fund schemes.

It is noteworthy that in equity mutual funds, if you have opted for the dividend option (for the reason that you want cash inflows to be managed through dividends), then the dividends which you received under the scheme is completely exempt from tax under section 10(35) of the Income Tax Act, 1961.

If you are caught in the wrong habit of short-term (period of less than 12 months) trading, then you got to forgo your profits/capital gains, if any, in the form of Short Term Capital Gains (STCG) tax. STCG are subject to taxation @ 15% plus a 3% education cess. However, if you are the one who deploys money for the long-term (over a period of 12 months) and thus subscribe to a good habit of long-term investing, then there is no tax liability towards any Long Term Capital Gain (LTCG). Moreover, at the time of redeeming your units you will also have to bear a Securities Transaction Tax (STT) @ 0.25%.

Similarly in debt mutual fund schemes too, if you have opted for the dividend option (to manage your cash inflows), then the dividend which the scheme declares will be subject to an additional tax on income distributed. Hence, in such a case you as an investor are actually paying the tax indirectly.

Unlike equity funds, in debt funds, you are liable to pay a tax on their Long Term Capital Gains (LTCG) tax, which is 10% without the benefit of indexation and 20% with the benefit of indexation. However in case of Short Term Capital Gains (STCG), you will be taxed at the marginal rate of taxation i.e. to simply put, in accordance to your tax slab. As far as STT is concerned, debt mutual fund investors do not have any liability to defray the same.

Thus you got to be aware of all these tax implications, which in turn would help you making a wise investment decision.

It always important to remember that investing is a serious business; and thus it is vital that you adopt enough prudence before you invest your hard earned money. Moreover, a disciplined approach to investing can help you to create wealth in the long run.

Fixed Maturity Plans (FMPs)

noreply@blogger.com (Pareesh Ratan Kundu) — Thu, 13 Mar 2014 15:55:00 +0000

Fixed Maturity Plans (FMPs)

What are FMPs?

FMPs are close-ended debt funds with a maturity period ranging from one month to five years. These plans are predominantly debt-oriented, while some may have a small equity component. The fundamental objective of FMPs is to provide steady returns over a fixed-maturity period, thus protecting investors from market fluctuations.

What are the benefits of FMPs?

Capital Protection - FMPs provide less risk of capital loss as compared to equity funds due to their investment in debt and money market instruments.

Better Returns - FMPs offer better post-tax returns than FDs as well as liquid and ultra short-term debt funds.

Less Exposure to Interest Rate Risk - As the securities are held till maturity, FMPs are not affected by interest rate volatility.

Tax Benefit - FMPs score over fixed deposits because of their tax effectiveness both in the short-term and long-term.

Lower Cost - Since these instruments are held till maturity, there is a cost saving with respect to buying and selling of instruments.

Double Indexation Benefit - Indexation helps to lower capital gains and thus lower the tax. Double indexation allows an investor to take advantage of indexing his investment to inflation for 2 years while remaining invested for a period of slightly more than 1 year.

How do FMPs work?

A portfolio of FMPs consists of various fixed income instruments with matching maturities. On the basis of the tenure of the FMP, a fund manager invests in instruments in such a way, that all of them mature around the same time. During the tenure of the plan, all the units of the plan are held until they mature on a specified date. Thus, investors get an indicative rate of return of the plan.

Who should invest in FMPs?

Investors looking at stable returns over the medium-term
Investors who are not pleased with returns from traditional fixed income avenues like Bank deposits, Bonds etc.
Investors who want to invest money for a fixed tenure to meet certain financial goals in the future
Investors with a conservative and risk averse profile
Retired persons, instead of making random withdrawals from their savings, can invest to have a flexible and regular income

Where do FMPs invest?

FMPs usually invest in certificates of deposits (CDs), commercial papers (CPs), money market instruments, highly rated securities (like ‘AAA’ rated corporate bonds) over a defined investment tenure and sometimes even in bank fixed deposits.

What is the difference between FMPs and bank fixed deposits (FDs)?

Returns - FMPs are the equivalent of a fixed deposit (FD) in a bank. While, the maturity amount of a fixed deposit in a bank is guaranteed, the maturity amount of an FMP is not guaranteed.

Duration of Investment – FMPs invest as per the tenure of the Scheme i.e ranging from 1 month to 3 years. FDs on the other hand have an investment horizon of 15 days to 10 years.

Taxation - In FDs, the interest income is added to the investor’s income and is taxable at the applicable tax slab. If you invest in the growth option of an FMP for less than a year, the gains are added to the investor's income and taxed at the investor's slab rate. If you invest in the growth option of an FMP for over a year, you pay either 10% capital gains tax without indexation or 20% with indexation.

Example – The following comparative table shows the returns where an Individual investor has invested 10,000 in a Fixed Deposit and a Fixed Maturity Plan for six months in the dividend option.

Particulars	FMP	FD
Amount Invested	10,000	10,000
Rate of Return	10	10
Projected Maturity Value ()	10,493	10,493
Gross Dividend/Interest ()	493	493
Dividend Distribution Tax / Short term Capital Gains Tax Rate %	14.1625	33.99
Tax ()	61	168
Net Dividend / Interest ()	432	326
Post Tax Value ()	10,432	10,326
Post Tax Returns	8.76%	6.60%

Note:-

The investor in this example falls in the highest tax bracket.
The 10 % return used in the example for FMP is for illustrative purposes only and not assured and the actual returns may go up or down depending on the market conditions. The Fixed Deposit rate is also for illustrative purposes only.

In case of FMPs; all accretions are assumed paid on maturity.

Investment Concepts - Power of Triggers

noreply@blogger.com (Pareesh Ratan Kundu) — Thu, 13 Mar 2014 15:47:00 +0000

Investment Concepts - Power of Triggers

Trigger facility is an additional, optional feature provided in mutual fund schemes, which enables investors to book profit automatically at a pre-defined time or value. In another words, the fund declares a dividend, redeems and/or switches the units automatically on behalf of the investor on the date of the event.

Principal Mutual Fund has introduced the option of Triggers in its funds. You can specify a specific event, which may be related to time or value, in advance and when this event takes place the trigger is activated. Thus, this facility enables you to keep track of your investments without having to put in time and effort to track portfolio movements on a regular basis. It also helps you maintain a disciplined investment approach that ensures that you meet your investment goals. Triggers are of three types –time-based, value-based and event-based.

Time-based triggers

Time-based triggers are activated on a particular date that you have specified. For example, if you wish to gift some units to your mother on her birthday, a trigger can be set for that date.

Value based triggers

These triggers are based on the change in value of your investments. For example, you need 7.5 lakh for meeting the expenses of son's higher education after 5 years and you have invested 5 lakh in an equity scheme for this. If you set a trigger for change in investment value by at least 50%, the money is shifted to a low risk scheme as soon the value reaches that figure. In this way, the dream of your son's higher education will not go sour even if the market turns bearish.

Event-based triggers

You can also set triggers based on the occurrence of a particular external event that affects the value. For example, you want to set the Sensex value of 20,000 as a trigger. If the Sensex is less than 20,000 on the date of allotment, the trigger would be activated when the Sensex closes above 20,000. However, if the Sensex is more than 20,000 on the date of allotment, the trigger would be activated when the Sensex closes below 20,000.

Systematic Withdrawal Plan (SWP)

noreply@blogger.com (Pareesh Ratan Kundu) — Thu, 13 Mar 2014 15:36:00 +0000

Systematic Withdrawal Plan (SWP)

An SWP allows an investor to withdraw a designated sum of money and units from the fund account at pre-defined regular intervals. It allows investors a certain level of independence from market instability and helps in avoiding market timing. The investor can reinvest the redeemed cash in another portfolio or use it as a source of regular income.

Advantages

Regular Income - SWP helps in creating a regular flow of money from investments on a periodic basis i.e. on a monthly or quarterly basis.

Tax Benefit - Instead of selling all the units at once, spanning the income across multiple intervals can lower the total tax. It is a tax efficient way of receiving regular income.

Avoid market fluctuations - It saves an investor from market fluctuations, as regular withdrawal averages out return value.

How does an SWP work?

An SWP allows you to withdraw a fixed sum of money every month or quarter depending on the option chosen and instructions given by you.

Let's say Ashish has 10,000 units in a mutual fund scheme on 1-Dec-11. He intends to withdraw 6,000 every month through SWP.

Date	Opening Balance (Units)	NAV	Units Redeemed	Closing Balance
1-Dec-11	10000	20	300 (6000/20)	9700
1-Jan-12	9700	18	333.33 (6000/18)	9366.67
1-Feb-12	9366.67	22	272.73 (6000/22)	9093.94

In this manner, units from mutual fund holdings will be redeemed in a systematic way to provide the investor with regular income.

Types of SWP

SWP is usually available in two options:

Fixed Withdrawal: In a fixed withdrawal option, the investor specifies the amount he wants to withdraw from his investment on a monthly/quarterly basis.

Appreciation Withdrawal: In an appreciation withdrawal option, the investor withdraws only the appreciated amount on a monthly/quarterly basis.

An SWP can help investors who require liquidity as it permits them to access their money precisely when they need it to meet their needs.

Systematic Transfer Plan (STP)

noreply@blogger.com (Pareesh Ratan Kundu) — Thu, 13 Mar 2014 15:28:00 +0000

Systematic Transfer Plan (STP)

An STP is a plan that allows investors to give consent to a mutual fund to periodically transfer a certain amount / switch (redeem) certain units from one scheme and invest in another scheme of the same mutual fund house. Thus at regular intervals an amount/number of units you choose is transferred from one mutual fund scheme to another of your choice. This facility thus helps in deploying funds at regular intervals.

Advantages

Consistent Returns – Through STP, you can transfer your money to a target equity fund while you are invested in a debt or liquid fund. Therefore, you will get the returns of the equity fund you are transferring into and at the same time remain protected as a part of your investment remains in debt.

Averaging of Cost – Like SIP, in STP too, a fixed amount of money is invested in the target fund at regular intervals. Since it is similar to SIP, STP assists in averaging out the cost of investors by purchasing more units at a lower NAV and vice versa.

Rebalancing Portfolio – STP facilitates in rebalancing the portfolio by allotting investments from debt to equity or vice versa. If your investment in debt increases money can be reallocated to equity funds through an STP and if your investment in equity goes up money can be switched from an equity to a debt fund.

How does a STP work?

The investor needs to select a fund from which the transfer should take place and a fund to which the transfer is taking place. Transfers can be made daily, weekly, monthly or quarterly depending upon the STP chosen and the options available with the AMC.

If an investor chooses to transfer from a liquid fund to an equity fund, the lump sum is invested in a liquid or a floating short-term plan and is transferred at regular intervals to a specified equity fund. For example, if one has 50,000 to invest in equities; he can put the entire amount in a liquid plan and go for a monthly SIP of 5,000 in an equity plan through an STP.

STPs can carry Exit Loads as per the respective schemes of the AMC.

Types of STP

A Systematic Transfer Plan is of three types; Fixed STP, Capital Appreciation STP and Flexi STP.

Fixed STP – In Fixed STP, the investor takes out a fixed sum of money from one investment to another.

Capital Appreciation STP – In Capital Appreciation STP, the investor takes the profit part out of one investment and invests in the other.

Flexi STP – In Flexi STP, the investor has a choice to transfer a variable amount. The fixed amount will be the minimum amount and the variable amount depends upon the volatility in the market.

Thus, STP is particularly suitable to investors who have lump sum money and wish to invest in equity funds but are wary of timing the market. They can then choose to park the lump sum money in a liquid or debt fund and use the STP option to systematically transfer a fixed amount of money at regular intervals into the target equity fund.

Systematic Investment Plan (SIP)

noreply@blogger.com (Pareesh Ratan Kundu) — Thu, 13 Mar 2014 13:01:00 +0000

Systematic Investment Plan

Systematic Investment Plan (SIP) is an option where you invest a fixed amount in a mutual fund scheme at regular intervals. For example, you can invest 1,000 in a mutual fund every month. It is a disciplined investment plan and helps reduce propensity to market fluctuations. It is a convenient tool that helps you preserve capital and also render significant wealth creation in the long-run.

SIP investments can help you reach your financial goals by taking advantage of rupee cost averaging, and growing your investments with compounded benefits.

Advantages

SIP has several advantages over one-time investment. Some of the advantages are mentioned below:

Disciplined approach to investments
Flexibility to invest small amounts every month
Benefit from the power of 2 powerful investment strategies
- Rupee cost averaging – helps counter volatility
- Power of compounding – small investments create a big kitty over time
Convenient and hassle-free mode of investment
No need to time the market

Rupee Cost Averaging

Rupee Cost Averaging is an effective mechanism which helps in eliminating the need to time the market. Under this method, one need not be concerned about when and how much to invest. A fixed sum of money can be invested regularly and over time it averages out the costs. Say, you invest 1,000 a month, and, the price of the selected mutual fund scheme unit is 10 in the first month, you will get 100 units.

In the next month, if the unit price falls to 9, you are allotted 111 units. In the third month, if the price drops further to 8, it can get you 125 units. Thus, by investing 3,000 over three months, you will get 336 units.

On the other hand, had you invested the entire amount in the first month itself, you would have gained just 300 units. In case of SIPs, the average unit cost is about 8.9 as compared to 10 in case of lump sum investments. Thus, SIPs help lower the average unit cost and can buy you more units.

Power of Compounding

You can gain from compounding by reinvesting the money you earn from your investments to earn even more. The earlier you start, the longer your money has the opportunity to compound and enhance your corpus helping you achieve your financial goals.

Below is an example for a SIP of 1,000 invested per month @8% till the age of 60.

Starting Age	Total Amount Saved ()	Value at the Age of 60 ()
25	4,20,000	23,09,175
30	3,60,000	15,00,295
35	3,00,000	9,57,367
40	2,40,000	5,92,947

Thus, the power of compounding can have a considerable impact on your wealth accumulation, particularly if the investment is for a long period of time.

Convenience of Investment

Register for SIP by signing up the required forms of periodic investments (monthly/quarterly) based on your suitability. Your account will be automatically debited on the requested date to purchase the units of the required fund.
SIP is a simple, convenient and affordable way to invest for your future. With as little as 1,000 every month, it’s an effective method to invest in the growth potential of Mutual Funds.

Investment Concepts

noreply@blogger.com (Pareesh Ratan Kundu) — Thu, 13 Mar 2014 12:24:00 +0000

Whether you are a new or experienced investor, investing in a modest or sizable portfolio, understanding certain key investment concepts is important. Principal Mutual Fund brings to you a primer to help understand concepts such as - diversification, time value of money, rupee cost averaging and others - as a foundation to form a sound investment strategy.

Inflation

Inflation refers to a continuous rise in general price level, which shrinks the value of money or purchasing power over a certain length of time. It is calculated in terms of per cent change in the value of price index consisting of a range of goods or services. An inflation rate of 8% means that the general level of prices of goods and services has increased by 8% over the previous period.

In other words, purchasing the same amount of goods and services will cost you 8% more than what it would have cost you in the previous period. Thus, Inflation can also be explained as a decline in the real value of money - a loss of purchasing power in the means of exchange, which is also the monetary unit of account.

There are several inflation measures available in India – the most commonly used are based on Consumer Price Index (CPI) and Wholesale Price Index (WPI). Within these, there are several sub-indices (e.g. CPI for Industrial Workers, CPI for Urban Non Manual Labourers, etc.) as well. These sub-indices are designed to see how price increases affect different set of people. Since WPI is available on a weekly basis, inflation based on that is the most commonly referred inflation measure in India.

Risk & Return

Risk is defined as the uncertainty or deviation in the return expected from an asset class. This risk could be measured in terms of standard deviation of an asset class. Risk can be classified as below:

Systematic Risk

Systematic risk is defined as a risk that takes place in all the risky assets because of macro-economic factors like earthquakes, floods, war, etc. However, it cannot be eliminated through diversification.

Unsystematic Risk

Unsystematic risk is defined as a risk that is unique to a particular asset class and can be eliminated or reduced by diversifying a portfolio.

A security's return is calculated by its holding-period return: the change in price plus any income received, expressed as a percentage of the original price. An improved measure would be to take into consideration the timing of dividends or other payments, and the rates at which they are reinvested. The total return on an investment has two components: the expected return and the unexpected return. The unexpected return comes about because of unanticipated events. The risk from investing stems from the possibility of an unexpected event.

Relationship between risk and return

A simple relationship exists between risk and return – the higher the potential return, the higher the level of risk involved. Whilst everyone would like to maximize return and minimize risk and would prefer to have a return every year of approximately 15-20% with no opportunity of investments falling in value, the reality is that these investments do not exist. As a common rule, the bigger the potential investment return, the higher the investment risk and the longer the investment time horizon.

Asset Classes

An asset class is a specific category of investment such as stocks, bonds, real estate or cash. Investing is a trade-off between risk and expected return. Depending on the risk appetite of an individual, he can choose to invest in a combination of asset classes that would optimize his returns. Some of the most common asset classes are as follows:

Cash

Cash assets comprise of near currency assets viz., T-Bills, commercial paper, money market instruments, and short-term government bonds that are liquid (i.e. they can be easily converted to hard currency at short notice).

Equity

Equity (also known as a stock or share) is a portion of the ownership of a company. A share in a corporation gives the owner of the stock a stake in the company and its profits. As the individual buys more stocks, he increases his ownership stake in the company. Stocks are generally more risky; along with providing an opportunity to earn significant returns, they also carry the risk of part or complete loss of the invested amount.

Bonds

A bond is a formal contract that obligates the borrower to repay the borrowed money with interest to the issuer of the bond. In India, the corporate bond market mainly consists of issuers of three different categories – government-owned financial institutions (FIs), government-owned public sector undertakings (PSUs) and private corporate entities.

Real Estate

Recently, investing in real estate has become increasingly popular making it a common investment vehicle. Although the real estate market has plenty of opportunities for making significant amounts of money, real estate as an asset class is not readily accessible to the retail investor. However, with the introduction of real estate mutual funds (REMF), investors across various sections of the society will be able to take advantage of the growth in this sector.

Gold

Of all precious metals, gold is the most popular as an investment. It is renowned as a hedge against inflation and has limited downside risk.

Diversification

Diversification indicates building/ creating an investment portfolio that includes securities from different asset classes. It spreads risks across various financial investments, reducing the impact that poor returns from any one investment are likely to have on the overall portfolio. The prices of shares, bonds, listed property and other investments often do not rise and fall in tandem. When one type of investment is on the rise, another may be on the decline. The result is that your portfolio's overall performance is likely to be less volatile. The objective of diversification is to reduce the risk involved in building a portfolio. Diversification reduces the risk for an investor because all investments may not move in the same direction in the same proportion at the same time.

A diversified portfolio should be constructed to reflect your personal goals and individual risk tolerance. There are many ways to diversify across several asset classes. Asset allocation is a method of strategically dividing your investment portfolio among stock, bond and cash investments to help protect your portfolio from the rise and fall in any one investment.

Diversification will help to:

Ease potential risk to overall portfolio
Improve chances for attaining consistent returns
Avoid the downside that can come from regularly readjusting your portfolio to follow current market developments

Power of Compounding

Compounding refers to the reinvestment of earnings at the same rate of return to constantly grow the principal amount, year after year. It is a technique of making your money work harder for you and is perhaps the most powerful tool that an average investor can use to plan for many of life’s financial goals, including retirement.

Sameer and Sanjay are friends, just started their career at 20 and plan to retire at 65. Sameer starts saving 5,000 every year from age 20 and continues to do so until he is 35 years old, after which he stops making any further investment. Sanjay, on the other hand, starts saving 12,000 every year from the age of 35 and continues to do so until he retires at the age of 65. If both earn, say, 12% per annum on their investments, which of them would be wealthier when they retire at 65? Sameer! Surprising, isn't it? At 65, Sameer would have accumulated 36.43 lakh whereas Sanjay's wealth would have been lower at 32.44 lakh.

The result would be the same even if one considers a one-time investment. For example, assume that Sameer invests 10,000 at the age of 20 in an instrument that fetches 15% per annum. Sanjay, on the other hand, invests 100,000 at the age of 40 in the same instrument. When both turns 60, Sameer's 10,000 investment would have grown to 26.78 lakh, while Sanjay's 1 lakh would have grown to only 16.37 lakh.

Thus, the longer you stay invested the more money you will make. The best way to take benefit of compounding is to start saving and investing wisely as early as possible. The earlier you start investing, the greater will be the power of compounding.

Power of Triggers

Time-based triggers

Time-based triggers are activated on a particular date that you have specified. For example, if you wish to gift some units to your mother on her birthday, a trigger can be set for that date.

Value based triggers

Event-based triggers

Duration

Duration measures a bond's sensitivity to changes in interest rates. It is a measurement of how long, in years, it takes for the price of a bond to be pay off by its internal cash flows. The longer the bond has until maturity, the greater will be its duration. The longer a bond's duration, the more responsive it is to changes in interest rates. Duration constantly adjusts as coupon payments are made over the life of a bond.

If an investor expects interest rate to fall during the course of time the bond is held, a bond with longer duration will be preferred as the bond’s price would increase more than comparable bonds with shorter durations. On the other hand, an investor, who is concerned about wide fluctuations in the principal value of bond holdings should consider a bond with short duration. Investors who are comfortable with fluctuation and are confident that interest rates will fall should look for a longer duration bond.

Yield Curve

Yield curve is a chart consisting of the yields of bonds of the same quality but different maturities. This is used as a measure to assess the future of interest rates. Here, the time value is plotted on the X-axis and yields on the Y-axis. The curve graphically demonstrates the rate at which market participants are willing to transact debt capital for the short term, medium term and long term. The yield curve is positive when long-term rates are higher than short-term rates; however, the yield curve is sometimes negative or inverted.

Types of yield curve

Normal Yield Curve

When long-term interest rates are higher compared to short-term interest rates, the shape of the yield curve is upward sloping.

Steep Yield Curve

This curve is normally observed at the beginning of an economic expansion or just at the end of a recession. The slope of the yield curve increases as the difference between long-term yields and short-term yields become wider. The inherent assumption behind such a curve could be that while short-term economic conditions warrant lower rates, factors like inflation, etc. could rise in the medium / long-term justifying much higher long-term rates.

Flat Yield Curve

When there is no change in market outlook on interest rates, we get flat yield curve. This is because yields are almost same across tenors.

Inverted Yield Curve

When short-term interest rates are higher than long-term interest rates the shape of yield curve takes downward sloping. This happens when markets expect high volatility in the near future however long term story remains same.

Time Value of Money

One of the most fundamental concepts in finance is that money has a “time value.” That is to say, money in hand today is worth more than money that is likely to be received in the future. For example, if you are offered the choice between having 10,000 today and having 10,000 at a future date, you would prefer to have 10,000 now. By accepting 10,000 early, you can put the money in bank and earn some interest. Thus, the time gap allowed helps us to make money. This incremental gain is time value of money.

The Time Value of Money concept is grouped in two areas: Future Value and Present Value. Future Value is the method of discovering what an investment today will grow to in the future. Present Value on the other hand is the process of determining what a cash flow to be received in the future is worth in today's value.

Rupee Cost Averaging

Rupee cost averaging is an approach in which you invest a fixed amount of money at regular intervals. This in turn ensures that you buy more shares of an investment when prices are low and less when they are high. By investing on a fixed schedule, you avoid the complex or even impossible duty of trying to figure out the exact best time to invest. The rupee cost averaging effect - averages out the costs of your units and hence lessens the results of short-term market fluctuation on your investments.

Getting started on a rupee cost averaging strategy

Decide on the amount you can invest on a regular and long-term basis
Select an investment you want to hold for the long-term
Invest at regular intervals (weekly, monthly or quarterly)

Mutual Funds

noreply@blogger.com (Pareesh Ratan Kundu) — Thu, 13 Mar 2014 10:47:00 +0000

What is a Mutual Fund?

A mutual fund is a professionally-managed trust that pools the savings of many investors and invests them in securities like stocks, bonds, short-term money market instruments and commodities such as precious metals. Investors in a mutual fund have a common financial goal and their money is invested in different asset classes in accordance with the fund’s investment objective. Investments in mutual funds entail comparatively small amounts, giving retail investors the advantage of having finance professionals control their money even if it is a few thousand rupees.

Mutual funds are pooled investment vehicles actively managed either by professional fund managers or passively tracked by an index or industry. The funds are generally well diversified to offset potential losses. They offer an attractive way for savings to be managed in a passive manner without paying high fees or requiring constant attention from individual investors. Mutual funds present an option for investors who lack the time or knowledge to make traditional and complex investment decisions. By putting your money in a mutual fund, you permit the portfolio manager to make those essential decisions for you.

How is a mutual fund set up?

A mutual fund is set up in the form of a trust that has a Sponsor, Trustees, Asset Management Company (AMC). The trust is established by a sponsor(s) who is like a promoter of a company and the said Trust is registered with Securities and Exchange Board of India (SEBI) as a Mutual Fund. The Trustees of the mutual fund hold its property for the benefit of unit holders. An Asset Management Company (AMC) approved by SEBI manages the fund by making investments in various types of securities.

The trustees are vested with the power of superintendence and direction over the AMC. They monitor the performance and compliance of SEBI regulations by the mutual fund. The trustees are vested with the general power of superintendence and direction over AMC. They manage the performance and compliance of SEBI Regulations by the mutual fund.

How does a mutual fund operate?

A mutual fund company collects money from several investors, and invests it in various options like stocks, bonds, etc. This fund is managed by professionals who understand the market well, and try to accomplish growth by making strategic investments. Investors get units of the mutual fund according to the amount they have invested. The Asset Management Company is responsible for managing the investments for the various schemes operated by the mutual fund. It also undertakes activities such like advisory services, financial consulting, customer services, accounting, marketing and sales functions for the schemes of the mutual fund.

What is Net Asset Value?

Net Asset Value (NAV) is the total asset value (net of expenses) per unit of the fund and is calculated by the AMC at the end of every business day. In order to calculate the NAV of a mutual fund, you need to take the current market value of the fund's assets minus the liabilities, if any and divide it by the number of shares outstanding. NAV is calculated as follows:

For example, if the market value of securities of a Mutual Fund scheme is 500 lakh and the Mutual Fund has issued 10 lakh units of 10 each to investors, then the NAV per unit of the fund is 50.

What are the different types of mutual fund schemes?

Based on the maturity period

Open-ended Fund

An open-ended fund is a fund that is available for subscription and can be redeemed on a continuous basis. It is available for subscription throughout the year and investors can buy and sell units at NAV related prices. These funds do not have a fixed maturity date. The key feature of an open-ended fund is liquidity.

Close-ended Fund

A close-ended fund is a fund that has a defined maturity period, e.g. 3-6 years. These funds are open for subscription for a specified period at the time of initial launch. These funds are listed on a recognized stock exchange.

Interval Funds

Interval funds combine the features of open-ended and close-ended funds. These funds may trade on stock exchanges and are open for sale or redemption at predetermined intervals on the prevailing NAV.

Based on investment objectives

Equity/Growth Funds

Equity/Growth funds invest a major part of its corpus in stocks and the investment objective of these funds is long-term capital growth. When you buy shares of an equity mutual fund, you effectively become a part owner of each of the securities in your fund’s portfolio. Equity funds invest minimum 65% of its corpus in equity and equity related securities. These funds may invest in a wide range of industries or focus on one or more industry sectors. These types of funds are suitable for investors with a long-term outlook and higher risk appetite.

Debt/Income Funds

Debt/ Income funds generally invest in securities such as bonds, corporate debentures, government securities (gilts) and money market instruments. These funds invest minimum 65% of its corpus in fixed income securities. By investing in debt instruments, these funds provide low risk and stable income to investors with preservation of capital. These funds tend to be less volatile than equity funds and produce regular income. These funds are suitable for investors whose main objective is safety of capital with moderate growth.

Balanced Funds

Balanced funds invest in both equities and fixed income instruments in line with the pre-determined investment objective of the scheme. These funds provide both stability of returns and capital appreciation to investors. These funds with equal allocation to equities and fixed income securities are ideal for investors looking for a combination of income and moderate growth. They generally have an investment pattern of investing around 60% in Equity and 40% in Debt instruments.

Money Market/ Liquid Funds

Money market/ Liquid funds invest in safer short-term instruments such as Treasury Bills, Certificates of Deposit and Commercial Paper for a period of less than 91 days. The aim of Money Market /Liquid Funds is to provide easy liquidity, preservation of capital and moderate income. These funds are ideal for corporate and individual investors looking for moderate returns on their surplus funds.

Gilt Funds

Gilt funds invest exclusively in government securities. Although these funds carry no credit risk, they are associated with interest rate risk. These funds are safer as they invest in government securities.

Some of the common types of mutual funds and what they typically invest in:

Type of Fund	Typical Investment
Equity or Growth Fund	Equities like stocks
Fixed Income Fund	Fixed income securities like government and corporate bonds
Money Market Fund	Short-term fixed income securities like treasury bills
Balanced Fund	A mix of equities and fixed income securities
Sector-specific Fund	Sectors like IT, Pharma, Auto etc.
Index Fund	Equities or Fixed income securities chosen to replicate a specific Index for example S&P CNX Nifty
Fund of funds	Other mutual funds

Other Schemes

Tax-Saving (Equity linked Savings Schemes) Funds

Tax-saving schemes offer tax rebates to investors under specific provisions of the Income Tax Act, 1961. These are growth-oriented schemes and invest primarily in equities. Like an equity scheme, they largely suit investors having a higher risk appetite and aim to generate capital appreciation over medium to long term.

Index Funds

Index schemes replicate the performance of a particular index such as the BSE Sensex or the S&P CNX Nifty. The portfolio of these schemes consist of only those stocks that represent the index and the weightage assigned to each stock is aligned to the stock’s weightage in the index. Hence, the returns from these funds are more or less similar to those generated by the Index.

Sector-specific Funds

Sector-specific funds invest in the securities of only those sectors or industries as specified in the Scheme Information Document. The returns in these funds are dependent on the performance of the respective sector/industries for example FMCG, Pharma, IT, etc. The funds enable investors to diversify holdings among many companies within an industry. Sector funds are riskier as their performance is dependent on particular sectors although this also results in higher returns generated by these funds.

What are the benefits of investing in a mutual fund?

Benefits of investing in mutual funds:

Professional Management

When you invest in a mutual fund, your money is managed by finance professionals. Investors who do not have the time or skill to manage their own portfolio can invest in mutual funds. By investing in mutual funds, you can gain the services of professional fund managers, which would otherwise be costly for an individual investor.

Diversification

Mutual funds provide the benefit of diversification across different sectors and companies. Mutual funds widen investments across various industries and asset classes. Thus, by investing in a mutual fund, you can gain from the benefits of diversification and asset allocation, without investing a large amount of money that would be required to build an individual portfolio.

Liquidity

Mutual funds are usually very liquid investments. Unless they have a pre-specified lock-in period, your money is available to you anytime you want subject to exit load, if any. Normally funds take a couple of days for returning your money to you. Since they are well integrated with the banking system, most funds can transfer the money directly to your bank account.

Flexibility

Investors can benefit from the convenience and flexibility offered by mutual funds to invest in a wide range of schemes. The option of systematic (at regular intervals) investment and withdrawal is also offered to investors in most open-ended schemes. Depending on one’s inclinations and convenience one can invest or withdraw funds.

Low transaction cost

Due to economies of scale, mutual funds pay lower transaction costs. The benefits are passed on to mutual fund investors, which may not be enjoyed by an individual who enters the market directly.

Transparency

Funds provide investors with updated information pertaining to the markets and schemes through factsheets, offer documents, annual reports etc.

Well regulated

Mutual funds in India are regulated and monitored by the Securities and Exchange Board of India (SEBI), which endeavors to protect the interests of investors. All funds are registered with SEBI and complete transparency is enforced. Mutual funds are required to provide investors with standard information about their investments, in addition to other disclosures like specific investments made by the scheme and the quantity of investment in each asset class.

What are the risks involved in investing in mutual funds?

Mutual funds invest in different securities like stocks or fixed income securities, depending upon the fund’s objectives. As a result, different schemes have different risks depending on the underlying portfolio. The value of an investment may decline over a period of time because of economic alterations or other events that affect the overall market. Also, the government may come up with new regulations, which may affect a particular industry or class of industries. All these factors influence the performance of Mutual Funds.

Risk and Reward: The diversification that mutual funds provide can help ease risk by offsetting losses from some securities with gains in other securities. On the other hand, this could limit the upside potential that is provided by holding a single security.

Lack of Control: Investors cannot determine the exact composition of a fund’s portfolio at any given time, nor can they directly influence which securities the fund manager buys.

Uncommon Theory-Mathod

noreply@blogger.com (Pareesh Ratan Kundu) — Tue, 11 Mar 2014 17:35:00 +0000

Chaos Theory'

A mathematical concept that explains that it is possible to get random results from normal equations. The main precept behind this theory is the underlying notion of small occurrences significantly affecting the outcomes of seemingly unrelated events. Chaos theory has been applied to many different things, from predicting weather patterns to the stock market. Simply put, chaos theory is an attempt to see and understand the underlying order of complex systems that may appear to be without order at first glance.

Related to financial markets, proponents of chaos theory believe that price is the very last thing to change for a stock, bond, or some other security. Price changes can be determined through stringent mathematical equations predicting the following factors:
1) A trader's own personal motives, needs, desires, hopes, fears and beliefs are complex and nonlinear.
2) Volume changes
3) Acceleration of the changes
4) Momentum behind the changes
Chaos theory is highly controversial and extremely complicated.

The science of chaos has given us a couple of principles that are applicable in the financial markets:

You, your nails, your market orders follow the path of least of resistance

The path of least resistance is determined by the always underlying (and typically unseen) structure

Let us say you have a river running down the mountain. The behavioural decisions that the river makes does not depend on the mind of the river but the riverbed itself. So if you have a riverbed that is shallow and narrow that river is going to go down in rapids. If you have a riverbed that is wide and deep you are going to have a calm pond. So if you want to change the flow of that river you can get buckets and start a bucket brigade or go up to the start of the river where the force of the water is still so slow that it only takes replacing a few rocks to change the direction and it will change everything.

Then there is this thing called the butterfly effect.

That theory simply says that somewhere in South America there is this little Monarch butterfly that flaps its wings as it is flying around looking for some pollen and it sees a flower over here and as he is going there he sees a better flower somewhere else and decides to change its path. As he changes his mind, that is a fractal. The change in his path sets up a little air current and that air current sets up another air current that sets up another air current that keeps the high level winds off of the Antarctica which causes a hurricane like the El Niño, which causes a drought next year in the bean belt and we are going to have beans in the teens because of this little Monarch butterfly that changed his mind.

So how do we trade fractals and what do they look like on a chart?

A fractal is a trend change
A swing top or a swing bottom is a fractal
The end of every Elliot wave is a fractal
A fractal requires a minimum of five bars
Fractals show the path of least resistance
A fractal trading system works in all time frames

In the example below you have the market going up as evident by the highs. All we care about here is the highs and not the open, high, low and close. Any time you have a sequence of five bars where you have one bar that has two preceding lower highs followed by two preceding lower highs you have a fractal.

If you have a fractal whose middle finger is parallel to the top, the second one does not count. They both count as one (as in the case below where you have two candles whose highs are identical). In the chart below you see how the market started trading up, changed its mind and now it is going down. Coming up, the left leg must be longer than the right leg for a buy fractal to be valid.

After the buy fractal triggers a long position, the sell fractal is negated. For a new sell fractal to set up you will need to see a high, followed by three lower lows and two higher lows, none of which can trade through the high of the first bar. When you have a fractal in one direction which is followed by a fractal in the other direction you have an Elliot wave of one degree or another.

So this market started trading up the page, changed its mind (like the Monarch butterfly) and traded down the page. It then changed its mind again and traded through the previous high, just following the path of least resistance. By religiously taking trades only when fractals break, we effectively rule out fighting the market. The challenge, of course, is to avoid double tops/bottoms and not get caught long on up thrusts and short on springs.

You always hear that what goes up must come down but one of the things that chaos teaches us is that Newton's laws of motions do not apply universally. They apply to man-made things. Market fundamentalists have a fundamentally flawed conception of how financial markets operate. They believe that financial markets tend toward equilibrium.

Equilibrium theory in economics is based on a false analogy with physics. Physical objects move the way they move irrespective of what anybody thinks but financial markets attempt to predict a future that is contingent on the decisions people make in the present. Instead of just passively reflecting reality, financial markets are actively creating the reality that they, in turn, reflect. There is a two-way connection between present decisions and future events, which George Soros calls reflexivity.

So having said all that; when do I want to be in a trade?

when I can make the most amount of money in the least amount of time
when volatility explodes and ranges expand
when odds increase of a directional move
when risk:reward is favourable

You do not want to put your hard earned cash at risk in a market that just moves about randomly but get onboard a market that has clearly signalled that it is done consolidating and now ready to move.

Look for inside candles (range contraction) and then a break uptown or downtown (range expansion). As a rule of thumb, the longer the timeframe the rarer the trade but the more powerful the signal will be.

Also the more inside candles within inside candles the more powerful the signal will be. The reason is that the more time traders have to build positions the bigger the effect as these positions are unwound.

Below is a great example of how just by looking at candles you can pinpoint the most opportune time to get in.

Only imagine how many traders looking at overbought indicators either sold out too early or faded the move.

Fractals

Many people believe that the markets are random. In fact, one of the most prominent investing books out there is "A Random Walk Down Wall Street" (1973) by Burton G. Malkiel, who argues that throwing darts at a dartboard is likely to yield results similar to those achieved by a fund manager (and Malkiel does have many valid points). However, many others argue that although prices may appear to be random, they do in fact follow a pattern in the form of trends. One of the most basic ways in which traders can determine such trends is through the use of fractals. Fractals essentially break down larger trends into extremely simple and predictable reversal patterns. This article will explain what fractals are and how you might apply them to your trading to enhance your profits.

What Are Fractals? When many people think of fractals in the mathematical sense, they think of chaos theory and abstract mathematics. While these concepts do apply to the market (it being a nonlinear, dynamic system), most traders refer to fractals in a more literal sense. That is, as recurring patterns that can predict reversals among larger, more chaotic price movements. These basic fractals are composed of five or more bars. The rules for identifying fractals are as follows:

A bearish turning point occurs when there is a pattern with the highest high in the middle and two lower highs on each side.
A bullish turning point occurs when there is a pattern with the lowest low in the middle and two higher lows on each side.

The fractals shown in Figure 1 are two examples of perfect patterns. Note that many other less perfect patterns can occur, but the basic pattern should remain intact for the fractal to be valid.

Figure 1

The obvious drawback here is that fractals are lagging indicators - that is, a fractal can't be drawn until we are two days into the reversal. While this may be true, most significant reversals last many more bars, so most of the trend will remain intact (as we will see in the example below). Applying Fractals to Trading Like many trading indicators, fractals are best used in conjunction with other indicators or forms of analysis. Perhaps the most common confirmation indicator used with fractals is the "Alligator indicator", a tool that is created by using moving averages that factor in the use of fractal geometry. The standard rule states that all buy rules are only valid if below the "alligator's teeth" (the center average), and all sell rules are only valid if above the alligator's teeth.

More than 50% of retirement age individuals to not have enough savings

Figure 2 is an example of such a setup:

Figure 2

More than 50% of retirement age individuals to not have enough savings

Figure 2 is an example of such a setup:

Figure 3

Here is a basic rule setup that is used when using a chart with a four-hour time frame:

Initiate a position when the price has hit the farthest Fibonacci band, but only after a daily (D1) fractal takes place.
Exit a position after a daily (D1) fractal reversal takes place.

Notice how the fractals pinpoint meaningful tops and bottoms? This helps to take the guesswork out of deciding at which Fibonacci level to trade - all we have to do is check to see if the daily fractal occurred. We should also note that the trend strength began increasing at the sell fractal, and topped at the buy fractal. Although we lose some pips with the confirmation, it saves us from losing out on mere market noise - 139 pips certainly isn't bad for three days!

Things to Consider Here are a few things to remember when using fractals:

They are lagging indicators. They are best used as confirmation indicators to help confirm that a reversal did take place. Real-time tops and bottoms can be surmised with other techniques.
The longer the time period (i.e. the number of bars required for a fractal), the more reliable the reversal. However, you should also remember that the longer the time period, the lower the number of signals generated.
It is best to plot fractals in multiple time frames and use them in conjunction with one another. For example, only trade short-term fractals in the direction of the long-term ones. Along these same lines, long-term fractals are more reliable than short-term fractals.
Always use fractals in conjunction with other indicators or systems. They work best as decision support tools, not as indicators on their own.

Conclusion As you can see, fractals can be extremely powerful tools when used in conjunction with other indicators and techniques, especially when used to confirm reversals. The most common usage is with the "Alligator indicator"; however, there are other uses too, as we've seen here. Overall, fractals make excellent decision support tools for any trading method. Resources These are the two main charting packages that contain fractals:

MetaTrader
TradeStation for equities (via plug-in)

If you want to know more about chaos theory and its applications in the marketplace, an excellent book on the topic is "Profiting From Chaos" (1994) by Tonis Vaga.

Chaos Theory Market Fractals - By-Nadeem Walayat's.

Are Elliott Wave's Chaos Theory?

Whilst there are many elements to chaos theory, my focus that grew out of studying the Julia and Mandelbrot sets was fractals. In that clearly the stock and other market price action resembles fractal structures as the same structure appears to repeat on ALL time frames. At the time it seemed that Elliott Wave and Chaos theory were very similar of not the same thing, in that Elliott Waves are the fractals for market price action that appear to on ALL time frames as discovered in the 1930's by RN Elliott which was decades before Mandelbrot appeared on the scene.
However on spending many, many years going down this path I concluded that Elliott Waves and Chaos Theory are NOT the same. Elliott Wave theory is something ELSE, yes, it resembles Chaos Theory i.e. Fractals, but it is not Chaos theory Fractals.
Again they look very similar but in a way Chaos Theory is Elliott Waves without having to know the WAVES! That may sound confusing but that is actually how it is. In Chaos Theory all one would know is What is Impulse and What is Corrective, and that is it! None of the 5th of the 5th of the 5th or ABC or the rest matter, just Impulse or Corrective. Which is probably what many experienced elliotticians eventually conclude without ever having ventured into chaos theory that at the end of the day the only thing that matters is Impulse or Corrective and not What Elliott Wave implies i.e. that Stocks 1987 peak was the final 5th of the 5th of the 5th and then so were each of the subsequent bull market peaks right into the present days bull market.

Fractal Theory

In a way Chaos Theory should really have been called Fractal Theory, because rather than chaos i.e. randomness it actually implies order and structure, and that structure is found in fractals.
The point about Fractals is that they give you a window into probabilities for price action on ALL market levels, i.e. hourly, daily, weekly, monthly, even yearly. I.e. fractals are akin to flexible pattern recognition, simple patterns that repeat and result in high probabilities given certain conditions which in themselves are flexible, so it unlike traditional chart patterns such as Head and Shoulders, the interpretation of market fractals is dependant upon changing conditions, such as trend, cycles, and volume.

What are Market Fractals ?

Simply put Market fractals are trend changes. A trend change is either a reversal of the Impulse trend or an end of the Corrective trend on ANY time frame.

Fractal Patterns

Fractal patterns are not complicated, you already know the more common ones, such as spike, double and triple tops and bottoms that occur on ALL time frames, what you don't know or have not studied are the conditions that increase their probabilities for particular markets at particular points in time, such as volume, preceding trend, and momentum oscillators (I use the MACD) once you factor these into the equation amongst your TRIGGER (Fractal) increases in probability exponentially, as it reduces the instances of its occurrence. Still it does requires HARD WORK for the market one trades to identify the current TRIGGERS (Fractals), especially when one starts going down the path of fractals of fractals i.e. in this example, a double top plus double top fractal.

Trading Fractals

It all boils down to practice, knowing current fractal patterns and having them engrained in your mind, and then you WAIT for the FRACTAL TRIGGERS, and REACT in real time, just as as you trade traditional price patterns such as double and triple tops as identified in real time. Fractal triggers are not limited to Bar charts, as you can use other types of charts, my preference is for swing charts as illustrated in "How to Trade Commodities" by WD Gann (not to confuse with the rest of his work which in my opinion is a red herring).
Once you understand that Chaos Theory comprises fractals that give a high probability of an outcome given x, y,z condition then one starts to see fractals EVERYWHERE, for fractals ARE Nature. It is how our universe is constructed on every level, we are living in an unfolding fractal universe, nothing is fixed, everything is in motion, if you understand this then you will now know more truth than anything you will find in any ancient superstition.
The bottom line is this, that there is no black or white, no holy grail, everything has its basis in how we interpret the world around us is be it markets or the wider environment, fractals appear to offer the best window into a better interpretation of the world in our time, until the next innovation comes along.

Combination of Trading Indicators

noreply@blogger.com (Pareesh Ratan Kundu) — Thu, 06 Mar 2014 07:06:00 +0000

The combined trading methods provide an objective view of price activity. It helps you to build up a view on price direction and timing, reduce fear and avoid over trading. Furthermore, these methods tend to provide signals of price movements prior to their occurring in the market.

The tools used methods are moving averages and oscillators. (Oscillators are trading tools that offer indications of when a currency is overbought or oversold). Though there are countless mathematical indicators, here we will cover only the most important ones.

Simple and Exponential Moving Average (SMA - EMA)

Moving Average Convergence-Divergence (MACD)

Bollinger Bands

The Parabolic System, Stop-and-Reverse (SAR)

RSI (Relative Strength Index)

1. Moving Average

A moving average is an average of a shifting body of prices calculated over a given number of days. A moving average makes it easier to visualize market trends as it removes – or at least minimizes - daily statistical noise. It is a common tool in technical analysis and is used either by itself or as an oscillator.

There are several types of moving averages, but we will deal with only two of them: the simple moving average (SMA) and the exponential moving average (EMA).

A. Simple moving average (SMA)

Definition The simple moving average is an arithmetic mean of price data. It is calculated by summing up each interval's price and dividing the sum by the number of intervals covered by the moving average. For instance, adding the closing prices of an instrument for the most recent 25 days and then dividing it by 25 will get you the 25 day moving average.
Though the daily closing price is the most common price used to calculate simple moving averages, the average may also be based on the midrange level or on a daily average of the high, low, and closing prices.

Advantages Moving average is a smoothing tool that shows the basic trend of the market.
It is one of the best ways to gauge the strength a long-term trend and the likelihood that it will reverse. When a moving average is heading upward and the price is above it, the security is in an uptrend. Conversely, a downward sloping moving average with the price below can be used to signal a downtrend.

Drawbacks It is a follower rather than a leader. Its signals occur after the new movement, event, or trend has started, not before. Therefore it could lead you to enter trade some late.
It is criticized for giving equal weight to each interval. Some analysts believe that a heavier weight should be given to the more recent price action.

Example You can see from the chart below examples of two simple moving averages - 5 days (Red), 20 days (blue).

B. Exponential Moving Average (EMA) The exponential moving average (EMA) is a weighted average of a price data which put a higher weight on recent data point.

Characteristics The weighting applied to the most recent price depends on the specified period of the moving average. The shorter the EMA period, the more weight will be applied to the most recent price.
An EMA can be specified in two ways: as a percentage-based EMA, where the analyst determines the percentage weight of the latest period's price, or a period-based EMA, where the analyst specifies the duration of the EMA, and the weight of each period is calculated by formula. The latter is the more commonly used.

Main Advantages compared to SMA Because it gives the most weight to the most recent observations, EMA enables technical traders to react faster to recent price change.
As opposed to Simple Moving Average, every previous price in the data set is used in the calculation of EMA. While the impact of older data points diminishes over time, it never fully disappears. This is true regardless of the EMA's specified period. The effects of older data diminish rapidly for shorter EMAs than for longer ones but, again, they never completely disappear.

Example You can see from the chart below the difference between SMA (in blue) and EMA (in green) calculated over a 20-day period.

2. MACD (Moving Average Convergence-Divergence)

The moving average convergence-divergence indicator (MACD) is used to determine trends in momentum.

Calculation It is calculated by subtracting a longer exponential moving average (EMA) from a shorter exponential moving average. The most common values used to calculate MACD are 12-day and 26-day exponential moving average.
Based on this differential, a moving average of 9 periods is calculated, which is named the "signal line".
MACD = [12-day moving average – 26-day moving average] > Exponential Weighted Indicator
Signal Line = Moving Average (MACD) > Average Weighted Indicator

Interpretation Due to exponential smoothing, the MACD Indicator will be quicker to track recent price changes than the signal line. Therefore,
When the MACD crossed the SIGNAL LINE: the faster moving average (12-day) is higher than the rate of change for the slower moving average (26-day). It is typically a bullish signal, suggesting the price is likely to experience upward momentum.
Conversely, when the MACD is below the SIGNAL LINE: it is a bearish signal, possibly forecasting a pending reversal.

Example of a MACD You can see from the chart below example of a MACD. The MACD Indicator is represented in green and the Signal Line in Blue.

3. Bollinger Bands

Bollinger Bands were developed by John Bollinger in the early 1980s. They are used to identify extreme highs or lows in price. Bollinger recognized a need for dynamic adaptive trading bands, whose spacing varies based on the volatility of the prices. During period of high volatility, Bollinger bands widen to become more forgiving. During periods of low volatility, they narrow to contain prices.

Calculation Bollinger Bands consist of a set of three curves drawn in relation to prices:
The middle band reflects an intermediate-term trend. The 20 day - simple moving average (SMA) usually serves this purpose.
The upper band is the same as the middle band, but it is shifted up by two standard deviations, a formula that measures volatility, showing how the price can vary from its true value
The lower band is the same as the middle band, but it is shifted down by two standard deviations to adjust for market volatility.
Bollinger Bands establish a Bandwidth, a relative measure of the width of the bands, and a measure of where the last price is in relation to the bands.

Lower Bollinger Band = SMA - 2 standard deviationsUpper Bollinger Band = SMA + 2 standard deviations.
Middle Bollinger Band = 20 day - simple moving average (SMA).

Interpretation The probability of a sharp breakout in prices increases when the bandwidth narrows.
When prices continually touch the upper Bollinger band, the prices are thought to be overbought; triggering a sell signal.
Conversely, when they continually touch the lower band, prices are thought to be oversold, triggering a buy signal.

Example of Bollinger Bands You can see from the chart below the Bollinger Bands of the S&P 500 Index, represented in green.

4. The Parabolic System, Stop-and-Reverse (SAR)

The parabolic SAR system is an effective investor's tool that was originally devised by J. Welles Wilder to compensate for the failings of other trend-following systems.

Description The Parabolic SAR is a trading system that calculates trailing "stop-losses" in a trending market. The chart of these points follows the price movements in the form of a dotted line, which tends to follow a parabolic path.

Interpretation When the parabola follows along below the price, it is providing buy signals.
When the parabola appears above the price, it suggests selling or going short.
The “stop-losses” dots are setting the levels for the trailing stop-loss that is recommended for the position. In a bullish trend, a long position should be established with a trailing stop that will move up every day until activated by the price falling to the stop level. In a bearish trend, a short position can be established with a trailing stop that will move down every day until activated by the price rising to the stop level.
The parabolic system is considered to work best during trending periods. It helps traders catch new trends relatively early. If the new trend fails, the parabola quickly switches from one side of the price to the other, thus generating the stop and reverse signal, indicating when the trader should close his position or open an opposing position when this switch occurs.

Example of an SAR parabolic study You can see from the chart below in green the Parabolic System applied to the USDJPY pair.

5. Relative Strength Index (RSI)

The RSI was developed by J. Welles Wilder as a system for giving actual buy and sell signals in a changing market.

Definition RSI is based on the difference between the average of the closing price on up days vs. the average closing price on the down days, observed over a 14-day period. That information is then converted into a value ranging from 0 to 100.
When the average gain is greater than the average loss, the RSI rises, and when the average loss is greater than the average gain, the RSI declines.

Interpretation The RSI is usually used to confirm an existing trend. An uptrend is confirmed when RSI is above 50 and a downtrend when it's below 50.
It also indicates situations where the market is overbought or oversold by monitoring the specific levels (usually “30” and “70”) that warn of coming reversals.
An overbought condition (RSI above 70) means that there are almost no buyers left in the market, and therefore prices are more likely to decline as those who previously bought will now take their profit by selling.
An oversold condition (RSI below 30) is the exact opposite.

Example of RSI You can see in red from the chart below the Relative Strength Index of the GBPUSD pair.

SAR with other indicators Combinations

noreply@blogger.com (Pareesh Ratan Kundu) — Tue, 04 Mar 2014 17:27:00 +0000

Combining the SAR with other indicators

The Parabolic SAR (i.e. stop and reverse) indicator is a trend seeking indicator which is used to detect when a trend stops and reverses. Therefore, it detects the stopping of an uptrend and a reversal of the price to a downtrend, and vice versa. On a chart, the Parabolic SAR is marked by dots which appear under the candlesticks when the downtrend stops and reverses to an uptrend, and appear under the candles when the uptrend stops and reverses to a downtrend.

If you look closely at the workings of the Parabolic SAR, it will be very obvious that this indicator has a lot of lag. Usually, the price would have been on its way by the time the signal appears, so a trader who relies only on the Parabolic SAR for trade signals will only be able to enter trades very late indeed, and will only pick a few pips, if any at all. Therefore, the trader must combine the Parabolic SAR with other indicators or trade signals to be able to catch the reversal moves early. In this article, we will show you two cracking ways that the Parabolic SAR can be used to pick out profitable trading signals.

Strategy 1: Using the Parabolic SAR with the MACD and the 200 SMA
This strategy which is used on the 4 hour chart, uses the following indicators:
a) 200 Simple Moving Average, which helps the trader to detect the ongoing trend. If the price action is below the 200 SMA, then this is a sign that the currency pair is in a long term downtrend. If the price action is above the 200 SMA, then the currency pair is in a long term uptrend. It is important to know this as this will eventually help you determine which Parabolic SAR is valid and which should be ignored.

b) The 13 Simple Moving Average, which is the short term moving average that will serve as a support (for a long trade setup) or resistance (for a short trade setup). A bounce of retreat of the price on this moving average is significant for trade entry as we will demonstrate shortly.

c) Forexoma-MACD Histogram, which is a custom forex indicator that was developed by Forexoma Corporation. Unlike the traditional MACD, the Forexoma-MACD is colour-coded and once the trend of an asset changes, the colour of the bars of the MACD changes as well, enabling traders to detect trend changes earlier instead of waiting for the traditional cross above or below the zero line.

d) Parabolic SAR, applied to the chart with its default settings.

Short Trade Setup
For a short trade, we will be looking for the following setup:

a) Price located below the 200 SMA. This is the first parameter. Therefore the bias for the trade should be to go short. If the 200 SMA is below the price but the 13SMA described below is above the price, then the 200 SMA can be used as a support line for trade exit. The 200 SMA can indeed act as a support or resistance if the price action is close enough. For the short trade, we are looking for the price of the currency pair to be below the 200 SMA, or for any upside correction to hit and retreat from the 200 SMA.

b) Any upside move that butts off the 13 Simple Moving Average, and this occurs at almost the same time as:

c) Parabolic SAR indicator appearing above the price action AND

d) Forexoma-MACD changes from blue to red, or has already changed to red colour.

Once these signals all align, then enter short at the open of the candle following the signal. We see a perfect example below:

In this example, we see the grey vertical grid line which we have drawn in order to show that the signals occurred at about the same time. So we see the Forexoma-MACD colour indicator change colour from blue to red, and the price action bouncer off in a downward motion from the 200 SMA and the 13 SMA, which both act as very strong resistance factors. This downward move was good for a massive 350 pips, which serves to show why the 4hour chart is such a brilliant chart for this trade setup.

Stop Loss: This should be set at a 5 pips below the first dot of the Parabolic SAR.

Profit Target: Use the change in the signal of the Parabolic SAR (i.e. appearing BELOW the price action) as the trade exit signal.

Long Trade Setup
We move ahead to just 4 days after the short trade setup above, to see how a long trade setup plays out. Remember, this is a stop and reverse strategy, so the end of the short trade above could signal the long trade setup if the parameters are correctly aligned.

We will be looking out for the following:
a) Price located below the 200 SMA. If the 200 SMA is located above the price action, then it should be used as a resistance level, suitable for trade exit. This condition only holds if the 13 SMA is located below the price action.
b) Candlesticks that bounce upward off the 13 Simple Moving Average, and this occurs at almost the same time as:
c) Parabolic SAR indicator appearing below the price action AND
d) Forexoma-MACD changes from red to blue, or has already changed to blue colour.
Look at the chart below:

Once more, we have our grey vertical grid line for referencing where the parameters line up. We can see that the MACD histogram has already changed colour to blue, so we look for where the candlesticks bounce up from the 13 SMA at the same time that the Parabolic SAR is below the price action. This is shown at the area circled with green ink. The long trade should then be opened at the open of the next candle. The trade shown above was good for at least 300 pips.

Stop Loss: This should be set at a 5 pips below the first dot of the Parabolic SAR.

Profit Target: You can use the 200 SMA as the exit point. Otherwise, the change in signal of the Parabolic SAR (i.e. appearing above the price action) can be used as the trade exit signal.

This is one of the two ways that the Parabolic SAR can be used with good results, securing many profitable trades in the process.

Strategy 2: Using the Parabolic SAR with the ATR, Simple Moving Averages and Multiple Time Frames

How interesting does this get? Now we want to show how to use the Parabolic SAR with multiple time frames so that you avoid the trap of getting signals when indeed the market is going to end up being flat for quite some time.

When the market is trending, then you can really make some good money with the Parabolic SAR. You simply trade with the corresponding stop and reverse signals. But when you run into a consolidating market, then things can get very ugly. You do not want to get a Parabolic SAR trade signal when the market is flat. Not only will you make no money, but indeed the risk of losing money can be very real. This strategy helps you avoid that by using the Average True Range (ATR) indicator which we discussed last week, and multiple time frames (15 minutes, one hour and 4 hour charts).

The strategy starts with attaching the simple moving averages to the chart. The simple moving averages are your key tools that tell you if the market is trending or flat. The moving averages to use are:
a) 8 Simple Moving Average
b) 21 Simple Moving Average

Ideally, the shorter term moving average (i.e. the 8 SMA) must have crossed the 21 SMA, and both must have been pointing to a particular direction. These are what will point to the trend of the asset. So they should be pointing upwards or downwards. If they are pointing sideways, then the market is going to be flat and you should stay away from the market.

Next, the Parabolic SAR indicator is added to the charts and left in its default settings (though you can change the color if you wish).

The ATR indicator is also added to the mix in its default settings. All these indicators are available on Forex4you’s MT4 trading platform and can be added using the Indicator tab or the Insert button at the top of the page.

Long Entry Rules
Ensure that the candlesticks (representing the price action) are above the 8 SMA and that the 8 SMA is above the 21 SMA. Both simple moving averages must be heading upwards, indicating an uptrend, and we want to trade with the trend because it is our friend. These scenarios must occur on the 15 minute, one hour and 4 hour charts simultaneously.

At the same time, the values of the Average True Range must be close to the upper limit of the range, signifying that the market will have enough volatility to perform according to the trade’s expectation. If the ATR were to be at the baseline, or at the lower end of the spectrum, this would negate the trade signal.

The entry should be made on the 15 minute chart, at the candle where the Parabolic SAR has appeared below the candlesticks, signifying a bullish signal. For better entry, you can wait to see if the price action will try to move down below the 8 SMA. Usually, it will be resisted at that level and start to move up. So you get the opportunity to take the trade from the true starting point, garner more pips and make money.

Stop Loss: This is set at the price level that corresponds to the first dot of the Parabolic SAR as the starting point. As a new dot of the Parabolic SAR appears below the candles but at a higher level, the stop loss is manually adjusted to the new levels. You continue to adjust the stop loss upwards (effectively locking in the profits as you move along) until the trade reaches its logical conclusion.

Profit Target: Profits are taken either by closing the trade manually when the Parabolic SAR appears above the price action, or when the moving averages start to turn sideways. This means that the trader has to watch the trade from start to finish; it is not a “set and forget” trade strategy.

Short Entry Rules
Simply reverse what is done for the long trade. Make sure that the price action is below the 8 SMA and that the 8 SMA is also below the 21 SMA. Both the 8 SMA and 21 SMA must be pointing downwards, signifying a downtrending price action, and this situation must be found on the 15 minute, one hour and 4 hour charts simultaneously.

At the same time, the values of the Average True Range must be close to the lower limit of the range.

Stop Loss: Set the stop loss at the price level that corresponds to the first dot of the Parabolic SAR, and keep adjusting it as the new dots of the Parabolic SAR appear above the candles but at a lower level, effectively locking in your profits as the trade progresses to its logical end.

Profit Target: Closing the trade manually when the Parabolic SAR appears below the candlesticks, or when the moving averages start to turn sideways are the two ways to take profits from a short trade entry.

See a typical BULLISH setup below:

Notice how the signals all tally with each other, allowing the opportunity to take the trade on the 15 minute chart. Practice how to detect a short trade setup as your assignment following this article.

Strategy 1 is a long term trading strategy while Strategy 2 is a short term trading strategy. If you have been mystified by the Parabolic SAR, this article should clear up the cobwebs.

Trading with Moving Averages Explained

noreply@blogger.com (Pareesh Ratan Kundu) — Sun, 02 Mar 2014 17:13:00 +0000

Understanding Moving Averages plus Trading with Moving Averages

Moving averages, also called MAs in short, are the most widely used and oldest technical indicator used by traders because of its simplicity in both construction and uses. It is among the “Lagging indicators” as it provides signals or direction of price after a significant change in that direction.

Moving averages are very effective in case of trend analysis as this indicator dampen short term fluctuations and smoothen out the price so that a trader or analyst can focus on major or long term price movement, due to this laggard. It is also a very popular indicator as its signals are simple, clear and easy to understand.

Moving averages calculated by taking the close price of the currency pair, or you can choose open, high or low price instead of close price. Moving averages are simply average price of the currency pair for last ‘X’ number of periods. It includes the new price data as it develops hence called moving averages.

Types of Moving Average

There are different types of moving averages, among them 2 types of moving averages are highly popular and widely use. They are,

Simple Moving Averages (SMA)
Exponential Moving Averages (EMA)

Simple Moving Averages (SMA) :

This is the based on the basic calculation of the moving average as mentioned above; by dividing the sum of the values of ‘X’ number of periods by the number of periods ‘X’. Because of its calculation method it is simple and smoother than other type of moving averages. You can choose any number as periods of any moving average, such as 10, 13, 15, 20, 25, 28, 30 etc. There are some numbers recommended in case of moving averages. Such as 10, 25, 30, 50, 100, 150 and 200; most of the traders use these periods of moving averages.

Calculation of SMA:

SMA of n periods = n period sum/n

n = the period or number of day’s you choose to plot moving averages. Such as 10,20 or 30.

There is an example of simple moving average given in the chart above. We can see SMA25 or 25 day’s simple moving average (blue colored line) in the daily chart of EUR/USD.

Exponential Moving Averages (EMA):

Exponential Moving Averages also known as EMAs. This type of moving averages designed and developed to reduce the lag or delaying nature of SMA by applying more weight on most recent price or data.

Calculation of EMA:

You have to go three steps to calculate exponential moving average. First, you have to calculate simple moving average of your chosen period. Then you have to calculate the weighting multiplier to put more weight in recent price data. Then you can calculate exponential moving average using simple moving average and weighting multiplier which you have calculated before. All three steps of calculation would be like this,

SMA = n period sum/n where, n = number of periods chosen to calculate EMA

Multiplier = (2/ (n+1))

EMA = {Close – EMA (previous day)} x multiplier + EMA (previous day)

Here is an example of EMA in the chart given below,

In the chart above, blue colored line is 30 day’s exponential moving average (EMA30) in the daily chart of EUR/USD.

Simple Moving Averages (SMA) Vs Exponential Moving Averages (EMA) :

Calculation of SMA and EMA is different. Thus, there are some differences in their characteristics. The key difference is the lag factor. If same periods of moving average plotted, then we will be able to see the significant difference. Let’s check out the significant difference between SMA and EMA.

In the daily chart of EUR/USD, we have plotted SMA30 and EMA30. Red colored line is SMA30, and blue colored line is EMA30. These two moving averages have a difference in appearance though they are of same periods. If you look at the chart carefully you will find that, EMA reacts faster with the price than SMA reacts with the price. This means, EMA is faster and choppier than SMA. Thus, SMA is lazier but smoother than EMA. Both SMA and EMA are an effective tool. It depends on trader who has to choose the type and period of moving average he/she will use depending on his/her trading style.

Trading with Moving Averages :

Moving averages can be used for various reasons. Such as,

Trend Identification
Trend Reversals
Dynamic Support and Resistance

Trend Identification :

Moving averages are very useful to identify trend and the direction of the trend. The trend is in an uptrend as price or candle is above the moving average. Inversely, if price/candle is below the moving average and the moving average is heading downward then the trend is downtrend. There is no valid trend (flat trend) if price or candle is in a range with moving average, and the moving average is flat. All these situations have shown in the chart of daily EUR/USD given below.

Trend Reversal:

Trend reversals identified by the crossover between two or more moving averages of different periods. Let’s take two moving averages in consideration, SMA10 and SMA30. SMA10 is faster than SMA30 as its period is smaller than SMA30. When SMA10 crosses above SMA30 then it is a sign that trend has reversed to uptrend from downtrend. We should keep in mind that if short term moving average is below the long term moving average then the trend is down. And if short term moving average is above the long term moving average then the trend is uptrend and if both moving averages stay in the same point then there is no or flat trend. Now, when SMA10 crosses SMA30 from above then it is a confirmation that the trend has reversed to downtrend from uptrend. Both uptrend and downtrend reversals have shown in the example in the daily chart of EUR/USD given below.

Dynamic Support and Resistance:

In an uptrend price tends to get support whenever its price or candle comes near moving average. Thus, most of the times price bounces back to its previous trend from the moving average. This scenario is bullish pullback. Inversely, when a currency pair is in downtrend then it tends to get resistance when price or candle comes near moving average. Thus, price tends to bounce back to downward from this moving average. This is a bearish pullback. Both bullish and bearish pullback has shown in the example chart of daily EUR/USD given below.

In this way, moving averages can be used as dynamic support and resistances.

Conclusion:

All the methods of using moving average are very useful for trend identification. Moving average crossover signals should be used only for trend identification. Trading crossover signals might make you depressed as these are late signals and can provide many whipsaws. Trading the pullbacks near the moving averages is a very effective strategy. However, other momentum indicators or oscillators should be use with moving averages to make a better combination to provide entry signals.

More About Volatility Indicators – Bollinger Bands Explained

noreply@blogger.com (Pareesh Ratan Kundu) — Sun, 02 Mar 2014 17:00:00 +0000

Volatility Indicators – Bollinger Bands Explained

Introduction:

Bollinger band is a volatility indicator developed by John Bollinger. This indicator measures volatility based on standard deviation. Bollinger band is most used volatility indicator and one of the widely used indicators in technical analysis.

Calculation:

Calculation of Bollinger band is based on a simple moving average. The default period of Bollinger band and moving average is 20. However, many traders use Bollinger bands of 15 or 25 periods. The calculation of Bollinger band is as follows,

Middle Band = 20 day SMA or Simple Moving Average

Upper Band = 20 day SMA + (20 day Standard Deviation)

Lower Band = 20 day SMA – (20 day Standard Deviation)

Bollinger band appears as a band consists of 3 moving averages like lines. Here is an example chart containing Bollinger bands.

Interpretation:

Bollinger band can be used in many ways. Different traders use this indicator in different ways. Such as,

Bollinger Band Bounce
Bollinger Band Squeeze
Bollinger Band Breakout

Bollinger Band Bounce:

This is very simple and effective trading method for short term trading. Traders usually use this for short term trading or scalping in forex market. This strategy involves buying when candlestick hit the lower Bollinger band and selling when candlestick hit upper Bollinger band. It is better if you follow the trend while trading Bollinger band bounces.

4 hour chart of USD/CAD is showing several entry signals for both long and short positions.

Bollinger Band Squeeze:

When a currency pair becomes less volatile, Bollinger band becomes squeezed. In squeezed condition, distance between upper, lower and middle bands becomes narrow. This scenario occurs when the price of the pair is ranging in a narrow range. This indicates low volatility and a sign of a breakout or breakdown. Squeezed Bollinger band after a prolonged downtrend indicates accumulation period. Inversely squeezed Bollinger band after a prolonged uptrend indicates distribution period. But it is extremely difficult to identify accumulation and distribution phase properly. This is why traders usually add other indicators to understand the possible price direction after the squeezed state.

On the 4 hour chart of AUD/USD, we can see entry signals for long positions as Bollinger band was squeezed and MACD moved above the zero line.

4 hour chart of AUD/USD (given above) is showing sell signal or entry signal for long position when the Bollinger band was squeezed and MACD crosses below the zero line/centerline.

Bollinger Band Breakout:

A breakout occurs when candlesticks hit upper or lower Bollinger band. Breakouts and breakdowns mostly occur after a squeezed state of the Bollinger band. A squeezed condition of Bollinger band indicates the possibility of a breakout or breakdown. Thus, traders generally trade breakouts or breakdowns after Bollinger band squeeze.

4 hour chart of USD/CAD is showing breakout and breakdown after a squeezed state of the Bollinger band.

Summary:

Volatility plays a vital role in Bollinger band trading strategies. Such as, Bollinger band bounce strategy works well when there is a confirmed trend and volatility is high. Breakouts and breakdowns carry more success if found after a prolonged squeeze state of the Bollinger band. Traders should consider these factors while trading with Bollinger bands.

More About Trendline from a different Look -

noreply@blogger.com (Pareesh Ratan Kundu) — Sun, 02 Mar 2014 16:47:00 +0000

More About Trend-line from a different Look -

What is A Trend-line ?

Trendlines are drawn with a diagonal line between two or more price pivot points. Look at the Daily chart below of the EUR/USD currency pair.

The pair made a significant swing high on February 1^st of this year, followed by another significant swing high on the 13^th of February. We can now draw a trendline by connecting the highs of these 2 price pivot points. You need a minimum of two price points to draw a trendline, although more is better of course.

How do you trade trend line?

There are two ways to profit from trendlines.
Method number 1 – Look for a continuation of the trend
The first and most obvious one is to look for price to turn once it hits the trendline. The chart below shows areas where price hit the trendline only to turn back down.

Where do you enter and place your stops?
The Entry is when price hits the trendline. These areas are marked with arrows on the chart below. The initial stop loss is placed above the trendline giving us a low risk entry. A trailing stop is also usually employed when trading trendlines. As the trendline moves lower you move the stop loss just above the line, thus lowering your risk further.
Trendlines are dynamic support and resistance levels
Trendlines are support and resistance levels but unlike horizontal lines which are static in nature, trendlines are dynamic. Notice how on the charts above we only connected the first 2 swing points. If we extend the trendline further down we get the chart below.

As price moves lower your trendlines may need to be adjusted somewhat to reflect the new price action. Don’t be afraid to make these changes as adjusting the line can lead to more accurate entries.
Method Number 2 – Look for the trend to reverse
The second way to trade trendlines is to look for areas of possible trend reversal. This happens when the trendline no longer can contain the price. The price makes a brakeout and reverses the previous trend. We have identified one such instance on the chart below.

The big 2 month downtrend in the EUR/USD during February and March is drawing to a close as the single currency starts to turn back up. The trendline is broken and soon after we get the first significant price close above the line. The stop loss is placed just below the price swing low.
An Example from the Long Side
Below is an example on the EUR/JPY 1 Hour chart. It shows the same concepts we talked about before just from the long side. The pair made a significant swing low on April 4^th, followed by another significant swing low the next day. We draw a trendline by connecting the lows of these 2 price pivot points.

Money Management

noreply@blogger.com (Pareesh Ratan Kundu) — Sun, 02 Mar 2014 11:40:00 +0000

Protecting your capital (or money management)

The biggest risk that any trader faces is that they will lose their capital. Often new traders will start out with a string of successful trades and their confidence grows: they never learn to apply sound money management and limit their downside risk. Sooner or later they encounter a string of losing trades that either wipes them out or wipes out a big enough portion of their capital that they quit trading.

Uncertainty

No trading system can deliver 100% accuracy. Prices can go up or down at any time: it is only the probability that varies. The best we can hope for is a probability of about 80% (that price will move in a specified direction). That means that at least one in five times you will be wrong and price will move against you. There is no such animal as a "sure thing". In fact, whenever you hear or use those words, you are at more risk of losing your capital than at any other time.

If you can't be 100% accurate, how can you make money?

In the same way that a casino makes money. If the odds are stacked in your favor (compare 80% to the house advantage of less than 55% on a roulette wheel) you will be able to gain more than you lose -- provided that you do not risk all your capital on a single trade.

The market is a dynamic system. I often compare trading to a military operation, not because of its' oppositional nature, but because of the complexity, the continual uncertainty created by conflicting intelligence reports and the element of chance that can disrupt even the best made plans. Prepare thoroughly, but allow for the unexpected. The formula is simple: trade when probabilities are in your favor; apply proper risk (money) management; and you will succeed.

Money Management: The 2 Percent Rule

The 2 percent rule is a basic tenet of risk management (I prefer the terms "risk management" or "capital preservation" as they are more descriptive than "money management"). Even if the odds are stacked in your favor, it is inadvisable to risk a large portion of your capital on a single trade.

Larry Hite, in Jack Schwager's Market Wizards (1989), mentions two lessons learned from a friend:

Never bet your lifestyle -- never risk a large chunk of your capital on a single trade; and
Always know what the worst possible outcome is.

Hite goes on describe his 1 percent rule which he applies to a wide range of markets. This has since been adapted by short-term equity traders as the 2 percent rule:

The 2 Percent Rule: Never risk more than 2 percent of your capital on any one stock.

This means that a run of 10 consecutive losses would only consume 20% of your capital. It does not mean that you need to trade 50 different stocks -- your capital at risk is normally far less than the purchase price of the stock.

Applying the 2 Percent Rule

Calculate 2 percent of your trading capital: your Capital at Risk
Deduct brokerage on the buy and sell to arrive at your Maximum Permissible Risk
Calculate your Risk per Share:Deduct your stop-loss from the buy price and add a provision for slippage (not all stops are executed at the actual limit). For a short trade, the procedure is reversed: deduct the buy price from the stop-loss before adding slippage.
The Maximum Number of Shares is then calculated by dividing your Maximum Permissible Risk by the Risk per Share.

Example

Imagine that your total share trading capital is $20,000 and your brokerage costs are fixed at $50 per trade.

Your Capital at Risk is: $20,000 * 2 percent = $400 per trade.
Deduct brokerage, on the buy and sell, and your Maximum Permissible Risk is: $400 - (2 * $50) = $300.
Calculate your Risk per Share:
If a stock is priced at $10.00 and you want to place a stop-loss at $9.50, then your risk is 50 cents per share.
Add slippage of say 25 cents and your Risk per Share increases to 75 cents per share.
The Maximum Number of Shares that you can buy is therefore:

$300 / $0.75 = 400 shares (at a cost of $4000)

Quick Test

Your capital is $20,000 and brokerage is reduced to $20 per trade. How many shares of $10.00 can you buy if you place your stop loss at $9.25? Apply the 2 percent rule.

Hint: Remember to allow for brokerage, on the buy and sell, and slippage (of say 25 cents/share).

Answer is--

Answer: 360 shares (at a cost of $3600).
Capital at Risk: $20,000 * 2 percent = $400
Deduct brokerage: $400 - (2 * $20) = $360
Risk per Share = $10.00 - $9.25 + $0.25 slippage = $1.00 per share
Maximum Number of Shares = $360 / $1 = 360 shares

Is 2 Percent Suitable For All Equity Traders?

Not all traders face the same success rate (or reliability as Van Tharp calls it in Trade Your Way to Financial Freedom). Short-term traders normally achieve higher success rates, while long-term traders generally achieve greater risk-reward ratios.

Success Rate (Reliability)

Your success rate is the number of winning trades expressed as a percentage of your total number of trades:

Success rate = winning trades / (winning trades + losing trades) * 100%

Risk-Reward Ratios

Your risk-reward ratio is your expected gain compared to your capital at risk (it should really be called the reward/risk ratio because that is the way it is normally expressed). If your average gain (after deducting brokerage) on winning trades is $1000 and you have consistently risked $400 per trade (as in the earlier 2 percent rule example), then your risk-reward ratio would be 2.5 to 1 (i.e. $1000 / $400).

Risk-Reward ratio = average gain on winning trades / average capital at risk

Confidence Levels

If we have three traders:

Trader:	A	B	C
Time frame:	Short-term	Medium	Long-term
Success Rate:	75%	50%	25%
Risk-Reward Ratio:	1.0	3.0	10.0

Trader A

Trades short-term and averages 125% profit over all his trades.

Winning trades:	75% * 1	0.75
Less: Losing Trades	25% * 1	-0.25
Average Profit		.50
As a percentage of capital at risk		50%

Trader B

Trades medium-term and averages 200% profit over all his trades.

Winning trades:	50% * 3	1.50
Less: Losing Trades	50% * 1	-0.50
Average Profit		1.00
As a percentage of capital at risk		100%

Trader C

Trades long-term and averages 325% profit over all her trades.

Winning trades:	25% * 10	2.50
Less: Losing Trades	75% * 1	-0.75
Average Profit		1.75
As a percentage of capital at risk		175%

This does not necessarily mean that Trader C is more profitable than A. Trader A (short-term) is likely to make many more trades than Trader C. You could have the following situation:

Trader:	A	B	C
Time frame:	Short-term	Medium	Long-term
Average Profit/Trade	50%	100%	175%
Number of Trades/Year	300	100	40
Times Return on Capital at Risk	150	100	70
Capital at Risk	2%	2%	2%
Annual % Return on Capital	300%	200%	140%

Relative Risk

We now calculate the relative risk that each trader has of a 20% draw-down. Use the binomial probability calculator at http://faculty.vassar.edu/lowry/ch5apx.html:

Trader	A	B	C
Success Rate	75%	50%	25%
Probability of 10 straight losses	0.0001%	0.1%	5.6%

Obviously, the higher your success rate, the greater the percentage that you can risk on each trade.

Bear in mind that, with a higher risk-reward ratio, Trader C only needs one win in 10 trades to break even; while Trader A would need five wins. However, if we compare breakeven points, it is still clear that lower success rates are more likely to suffer from draw-downs.

Trader	A	B	C
Number of wins (out of 10 trades) required to break even	5	2.5	1
Normal Success Rate	75%	50%	25%
Probability of making a net loss in 10 trades	2.0%	5.5%	5.6%

Low Success Rates

Although your trading system may be profitable, if it is susceptible to large draw-downs, consider using a lower percentage of capital at risk (e.g. 1 percent).

Back to the Real World

In real life trading we are not faced with a perfect binomial distribution as in the above example:

gains are not all equal;
some losses are bigger than others -- stop losses occasionally fail when prices gap up/down;
probabilities vary; and
outcomes influence each other -- when stocks fall, they tend to fall together.

Covariance

The biggest flaw in most risk management systems is that stock movements influence each other. Individual trades are not independent. Markets march in unison and individual stocks follow. Of course there are mavericks: stars that rise in a bear market or collapse in the middle of a bull market, but these are the exception. The majority follow like a flock of sheep.

Thomas Dorsey in Point & Figure Charting gives an example of the risks affecting a typical stock:

Market risk
Sector risk
Stock risk

66%
24%
10%

The risk of the market moving against you is clearly the biggest single risk factor. How do we protect against this?

Protecting your Capital from a String of Losses

The 2 percent rule alone will not protect you if you are holding a large number of banking stocks during an asset bubble; insurance stocks during a natural disaster; or technology stocks during the Dotcom boom. We need a quick rule of thumb to measure our exposure to a particular industry or market.

Independent Sectors

Limit your exposure to specific industry sectors. Not all sectors are created equal, however. Industry groups in the (ICB or GICS) Raw Materials sector have fairly low correlation, and can be treated as separate sectors, while industry groups in most other sectors should be treated as a single unit.

We can see from the above chart that Chemicals and Containers & Packaging tend to move in unison and should possibly be treated as one industry sector, but other indexes shown are sufficiently independent to be treated separately.

Sector Risk

As a rule of thumb, limit your Total Capital at Risk in any one industry sector to 3 times your (maximum) Capital at Risk per stock (e.g. 6% of your capital if you are using the 2 percent rule).

This does not mean that you are limited to holding 3 stocks in any one sector. You may buy a fourth stock when one of your initial 3 trades is no longer at risk (when you have moved the stop up above your breakeven point on the trade); and a fifth when you have covered your risk on another trade; and so on.

Just be careful not to move your stops up too quickly. In your haste you may be stopped out too early -- before the trend gets under way.

I also suggest that you tighten your stops across all positions in a sector if protective stops are triggered on 3 straight trades in that sector (within a reasonable time period). By protective stops I mean a trailing stop designed to exit your position if the trend changes (e.g. a close below a long-term MA). A reasonable time period may vary from a few days for short-term trades to several weeks for long-term trades.

Market Risk

You can limit our market risk in a similar fashion.

Limit your Total Capital at Risk in the market to between 5 and 10 times your (maximum) Capital at Risk per stock (e.g. 10% to 20% of your capital if you are using the 2 percent rule). Adjust this percentage to suit your own risk profile. Also, the shorter your time frame and the higher your Success Rate, the greater the percentage that you can comfortably risk.

It is also advisable to tighten your stops across all positions if protective stops are triggered on 5 straight trades within a reasonable time period. Protective stops do not have to be the original stops set on a trade. You may make an overall profit on the trade, but the stop must indicate a trend change.

Money Management Summary

A general rule for equity markets is to never risk more than 2 percent of your capital on any one stock. This rule may not be suitable for long-term traders who enjoy higher risk-reward ratios but lower success rates. The rule should also not be applied in isolation: your biggest risk is market risk where most stocks move in unison. To protect against this we should limit our capital at risk in any one sector and also our capital at risk in the entire market at any one time.

Stop Loss Orders

noreply@blogger.com (Pareesh Ratan Kundu) — Sat, 01 Mar 2014 17:34:00 +0000

Stop Loss Orders

Stop loss orders ("stops") are limits set by traders at which they will automatically enter or exit trades - an order to buy or sell is placed in the market if price reaches a specified limit.

The first discipline that any trader should master is to always limit your losses.

A stop loss order is set to limit a trader's potential loss. The stop loss is placed below the current price (to protect a long position) or above the current price (to protect a short position).

      Example: If you purchase 1,000 IBM at $90.00 you may decide to place a stop loss as follows:
                      SELL 1,000 IBM IF price is less than or equal to $87.00
                      If price falls to $87.00 your order will be activated.
                      Your loss is limited to $3.00 per share (plus brokerage).

As a rule: avoid markets with low liquidity where extreme price fluctuations are possible.

Stop Loss Order Types

Market Stop Orders
This is a conventional stop loss order - the stop activates a market order to sell (or buy) at the prevailing market price.
Limit Stop Orders
The limit stop activates an order to sell at the prevailing market price but not below a specified limit (or buy at the prevailing price up to a specified limit).
Fixed Price Stop Orders
The stop loss activates an order at a fixed price. Some exchanges refer to these as limit stop orders so check that you are using the correct stop loss order.

Limit stop orders are recommended for entering a trade: they have a greater chance of success than fixed price orders but are not as open-ended as market orders (where your order will be executed no matter what the market price is).

Market stop orders should be used to exit trades: to ensure that the order has the best possible chance of execution. Never hold on to securities if price falls sharply - in the hope that they will recover. Edwin Lefevre sums up the predicament in Reminiscences of a Stock Operator :

It was the same with all. They would not take a small loss at first but had held on, in the hope of a recovery that would "let them out even." And prices had sunk and sunk until the loss was so great it seemed only proper to hold on, if need be a year, for sooner or later prices must come back. But the break "shook them out," and prices just went so much lower because so many people had to sell, whether they would or not.

Evaluation of Stop Losses

Stop loss orders do not always work perfectly. If a major support level is breached, a large number of stops may be activated at the same time. Sellers will far exceed buyers, causing price to fall sharply and leaving sell orders unfilled. In extreme cases there may be no buyers at all for a security -- not at any price.

Imperfect as they are, stops are still an effective mechanism for limiting risk and protecting capital.

If stops are not accepted in a market, set your own limits and place buy or sell orders when the price is reached. Use SMS alerts if they are available from an online broker. Self-discipline is required to execute stops without hesitation.

Steps Required

First, determine your maximum acceptable loss;
Set stop loss order levels based on sound technical levels;
Adjust your stop loss levels over time to lock in profits;
Use trailing stops to time your entry and exit from the market.

Setting Stop Loss Orders

Stop loss order levels need to be technically consistent, otherwise they will cost you money. Arbitrary levels are likely to be activated by the normal cycle.

Base your stop losses on technical levels, such as:

Support/ resistance levels,
Above/below the most recent peak/trough,
Above or below reversal signals; or
At the crossing of moving averages.

Example

This example illustrates the use of 2 different technical levels for stop losses:

The first stop loss is placed just below the level of the most recent trough.
The second stop loss is placed below the support line (on a reversal signal above the support line).

Support and Resistance Levels

Avoid placing your stop loss exactly at the support or resistance level for two reasons:

Trends often reverse at these levels and you may be stopped out unnecessarily;
A large number of stops may be set at the support or resistance level, especially where it has formed at a round number.

Rather set your stop loss one or two ticks below a support level or one or two ticks above a resistance level. For example: If a support level has formed at $20.00, set the stop loss at $19.90 so that you are only stopped out if the support level is penetrated.

Adjusting Stop Loss Orders

Adjust your stop loss orders, over time, in the direction of the trend being traded:

In an up-trend move your stop loss up to below the Low of the most recent trough.
In a down-trend move your stop loss down to above the High of the last peak.

Only a break in the trend (or large correction) will stop you out.
Using Moving Averages

An alternative approach, that may prevent you from being shaken out of a trend too early, is to use a long-term moving average in conjunction with the above. Stan Weinstein (Secrets for Profiting in Bull and Bear Markets) suggests using a 30 week moving average. This is suitable for investors following the primary trend, adjust the length of the moving average if trading in a shorter time frame.

In an up-trend move your stop loss to below:

the Low of the most recent trough, or

the moving average, whichever is lower.

In a down-trend move your stop loss to above:

the High of the most recent peak, or

the moving average, whichever is higher.

Example

Johnson & Johnson is charted with a 63 day exponential moving average. Stop loss order levels are depicted by horizontal trendlines.

Go long [L]. The signal is taken when price respects the moving average. A stop loss order is placed at [S1], below the Low of the most recent trough or below the moving average, whichever is lower (shown by the start of the trend line).
At [S2] move the stop loss up to below the moving average at the next trough.
At [S3] move the stop loss to below the Low at the next trough (this is lower than the moving average).
At [S4] move the stop loss to below the moving average at the next trough.
The stop loss order is activated [X] when the next correction falls below the previous trough.

Ranging Market

In a ranging market adjust your stop loss based on the cycle in one time frame shorter than the cycle being traded. For instance, if trading an intermediate cycle (in a ranging market), move your stop loss orders up or down in accordance with the short cycle.

Maximum Acceptable Loss

Set the maximum loss that you are prepared to accept on any single trade. This is usually expressed as a percentage. Avoid trades where the difference between your entry level and the stop-loss exceeds the maximum acceptable loss.

Consider the following factors when determining your maximum acceptable loss:

Whether you are investing or trading;
The time frame that you are trading in;
Whether you are trading on margin;
Your overall risk profile; and
Your level of diversification.

A long-term investor/trader with reasonable risk diversification may find 6%, or even 10%, an acceptable limit. A short-term trader may set a limit of only 2%.

Trailing Stop Loss Orders

Trailing stop loss orders have three uses:

To limit your losses,
To protect your profits, or
To prevent you from entering (or exiting) a trade too early or on a false signal.

Stops can be based on the high/low of the daily trading range or on a trailing percentage. Welles Wilder's Parabolic SAR is a further form of trailing stop.

The rules below are based on Screen 3 of the Triple Screen trading system, described by Alexander Elder in Trading for a Living.

Buy-Stop

When you get a signal to go long - place a buy order one tick above the High on the signal day. If price rallies, you will be stopped in on the next day. If price falls, the buy order will remain untouched. Move the buy order down to one tick above the High on the second day. Continue to lower the buy order on each subsequent day until price rallies and you are stopped in.

When you are stopped in, place a stop loss below the Low of the recent down-trend (the lowest Low since the signal day).

Sell-Stop

When you get a signal to go short - place an order to sell short one tick below the Low on the signal day. If price falls, you will be stopped in on the next day. If price rallies, the buy order will remain untouched. Move the sell-stop up to one tick below the Low on the second day. Continue to raise the sell-stop on each subsequent day until there is a correction and you are stopped in.

When your sell-stop is executed, place a stop loss above the High of the recent up-trend (the highest High since the signal day).

* Day 4 makes a new High and a new Low. If the High was made before the sell-stop is reached, the stop-loss will be placed as shown. If the sell-stop was activated before the new High was made, then the stop-loss would have been placed above the High of Day 3 and the trade would have been stropped out on making the new High.

Example

Intel Corporation is shown with a 21 day exponential moving average and 7-day Stochastic %K and %D.

%K falls below 20. Place a trailing buy-stop just above the day's High of $33 1/2.
Move the buy-stop down to $33, above the High of day 2.
Move the stop down to above the High of day 3.
Move the stop down to $32 1/2 - one tick above the High on day 4.
The day opens with a new Low of $31 3/8 and then rises until we are stopped in at $32 1/2. Place a stop-loss below the Low (i.e.. the lowest Low since day [1]). Thereafter, price falls back to the day's Low, but fails to activate the stop-loss one tick below.

Inside Days

The rules for sell and buy stops are sometimes varied by excluding inside days:

no adjustment is made to a buy-stop if the day does not make a new low;
no adjustment is made to a sell-stop on days that do not make a new high.

Trailing Percentage Stops

Trailing percentage stop orders are offered by some online brokers. The stop order works with a ratchet effect - it trails price movements by a set percentage, but only in the direction of the trend. If price reverses direction, the stop remains at its previous level and will be activated if price reverses by more than the trailing percentage.

Buy-Stop

Buy-stops are used to enter long positions or to close short positions.

In the example below, the trailing stop is set at 6%. The trader will be stopped in if price rises 6% above the lowest Low.

The buy-stop ratchets down on each day that price forms a new low. The stop loss for each day is set at 6% above the lowest Low since the signal (Day 1).

Note that the stop loss remains unchanged if the previous day does not form a new Low.

Sell-Stop

Sell-stops are used to exit long positions or to enter short positions.

Compare the 10% trailing stop, in the example below, to a 6% trailing stop. With a 6% sell-stop the trade would have been exited at 48.9 on Day 3 (52.0 - 10%).

Setting the Trailing Percentage Stop

When setting the trailing percentage, consider the following factors:

If the stop losses are being used to limit your losses, decide on your maximum acceptable loss beforehand.
Determine the magnitude of the intra-day cycle - you do not want your stop loss to be activated by normal intra-day fluctuations. Use intra-day charts or in-depth information from an online broker.

A Word of Caution

Check how your broker calculates trailing stops!

Many brokers calculate trailing stops on the last close and do not adjust on an intra-day basis. If price runs up from $20.00 to $28.00 during a single session and then falls back to close at $21.00, you will not be stopped out with a 5% trailing stop calculated on this basis, because price is still above yesterday's high, even though it has fallen 25% intra-day!