Tuesday, June 16, 2009

How to build a trading system

Devesh dikshit asks
"i have cap of around 3 lk and i want two trade in nifty futures so what should be my voloume should i trade 10 lots in intraday"

You should keep enough capital for the margin (assumed at a higher side) and at least two times the expected loss. If the expected loss is 10% of the face value of futures, then the loss reserve should be 20%. Assuming margin to be 20% maximum, you should have 40% of the face value as your capital.
One Nifty futures contract is 50 units. At the current price of 4500, it is valued at 2,25,000/ Now 40% of this is 90,000. With three lakh rupees, you should trade 3,00,000 / 90,000 = 3 lots. If you follow this capital allocation rule, I would feel that your chances of success are almost 100% (nothing is perfect!).

Scunge asks:
Suppose I have a trade which drops after I enter, and it reaches my stop-loss but is still giving a "Buy" signal under my trading system.With discipline I will then sell, but then should immediately buy back in (since there is a "Buy" signal!). However, if I save the sell-and-rebuy trading costs and simply hold instead, I am risking more of my capital than the stop-loss intended and so what's the point of having the stop-loss in the first place?So I have a contradiction and am unsure how to best handle this situation.My question is thus: in this case do you abandon your discipline by overriding your stop-loss signal and holding (up to what point?), or do you sell as per the system and so at which signal would you start considering buying back in?

My Notes: Interesting, valid question. I appreciate the effort made in developing the trading system. Such sensible questions emerge when you do it yourself with sincerity.
I will explain with an example what Scrunge is saying.
I have a moving average system which says I should buy when the moving average is moving up. I will sell when the moving average is moving down. (Moving up means, the current average should be higher than the previous average). To protect from unneccessary losses, the system has a stop loss.
Now, I am long because the moving average is rising. Unfortunately, there is a sudden volatile move and I am stopped out. On the next price bar, the moving average is higher than the previous average. So, I should buy again. I end up buyng after I got stopped out. This process could continue many times, till the volatility ends or the average turns down cancelling the buy signals.

One you understand the problem, finding the solution is much easier.

What you need is to define your trading sustem to take care of such possibilities.
Option 1. Once you are stopped out, there will be no reentry in the same signal. (Remember, the buy signal continues )
Option 2. Renetries are allowed after getting stopped out.
Option 3. Once you are stopped out, reentry in the same signal is allowed only on additional conditions getting satisfied. In the moving average exmple, after getting stopped out, you now require not only the moving average direction, but also that the price bar should record the highest high of last 5 bars (as an example).

In my systems, I follow Options 1 & 3, but never 2.
I hope I have understood the question properly and given a satisfactory answer.

4 comments:

Vinod Dhandapani said...

In the monthly Charts of Nifty Iam seeing an inverted Head and Shoulder pattern in the making...with the neckline around 4700 and bottom of right shoulder at 3800. So Iam expecting nifty to go to 3800 in the coming months and to break 4700 after 3 to 4 months...If that happens then nifty could head towards 6500. Is my analysis correct...Iam a novice in tech analysis....If iam wrong please teach how to identify the correct H&S pattern if you have time...

Thanks
Vinod D
Chennai

gofi said...

1. Nifty has gone UP for 8 months from october lows.
2. Nifty has gone UP for 34 Weeks since october lows.
3. Nifty has gone up for 144 days since october lows to 4600 levels.

All the three numbers 8, 34, 144 are fibonacci numbers. Based on these data, is there any to predict for how long nifty will correct ?

gulshan said...

I am regularly reading your blog and tying to follow the same.
Now I have a doubt and I think you can answer my question.
My question is whether today, the nifty has breached swing low of 4365 or not?

Please reply as your Yes or No will certainly help me a lot because I don't have enough experience in trading.

Vipin said...

Dear Sir,

Your early morning positional call on CNBC gave superb returns intra day.

Excellent analysis.

Best Regards
Vipin