Price Channels - How to encash mkt hysteria

Hi Friends,
I am going to discuss one of my favourite strategies for swing trades. There is always a few dilemmas in front of the traders in terms of:

1. Which direction to trade?
2. Where to enter the trade?
3. Where should be our stop losses?
4. What should be our profit target?

This is an attempt to answer above questions one by one and develop a sound swing trading system. I read about it in last year in one of the authored by Elder Alexander and I have customised to NIfty and other Indian stocks. Its an excellent book called 'Come into my trading room' and I recommend all to read it.

Coming back to the strategy:

1. Which direction to trade?
The best way to ascertain which direction to trade is to ascertain the current medium term trend. I use 100 EMA (EOD Time Frame) to ascertain the medium term trend i.e if 100EMA is sloping up trend is up so always look to enter longs and shorts are prohibited. Similarly if 100EMA is sloping down shorts are permitted but longs are prohibited. Hope this answers question 1

2. Where to enter the trade?
In an uptrend, obviosuly one would want to buy as cheap as possible and similarly in a downtrend one would want to sell as high as possible. What we dont want is we end up buying too high or selling too low. Markets swings go through two phases .. the phase of hysteria and the phase of composure. You want to enter into a trade when the mkts are going through a phase of composure rather than the phase of hysteria. For eg in bull run you want to buy in a phase of compure but sell as soon as mkts enter a phase of hysteria, opposite in bear markets. The way I define state of compusure is when price is touching 22 EMA (22 signifies a month). Hence I would only buy near 22 EMA in bull mkt ( bull means upward sloping 100 EMA) or short near 22EMA in bear mkt (downward sloping 100EMA).

So plot 100 EMA to decide the medium term trend and enter trades in composure phase i.e when prices are at 22 EMA.

3. Where should be our stop losses?
There are many ways to put an SL depending on risk management which is different with different people. I prefer to put a stop of 2%% i.e if I long at 3000 NF my SL will be 3060 NF for swings. Just make sure your stop losses are away enough to ensure you dont get stopped out due to market noise.

4. What should be our profit target?
This is the most fascinating part ....where to book my profitable trades. Some people tend to book based on some pre-detrmined levels, some based on risk reward ratio etc etc. The art is to let profit run until the hysteria stage is reached and book immediately while markets are still in a hyesteria stage. In 90% of cases mkts would stay in hesteria for a couple of days, would return back to compsoure in the following 2-3 days and you are good to enter the next trade again !! Hysteria is when the price moves away the value zone of 22 EMA. For this I plot a price channel (its available of Icharts - Charts Premium only .. not available on any RT charts). I plot Envelope (20 +/- 10%) with parameters 17,0.1. This will draw a beautifyl channel around your Nifty price and the channel walls are your profit targets. As soon as price hits the channel wall...it signifies mkts have entered a state of hysteria and hence a good place to exit profitable trades.

This is an excellent strategy and can be customised by different users. But remember the rule of 100EMA & 22EMA and you would never fail. In 2008, this strategy generate 7-8 sell signals with 500 odd point profit each... thats Rs 25000 per nifty lot per trade ! I will post a chart after this and will let you spot places where SL might have been hit :-)

I clearly see 3-4 places where SL was hit for 60 points per trade. Small SL big rewards is the key!

If a reverse trade was taken (i.e buy at 22 EMA book at channel wall and reverse sell at channel wall book at 22 EMA) would have meant additional 150 points profit per trade.. however this is a bit tricky to do and requires money management so dont try it yet !!

If one can just master this technique and follow the discipline…. I can guarantee a person can turn 50K to 5Lakhs in an year. The key is discipline and patience….

Please let me know your comments and valued feedback.

Cheers
SH