Trading Strategies

Have you ever felt that you're too small (or retail) to make big money in the markets, and the big guys take all the profits...or that you wish someone would give you a magic wand which will show you a glimpse of today's market's closing prices at the beginning of the day...or that you're trying your best to trade but somehow the stock moves up only after after you've sold it? Well, i won't give you my magic wand (:)), but can tell you about how I deal with these nagging queries.

This post is about various Trading Strategies that are used by retail people, people like  you and me. I've tried to cover as many as I can think of / have used at sometime or the other...please let me know if there are any I've missed and I'll add them as an addendum to this post. I'm sure among those of you who trade, (not necessarily for a living) you've also used some of these, but the point here is in figuring out if a little improvisation is possible. Note that some of these forms could be quite India specific (like IPO Trading), but the rest are fairly general and are applicable to almost all markets.

• Tip-based Trading:

This is the most popular form (and arguably the least rewarding) of trading - the only variation here in different cases is the source of the tip. The sources can vary from friends, acquaintances and brokers / broker reports to Electronics and Print media. Now, this form of trading is really tempting, with no underlying rules / analysis from our side...someone tells us what to buy / sell and we do it...hoping that that person has done enough research. 

But more often than not, these tips are released at the fag end of the move...so your risk - return ratio is not very tempting (buy something for 200 bucks, stop-loss 190, target 210 for 3 - 5 days, gives us a risk-reward ratio of nearly 1 (5% / 5%), which is not very tempting). The reason risk-reward ratio should be taken into account in every trade is because no one can make money on all the trades...so lets say, out of 10 trades, you went right 5 times and wrong 5 times. Assuming you had a risk-reward ratio of 1 every time, and you managed to keep your stop losses and target strictly in place...you'd have made 0 bucks !


Thus, with such forms of trading, the reduced effort on analysis needs to be compensated with far higher efforts on trade management. You need to always be on top of your positions. Some people use these tips to identify stocks with interest of large operators. The operators are a reality of the market...they pump in / take out huge money in small / mid / large cap stocks and cause significant movements therein. These tips only tell us, which stocks operators are / were interested in...


Just as a parting note - if you do trading based on this style, have you ever measured how much your returns have been on an overall basis (year till date) / how much the stock has moved in anticipated direction before and after the tip? If not, I recommend that you do this analysis, I'll definitely open your eyes to some new insights !

• Twitter based Trading

Ideally, I'd have liked to include this as well in the above section, but since its a relatively newer form of receiving tips, I decided to have a separate section on this. Twitter is a good source of getting accumulated tips from various sources, all at one place...(I think this is the best use of twitter, don't really know what else people would want to use Twitter for ;)). And you receive tips at the speed of light. Just follow various broking houses / independent analysts / brokers / print media tweets, etc. and you'll remain on top of tipping world !

But again, just like above, use this with your own discretion. Use these tips to identify stocks which are on the move, analyze those (its not too difficult)...and take a call on a case-to-case basis. Overall, this form of trading reminds me of a quote from someone during 2008 crisis - "Its amazing how world keeps finding new ways of losing money when the old ways seemed to be working just fine...". I'll always remember this quote ;)

• IPO Trading

This is generally regarded as a risk-free trading strategy. Apply in IPO, it opens up anywhere between 20 -200%, sell and get out of the stock...Instances of IPO opening below IPO price is far lower than otherwise, so it is a good strategy that yields decent to excellent returns. But here as well, some research on the company (whether to apply or not) and money management (how much to apply, also, which ones if multiple IPOs are open) will definitely help. One not so difficult way of doing this (atleast in India, not so sure about other markets), is to see the premium being quoted in the grey market.

The grey market starts predicting the gains per application (each application of 100k / 200k) well before the IPO closes. These rates are available on various websites...and are a decent indicator of how the IPO is going to perform.

• News based Trading

This form involves tracking news (publicy disclosed, potentially having large effect) and trading based on that. For example, if interest rates are increased, the markets usually will not like this as it is a sign of Central Bank cooling off the growth, or if industry specific / stock specific news is released, people will quickly take a stance on that and trade accordingly.

The essence here is that of both analysis and time...you need to understand firstly, whether the news is good / bad for a particular stock / industry / market. Secondly, how large could the potential impact be (a company instead of posting 15% top-line growth in a quarter, posted 17% growth - its positive, but the news will get incorporated in the stock as soon as it is released). And thirdly, you need to implement the conclusions from the above two points quickly....'coz as soon as the news is released, market players with ready access to trading terminals, (and of course, quick fingers) will take the lead in entering trades. But large impact news is usually analyzed thoroghly in trading rooms End-of-day for large trading houses...and they adjust their positions over the next few days...So you still have time to move and run with the majority of the profit leg.

I've known a few people who trade on this form (among others). I'd say, if you have a macro & micro perspective, there is no dearth of data coming in everyday...from inflation figures, to unemployment, to bond market movements, budget sessions, quarterly results, housing data, confidence level in businesses...all you need is a keen eye, an understanding of the potential intensity and direction of movement, and of course, quick fingers...!

• Analysis (Technical / Fundamental) based Trading

This form of trading has seen most amount of ink flow under it. So many, so many readings are available on this, that I dont think i can ever do justice to this form by getting into the details. One of my personal favorites on Fundamental Analysis is "One Up on Wall Street" by Peter Lynch. Simple and applicable....just the kind I prefer. Technical analysis is also fairly widely available on the internet, including free e-books and numerous articles.
Which approach you'd like, is something you'll have to figure out on your own...I've moved between both fundamental and technical to a point where I look at both now...and weightage given to these techniques differs based on how long I'd like to hold the stock....(fundamentals for really long term, technicals for really short term). If you're going to start with technical analysis, I'd suggest that you take a subscription of an online technical analysis tool which has data for your market...generally such subscriptions are not very costly ...(approx your monthly phone bill) but will enable you to implement your understanding well.

• Strategy based Trading

Now, this is where quants come in and retail sits back. Apart from a few guys here and there, I've not seen too many people dealing with this form of Trading. In strategy based trading, you need to have some kind of strategy - it could be an arbitrage strategy, or stats based strategy, or based on some kind of algo which tracks fundamentals & technicals both and suggests the best buys / sells...or anyhting else. This form is not so well written, and is also kept close-to-their-hearts by whoever has devised the strategy.

One of the popular strategies is called Pair Trading...in this strategy, the price ratio of a pair (logical one - like MS and Oracle OR Citibank and BankAM) is tracked. Under normal circumstances, it would move within a fairly narrow range, but if the ratio goes 2 or 3 standard deviations above or below normal, you can take a long position in one and short position in another. E.g. If Oracle / MSFT ratio is 1.075, and if it goes suddenly to say, 1.11...you can see if this kind of volatility is normal or not, and if not, you can sell Oracle futures and buy MSFT futures at prices such that the ratio is 1.11 or higher. 

The assumption here is that in a few days, the ratio will come down to 1.07 levels or lower. For this to happen, there are multiple ways...either Oracle has to move down, or MSFT has to move up, or a bit of both. Alternatively, oracle stock price rises, but MSFT rises even more...OR Oracle falls, but MSFT falls lesser...in either case...you'll make money on at least one leg even after deducting losses made on the other.


Notice the beauty of this strategy, its market neutral - you don't care too much about which direction the market or these stocks move...all that you care about is one moves lesser than the other. In the Indian markets as well, there are several such pairs possible - Infy-Wipro, HDFC Bank - ICICI Bank, ACC-Gujarat Ambuja, TCS-Infy, Axis Bank - HDFC Bank....and so on. Now, its not that there is no risk here, the ratio may not come back to its normal levels before the futures expire, in which case you'll book a loss...but studied well and executed well, this strategy can potentially beat many other strategies hands-down - primarily because the risk involved in this is lesser.


There are other forms of Strategies as well, like Moving Average (MA) strategy, wherein - you buy whenever a stock's 20 day MA cuts 50 day MA on the upside and sell when its the reverse. There are multiple choices available here as well, 5-20, 10-30, etc. There are chances of a whip-saw, wherein, the 20 DMA cuts 50 DMA on the upside, you take a long position, and then soon after the stock goes down and 20 DMA cuts 50 DMA again but on the downside making you reverse your position. But overall its fairly simple and mostly effective strategy to follow...take a look at the opportunities available in Nifty over the last couple of years based on only this strategy. It can work wonders in trending markets. In the chart below, I've used 30-50 combination...check it out.

(Click for a larger image)

There are some other strategies as well, like Algorithmic trading, Basket trading etc...but those are advanced ones...may be in some other post...!


Please do let me know if you too use one of these / any other...I'll probably compile a list of those as well and make another post on that...