Fibonacci numbers and ratios

Fibonacci, a famous 13th century mathematician discovered a number sequence called “the Fibonacci sequence,” adding the two previous numbers in the sequence to come up with the next number: 1, 1 + 1 = 2, 1 + 2 = 3, 2 + 3 = 5, 3 + 5 = 8, 5 + 8 = 13, 8 + 13 = 21, 13 + 21 = 34 and so on to infinity.

Importantly, after the first several numbers in the Fibonacci sequence, the ratio of any number to the next higher number is approximately 0.618, and the next lower number is 1.618. These two figures (0.618 and 1.618) are known as the Golden Ratio or Golden Mean. Its proportions are pleasing to the human eyes and ears and appear throughout nature and in biology, art, music and architecture. A few examples of shapes based on the Golden Ratio include playing cards, sunflowers, snail shells, the galaxies of outer space, hurricanes and even DNA molecules.

Two Fibonacci technical percentage ratios that are particularly important to traders are 38.2% and 61.8%. Most market technicians will track a “retracement” of a price uptrend from its beginning to its most recent peak, and those retracements in price often stop at these Fibonacci ratios, indicating places where markets may turn or show signs of strength. Other important retracement percentages include 75%, 50% and 33%. For example, if a price trend starts at zero, peaks at 100, and then declines to 50, it would be a 50% retracement. The same levels can be applied to a market that is in a downtrend and then experiences an upside “correction.” Perhaps it is a self-fulfilling prophecy, but traders know where these price retracement levels are, and the market frequently respects them.

What is most fascinating about Fibonacci numbers, the Golden Ratio and the Elliott Wave Principle as they are applied to technical analysis of markets is that these principles are a reflection of human nature and human behavior. The longer you are in the trading business and study the behavior of markets, the more you will realize that human behavior patterns and market price movement patterns are deeply intertwined. If you want to figure out prices, you need to figure out the trading crowd.

Volume and open interest reported by the exchanges are significant factors to monitor when trading futures!

What is Volume?
Volume is the number of transactions in a futures or optiion contract made during a specified period of time. One buy and one sell equal two decisions but one trade or transaction and a volume of one. Volume is usually recorded for one trading session (like every day).

What is Open Interest?
Open interest is the total number of futures or options on futures contracts that have not yet been squared off or fulfilled by delivery. Open Interest is an indicator of the depth or liquidity of a futures market.

How is Open Interest Calculated?
If a new buyer (a long) and new seller (a short) enter a trade, open interest increases by one. However, if a trader already holding a long position sells to a new trader wanting to initiate a long position, open interest remains the same. And if a trader holding a long position sells to a trader wanting to get rid of his existing short position, open interest decreases by one.

Always trade liquid contracts that have high open interest and high volumes. Avoid illiquid contracts at all costs.

How to use Volume and Open Interest?
Volume and open Interest are secondary indicators and can be used to confirm other technical indicators in a chart.

If there is a big upside price breakout that is accompanied by heavy volume, then that only makes the upside move a stronger trading signal. Alnernatively, a big upside move or a move to a new high that is accompanied by light volume makes the move suspect.

Big price moves (up or down) accompanied by heavy volume are powerful trading signals. If prices make a new high or new low on lower than average volume, then that is an indication a top or bottom may be near or in place. Also, if volumes increases on price moves against the existing trend, then that trend may be nearing an end.

As a general rule, volume should increase as a trend develops. In an uptrend, volume should be heavier on up days and lighter on down days within the trend. In a downtrend, volume should be heavier on down days and lighter on up days to reinforce the direction of the trend.

Open interest can help the trader gauge if money is flowing into a market or if money is flowing out of a market. This is helpful when looking at a trending market. If both volume and open interest are increasing, then the trend will probably continue in its present direction, either up or down. If volume and open interest are declining, this can be interpreted as a signal that the current trend may be about to end.

High open interest at market tops can cause a steep and quick price downturn, and open interest that is building up during a consolidation, or “basing” period, can strengthen the price breakout when it happens.

Technical trading systems can help any individual trader make a trading decision based on clear objective and predetermined set of rules. The techniques used in technical trading systems are based on price, volume and open interest.

Technical trading systems can be broadly divided into these five types:

1. Trending market trading systems
2. Countertrend trading systems
3. Breakout Trading Systems
4. Trading range trading systems
5. Hedge trading systems

A individual trader has the best chance to be a profitable trader if he or she adopts a technical trading system.  Technical trading systems are the only surefire way to minimize the emotional influences that inevitably destroy nearly every trader.

A Trading System is nothing but a set of rules or parameters developed using certain formulas and/or indicators based on the price action of the underlying security.

A complete and well developed trading system will contain:

• Entry Level.
• Exit Level.
• Profit Booking Level.
• Stop-Loss Level.
• Money/Risk Management tailored to the individual traders capital and risk profile.

Trading systems have been around for many many years. Most traders use trading systems without actually knowing it. However to become a successful and profitable trader you need to include all of the above components in your trading system.

50 Trading Rules to Live BY

These Trading Rules appear on many websites all over the net, but I’ve never seen anyone credited with having written them. So, to the anonymous trader who created these…thank you!

1. Plan your trades.

2. Trade your plan.

3. Keep records of your trading results.

4. Keep a positive attitude, no matter how much you lose.

5. Don’t take the market home. Continually set higher trading goals.

6. Successful traders buy into bad news and sell into good news.

7. Successful traders are not afraid to buy high and sell low.

8. Successful traders have a well-scheduled planned time for studying the markets.

9. Successful traders isolate themselves from the opinions of others.

10. Continually strive for patience, perseverance, determination, and rational action.

11. Limit your losses – use stops!

12. Never cancel a stop loss order after you have placed it!

13. Place the stop at the time you make your trade.

14. Never get into the market because you are anxious because of waiting.

15. Avoid getting in or out of the market too often.

16. Losses make the trader studious – not profits. Take advantage of every loss to improve your knowledge of market action.

17. The most difficult task in speculation is not prediction but self-control. Successful trading is difficult and frustrating. You are the most important element in the equation for success.

18. Always discipline yourself by following a pre-determined set of rules

19. Remember that a bear market will give back in one month what a bull market has taken three    months to build.

20. Don’t ever allow a big winning trade to turn into a loser. Stop yourself out if the market moves against you 20% from your peak profit point.

21. You must have a program, you must know your program, and you must follow your program

22. Expect and accept losses gracefully. Those who brood over losses always miss the next opportunity, which more than likely will be profitable.

23. Split your profits right down the middle and never risk more than 50% of them again in the market.

24. The key to successful trading is knowing yourself and your stress point.

25. The difference between winners and losers isn’t so much native ability as it is discipline exercised in avoiding mistakes.

26. In trading as in fencing there are the quick and the dead.

27. Speech may be silver but silence is golden. Traders with the golden touch do not talk about their success.

28. Dream big dreams and think tall. Very few people set goals too high.A man becomes what he thinks about all day long.

29. Accept failure as a step towards victory.

30. Have you taken a loss? Forget it quickly. Have you taken a profit? Forget it even quicker! Don’t let ego and greed inhibit clear thinking and hard work

31. One cannot do anything about yesterday.

32. When one door closes, another door opens. The greater opportunity always lies through the open door. The deepest secret for the trader is to subordinate his will to the will of the market. The market is truth as it reflects all forces that bear upon it. As long as he recognizes this he is safe. When he ignores this, he is lost and doomed.

33. It’s much easier to put on a trade than to take it off.

34. If a market doesn’t do what you think it should do, get out.

35. Beware of large positions that can control your emotions. Don’t be overly aggressive with the market. Treat it gently by allowing your equity to grow steadily rather than in bursts

36. Never add to a losing position.

37. Beware of trying to pick tops or bottoms.

38. You must believe in yourself and your judgment if you expect to make a living at this game

39. In a narrow market there is no sense in trying to anticipate what the next big movement is going to be – up or down

40. A loss never bothers me after I take it. I forget it overnight. But being wrong and not taking the loss – that is what does the damage to the pocket book and to the soul..

41. Never volunteer advice and never brag of your winnings.

42. Of all speculative blunders, there are few greater than selling what shows a profit and keeping what shows a loss.

43. Standing aside is a position.

44. It is better to be more interested in the market’s reaction to new information than in the piece of news itself.

45. If you don’t know who you are, the markets are an expensive place to find out.

46. In the world of money, which is a world shaped by human behavior, nobody has the foggiest notion of what will happen in the future. Mark that word – Nobody! Thus the successful trader does not base moves on what supposedly will happen but reacts instead to what does happen.

47. Except in unusual circumstances, get in the habit of taking your profit too soon. Don’t torment yourself if a trade continues winning without you. Chances are it won’t continue long. If it does, console yourself by thinking of all the times when liquidating early reserved gains that you would have otherwise lost.

48. When the ship starts to sink, don’t pray – jump!

49. Lose your opinion – not your money.

50. Assimilate into your very bones a set of trading rules that works for you.

A stock market cycle is very similiar to a business or economic cycle which consists of:

1. Expansion
2. Peak
3. Decline
4. Recovery

To trade stocks successfully, you must first understand the four stock market stages that individual stocks and the overall market go through.

These cycles tell you if you should be long, short or in cash. Once you are able to identify what stage it is in, you can then trade accordingly to those characteristics.

After a while you won’t even have to think about whether you should be long or short. You will know, without question, exactly what you should be doing NOW. You will either be focusing on long positions, short positions, or you will stay safely in cash – just by glancing at a chart!

Four Stages of a Stock Market Cycle

In the case of a stock market cycle we have the following four stages:

1. Accumulation: After a period of decline or correction, stocks go through a period of accumulation. During this stage bulls & bears fight it out with each other  to take control of the trend. Stocks change hands without any noticable change in trend. This is a sideways phase and does not really provide any sizable trading opportunity.
2. Markup: During this stage the bulls wrest control of the stock from the bears and the stock goes into a new uptrend. Stocks pick up speed and momentum. This is the most profitable stage for a trader as maximum profits can be extracted during this stage trading on the long side. Stocks make a series of higher highs and higher lows and a new bull market begins.
3. Distribution: After the glorious bull market in stage two, markets get exhausted and pauses its uptrend. Smart money (professionals) who bought earlier are now selling to the amatuers. Stocks and markets just drift along sideways without any discernable trend and does not provide any profitable trading opportunity.
4. Decline: After the professionals have dumped their holdings on to the amatuers during the distribution stage there are no more buyers left. The lack of buying by buyers and aggressive supply by sellers leads to a sharp fall in prices and a bear market. During this stage stocks make lower lows and lower highs. This again is a very profitable stage for traders. The sharp decline in prices with momentum provides excellent trading opportunity to a trader.

Stock market stages occur in all time frames on every chart you look at. This could be a five minute chart of Nifty or a weekly chart of the ACC.

Trading Strategy
Generally, you want to stay in cash when a stock (or the market itself) is chopping around in a stage one. In stage two you will want to be aggressively focusing on long positions. In stage three you want to be in cash. In stage four you want to be aggressively focusing on short positions.

After a three month consolidation the Bank Nifty seems ready for a breakout to begin a new intermediate uptrend.

NSE Bank Nifty on verge of a breakout

Traders can look for a breakout above 7750.00 for a confirmation of a profitable new intermediate uptrend. Subscribers can check out our trading calls on the Bank Nifty.

Although the NSE Nifty 50 and the BSE Sensex have not yet crossed their June 2009 highs a few sectorial indices have done so.

Some of the sector indices that have outperformed are:

The Auto Index has clearly confirmed its intermediate uptrend.

Investor/traders can concentrate their trading into the following stocks that belong to the Auto Index:

• Amtek Auto Ltd.
• Apollo Tyres Ltd.
• Ashok Leyland Ltd.
• Bajaj Auto Ltd.
• Bharat Forge Ltd.
• Bosch Ltd.
• Cummins India Ltd.
• Escorts Ltd.
• Exide Industries Co. Ltd.
• Hero Honda Motors Ltd.
• Mahindra & Mahindra Ltd.
• Maruti Suzuki India Ltd.
• MRF Ltd.
• Tata Motors Ltd.

The IT Index also clearly confirms a new intermediate uptrend.

The list of stocks belonging to the IT Index are:

• Aptech Ltd.
• Financial Technologies (I) Ltd.
• HCL Technologies Ltd.
• Infosys Technologies Ltd.
• Moser Baer India Ltd.
• Mphasis Ltd.
• NIIT Ltd.
• Oracle Financial Services Software Ltd.
• Patni Computer Systems Ltd.
• Rolta India Ltd.
• Tata Consultancy Services Ltd.
• Tech Mahindra Ltd.
• Wipro Ltd.

As a positional trader or investor it would be best to look for buying opportunities in stocks that belong to the outperforming sectors. Being able to trade in stocks belonging to outperforming sectors is a traders or investors best bet to trading profits.

One crucial difference between successful and unsuccessful traders is that the successful ones have a trading plan and they follow it. Unsuccessful traders do not have any kind of plan for their trading. They go from trade to trade applying various ideas they have learned without any consistency and without any testing. They make decisions based on hot tips, something they read, today’s news, etc. Most unsuccessful traders are acting from emotion rather than using a proven methodology.

There are two psychological traits that separate successful traders from unsuccessful traders are patience and discipline. It is not enough to have a carefully tested trading plan. You must also be able to follow it religiously.

A very high percentage of those who try trading eventually lose money. The ratio of losers could be as high as ninety-five percent. However if you are able to correctly identify the reasons why most people lose, you can improve your odds of becoming a successful trader significantly.

Successful traders look at trading as a business, unsuccessful traders look at trading as a hobby.

It is hard work to create a winning trading plan. It is hard psychologically to follow the plan after you create it. This is why so many people fail. Do you have what it takes to be a successful trader?

The Four Pillars to any Successful Trading Plan are:

1. Trade with the trend
   One of the most useful skills that any trader can develop is the ability to identify a trend. If you can identify a market in an uptrend and enter a long position or identify a market in a downtrend and enter a short position, you have the potential to make a great deal of money. Unfortunately traders spend a lot of their time trying to “predict” what will happen next, rather than simply focusing on answering the question “what is the trend right now?”
2. Cut losses short
   This is the primary reason why most individuals cannot become successful traders. Taking a loss is against the human nature. Taking a loss goes against the very grain of our upbringing.  To become a successful trader you need to learn how, when and where to take a loss. Professional traders accept that losses are part of the game.
3. Let profits run
   To become a successful trader you need to stay with your profitable trades as long as possible because the trend is likely to continue and make your profits even larger. Most traders are inclined to take their profits too soon. This can be fatal to long-term success because big profits are necessary to overcome the inevitable collection of small losses. As long as the trend keeps moving in your favor, you stay in the trade. If the market reverses direction by the amount of your trailing stop, you exit the trade.
4. Manage risk
   It is by managing risk that you limit losses and preserve your capital. The most important element of managing risk is keeping losses to a small percentage of your trading capital.

Your trading plan will serve as your roadmap to help you through the twists and turns that the markets will throw at you. It should also serve as a constant frame of reference. Thus forming a comprehensive trading plan is your first step toward trading success.