Short-term strategies for investing in stocks
- Day trading – Day trading means trading in the stock for a day. In the type of strategy you buy and sell the stock in the same trading day. One can trade multiple times in the same stock in the same day but all the stocks are squared off on the same day. Here you look for small gains during the trading day and try to profit from small movements during the day.
When you Place an order with the broker you have to select the option if the trade will be a delivery trade or intra-day trade and the reason is margin. You have to pay lesser margins for intra-day day trades compared to delivery trades due to the time factor and no risk of overnight uncertainties. Day trading has many sub styles like momentum trading where it involves identifying a moving pattern in a stock and investing in that momentum. Another one is called scalpers where raid and repeated high volume trades are executed within seconds or minutes. The main advantage of such type of trading is that there is no risk of overnight uncertainties, you get increased leverage for your trades and you can get profit immaterial of the direction of the market movement.
|Prev close||Buy||Stop loss||Target|
- Margin trading – In margin trading, you have to pay only a marginal amount of the stock to buy it. In other words, you can purchase shares more than you can afford. People mistake margin trading as intra-day trading which is not correct. They have a similar feature where shares are bought and sold on the same trading day but the applicability of margins is totally different.
If you want to buy some stock in the market let’s say 1000 shares of company X at Rs 200. You have to pay Rs 200000/- to buy the shares. Now, you may purchase Stock futures by paying 15% margin which comes to Rs 30000/-. So by paying Rs 30000/- you can get exposure to stocks worth Rs 200000/-. Now, we can apply the same logic of futures to cash market, then it becomes margin trading. So you would naturally think why we need margin trading then? There are a few reasons like Stock futures contract are not available for all stocks in the market, time period of a futures contract is limited and some brokers give better interest rates on margin trading than the prevalent rates in the futures market.
A Call option give a person the option to buy the options at certain price. So, a person will buy a call option when he thinks that the price will go up. Here if the price of the stock in the market goes up, the buyer will exercise his right to buy at the strike price which will be less than the market price and then sell the stock in the market price and earn profit. But if the price of the stock is less that the strike price, the buyer of the option can let the option expire and can avoid losses. This is the reason for the graph we saw in FIg- 1 has no payoff line in the loss column. On the other hand the seller of the call option has the obligation and not the right so he believes that the underlying stock’s price will drop and the buyer will not exercise the option and he earns the premium amount.
Put options gives the person the option to sell at a certain price. So if the person is bearish and thinks that the stock will fall then he will buy a put option. Here if the price of the stock in the market goes down, the buyer will exercise his right to sell at the strike price which will be more than the market price. But if the price of the stock is more that the strike price, the buyer of the Put option can let the option expire and can avoid losses.
- Short selling – “Short selling” can be defined as selling the stock which you the seller does not own at the time of executing the trade. There are two types of short selling. One is covered short selling and other is naked short selling. All class of investors (Retail and institutional investors) are permitted for covered short sell. Naked short selling is not permitted in the Indian securities market. Further, all the investors have to honor the obligation of delivering the securities at the time of settlement. Here there is a twist, settlement of shares happen of a net basis and for a single trade day. Suppose, you buy 100 shares of company X and later sell 100 shares of X on the same trading day, the net settlement of shares if nil. So, if you want to do a naked short sell, you can do so but you have to buy back the shares before the close of the trading day. So basically you can do naked short sell during the intra-day trade.
Covered Short sell means you do not own the stock at the time of executing the trade but you can arrange to deliver the shares at the settlement date by borrowing them. Many long term investors have stocks kept in the demat account and they are sitting idle. Instead they can lend these shares to a covered short seller for a small fee. This is call Securities Lending and Borrowing scheme.
- Swing trading – Swing trading is a strategy that tries to gain from short term movements in the stocks. The swing trade usually lasts from 2 to 6 days. The purpose of swing trading is to find out the trend of the stock and try to capture the gains within that trend. Generally, traders use Technical Analysis as a medium to read the current trend in a stock. These days’ traders have moved away from riskier trading style like trend based trading and moved to swing trading techniques. Swing trading is a very good option for retail investors because large institutional based investors generally do not follow this type of strategy due to short holding period and small profits. Swing trading means either reversing back to the median or fading a rally. It is very important to understand that Swing trades are generally done in the most liquid stocks or indices. Swing traders avoid flat markets as it is difficult to gauge the trend and this is the reason swing trading is also known as momentum trading. As they say in stock markets that trend is your friend. Generally, some methods that are used to identify a trending stock are average directional index, moving average convergence divergence and fast moving averages.
Example – Buy Stock : DREDGECORP ABOVE 770. SIGNAL : CHANNEL BREAK OUT WITH HIGHER VOLUME. Stop Loss : 730.
- Positional trading – Positional trading is considered more of a longer term strategies compared to the other strategies we have discussed. In positional trading, a trader buys a stock in which he holds a long term view of the stock. Positional traders are not concerned with the short term fluctuations of the stock and believe that these fluctuations will average out in the long term. Positional traders take a look at weekly or monthly charts to find out the trends. The goal here is the exact opposite of day trading where you look for fundamental long term gains rather than short term fluctuations. Positional traders use fundamental analysis and technical analysis while arriving at a decision. This type of trading is closely resembling to investing. Both styles typically involve long trades but in Positional trading, traders make gains from both long and short trading strategies.
There are a few approaches to position trading like one can buy stocks that have strong trending potential. Finding a stock that has already started to trend is far easier to detect than a stock that is about the start trending. Buying a stock that is already begun trending is a less research-intensive endeavour as well.
SBIN last week had closed on gain of 1.10% (appx). The resistance for the stock is at 312 to 314 and the stock has broken this on weekly charts. If it closes higher, then it can move to 322 to 325. Support for the stock lies in the zone of 306 and if it cracks that it will fall to 300. Which was the support for December 2017. Next level of support is at 290 where the long term moving averages are lying.
(Short term i.e weekly basis – sell and long term i.e monthly basis buy recommendation)
- Event based trading – Event based trading means placing a trade based on the event which can range from corporate announcements to industry impact to natural disasters. It is during such events that volatility in stocks increases and there are chances to make gains. After the trader has understood the chances of increased volatility in a stock, he then has to determine the direction of the price movement and then adopt a suitable strategy to get advantage of the price movement and increased volatility. Technical analysis and indicators along with chart patterns are good indicators to help determine the opportunity. Stock prices keep changing due to number of external and internal factors.
There is some information received from the company at all times and the stock prices react with the flow of new information and changing investor expectations Most of the information is regular in nature and barely moves a stock price to make any short term gain. However, there are many events that hold the key to moving the stock price. Micro-level events to look out for can include corporate announcements like earnings for the financial year, macro-economic outlook of the company, earnings potential, mergers and acquisitions, etc. Other events which are at macro level to look out for can include political scenario and stability, natural disasters and monetary policy of the country etc (example can be seen at the option strategy for budget day).
- Money Flow Index trading – This strategy uses the price of the stock and the trading volume of the stock to gauge the pressure i.e buying pressure or selling pressure. This strategy was created by Gene Quong and Avrum Soudack. Money Flow trading is a volume-weighted version of Relative Strength Index. When the typical price of a stock rises then the money flow indicator will be positive and when the typical price falls then the money flow indicator will be negative. The Relative strength index is first modified by adding a ratio of positive and negative money flow which creates an oscillator reading 0 to 100. Money flow index trading strategy is best suited to find out stock price reversal and extreme prices as the momentum oscillator is a variable of volume of trading. Now, we will see an example for a 14 period money flow index which is highly recommended by its creators. You will need a the stock price (High price for the day, low price of the day and its closing price) and the volume of trade done on a daily basis to calculate
Calculation is as below:-
Typical Price = (High + Low + Close)/3
Raw Money Flow = Typical Price x Volume
Money Flow Ratio = (14-period Positive Money Flow)/(14-period Negative Money Flow)
Money Flow Index = 100 – 100/(1 + Money Flow Ratio)
Raw Money Flow is volume multiplied with typical price. Raw Money Flow will be positive when the typical price increases the next day and Raw Money Flow will be negative when the typical price falls the next day. The Raw Money Flow must not be calculated when the typical price remains unchanged. Then we write positive money flow in one column and negative money flow in the other column. Then we take a 14 day moving sum of positive money flow and a 14 day negative money flow sum. Positive Money Flow sum is divided by the Negative Money Flow sum to create the ratio. Then, the RSI formula (found on google easily) is applied to create a volume-weighted indicator.
If the money flow index is greater than 80, the the stock is considered as an overbought stock and if the Money Flow Index is below 20, then the stock is considered as oversold. We have to only look out for stock that have a very strong trend and seem to continue that trend due to euphoria, internal or external factors. In these circumstances stock that have money flow index in excess of 80 still keep rising and stocks that have money flow index lower than 20 keep falling. So, the inventor says to look out for levels above 90 and below 10 where breaking those levels is a rare phenomenon and suggest a price move is unsustainable. Theories suggest that volume leads prices. There are three signals that we get from money flow index – unsustainable prices on overbought or oversold stocks, bullish and bearish divergence used to anticipate trend reversals and swings at 80 or 20 can also be used to identify price reversals.
|Name||Symbol||Current Price||MFI||Over Sold days|
|Gujarat Industries Power Co. Ltd.||GIPCL||120.35||14.4222||4|
|Reliance Power Ltd.||RPOWER||44||14.608||3|
|State Trading Corporation of India Ltd.||STCINDIA||155||15.9887||5|
|Name||Symbol||Current Price||MFI||Over Bought days|
|Varun Beverages Ltd.||VBL||690.7||88.2601||6|
- Arbitrage trading – Arbitrage trading is the act of taking benefit due to the difference in price that prevails between two or more stock exchanges. For e.g. if we talk in the Indian context, there are two major exchanges – namely the NSE and BSE, so arbitrage trading here would mean buying the stock from one exchange and selling it off in another exchange and thereby the difference could be earned as the profit. Arbitrage is legally allowed. In fact arbitrage is responsible for contributing bulk of the daily volumes on the NSE & BSE exchanges.
There are few points that need to be kept in mind, like arbitrage trading does not mean that the stocks can be bought and sold on the same day from different exchanges. Arbitrage comes into picture only if you have higher bid price and lower offer price in either of the exchanges. Arbitrage trades should never be done manually. One should avoid spotting arbitrage in low volume stocks as the pair trade execution could get difficult in these cases.
Arbitrage is generally termed as risk free, but there could be cases where a part of the transaction fails and a sudden surge in the prices can make the trade close without a profit.
- High frequency trading – High frequency trading are the trading that is governed by algorithms and are guided by high speed, high turnover rates and high order to trade ratios that give rise to high frequency financial data and electronic trading tools. The high frequency trading platform enables traders to execute humungous number of orders at a jiffy, thereby providing the institutions with the scope of huge advantage in the open market.
High-frequency trading became the buzzword when exchanges began incentivizing companies for promoting liquidity to the market.
The biggest advantage of high frequency trading is that it has raised the market liquidity. By forecasting the probable trends to the market, institutions practicing high frequency trading can expect a high amount of return on their trades with the help of bid-ask spread, which results in magnum profits.
It has also been criticized too on ground of replacing many brokers and dealers, as it purely depends on algorithms and mathematical formulae thereby ruling out the involvement of human decisions and logic. Also, since the decisions take place very fast they could result in some unnecessary market shift. This system helps the big companies to garner profits whereas the intermediaries, like the brokers and retail investors suffer.
- Quantitative trading – Quantitative trading is a trading strategy which is based on quantitative analysis. You need to be good with mathematics and statics to pursue this type of trading strategy. This quantitative trading has a lot of reliance on mathematical computations and calculations to locate trading opportunities. Since this is a specialised type of trading, it is generally followed by large brokerage houses, institutional investors or large hedge funds, where the transactions size are usually large. Quantitative trading involve buying and selling of thousands of stocks securities. It has been noticed recently that quantitative trading is being used more and more by retail investors. The traders using the quantitative trading take the benefits derived from modern technology, statistics and comprehensive database for making trading decisions.
Quantitative trading involves a technique where traders create a model using mathematics, and later develop a program that applies the same logic to market data. Finally after showing results, this model is then tested with historical data and then optimized. The system is implemented in real-time if and when favorable results are achieved. To better understand a technique, we can use an analogy to something we already know and this makes it easier to understand. Imagine a weather report which forecasts a 90% chance of rain. The forecast has been arrived at after analyzing climate data. A quantitative analysis shows that 90 out of 100 times in the past, when a similar pattern was observed, it did rain. The same process is applied to stocks to make trading decisions.
- Moving averages Trading – Moving average is a tool which is used in technical analysis. Every stock price movement has some excess movement which are very specific to an event or euphoria, we call this as noise. Now, when we do our technical analysis, we need to avoid all the noise or extreme points to have a better gauge of the movement of the stock to predict the future trend. Average is taken over a specified time period like 10 days, 20 days, or even 30 weeks as deemed fit by the trader. More the noise and sensitivity in the stock more should be the duration a trader must choose. We draw a chart and look at the direction of the moving prices (average). If the trend line is angled up, the price is moving up and if it is angled down, the price of the stock is moving down. It has been observed that moving average can also be judged to as a support or resistance for a particular stock or indices. Typically, traders take a 50-day, 100-day or 200-day moving average to judge the support and resistance levels. The moving average act as a support and the stock prices bounces up off of it, in an upward trend. Whereas in a downward trend, the moving average act as a resistance of a ceiling and the stock prices hit it and then drop down.