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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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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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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.

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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 

 

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Podcast | CWT | Mike Bellafiore

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This is one of those podcasts' which should not just be listened to, but should instead be understood and assimilated. That's all there is to trading, esp. day trading.

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Behind the ‘veil’ of Price | Indicators that signal market microstructure dynamics | Part 3 of 4

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Part 1

Part 2

In this part we will explore the third indicator that I use which helps us in understanding the dynamics that happens in the Limit order-book before large moves, in a way this is one those “predictive” indicators as it signals oncoming volatility a few minutes before it actually does – The Average Bid-Ask Spread.

In the slack room, I call it SOS – No not “Save our Ship” but “Spikes on Spread” – Which indeed is an SOS signal if you have any positions on, as it signals one to be alert.

Before we get to the mechanics of this indicator, one needs to have a basic understanding of how the Limit Order book (LOB) works.

So if you look at the L2 market depth, this is how it would typically look at a given moment (Graphically i.e.)

 

Now let’s see what happens when a Market Order hits the book. In this example a Market Buy Order hits the book.

The contracts marked in Yellow are the one which are consumed by the Market Order. Now do compare the spread in the two illustrations. In the first one we have a spread of 1 and in the second, because of the market order coming in the spreads doubles to 2. Now let’s see what happens next.

As you can see in the above illustration, the limit orders (Bids) come in to fill the spread. This Expansion-Contraction of spread due to market orders coming in can happen and can be observed over different timeframes. But the concept remains the same.

Microstructure academicians also call this the Liquidity Cycle or more specifically the Make – Take Phases

Typically you have shorter “Take Phases” and longer “Make Phases”, which fits in with the fact that we would typically have lesser market orders compared to limit orders.

With theory covered now let’s move to practice.

Look at the NIFTY Futures 1 minute time frame chart (Date – 8th May’18)

On the top pane is NIFTY Futures Price, the second pane has Average Bid-ask spread as a Histogram aggregated for each minute. On the Second pane is a 5 minute (Orange) over 45 minute (Grey) SMA of the Spread, the last pane has Volume rate which we’ve looked at already in part 1 of this series.

If you notice the spread for NIFTY Futures oscillates in a range of 0 to 2.

So how do we use this indicator?

Observe the spread from 12:05 to 12:45 – If you see the price has largely been range bound but the spread moved from the upper band to the lower band – Remember the concept of “Take Phase”?

My conjecture is this is a period where liquidity takers are sort of sweeping the book, the price remains range bound up till the point where adequate liquidity exists, the moment there is an imbalance we see large moves or volatility come in, and as these initial bursts come in, perhaps herd and threshold behaviour takes over causing extensions of these moves.

Since this indicator is like an oscillator with a fairly defined range – it’s easy to spot deviations and be prepared for an upcoming move, however one must remember this indicator does not predict direction all that it does it predict volatility.

As of now I am still testing and collecting data to do back-tests on this indicator, so I do not have any statistics to support my claim, but people in the slack group know – how often I call out an ‘SOS’ and how accurate or inaccurate it turns out to be.

The usual disclaimer applies to this indicator as well – this indicator  is to be used within the context of the market structure and in combination with other indicators discussed in this series.

Update - Another screen shot of NIFTY FUT 10th of May'18

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Behind the ‘veil’ of Price | Indicators that signal market microstructure dynamics | Part 2 of 4

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Previous part here 

In this part we will explore the second indicator that I use which helps us in understanding the dynamics which happens as price action unfolds, i.e. points where price turns, also known as "Imbalances". Adam Grimes in his book "The Art and Science of Technical Analysis" says something interesting about Imbalances.

4.PNG

Imbalances happen in the Limit Order book (LOB), however in the absence of LOB info. we can use executed order info. as a proxy to access LOB imbalances. The indicator known as “Volume Delta” tries to do just that. It looks at volumes executed at ask vs. volumes executed at bid to make an assessment of an imbalance.

Delta here is defined as - The net difference between the buying and selling (volume) at each price (footprint delta), each bar (bar delta), or the entire day (cumulative delta).

All that you need to know about delta is here - https://marketdelta.com/what-is-delta/ and it makes no sense to reinvent the wheel, what I think is of more value to the readers here is to know how to use it in the context of NIFTY.

Delta becomes important only at points where there is a divergence, meaning price moving in one direction but delta getting skewed in the opposite direction or in other words – More aggressive buying as the price goes down and more aggressive selling as the price moves up  Such divergences point to a possible change in trend or a reversal.

Now it’s important to understand that this indicator measures divergence caused by aggressive buying or selling i.e. through Market Orders, but in reality passive limit orders could also cause both reversals and continuations and in NIFTY the ratio of market orders to limit orders would be close to 30:70, so one has to factor that in.

At this point I want to categorically say that as far as I know there is no programmatic way of determining if an execution is a market, limit, or a stop order. So the idea that attributes “aggressiveness” to market order driven (long/short) at that price point is not correct, it could always be stop’s being hit as well, or for all you know it can also be marketable limit order. This is the reason why divergences per-se can be both a point of reversal or continuation.

Let’s look at the following chart.

In the image above – The Red colored candles mean (Greater than “x” size volume at Ask compared to Bid) and the Green candles mean (Greater than “x” size volume at Bid compared to Ask) in that specific bar. X can be set to a User defined value or you could ignore it totally and let the indicator point you to every imbalance that occurs. This is an illustration of "Per Bar Delta" which is what I use.

As you can notice there are some divergence signals which act as points of continuation and some act as point of reversal, meaning some Red markers which don’t lead to a fall instead cause further up-move and some green candles which don’t lead to a raise but instead cause a further fall.

I repeat this, because a lot of novices buy into the fact that this (Indicator ie not the idea of Imbalance) is some sort of a holy grail and all that they need to do is follow the divergence signals and buy or sell accordingly, twitter traders and indicator sellers don’t make life any easy either.

That’s the reason we really need to use this indicator within the probabilistic context of the market structure of a given product.

There is another nuance in terms of the input factor for this indicator usually Volume Delta Indicators come with two modes of inputs – Up/Down Tick and Bid/Ask, choosing either of these can also alter the output.

At the end, like all other indicators this is no holy grail stuff, however can be an extremely useful reference if you can combine it with market statistics and other indicators referenced in this series.

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Behind the ‘Veil’ of Price | Indicators that signal market-microstructure dynamics | Part 1 of 4

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As most of you in the slack group know, this year my focus is on finding indicators which would help us get better, more refined entries and exits in our existing setups.

And I was sure that these indicators either have to be some sort of visualization of the Limit Order Book (LOB) activity or at least must signal the change in state of the book, even if it takes inputs from executed orders.

In this post we will look at the concept of Trade Rate/Pace of Tape/Trade Intensity  - these are conceptually the same. Essentially we are looking at the time taken for the price to move from 1 tick to another or volume acceleration in a given time.

Let me tell you how I landed on this idea – After having watched the market depth (L2) for years, I knew for sure that the beginning and the end of a micro-trend usually happens with a flurry of orders and then the pace comes down and the price retraces a bit or coils around for a while. Being a visual person, I wanted to chart it and that’s where my search for such an indicator began.

I did find several mentions of it for different platforms but didn’t find one for NT8.

To read more about it, some good soul has collated all the information here

https://www.sierrachart.com/SupportBoard.php?ThreadID=345

Similar Indicator for a Different Platform

https://www.jigsawtrading.com/2018/03/26/jigsaw-smartgauge-pace-of-tape/

I later found this one

https://readtheprospectus.wordpress.com/2009/04/16/sponsored-indicator-davinci-trade-rate/

Since it had a selection for both Volume and Trade rate I thought it would be better to play around with. So I got this one coded for NT8

Now let's see how to use this indicator. If you have read the links above you would have guessed by now that this indicator is used mainly to identify the location of a trend or micro-trend change. As always it cannot be used in isolation and without relevant context of the market structure.

Now let’s look at a an example from NIFTY Futures

Look at the areas marked with a rectangle, what you see in the above chart is Price (100 Tick)/Volume Rate/Trade Rate (Green Line Chart)

You will notice that trend reversals coincide with the Trade rate being in the upper band. You will also notice that it coincides with the spikes on the Volume Rate. More importantly one needs to observe what I call the “Trade Rate Cycle” and look at turning points in the Trade Rate, which is easy to identify as it operates within a range/band.

Again, this is no holy grail, but at least offers information that is behind the veil of price.

 Note – I am still testing this and would in future do some back-tests as well.

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Honest Serving Men | Finding Indicators that work for you | Part 3 of 3

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In the previous two parts of this series, we looked at aspects like

a)      How to go about looking for Indicators?

b)      Do Indicators have any predictive value?

In this part we will explore the idea of leading vs. lagging – the concept of leading vs. lagging can get confusing if you compare it with the previous post on “predictive value” of Indicators.

I look at it this way – Any indicator that uses “Price” or “Volume” as the input is lagging, simply because a given price point does not cause another price point and a given level of volume does not cause another level of volume.

That is the single biggest reason indicators like Moving Averages or Volume Underlays look so elegant in retrospect but are not tradable as such.

For something to be categorized as “Leading” – We would need to look behind the “veil” of price and volume. Market microstructure aspects like (Simple - 'Executed Order Info.') Bid-Ask Spread, Delta Divergence, Executed Trade Rate - and more (Complex - 'State of LOB Info.') Limit Order Book (LOB) Slope, Relative Depth of the LOB, LOB Volume/Order Arrival Rate etc. are the factors that “lead” to the midpoint of the spread a.k.a “Price”. 

Again, one has to understand that irrespective of whether the input for the indicator is Leading or Lagging, one has to do backtests to check for validity, and predictive effectiveness.

That brings me to the end of this 3 part series. In the coming posts, I will explore some such (Simple) Indicators and see how they work for NIFTY.   

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The Dark Side of Being a Full-time Retail Trader

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Most aspiring traders that I have met, seem to have a few things in common

  • They want to be independent i.e not to work for someone
  • They also want independence in terms of their time, they perhaps want to spend time doing several things and not just trading
  • They want to make some reasonably good amount of money by investing around a year or two worth of time

These are the sort of expectations that aspiring traders usually have. And as they say, reality is usually quite different from what we expect it to be. So let’s look at the other side, the reality, the darker side i.e.

  • The other side of Independence is responsibility – responsibility to succeed at something by oneself, all by oneself – the impact of this on one’s self-worth can be massive, much more than one can even imagine – Especially if you’ve had considerable success or acceptance in your previous career, the impact could be even more.
  • The other side of freedom to use one’s time could be either indifference or obsession, both the extremes won’t help usually, obsession is a shade better than indifference though
  • Long streaks of losses can psychologically break the strongest of the people, which can have further ramifications, from depression to suicide, yes I am serious.

While all that I described above could be two extremes and the reality would be somewhere in the middle, but I guess what matters is

a) Getting a better sense of reality before diving into this business, yes I call this a business because, like any business, this too requires you to risk your time and money.

b) Developing a plan which includes the possibility of a fairly long learning curve 

c) Viewing this as one of the ventures in your entrepreneurial journey

d) Viewing trading as a performance sport – which would mean hours and years of practice and focused effort and an understanding that you need to be at the top of your game and like anything which is performance oriented very few can be.

e) Viewing the effort towards the goal not just in a linear sense, but also in another sense, be open to the idea of landing on something else altogether, in a serendipitous sense, which could alter the course, perhaps all for your good.

f) Finding like minded people to work with, not falling into the lonewolf trap, there are limits to what one can do by oneself

So with all this said, you can imagine how your everyday life as a trader is going to be. In all probability, you may end up being unhappy, and fairly stressed more number of days than you ever imagined. Depending on your general constitution, it may also affect your health. Depending on the quality of your relationships and life context that too may suffer. All this happens not just in trading, this is the truth for any entrepreneurial venture.

Even after being aware of all this, it’s still different when it really hits you. Because in the beginning, you tend to think “maybe it may work out differently for me” and then it doesn't, you may delude yourself for some time but then, sooner or later it does it hit you. And when it does, you end up asking yourself questions like – Till when do I be in this venture? Should I just quit and take up something else?

Valid questions with no simple answers.

As clichéd as it may sound – as they say - Nothing great ever was that easy.