Key Takeaways
1. Master the Art of Trend Identification with ADX
The ADX can tell the strength of the move that a market may be in and thus help you keep you out of a whipsawing market and by keeping you in long enough during a trending market to make huge profits.
ADX Decoded. The Average Directional Movement Index (ADX) is your compass in the market wilderness, revealing whether the market is trending or range-bound. Developed by Welles Wilder, the ADX doesn't tell you the direction, but the strength of the trend. A high ADX signals a strong trend (up or down), while a low ADX indicates consolidation, a time to tread carefully.
Interpreting ADX Values. An ADX below 20 suggests a weak trend, favoring oscillators like RSI. A rising ADX from 15 to 25 signals a strengthening trend, perfect for trend-following systems. An ADX above 30 confirms a strong trend, while an ADX exceeding 45 suggests the trend is nearing exhaustion. Think of ADX as the market's heartbeat: a strong, steady beat means a healthy trend, while a weak, erratic beat calls for caution.
Practical Application. Use ADX to filter signals from other indicators. In trending markets (high ADX), trust trend-following indicators like MACD. In range-bound markets (low ADX), rely on oscillators like RSI and stochastics. This strategic approach prevents whipsaws and maximizes profit potential. ADX works on all timeframes, from intraday to weekly charts, making it a versatile tool for any trader.
2. Combine Technical Tools for High-Probability Trades
Profitable trading does not depend on the knowledge of a large number of theories, rather it depends on successfully implementation of a few.
Confluence is Key. Don't rely on a single indicator; instead, seek confluence, where multiple indicators confirm the same signal. Combine trend-following indicators (MACD, moving averages) with oscillators (RSI, stochastics) and chart patterns (trendlines, flags) for robust trading decisions. This approach increases the probability of success by validating signals from multiple angles.
Trend Following vs. Oscillators. Use trend-following indicators like MACD and moving averages in trending markets (high ADX). Oscillators like RSI and stochastics excel in range-bound markets (low ADX), identifying overbought and oversold conditions. Applying the right tool for the market condition is crucial.
Trendlines as Guides. Trendlines are simple yet powerful tools for identifying and trading trends. Connect at least three non-consecutive points to form a valid trendline. Breakouts or breakdowns of flatter, longer trendlines are more significant. Use trendlines to place stops and scale into positions.
3. Swing Trading: Capitalizing on Market Swings
Swing trading is the most consistently profitable strategy that you can use in the futures market.
Capture Short-Term Moves. Swing trading involves holding positions for a few days to a couple of weeks, capitalizing on short-term market swings. The key is to identify the trend in a higher timeframe (e.g., weekly) and then look for low-risk entries in the direction of that trend on a lower timeframe (e.g., daily). This approach allows you to ride the dominant trend while minimizing risk.
Entry Techniques. Three primary methods for entering trends on reactions are:
- 20-day Moving Average (DMA): Enter when the price corrects below the 20 DMA and then moves back above it.
- RSI (7): Enter when the RSI (7) moves below 40 (oversold) and then turns back upwards in an uptrend.
- Stochastics (7,10): Enter when stochastics (7,10) go below 20 (oversold) and then turn upward in an uptrend.
Support and Resistance. Draw support and resistance lines on your charts to create a roadmap for your trades. These levels act as potential entry and exit points, helping you manage risk and maximize profit. Remember, swing trading is about catching the meat of the move, not necessarily predicting the ultimate top or bottom.
4. Day Trading: Guerrilla Warfare in the Stock Market
Day trading is about discipline and training of the mind.
Preparation is Paramount. Day trading is akin to a military operation, requiring meticulous planning and discipline. Conduct thorough research outside market hours, identifying potential trading stocks and derivatives. Review their behavior from the previous day and formulate a trading plan.
Rules of Engagement. Stick to a schedule, arriving before the market opens and staying focused throughout the day. Manage losses aggressively, limiting the rupee value loss per trade to no more than 2% of your trading capital. Avoid overtrading, restricting yourself to a maximum of five trades per day.
Exploit Intraday Patterns. Focus on trading during the most active periods of the day, typically before 11:00 a.m. and after 2:00 p.m. Wait for the best entry setups, such as trendline breakouts, flag patterns, and news-based gaps. Use stops and targets to manage risk and reward, aiming for a risk/reward ratio of at least 1:2.
5. Arbitrage: Generate Risk-Free Returns
The cash and futures arbitrage is a strategy which often offers risk free returns at rates better than savings accounts deposits and most other risk free liquid asset classes.
Exploit Price Discrepancies. Cash and futures arbitrage involves exploiting price differences between the cash market and the futures market. When the futures price is higher than the cash price, buy the stock and sell the futures. When the cash price is higher than the futures price, sell the stock and buy the futures. This strategy aims to capture the cost of carry, the difference between the futures price and the cash price.
Understanding Cost of Carry. The cost of carry should theoretically be positive, reflecting the financing cost of holding the underlying asset. However, in the Indian market, sentiment can drive the cost of carry negative, creating arbitrage opportunities. High costs of carry often signal overbought markets, while negative costs of carry suggest oversold conditions.
Benefits of Arbitrage. Cash and futures arbitrage offers risk-free returns, especially during periods of market consolidation. It provides a reasonable return when no other trades are visible, allowing you to deploy idle cash. It also reduces the market risk of a portfolio by hedging against market declines.
6. Options: Control Risk and Amplify Returns
The huge benefit of options, on the other hand, is that they are non-linear products with only limited downside but unlimited upside for the buyer.
Non-Linear Power. Options are non-linear instruments, offering limited downside and unlimited upside for buyers. Calls give the right to buy, while puts give the right to sell. Options can be used for speculation (trading) or hedging (risk management).
Key Concepts. Understand market lots, strike prices (in-the-money, out-of-the-money, at-the-money), and expiration dates. Option value comprises intrinsic value (the amount an option is in-the-money) and time value (the portion of the premium exceeding intrinsic value).
Volatility is Key. Volatility, a measure of price fluctuation, is crucial in options trading. Historical volatility reflects past price changes, while implied volatility reflects the market's expectation of future price movements. Buy options with low implied volatility and sell options with high implied volatility.
7. Covered Calls: Generate Consistent Income
Gujral's book is heavily under-priced for the great ideas it offers so liberally.
Rent from Your Stocks. Covered call writing involves selling call options on stocks you already own. This strategy generates income from the option premium while maintaining ownership of the underlying stock. It's ideal for sideways or mildly bullish markets.
How it Works. You own a stock and sell a call option with a strike price above the current market price. If the stock price stays below the strike price, you keep the premium. If the stock price rises above the strike price, your stock is called away, but you still profit from the premium and the stock's appreciation up to the strike price.
Choosing the Right Stocks. Select stable, large-cap stocks with good liquidity and limited downside risk. Avoid stocks with speculative bubbles or questionable fundamentals. The goal is to generate consistent income, not to chase high-risk, high-reward opportunities.
8. Special Situations: Profit from Predictable Events
The key here is not to speculate on what announcements the budget might contain but to see if the implied volatility of the option premium is high enough to sell.
Capitalize on Market Expectations. Certain events, like budget announcements, company results, and election results, create predictable volatility spikes. Sell options before these events to capture the inflated premiums, as the market often overestimates the impact of the news.
Budget Trading. The budget, once a major market driver, now has a limited impact. Focus on selling straddles (selling both calls and puts) when implied volatility is high, regardless of the expected direction.
Company Results. Write covered calls on fundamentally strong companies before their earnings announcements. The key is to assess the implied volatility and the stock's technical position, ensuring it's not overbought.
9. Discipline: The Bedrock of Trading Success
The market takes away money from indisciplined traders and gives it to the disciplined ones.
Discipline Over Knowledge. While technical analysis is important, discipline is paramount. A disciplined trader follows a trading plan, manages risk, and controls emotions. They avoid overtrading, stick to their strategy, and learn from their mistakes.
Qualities of a Disciplined Trader. A disciplined trader is organized, patient, and self-controlled. They have a trading plan, do their homework, and avoid emotional decision-making. They treat trading as a business, not a gamble.
Traits of an Indisciplined Trader. Indisciplined traders jump into trades impulsively, ignore market signals, and chase emotional highs. They overtrade, blame the market for their losses, and fail to learn from their mistakes.
10. Money Management: Protect Your Capital
The size of Your Trading Positions should be Based on the Size of Your Trading Capital
Preserve Your Capital. Money management is about protecting your trading capital and ensuring long-term sustainability. It's not about maximizing profits on every trade, but about surviving the inevitable drawdowns and staying in the game.
Position Sizing. Determine the appropriate size of your trading positions based on your account equity. A conservative approach involves trading one Nifty futures contract for every Ͳ2 lakh in your account. A more aggressive approach may involve trading one contract for every Ͳ1 lakh.
Stops and Exits. Use stops to limit your losses and protect your capital. Place stops at logical levels based on chart patterns and market volatility. Have a clear exit strategy before entering a trade, and stick to it.
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FAQ
1. What is "How to Make Money Trading Derivatives" by Ashwani Gujral about?
- Comprehensive Indian derivatives guide: The book is an insider’s manual on trading Indian futures and options, covering charting, entry techniques, money management, and trading psychology.
- Practical, real-world strategies: It provides proven trading strategies, real trade examples, and explains how derivatives have transformed the Indian stock market.
- Holistic trading approach: The book discusses market trends, day and swing trading, arbitrage, options strategies, discipline, and stock selection, offering a complete roadmap for successful trading in India.
2. Why should I read "How to Make Money Trading Derivatives" by Ashwani Gujral?
- Expertise and credibility: Ashwani Gujral is a seasoned trader and technical analyst with decades of experience and regular contributions to major financial media.
- Practical, actionable insights: The book focuses on what works in the Indian derivatives market, emphasizing money management and trading psychology often neglected elsewhere.
- Endorsed by industry experts: It comes highly recommended by editors of leading trading magazines, making it a trusted resource for aspiring and experienced traders.
3. What are the key takeaways from "How to Make Money Trading Derivatives" by Ashwani Gujral?
- Limited-risk strategies are essential: Use vertical spreads, covered calls, and other defined-risk approaches to manage risk and maximize returns.
- Discipline and money management: Strict discipline, emotional control, and proper position sizing are highlighted as the foundation of trading success.
- Stock and sector selection: Focus on market and sector trends, and use technical analysis to select the best trading candidates.
- Active trading periods: Trade during high-probability periods, such as the last hour of the trading day, to improve win rates.
4. What are the best quotes from "How to Make Money Trading Derivatives" by Ashwani Gujral and what do they mean?
- On discipline: "The market takes away money from indisciplined traders and gives it to the disciplined ones." This emphasizes the critical importance of emotional control and sticking to a plan.
- On covered calls: "Markets don’t trend most of the time... it is the option writer who makes a killing — or, as I call it, gets rent from his building." This highlights the advantage of option writing in sideways markets.
- On trading psychology: The book repeatedly stresses that trading is more about mindset and discipline than just technical knowledge.
5. What are the three key aspects of successful trading according to Ashwani Gujral’s book?
- Charting and entry techniques: Mastering technical indicators like ADX, MACD, RSI, and using setups such as swing and day trading rules.
- Money management: Limiting risk per trade, determining position sizes, and protecting capital to ensure long-term sustainability.
- Trading psychology: Developing discipline, controlling emotions, and making mechanical, emotion-free trading decisions for consistent profitability.
6. How does Ashwani Gujral define the difference between a trader and an investor in the Indian context?
- Trader’s approach: Traders buy and sell shares or derivatives over short intervals, using technical analysis and actively managing risk.
- Investor’s approach: Investors buy and hold stocks for years based on fundamentals, generally not trading market swings.
- Outcome difference: Gujral notes that investors often lose money except in long bull markets, while traders can profit from both up and down moves by managing risk.
7. What technical indicators and methods does Ashwani Gujral recommend for trading derivatives?
- Trend-following tools: MACD and moving averages are used to identify and follow market trends.
- Oscillators for range markets: RSI and stochastics help spot overbought and oversold conditions in consolidating markets.
- Fibonacci and candlesticks: Fibonacci retracements identify support/resistance, while candlestick patterns provide sentiment and reversal signals.
8. How does Ashwani Gujral suggest applying technical analysis to Indian derivatives trading?
- Identify the main trend: Use moving averages (like 200 DMA), MACD, and visual inspection on higher time frames.
- Low-risk entries: Enter on corrections or pullbacks using 20 DMA, 7-day RSI, and stochastics on smaller time frames.
- Setups and risk management: Use patterns like successful retests and flag formations, with clear stop loss and profit targets.
9. What is the role of the ADX indicator in Ashwani Gujral’s trading methodology?
- Market phase identification: ADX helps determine if the market is trending or range-bound, guiding the choice of trading strategies.
- Trend strength measurement: ADX values below 20 indicate weak trends; above 30 signal strong trends suitable for trend-following.
- Entry and exit signals: Combining ADX with +DI and -DI provides actionable trade signals and helps avoid false moves.
10. What are vertical spreads and how are they used in "How to Make Money Trading Derivatives" by Ashwani Gujral?
- Definition and types: Vertical spreads involve buying and selling options of the same type and expiry but different strikes, such as bull call and bear put spreads.
- Risk and reward: They offer limited risk and limited reward, with debit spreads risking the net premium paid and credit spreads profiting from the premium received.
- Strategic application: Traders use vertical spreads based on market outlook, and the book explains how to calculate profit, loss, and breakeven for each.
11. How does Ashwani Gujral explain and recommend the covered call strategy for Indian markets?
- Covered call basics: Own the underlying stock and sell call options against it to generate income from premiums.
- Why it works in India: Since markets trend only 25-30% of the time, option writers often profit from premium decay in sideways markets.
- Stock and strike selection: Choose stable, liquid stocks with moderate volatility, and use technical analysis to select strike prices and manage risk with stop losses.
12. What is the AG Last Hour Trading Technique described by Ashwani Gujral and how does it work?
- Strategy overview: This is a "buy today, sell tomorrow" or "sell today, buy tomorrow" method focusing on the last hour of the trading day and the first hour of the next.
- Rationale: The last and first hours are the most active and volatile, offering high-probability setups driven by institutional activity.
- Trade selection and execution: Use breakouts or breakdowns from narrow ranges or pivots on high volume as entry signals, with exits in the first hour of the next day to avoid midday noise.
Review Summary
How to Make Money Trading Derivatives receives generally positive reviews, with readers appreciating its focus on the Indian stock market. Many find it informative and useful for beginners, praising the explanations of concepts like trading capital and money management. However, some note that the book is outdated, with the last update in 2006. Readers value the practical insights and technical analysis but suggest complementing it with more current resources. Despite its age, many still recommend it for those interested in derivative trading in the Indian context.
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