Stocks & Commodities V. 23:3 (64-71): Interview: Trading Diverences With Ashwani Gujral by Jayanthi Gopalakrishnan INTERVIEW
Intraday Swings In Index Futures
Trading Divergences With Ashwani A Asshwani hwani Gujral Ashwani Gujral first got acquainted with technical analysis when he was studying for his master’s degree in business administration in the US during the mid-1990s — and since then, there’s been no turning back. These days, Gujral is an India-based technical analyst, commentator, author, and trainer who follows both Indian and US markets; he’s also an active short-term trader and a money manager. He is a frequent contributor to various US trading magazines and makes regular weekly appearances on Indian business television channels. Not only that, he has an Internet presence, as he runs an index futures trading chatroom, as well as a print presence, since he has just published a book called How To Make Money Trading Derivatives: An Insider’s G uide. He can be found at www.ashwanigujral.com. STOCKS & COMMODITIES Editor Jayanthi Gopalakrishnan conducted the interview with Gujral via instant messaging on the Intern et, starting on January 4, 2005.
H
ow did you get started in tech nical analysis? I did my master’s in business administration (M BA) in the US in 1995, which was when I became fascinated by the money management business. The first real gurus I wanted to emulate were Warren Buffett, George Soros, and Peter Lynch.
This was one of the many reasons I chose technical analysis as my methodology for analysis. Back in 1995, I had a hard time just finding annual reports, but of course that has changed. And that’s how my fascination with charting began, because that put me on a par with large investment banks with thousands of analysts making the same forecasts.
Not a bad place to start! Being an engineer and having an M BA Basically, one thing led to another, in finance certainly helped. As an engiand it’s become my life’s mission neer, I was trained to build frameworks and models to solve problems, and this How so? to create successful traders. helped in developing a quantitative and I learned that I did not have a logical approach to forecasting stock to decide the trend — all I price movements. As an M BA, I was had to do was to catch the trained to understand business models, major part of the move. Meanwhile, Again, like the rest of the financial so that helped me understand the busi- reforms in Indian capital markets took markets. ness of companies whose charts I picked place, so like the rest of the financial Earlier, the margin trading and cash for analysis. This is important because I markets around the world, we totally markets in India were interlinked, and advise investing in only fundamentally turned away from physical delivery. we had a local financing system called sound and pedigreed companies, even We had 100% electronic trading in In- BADLA for buying and selling securiif it is done on the basis of charts. In dia, followed by the big software boom ties. The problem with that was when addition, when I returned to India, I all over the world. Then, of course, the people used to build large positions on found that technical data was much more subsequent bust also affected us. the margin trading side, the cash also easily available than fundamental data. used to come crashing down. Then in Copyright (c) Technical Analysis Inc.
Stocks & Commodities V. 23:3 (64-71): Interview: Trading Diverences With Ashwani Gujral by Jayanthi Gopalakrishnan
2001, the Indian market was hit with the Ketan Parikh scam.
fundamentals as far as I was concerned, but then I found out that markets predicted fundamentals before they happened. I couldn’t have such in-depth knowledge of the markets to analyze them fundamentally, so I moved to technical analysis. I used fundamentals only to the extent of making sure of the company pedigree and used technical analysis to buy and sell stocks. This went on till 2001, and once derivatives were introduced into the market, that was it. I have not purchased a stock since.
Can you tell the readers who that is and what that’s in reference to? Ketan Parikh bought stocks in the forward market — margin trading — and used the proceeds as they got credited in his account every evening to build huge positions. So he used proceeds of leverage to build even more leverage. This was because, like in the ordinary futures market, in this market you also had mark-to-market, so gains and losses were added or subtracted from your account in the evening. In Is that because technicals work better addition, he took loans from coopera- in derivatives? tive banks and bought stocks on margin, Technical analysis works well with sending his favorite software stocks to anything that can be charted. The charts the stratosphere. I analyze are for equities, but since we This game was a lot of fun, but when don’t have margin trading, trading futhe bust happened, it put a few regional tures provides us with better leverage, stock exchanges and banks under a pay- and hence a better risk/reward. ments crisis. Finally, the government I use the index chart and trade its stepped in and scrapped the entire futures. You can use the index futures BADLA financing system and introduced chart as well, but here in India, the derivatives. Today, all our derivatives futures keep moving into discount or are cash settled. With all these reforms premium, based on the bearishness or happening, it was natural that trading bullishness. It made sense to use the started taking a professional form. index chart itself. With derivatives, I have more flexibility: When I am get And then? ting good signals, I trade the futures. As word of mouth grew about my When the markets get choppy, I just sell money management and technical analya straddle on index options and sit tight. sis activities, I started making appearIf markets are not showing strong trends ances on CNBC-TV18 [ Editor’s note: I tend to do lower volume and not add, the Indian affiliate of C NBC] and other so I can book quicker profits. channels, wrote a book and articles for several US trading magazines, and be- How do you trade deriva tives? gan an index trading chatroom on the Almost all liquid derivatives instruInternet. Writing helped my technical ments settle on the last Thursday of analysis and trading, because it inter- every month. When markets consolinalized a lot of what I learned. Basi- date, selling index straddles often works cally, one thing led to another, and it’s better than getting chopped around takbecome my life’s mission to create suc- ing marginal trades. These have a onecessful traders. month expiry so you end up making money if the market is going into a Did you start out by trading equities, or consolidation on the daily time frame or did you jump into futures? the weekly time frame. Every month, When I started trading in 1996, equi- there are about 22 trading sessions, so ties were the only thing out there. There time is on the side of the option seller. were no books to learn technical analysis from, just one or two software pro- What type of money management stratviders; most of the educational tools, egies do you use? books and courses, came around after I I do not risk more than 2% of total had started. Initially, it was a bit of account equity on any one trade. I do not Copyright (c) Technical Analysis Inc.
carry losses home. I also do not carry marginal profits home unless there are extraordinary circumstances involved, such as when the market is closing at highs. Once a position is deep in-themoney†, I look for consolidations to add. I use patterns like bull and bear flags to add positions. The setups I discuss here can also be used to add positions, as they occur almost once a day. [ Editor’s note: See sidebar, “Setups.”] Once I am in a good position I try to push it, on all time frames. But I make sure that every time I add contracts, they are a fraction of the original position, so my breakeven does not run up too close to the current market price. I take a lot of trades but really make most of my money on a few big ones. Tell us about your trading system using index futures. It’s for intraday traders who trade the five-minute time frame, but it can be used to time entries by longer time frames as well. Let’s start with momentum setups, which is what I call them. I believe price follows momentum in general, but whenever the two diverge, you get buy and sell signals. Now, the buy setup means the momentum makes a low for the day, whereas the price does not. Even though momentum went to oversold, the price had enough strength to hold its lows. So when this momentum turns, you will get a stronger move to the upside — something like an a-b-c wave. We believe all price moves take an A BC form, where you have a move in a direction called A, then a correction or consolidation in the opposite direction called B, and then a continuation of the move A called C. So basically, we w ait until the market shows us its hand. Now, the sell setup occurs when momentum makes a high, while the price does not. This means even though the momentum went to its highest, the price had such weakness that it could not follow. So when the momentum turns down, you get a larger move on the downside. We use stochastics, both fast and slow, as the measure of momentum. Could you walk me through it using
Stocks & Commodities V. 23:3 (64-71): Interview: Trading Diverences With Ashwani Gujral by Jayanthi Gopalakrishnan
tion. But if you strictly go by the slow stochastics, you get fewer but better percentage trades.
! O O H A Y
FIGURE 1: MOMENTUM SETUP. Here you see a setup on the S&P 500 index using fas t and slow stochastics .
the chart in Figure 1 as an example? In Figure 1, the market opened with two up bars and then started coming down. So it touched lows for the day, as did the momentum from our system. This tells us that the market is planning to move down. Now, what you want to do is make an entry into this downward movement. The window directly below the price chart displays the slow stochastics. The window below that shows the fast stochastics.
US because the S&P consists of 500 stocks. When you’re looking at the breadth of the market, you know whether it is a narrow- or broad-based rally or a decline. The broader the market in a particular direction, the better the chances of the trade succeeding. Still, it gives you a feel for what is happening. Now, coming back to Figure 1, which shows a sell setup when the slow stochastic reaches oversold levels initially, you get move A, in which you have to wait for the market to react on the upside to look for a short entry. As you can see, around 11 am the market started reacting on the upside, starting the wave B. Both the slow and fast stochastics started moving.
Why do you use both fast and slow stochastics? As you know, stochastics can be used to define market momentum. I use fast and slow stochastics because the fast one hints at where the slow one may move next. The red line you see on the Stan- Do you have a particular point at which dard & Poor’s chart is the 20-period you like to trade? exponential moving average (E MA). By Ideally, I trade only when the slow the way, the Yahoo! chart is a five-minute stochastic is at extremes, because I find chart, so once you form a bias based on the that it gives the best trades on a percentinitial move of the market to try to get a age basis. But sometimes if the market better feel, you check out the market is showing a lot of weakness or strength, breadth. This is available via Yahoo! and the slow stochastic may not reach overupdated throughout the trading day. bought or oversold levels. When that happens, you can use some finesse. I Can you tell our readers what happens use the fast stochastic in conjunction in India? with the 20-period MA. The moment In India, what happens is that index the fast stochastic becomes overbought, heavyweights sometimes skew the mar- and price moves above the 20-period ket. That problem may not exist in the EMA, you have a low-risk short situa-
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Why? Say the momentum made a high but the market did not, so you have an a wave down, a b wave up, and then you ride a c wave down. This also gives the closest stop — you use the high of the day as your stop, for the sell setup. Similarly, use the low of the day as a stop for buy setups. The triggers can be set according to each trader, which we will discuss shortly. All you really need is just one entry like that in a day, so instead of beating around the bush— which is what daytraders usually do— you get a clear way of taking a trade once the market shows its hand. I will introduce qualifications to this as well, but this is the basic trend. What is the essence of this system? You know, I work with traders all the time, and these guys basically go around chasing the market like a chicken with its head cut off. The beauty of this technique is that whichever way the market goes, this system forces you to buy dips after an intraday uptrend and sell rallies after an intraday downtrend. That is what you’re supposed to do. Because if you sell dips in an intraday uptrend and buy rallies in an intraday downtrend, you will be stopped out several times a day, even before the trade works out. In addition, my system makes you sell momentum — overbought and oversold — which means if and when the momentum does turn downward, even if the trade is not working out, you will get a decent exit because the reversal in momentum will pull it in its direction to some degree. What are some other benefits? You also get to trade divergence in price and momentum. I discuss only two types of divergence between momentum and price, because they work the best. Through testing, I have found that other types of divergences do not work as well. The classic dilemma that traders face is whether a certain
Stocks & Commodities V. 23:3 (64-71): Interview: Trading Diverences With Ashwani Gujral by Jayanthi Gopalakrishnan
support or resistance will hold or break down or out. This can help solve that dilemma to some degree. The best part of this system is when the market is just chopping around, it does not go to extremes as often. So you’re kept out of impulsive trades. But sometimes something that looks like a strong momentum move is only short-liv ed. Yes, that is the reason we’re not ch asing momentum, but trying to trade divergences. We’re trying to trade the exception to the rule that price follows momentum. Do you find yourself out of the market often when you use th is system? Yes. When a trend starts stalling, I get out of there. I know I will always get an entry in the next day or two. When the market is chopping around in a narrow range, the system either does not give signals or at least gives very few, as the slow stochastics don’t reach overbought levels as often. Now I’ll write a few words on how to filter signals. I wrote an article on average directional movement index (A DX) for STOCKS & C OMMODITIES, if you’ll remember. Now, as with all technical analysis methods, if the market is in a strong trend, techniques work much better. These techniques are no exception, so a key parameter to watch is the daily ADX. If it’s above 30, these setups work very well. When the ADX is not showing a strong trend, you should keep volume low and take profits quickly. Another filter mechanism is the 30minute chart (Figure 2). When slow stochastics on the 30-minute chart is overbought and starts weakening, the chances of getting a good five-minute sell setup are much higher. Similarly, when slow stochastics on the 30-minute chart is oversold and starts strengthening, the chances of getting a good fiveminute buy setup are higher. If the market on the 30-minute time frame is showing slow stochastics at overbought levels [above 80], I try to take only the five-minute sell setups. If the market on the 30-minute chart is showing slow stochastics as oversold, I
L A N G I S e
FIGURE 2: FILTERING MECHANISM. Here is an example of using a 30-minute chart as a filtering mechanism. Note the favorable points to take five-minute buy and sell setups.
FIGURE 3: AN IDEAL SETUP. If the stochastics moves up and the price makes a new high, you would stop looking for a setup. In this case, the stochastics moves drastically, but price doesn’t.
will take only the buy setups. The trade preferably is taken as the slow stochastics comes down from the 80 level or moves up above the 20 level. If I am trading a range-bound market, I keep my volume 60% of those during trending markets and take profits quickly. This can be used as a profit booking mechanism as well. Say you take a trade using this method and it works well. How do you book a profit? You wait until the next opposite setup occurs again. This means if you traded the buy setup, you would use the next sell setup to book profits. If you traded the sell Copyright (c) Technical Analysis Inc.
setup, you would use the next buy setup to book profits. This is particularly useful if you are carrying overnight positions and want to get out at a good exit. That will make sure either you book your profit near the high on a buy trade or near the low on a sell trade. It’s important to note that if you use slow stochastic overbought/oversold levels, you get fewer trades, but large moves. What about triggers? For the triggers I have spoken about, I think you can use the previous twobar low, or the previous two-bar high
Stocks & Commodities V. 23:3 (64-71): Interview: Trading Diverences With Ashwani Gujral by Jayanthi Gopalakrishnan
SETUPS Key points about momentum setup • Buy setup Slow stochastics makes a low for the day, but the market does not make a new low for the day Sell setup Slow stochastics makes a high for the day, but the market does not make a new high for the day •
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• Take quicker profits in a range-bound market, prefe rably as the slow stochastics reaches the other end • Use 60% of trending volume in a rangebound market
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If, because of a strong trend, the slow stochastics is not reaching extremes, the fast stochastics can also be used. Things that this setup forces traders to do • Buying on dips, selling on rallies • Buying when momentum is oversold, selling when momentum is overbought • Divergence between momentum and price • Even if the trade does not work, it considerably reduces risk as the trade is taken on a momentum extreme and a good exit is provided Key framework to apply these setups in • In a trending market, when ADX>30, take trad es only in the direction of the trend • In a range-bound market, when the ADX is declining below 30, define daily support and resistance, buy on support and sell at resistance
on the five-minute chart, or when the price goes through the 20-period E MA in the direction of the trade. I just use the oversold and overbought levels on the slow stochastic and use a stop of the high or the low. Now we move to the stuff below the triggers. Check out Halliburton (Figure 3). From that chart, you can see that the stock prices corrected upward slightly after trending down for most of the day. This prompts you to short as the slow stochastic reaches overbought levels. Scenarios like this do happen. Note that stochastics moves drastically, but price doesn’t. If the stochastic moves up and the prices also make a new high, then we quit looking for a sell setup. It’s the same with lows, so basically this setup keeps you out of trouble a number of times. What else do you look at? I look at the high and low of the given day. If you look below when you bring them up on Yahoo! charts, you’ll see a table that displays the highs and lows that you can use as your reference. Let’s move along to the C ISCO chart
Triggers • Previous 10-minute lows • Breakdown/breakout below the 20-period moving average • Just reaching extreme areas and then keeping a standard stop because the momentum moves the other way at some point Setup conditions The following information, which is available on Yahoo!, sets up the conditions for the trade: • Strong positive breadth facilitates buy trades • Strong negative breadth facilitates sell trades • Marginal breadth usually discourages trading, as it means a consolidation day • Reversal of breadth from one extreme to another serves as confirmation of a larger move in the direction of breadth reversal —A.G.
FIGURE 4: CHOPPY MARKET. Even when the setup does not work well, you still get a decent exit.
(Figure 4). Now, this is where the setup kind of diddles around. But you still don’t get chopped, and if you’re not comfortable, you can exit at a decent price again. The slow stochastic made new highs. Prices did not see their previous prices because everything closed lower. I could not find a buy setup, but I guess on an up day, you will find Copyright (c) Technical Analysis Inc.
plenty of that. Now, right below the chart [not shown] you have breadth. Believe it or not, I refresh the breadth every five minutes — that really tells me the odds of my trade working. If I have an open position and the breadth strengthens, I am confident that this move has more to go. If the breadth weakens while I am
Stocks & Commodities V. 23:3 (64-71): Interview: Trading Diverences With Ashwani Gujral by Jayanthi Gopalakrishnan
long, I tighten the stops. It’s the same with sells. If the breadth is iffy, meaning very close to a 1-to-1 ratio, it’s a sign that you need to take profits quickly, as the market is not overly bullish or bearish. The best trades, of course, occur when breadth moves from one extreme to the other. The best thing this system has done for me is that it allows me to watch the market action and take in what’s going on while I wait for the setup to occur. And you do this with just an Internet connection? Yes, this is probably the most inexpensive way to trade the US markets, although you may need a 30-minute datafeed for filtering purposes.
I must stress again that having a perspective of the daily trend is important. I place a lot of emphasis on support and resistance, which I draw on my charts before planning the day’s trade. Since I have been using this technique, I have not had a stop that was hit because the entries are always on the opposite extreme. In my earlier days, I used to sell bottoms and buy tops. Using this system reduced all that, even if I was wrong. You get a decent burial and don’t get shot. You can make four points a day on the S&P. Most people will take that, and sometimes this lands you in large moves. If you understand the essence, it just makes you do the right things.
Thank you for your time, Ashwani.
SUGGESTED READING Gujral, Ashwani [2005]. How To Make Money Trading Derivatives , Vision Books India. _____ [2004]. “Candlestick Filtering,” Technical Analysis of STOCKS & COMMODITIES, Volume 22: April. _____ [2004]. “ADX: An Indicator And Trading System,” Technical Analysis of STOCKS & COMMODITIES, Volume 22: May. _____ [2004]. “The Shark Attack Strategy And Fibonacci Levels,” Technical Analysis of STOCKS & COMMODITIES, Volume 22: June. †See Traders’ Glossary for definition
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