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Putting Losses in Perspective - Do you have an Edge?

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One of the fundamental reasons for losses in trading can be traced to lack of an “Edge”. But then you would ask me what is an Edge?

To me a trading edge is -

An ability to isolate a condition or a set of conditions among a market variable or a set of market variables - that has a non random way to evolve over a specific period of time.

I remember reading somewhere, but I cannot place it where - it said - “If you can’t explain your trading edge, you don’t have one” - Let me take it to the next level

If you do not know the statistical a) probability of the set of (prerequisite) condition/s that need to occur b) the probability distribution of the outcomes once the conditions (a) occur.

If you cannot articulate both then in my world you do not have an edge.

It’s quite possible that you are a veteran and even though you cannot articulate your edge, you have internalized it over a long period of time. But that according to me is a long winded route and I would personally prefer to be in the know of my edge.

So coming back to losses, the reason we need to be able to articulate our edge is - in the event of a loss, we need to know if its a part of our larger probabilistic framework or is it something which is beyond that. We need some objective reference. For example if you have a loss streak of 5 days, you need to know its statistically “normal” in your trading system or is it an anomaly.

In other words, your understanding of the variables of your edge helps you put your trading outcomes in a measurable context.

In the same breadth, it also helps us understand if the market regime itself is changing, and helps us adapt better.

So the next time you make a loss you know who to catch first?

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Putting Losses in Perspective | Introduction

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“I just want to breakeven”

“I just need to recover my last loss”

“I just need one move in my direction and I will be in profit”

“Let me widen my stop loss I’m sure the price will turn in my favor”

How about these lines?

“I should have stuck to my strategy/my rules”

“I should to have got out earlier with little losses and instead I stuck around”

“I should have closed my trades than choosing to go positional…big mistake”


Sounds familiar? The ongoing chatter in a loss making mind. Sometimes it’s there during the trade and more often, after a loss making day!

As much as we credit ourselves as rational beings capable of making sound decisions, literature proves otherwise. We are just a Rider on the Elephant, and if and when there is a disagreement the Elephant usually wins.

But then in the real world, sometimes it's not just the rider and the elephant, it could also be the terrain, the skills of the rider, or the elephant itself, and a whole lot of other factors.

This is an introductory post of our month long exploration on dealing with losses, we will look at the genesis of losses and what is it that we can do manage, minimize and make peace with it.

Losses in trading can happen due to a lot of reasons, sometimes they can be point one specific focus area like emotions etc? but most often they are combinatorial. It could be emotions plus an infra issue. or execution plus a trading strategy issue.

To look at losses, and to be really at peace with it, you need to isolate the causes, you can make peace with your losses only and only if you are damn sure that it’s a part of your system, and adheres to your trading system’s win/loss rate and size.

Its like this, you have a headache, and you wonder why do I have this headache - on a spectrum of causes, on one end it could be dehydration and on the other extreme it could be a brain tumor. Now for you to be at peace and ignore the headache you need to be damn sure it’s only dehydration and not a malignant brain tumor. (Sorry if that sounds morbid, losses can be equally bad)

Dehydration in trading will be a “loss that is part of the trading plan” and Brain tumor will be everything else.

In the coming weeks Kavitha and I will spend some time on strategies, methods and models to manage losses both behaviorally and financially.


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Through the Looking-Glass, & what NiftyScalper found there | Market Internals - Part 3

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This is the third and last post in this series,

Part 1 - Here

Part 2 - Here

**Read about what RSI is over here

In this post we will look at the good old RSI Indicator which has been re-purposed to be used as, both a trend indicator and an oscillator.

The math - We took the top 25 stocks (by weight-age) of NIFTY 50 and Averaged their RSI Value. So we have a Average RSI of the top 25 stocks vs. RSI of NIFTYFUT or RSI of 50 Stocks. Since the 25 stocks have close to 80% weight-age the cross over of the Average RSI and NIFTY RSI acts as a trend Indicator.

Notice the RED colored (NIFTYFUT RSI) Crossing over the Yellow Dotted line of (Average RSI).

We also back-tested for ideal Oversold and Overbought levels - you will see it marked with Blue colored markers in the images below. Typically a RSI Absolute Difference of 10 - 12 i.e (NIFTY RSI - Average RSI)

So here you have a Market Internal based Trend Indicator + Oscillator all built into one since indicator.

There are several other setups for trading pullbacks using this indicator, but thats for another day..

Please do not ask for the RSI Period settings on this one, but its no rocket science. Also, at NiftyScapler we don’t use any of these three indicators in Isolation.

Image 1

Image 2

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Educational Explainers - Lead Lag Effect - NIFTY

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Last week we looked at what Indexes are (Over here).

This week we are investigating the lead-lag relationship between Spot price and Future prices in NIFTY.

So what does academic research and years of observing the market tell us? The verdict is out..

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What moves the Index? - The concept of 'Information Flow' and how it works in ^NIFTY50

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whatindex.PNG

We’ve all wondered at some point or the other as to what moves the Index? 

And if you are an avid Fintwit follower, you would also have heard people saying “The futures are at a discount, looks like market will fall” or “I see some big orders being punched in NIFTY FUTs, the index is going to rocket”, and other similar things.

In this post, Let’s try to deconstruct how an index moves from one point to another.

So let’s start with the basics

What is an Index? - An Index is a collection of Stocks, the prices of which are weighted and together they arrive at an aggregate value. The weightage in case of ^NIFTY50 Index is based on the market cap of the constituent stocks. If you want to learn more about the constituent stocks and their weight-age, this is the place.

So how do we trade or speculate on an Index? - There are two broad ways to speculate on an Index, and that’s is either through Index Futures or Index Options. For Investors though the choices are ETFs and Index Mutual Funds.

For the context of this post we will stick with Index Futures. In our case that would be NIFTY FUT.

What makes the Index move up or down? - Say the average change in the value of an index is 30 points, why does it move so much?

Average change here means the average of the Open-Close value of the index.

For example if the index opened at 11050 today and closed at 12000 we had a change of +50 points. So if we average this value over say 20 trading days, we may arrive at a value something close to 30. So what’s making this move happen?

It moves because the prices of the constituent stocks change. Say for instance if the top 5 stocks, by market cap - Reliance, HDFC, HDFC Bank, ITC, Infy etc. move down, the market will move down, and visa versa. However, there could be other factors which can effect the change as well, for example, in very short time frames like under 5 minutes, in certain indexes, its the Futures which leads the change in the Index value.

Time-frame of analysis and how it can make a difference?

Are we looking at reasons as to why index moved since last week? or are we looking at reasons as to why index moved since last minute?

As you can see, if you are looking at change on larger time frames, its always Constituents Stocks leading the change in Index value, however on shorter time frames it could be Futures leading the change in Index value.

What is “Information Flow” and what is its relevance here?

Information flow is about the direction of causality of price discovery in a given market, due to the flow-of-information (news/announcements etc.) If that sounds a bit wonkish - what it means is, its either the traders of the constituents stocks who react to the news flow first or its the Index Futures traders who do. These two types of reactions cause two different types of Information flows across Indexes (Spot) and Futures.

The two types of informational flows

Type - a) (Stocks) Spot to Index Futures : Spot value changes first leading the Futures prices to change

Type - b) Index Futures to (Stocks) Spot : Futures prices change first leading the change in the Spot value

Like everything else, it’s more about which type of information flow is more dominant in a given market. It’s not necessarily binary.

As pointed out in the research paper below, for ^NIFTY50 its Type (a) which is more dominant (Image below from reference #2).

This however is not true for all markets, for instance the S&P 500 works on Type (b) logic.

excerpt.PNG

So if you are a short term / intraday trader in ^NIFTY it may be of more value for you to know that its the Spot that leads the Futures.

And one more thing

How do the quants/researchers know, which of the two moves first - Index Value (Spot) vs. Index Futures? 

There are different statistical ways of measuring the strength and direction of causality, look up “tests of causality” if you are interested, for further reading, look up Judea Pearl’s work.

As an Intraday trader, the next time you think about - Why did the ^NIFTY50 index move? You might ask well ask - Which of the constituent stocks moved ^NIFTY50?

Trivia

The name NIFTY50 actually comes from the US Markets, more here.

Judea Pearl happens to be Daniel Pearl’s father

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Lead-Lag / Volatility Spillover Effects | Some evidence from academic literature

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One of the most fundamental concepts one needs to understand as an Index Trader is that of Lead-Lag effect. I have been reading through several academic papers to get a grasp of it. Here are some that stood out.

Notice the difference between NIFTY and the other markets, I rest my case here.

Price discovery on the S&P 500 index markets: An analysis of spot index, index futures, and SPDRs -  Quentin C.Chu, Wen-liang, Gideon Hsieh, YiumanTse

Price discovery in the German equity index derivatives markets - G. Geoffrey Booth , Raymond W. So , Yiuman Tse

Domestic and international information linkages between NSE Nifty spot and futures markets: an empirical study for India Sanjay Sehgal Mala Dutt

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Announcement - Educational Explainers - Trading Indexes - NIFTY

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Capture3.PNG

Over the past few months, we received several emails asking us to explain the whole idea of “Market Internals”, and in our attempt to explain things we typically had to start with the basics.

This series is a conversation, where Kavitha is asking all the basic trading questions you would ask and my response to them is an attempt to help you ease into what it means to trade the markets.

We are calling it Explainers, as the word suggests we would get down to the brass tacks of why the Market Moves. Our attempt to explain would be evidence-based and we would avoid conjectures as far as possible.

In the initial few topics you would have access to, is a three part explainer on trading indexes in India.

Capture1.PNG

While we have a set of topics we think will add value, to both absolute novices and developing traders, understand the nuances of trading indexes, do suggest other topics that you think NiftyScalper should add to the mix.

Happy trading!

Here’s the first one from the series - What is an Index and how do we trade them?

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Through the Looking-Glass, & what NiftyScalper found there | Market Internals - Part 2

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In the previous post here we looked at the NiftyScalper Advanced Relative Strength Indicator which is a Price based internals indicator, in this post we will look at the next piece of the puzzle ie Volume.

If you read about internals for the US Markets you will come across something called NYSE UpVol and NYSE DownVol, more about it here.

Unfortunately our indexes don’t broadcast this info. But what do you do when you need something badly and cant get it, you build it.

Yes, that’s what we did, we created our own NIFTY UpVol-DownVol indicator for the top 25 stocks.

Do note that, instead of a ratio we decided to look at the Net Volumes as we would also get a sense of liquidity/participation along with the direction.

CumValue - Cumulative UpValue-DownValue; CumVol - Cumulative UpVolume-DownVolume

As you can see in the above image, there is a massive net sell in the volumes of the constituent stocks, now follow the price action in the next 30 to 45 minutes. Lets move to the next idea.

Based on a suggestion from a fellow trader and friend Navdeep we came up with a variant of NIFTY UpVol-DownVol which we call NIFTY UpValue-DownValue, here we look at not just the volume but Value i.e Volume * Price. This helps us normalize for situation where the volumes could be skewed due to higher or lower face values of stock prices. It also helps us recognize situations where only a few key stocks try to pull the index up or drag it down.

Look at the image below

You an see there was buying that was initiated, perhaps in a few stocks (quite heavily) hence reflecting in the Up-Down Value but Up-Down Vol remains in the red. As you would imagine this was a narrow range day with a tug of war between a few heavy weights and rest of the index.

As I sign off, I must contend that I these Internals based Indicators have really saved me a lot of head and heartache. I am able to filter out contexts that I don’t want to trade, quite well.

Update: 16th Jan’19

I found a similar spike in the CumVol, this time on the upside as discussed in the first image. Notice the price action after that.

Trend Day - 15th Jan’19

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Life as a Resource Allocation Problem | Year End Musings - Delivered late!

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The missus and I were off to Bhutan this year end, and while I was there, I was receiving some calls to attend a trading conference. So there began a discussion on the value of attending conferences and my view on it.

My view is that trading or anything of value has to have a lot of nuance, which comes from years of experience and practice, and expert is an expert because he/she has developed that nuanced skill/intuition.

With that said, ask yourself as to what would you like to focus on, depending on were you are on your learning curve -

If you are a beginner - It would help immensely to find a mentor, and work with him/her to develop core skills, in other words try to be an Apprentice - Takes at least 8 to 10 Years

If you think you are at an Intermediate level - At this point, it would help to connect with more experts to understand what others are doing, and and build your skills by borrowing ideas and adapting them to your context, as Cal Newport says - this could be the Creative Active phase. - Beyond 8 to 10 years

If you think you are an expert - It would again help to engage with others in the space, to continuously learn and understand the space at a more macro level. This is at a point when you have reached Mastery - 15 + years of experience

Now the reason I called these things out is to help you contextualize - what would help you at a given point of time. I personally believe a lot of our adult life is a Resource Allocation Problem, the better we get at it, the better would be the outcomes.

We have these three fundamental resources which feed into one another - Time, Energy (Cognitive & Physical) and Money.

Money can help us buy Time a bit, but Energy determines how well we can use that Time.

Hence we need to ask ourselves where would you like to allocate your fundamental resources so as to achieve your goals.

You can use your time, money and energy to either attend a conference or perhaps buy a few books or may be fund a trading account. Which one these would help you get to your goals faster, and that depends on where you are on the learning curve.

Lastly think of it this way, if you have to choose a heart surgeon, which one of would you choose, the one who has spent 10,000 hours doing surgery or the one who has attended 100 conferences.

To flip the context - So which category of surgeon would you want to be?

Its the same with Trading.

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Coffee table chat with Sandeep | Alpha

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Come join my little coffee chat with Sandeep where we talk about everything from Alpha (not the male type) to Amygdala…

~K7

Welcome aboard K7!

I am excited to announce that Kavitha (K7) is joining NiftyScalper as a Performance Coach!

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K7, a former Global Learning Manager in the financial industry, she played a huge role in embedding a coaching culture within the organization. She is a unique blend of a Coach who can also trade.

Drawing on her experience to ask tough questions and take NiftyScalper in a new direction and roll out Trading Performance focused offerings, I welcome her to join the team.

“Trading is such a performance oriented profession, but people focus a way too much on the mechanics to the extent of completely ignoring the role that one’s ‘mind’ plays.” - Kavitha (K7)  

Content creation and curation is another forte that K7 will leverage at NiftyScalper. I look at K7 to re-create that performance magic for serious traders who would like take a more holistic approach in their journey to become better traders.

I am super excited to have her aboard. Welcome K7!

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Pullback vs. Reversal | Can Market Internals Help?

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Those of you who follow the blog regularly know that we at NiftyScalper have been working on creating tools to look at NIFTY Market Internals as a way of understanding the index moves better.

In this post I will spend some time on one aspect which if learnt can make a massive difference in your p/l.

We will look at understanding what is a Pullback and how do we know that its not going to turn into a Reversal.

What is a Pullback?

A pullback is a micro-counter-trend within a macro trend. Micro and Macro are time references, and for scalpers and day traders it can be 5 to 10 mins for Micro and 45 to 60 minutes for macro.

Pullbacks can be great opportunities to scalp so long as the macro trend continues.

What is a Reversal?

A reversal is a move which starts like a micro-counter-trend move, however does not go back to the initial macro trend and can potentially be the beginning of a counter-macro-trend.

I don’t want to hear your stories as to how many times what you thought was a pullback turned into a reversal, and that was the end of it, for some people I know that was the end of their trading account. Especially if you don’t have your stops in place instead have ‘hope’.

Given such grave and potentially devastating outcomes of what was essentially a misread price pattern, we at NiftyScalper thought why not check if Market Internals can help us with increasing our odds of identifying ‘potential’ reversals.

If you have questions about the market internals based indicator that I am referencing here, read this post.

Look at this image below. If you notice from the point which I have marked with a blue dot, the % of stocks below 1SD of VWAP which is the red line has been inching up, along with price also rising, almost crossing over the green line (% of stocks above 1SD of VWAP). Which is obviously a sort of divergence. From that point onwards, I would be wary of pullbacks as the strength of the move, in terms of the number of stocks supporting it is waning. So this was one way of looking at it.

NIFTY Futures 28t Nov’18

Lets look at this next chart, same day, same time frame. The blue dot is a common time reference across both charts.

The Red and Green line here are from a slightly different Market Internals indicator where we look at Standard Deviations from a 45 Minute Mean Price. As you can clearly see here, this one is far more pronounced, the % of stocks above 1SD of 45 Min Mean has been downward sloping as the price makes new highs and peaks.

You can see or yourself, as the support from internals declines, the probability of a pullback being just a pullback also declined.

To me it looks like there is a story here, something to follow up on.

I will keep you all posted. Till then Trade safe folks!

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Finding 'edge' through Data Curation

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When we talk of ‘edge’ in trading it essentially means, what is it different that you or your system has which would lead to an ‘alpha’ in terms of returns. One way to extend that question is to ask ourselves, as to what are the sources of that edge?

To me having a more deeper and nuanced understanding of the contexts and setups that I trade, exponentially adds to my edge. To get a better sense of my contexts, one of the practices that has massively helped me in my trading, is curating setup specific data. This is a lot of work, let me tell you. Sometimes it’s very difficult to train the computer to do what we humans can do intuitively, which means a lot of it is manual labor.

Let me try to give you a sense of what I mean, if you follow my blog you would know that, these are the three setups that I trade.

NIFTY - Scalping Set-up - 01 - Opening Spikes & Opening Drive

NIFTY - Scalping Set-up - 02 - Mid-Day Mean Reversion

NIFTY - Scalping Set-up - 03 - Afternoon Range Extension

Now each of these setups have their nuances and details, like

a) At what time did the entry get signaled? Is that time range bound? Is there a seasonal skew to it?

b) Range breakouts on VIX? Time and Amplitude.

c) What is the average size of the pullbacks that in the setups you trade?

d) What is the ideal holding time for your some of your setups, based on the length of the trends?

A lot of these computations are possible only if you have specific data. Therefore, this is a practice that we follow in-house and for our clients - i.e. to capture such data so as to run tests on it.

Here is a mini snapshot of the data. (Disclaimer : The snapshot may make no sense whatsoever without context)

This practice when followed over long periods of time can give you a gold mine of data, which (I believe) can add to your trading expectancy.

Through the Looking-Glass, & what NiftyScalper found there | Market Internals - Part 1

In this earlier post here we talked a bit about what moves an index, specifically what moves NIFTY, in today’s post we will take that idea a bit further and look at the internals from different lenses.

Long back I came across this idea on the Traderfeed blog. I thought of testing it out for NIFTY and see if it helps understand the market moves any better.

We call it the (ARS) Advance Relative Strength Indicator.

So here is a brief about the idea.

1) Identify a basket of stocks - In case of NIFTY I choose to use the top 25 stocks by market cap, which constitutes close to 80% of index by weight-age.

2) The math - I extended Brett’s logic a bit by including not just VWAP but also (+/- 1) SD (Standard Deviation) from VWAP as reference points. The idea is to see the % of stocks above and below these references. I have also added % of stocks above or below their PDC (Previous Day Close) as well.

The concept is as simple as that, now lets see if helps us understand the index moves better.

We will look at three types of days. First a Trend Day, Second a Mean Reverting Day, and Third a Low/Narrow Range Day

Trend Day

Here is how the internals looked like on this up trending day. As you can see the lines are all clear.

The blue line is % of stocks above VWAP, Green is % of stocks above 1 SD of VWAP and Red is % of stocks below 1 SD of VWAP, and the yellow line is % of stocks above its Previous Day Close (PDC)

NIFTY Futures 12th November’18

Look at how the Blue and Yellow lines are quite stable around the 60% level and 90% level. The way to read this is 90% of the basket stocks were trading above their PDC all through the day, and 60% of stocks were trading above their VWAP all through the day. And around 25% of stocks were trading above 1SD of VWAP largely all through the day.

While this is how the basket constituents behaved, we would need to test if all trend days demonstrate similar patterns, more importantly we would need to identify ‘markers’ which occur in the first hour of the day that could further point to a trend day.

However the +/- SD Lines can offer good short term trading entries.

Mean Reverting Day

Compare this with Trend Day image above, and you will see clearly the Blue Line is not holding up as it did earlier. Here the Red line (-1 SD) crosses both (+1 SD) and VWAP (Blue) line multiple times, indicating a dispersion in the basket stocks which perhaps leads to a more Mean Reverting day. Again the crossovers and divergences offer good entry points for trades.

Narrow Range Day

In this chart, you can see a large part of the day is extremely constricted, all lines overlapping with a minor downside bias in the early part of the day and a minor upward bias during the last hour.

We are still back-testing setups on this indicator, to isolate high probability contexts. But nevertheless its interesting to view the index almost like an X-ray to see what is happening and this gives you a far better and nuanced sense of the Market Internals than the usual Advance Decline indicators.

Do write to me if you have some ideas to improve this, or any thoughts for that matter.

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ATR (Average True Range) vs. ADR (Average Day Range) | What they don't tell you

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I was having this conversation with a coachee of mine, who was bent on using ATR instead of ADR as a reference for trading and I had to help him understand the difference and the context as to what is relevant where, and why I lean towards ADR. Below is an excerpt of what I told him.

The case for ADR

First things first - What is ADR - ADR is simply the average of intraday (High-Low) value. This excludes Gaps.

So - What is ATR? - Here is a better explanation. Essentially ATR is a range calculation which includes Gaps as it calculates from PDC (Previous Day Close).

So it essentially boils down to the significance of Gaps.

Let’s digress a bit to understand why do we use Range as a reference.

To me Range is a good indication (of / or a proxy for) volatility. You will see that for yourself, if you follow VIX, as VIX increases, so does range (Ref. the plot below). By including Gap in the calculation we may get an incorrect and irrelevant view of the intraday volatility.

Based on Past 60 Days’ data - NIFTY Futures and INDIAVIX

As an Intraday trader I am concerned only about what happens between the Open and Close. That is what is my playing field. I am not a positional trader to take advantage of or get affected by Gaps.

So the next question to ask is? Is there a correlation between the size of the gap and the ADR for the day? This would determine if including GAP data helps us in any way.

I did a quick math by calculating the Correlation Coefficient with Gap size as an independent variable and (ADR) Range as a dependent variable and I get a score of 0.36. Take a look at the scatter-plot below.

Based on Past 60 Days’ data - NIFTY Futures

As you can see there is no linearity in there.

So given that there seems to be no correlation between Gaps and ADR, I would recommend using ADR and not ATR,

ATR is relevant in markets or products were Gaps have a correlation with Range, which does not seem to be the case with NIFTY.

However, I do keep an eye on the Gaps, but that is more from a perspective of understanding if there is a visible change in the market structure, more on it later.

Here is a snapshot of the data that I reference during the day. It gives me a clear sense of the developing range with references of Previous day and a 20 day Look back period.

Snapshot of NS-RangeByTime Indicator for NT8

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What are Market Internals & Why should you bother?

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Before we delve into what Market Internals are, lets ask another question to ourselves - Why does a (Stock Market) Index move?

To understand that we need to move to one level deeper and ask as to - What is an Index?

What is an Index? - An Index is a weighted average value derived from a set of constituent stocks, ie the price of the constituent stocks. So if the prices of the constituent stocks go up the Index which is nothing but an average of those prices would also go up, and the same would happen if the prices of the stocks go down.

In a way we have now answered the question - Why does a (Stock Market) Index move? - An index moves because the prices of the constituent stocks change.

These changes can happen over various time frames. Within a few minutes? Sometimes hours, days, years and so on. But the phenomenon is the same - Prices of Constituent Stocks Change leading to a change in the Index Value.

Now with that sorted, lets move to the concept of Market Internals - Market Internals refers to the data derived from the constituent stocks, which could be used to understand the Index’s structure and strength better.

One way to think of Market Internals is to think of it as Instrument Panels in a Cockpit. If The Aircraft has to fly the way it ought to, all the reading on the instrument clusters need to be within a threshold.

Same is with an Index. If the Index is expected go up then the “Instrument Clusters” ie the Market Internals need to align in a particular way.

Lets take an example -

^NIFTY has 50 Constituents. Their Weight-ages look like this. The top 10 stocks account for close to 60% of the Index, the next 15 add up to 20% more, and the last 25 add up to another 20%.

In other words, being an index with just 50 stocks of which 10 stocks constitute close to 60% of the index makes it a very top heavy index.

This NSE Replica by Equity Master is a nice tool to give you a sense of what they call NIFTY Sensitivity. What it tells us is - For a given change in the price of Stock A how much will the Index Move. Lets look it up for HDFCBANK

For reference lets take the last one on the list HindPetro

HDFCBANK has a 15x more impact on the Index compared to HPCL.

Hope you are with me so far? - We are still exploring what Market Internals are?

Back to where we left.

Lets say you are an Intraday Trader and you expect the market to go from 10600 to 10700 today. A good 100 point move. For such a move to happen? What do you think would happen under the hood? Can HDFC bank be down say by 2% and a few other heavy weights are down or perhaps flat, would we still get a 100 point upside move. As you would guess the chances are quite less.

Like wise what if you see that the top 8 stocks by weightage are all nice and green, trending up - Now what would be the odds of getting that 100 point move? Quite good right.

Lets look at another aspect, what if the trading volumes in the top 10 are quite light compared to its 20 day average? Do you think we would have a trending high range day?

What if the to 10 and the next 15 stocks are going in opposite directions? Do you think we would get a trend day?

I hope you get the drift. Market Internals are these variables or data which are generated by the constituent stocks, analyzing which can help us understand the overall state or health of the market.

If you look at the US Markets esp. NYSE you will see that the exchange broadcasts live Market Internals like NYSE Tick - Which is the number of Stocks Upticking minus the number of stocks Downticking. In lie markets it gives you a sense where in which direction the skew is. This data can be in turn back-tested to identify thresholds of Intraday tops and bottoms. It should not be confused with Advance Decline Indicator which references the Previous Day Close for its calculation. Where as the Tick uses the previous close.

It would look like the one in the image below.

Image Courtesy - RedlionTrader

Second, they have something called NYSE Upvol and DownVol, which is broadcasted as two separate values, but many platforms allow you to plot the difference ie Upvol-Downvol. Which tells us which side is volume skewing i.e How much volume is associated with the Upticking stocks vs how much of it is with the Downticking stocks.

Image Courtesy - http://www.traderslaboratory.com/forums/topic/2524-nyse-up-volumeuvoldown-volume-dvol-comparison/

As Intraday Index Traders we in India miss out on this vital informational edge. Not calling it a Holy Grail but nevertheless extremely important to gauge the mood of the market.

As they say what do you do if you cant find what you want? You build one.

In the following weeks we will look at the various Market Internals based Indicators which we have created for our use at NiftyScalper.

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Market Profile & Order-flow Charts | Revisited

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A few days back I received a comment on the blog about Market Profile and Order-flow as a tool which offers an edge in the market.

Here is the comment.

And here are my previous articles about the same.

Part 1 & Part 2

I thought it’s important to explain to novices as to how the “information flow” in stock market works and which is what is the foundational reason behind price moves in an Index.

Disclaimer: My comments here are only in the context of Indexes and specifically about NIFTY 50 and NIFTY FUT

So let’s start with the basics

What is an Index? - An Index is a Collection of Stocks which are weighed together to arrive at an aggregate value. This weightage is based on market cap of the constituent stocks for NIFTY. If you want to have a look at the constituent stocks and their weight-age, this is the place.

What makes an index move up or down? - Say the average range of the index is 100 points, why does it move so much? It moves because its constituent stocks move. Say for instance if the top 5 stocks by market cap - Reliance, HDFC, HDFC Bank, ITC, Infy etc. move down the market will move down, and visa versa.

Now that we know what is an Index and why does an Index move up or down, lets get to some nuances here.

What is “Information Flow” and what is its relevance here?

Information flow is about the direction of causality for price discovery in a given market. If that sounds a bit wonkish - it essentially means, in the context of an Index, what moves first, and what causes what. Does the future prices move ahead of Spot? or it is the other way around. There are different statistical ways of measuring the the strength and direction of causality, but that is beyond the scope of this post, look up “tests of causality” if you are interested, if you are even more interested look up Judea Pearl’s work. Oops! Sorry for that diversion, back to Information flow and price discovery.

So to repeat, there can only be two types of informational flows

a) (Stocks) Spot -> Index Futures - Spot prices lead Futures

b) Index Futures -> (Stocks) Spot - Futures prices lead Spot

Like everything else, its more about which type of information flow is more dominant in a given market. Its not necessarily binary.

As I pointed out here, for NIFTY its type (a) which is more dominant (Image below from 2) Reference). Which is not true for all markets though, for instance the S&P 500 works on type (b) logic.

If you are wondering as to why does it happen, well there are tomes of academic papers on that, but it boils down to two factors largely, one is cost/barriers to trading in a given product, and relative volumes.

So to sum this point while type (a) is a fundamental reason for index moves, type (b) can also happen and may provide a minor edge to the participants.

Hope you all are still with me.

So far we looked at

1) What is an Index? 2) Why does it move/What causes its moves?

Now lets get to the topic of this blog post.

Market Profile and Order-flow Charts. I will not spend time in explaining the basic concept of Market Profile and Order-flow, that I did in the previous posts, do refer to them for the basics. But here I am going to explain Order-flow more than Market Profile. Both are unrelated but for some reason a lot of sellers and vendors offer them together. Let’s move on.

Let’s understand the process flow of an order, i.e. an order you put to buy or sell one lot.

  • Buy/Sell Order Placed by you ->

  • Order goes to Broker’s OMS (Order Management System) ->

  • Then goes to Exchange’s OMS ->

  • Finally reaches the CLOB (Central Limit Order Book) ->

  • Order now gets queued based on Price and Time priority (Depending on Market or Limit Order type) >

  • Finally once it matches another Buy or Sell order it gets executed.

If you notice I have not used the word order-flow anywhere yet in this sequence of events. The reason being, only after an order is executed we get to see the Order-flow Information i.e. Bid/Ask Volume traded at a given Price.

To reiterate Order-book (LOB - Limit Order Book) comes first and Order-flow later.

^LOB is the information that you see in the Market Depth window of your trading platform

So in a way Order-flow is stale info. Its all done and over by the time you see it (*Assuming what you see is what it is).

If someone claims that there is a “Predictive Edge” in Order-flow they are essentially claiming that “if X volume at bid or ask happens at a given Price” it means the price will go further up or down.

For a second ignore predictive edge, even a statistical edge will do? Show me one Order-flow based back-test and I would be happy to update my views here.

If this is not enough, you also need to understand how Level 1 Data Feeds work.

None of the feeds in India give you tick by tick data, we don’t have the infrastructure as retail traders to receive it, what data-feed providers like TrueData, GDFL and E-signal give is a Per Second Aggregate of Ticks. So what you see in an order-flow is an *aggregate information for a second or as some call it “Snapshot Data”. Which can never be accurate, to put it differently its not meant to be, there will always be “missing” info. in it.

And lastly always ask yourself, if Order-flow info had such an edge, why wouldn’t these indicator sellers keep it to themselves and print money.

Personally, I have used and tested both Order-flow and Order-Book information to the extent it’s possible with retail level latency and infrastructure and have not found any edge there.

So to sum it all up, Order-flow, if at all has an edge, it would be in a market with type (b) information flow, which we are not. And secondly, in markets with type (b) information flow, you might-as-well use Order-book Info. why would you want to look at stale order-flow info.?

This is all I had to share, hope it helps you, saves a bit of your time (by helping you avoid rabbit holes) and more importantly your money.

References

1) Does Index Futures Dominate Index Spot? Evidence from Taiwan Market - Ching-Chung Lin, Shen-Yuan Chen, Dar-Yeh Hwang and Chien-Fu Lin

2) Domestic and international information linkages between NSE Nifty spot and futures markets:an empirical study for India - Sanjay Sehgal & Mala Dutt

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Vacation Musings | Quantity vs. Quality of Ideas – What helps in the long run?

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I often tell people that the job of a trader is more like a scientist on a path to discover something, because essentially discovery is a process of looking at various combinations and correlations of variables which are otherwise not observable to an untrained eye. Both are looking to discover something, the trader is looking for an “edge” an “idea” and the scientist is looking to find a cause or solve a problem.

So my question was to be a better scientist who makes several breakthroughs, should one focus on generating quality ideas or should we focus on generating many ideas some of which would fail and others may take us a bit closer to what we are looking for.

I came across this interesting article. - https://blogs.scientificamerican.com/beautiful-minds/why-creativity-is-a-numbers-game/

Which says, if you look at scientists like Edison, and others it seems to be a numbers game. The more your ability to generate ideas (good or bad), the more is the probability of you landing on a good idea.

So ask yourself, how many trading ideas can you generate? Is your mind constantly thinking about new ideas? Are you continuously testing and refining new ideas?

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Behind the ‘veil’ of Price | Indicators that signal market microstructure dynamics | Part 4 of 4

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In the first three parts of this series we looked at indicators which give us a sense of the microstructure activity of an instrument. In this last and final part, we will try to put it all in context.

Lets’ start with the first principles, the key to all that we are discussing is to see - if LOB (Limit Order Book)/Microstructure dynamics leads price change? If so, is the lead time ‘tradable’. What I mean here is, if it leads by a fraction of a second, then it’s not easy to trade on that signal, we need a lead time within which we can execute a trade.

Another way of articulating the first principle is - What moves price esp. Index Futures? What is the direction of causality as the academicians would say? Does spot/cash market lead futures or is it the other way round?

The reason it’s important to get a handle on this is, because the tools that one would design or use would need to be completely different.

For instance if the Index Futures lead price discovery, then it makes good sense to use Orderbook/Microstructure information as that would ideally precede the move in price. However, if it’s the spot or the cash market that leads, then you may want to look at indicators that capture the bias within the index constituents.

 If you look at the academic literature that examines lead-lag relationships between index futures and spot, you would find indexes which fall on either ends of the spectrum in terms of their bias, almost all would be bidirectional at some points. It seems the degree of participation from Individual Investors, Domestic Institutional Investors and Foreign Institutional Investors has an effect. I am sure there are many other structural reasons which influence this lead-lag effect.

Evidence for NIFTY suggests a Spot to Futures direction of causality.

 

Now that we have some sense of the direction of causality, I leave it to you figure out, which indicators (in a shorter time frame) would better predict NIFTY Futures. It’s also worth exploring if this lead time between the Spot and futures market is “tradable”.

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Announcement | Taking a short break

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I thought its only fair to let you all know that, I have been extremely busy with some LOB data back-testing, Trading Strategy consulting projects and a data visualization project. All this does not leave me with much time to write meaningfully. So apologies for the lull on the blog.

I foresee the situation to improve in a couple of months, and I should be back on the blogging track.

For anything else feel free to write to me at srao@niftyscalper.com