BASICS OF MARKET

What is economics? 

 Economics can be defined as a science which deals with distribution,production and consumption of goods and services. 

 What is GDP ? 

GDP stands for Gross Domestic Product which is an indicator shows the total value of all the goods and services in a country within a specific time period. 

 What is the significance of GDP ? 

It shows the economic stability of the country. GDP has an impact on everyone who is in the economy. Higher the GDP means, higher is the business, unemployment is low, everyone earns money and spending is also more. That results in good growth for Companies and as regards the stock market, the share price of the companies goes up. 

 How GDP is calculated ? 

Most basic understanding of GDP calculation is adding up all the values what everyone under the economy earned in a year. This is also known as income approach. Another way of calculating GDP is adding up all values what everyone spent in a year. (expenditure method). Expenditure method is the common approach calculated by adding total consumption, investments, Govt spending and net of exports. In India, Reserve Bank of India announce the GDP growth rates periodically. 

 What is inflation ? 

In a general term, Inflation is a sustained increase in the average price of all goods and services produced when compared between two given periods. Eg : If the price of 1 Kg wheat is Rs 30/- in December 2010 and if it is Rs 33/- per kg now in December 2011. That means that inflation on wheat is 10%. ( price has increased by Rs 3/- over Rs 30/-in one year). 

 What are the causes for inflation ? 

Inflation (Increase in price) can happen for various reasons. 

1) If there is an increase in the cost of production like raw material price, rise in the labor costs etc, then the price of the finished products will definitely going to rise which may lead to inflation 

 2) Inflation may occur if the government of a country prints money in excess than what is actually required, to deal with financial emergencies. As a result, there will be more money in circulation than the products or services available in the market and demand for products increases which will drive the price higher. Money supply plays a large role in inflationary pressure as well. It is important to control the money supply adequately, otherwise it may actually grow at a rate faster than that of the potential output of products in the economy, or real GDP. This will drive up prices and hence, inflation. Low interest rates correspond with a high levels of money supply and allow for more investment in big business and new ideas which eventually leads to unsustainable levels of inflation as cheap money is available. 

 3) Inflation may also occur when Govt. imposes taxes on consumer goods like fuels or cigarettes. When the taxes increase, price also increase. 

 4) Inflation may be due to the national debts and international lending. The countries has to pay interest on the money borrowed from international institutions and as result increases the overall prices of commodities, to keep up with their debt repayment programs. 

 5) A fall in the exchange rate can also be a cause for inflation. Since the Govt has to deal with the differences in the imports and exports of the country, to make up with the difference there may be a overall price rise or taxes on other commodities. 

 How The inflation is measure ? 

Consumer Price Index (CPI) Inflation is measured through the consumer price index (CPI) CPI is a weighted average of prices of a specified set of goods and services purchased by consumers. It is a price index that tracks the prices of a specified basket of consumer goods and services, providing a measure of inflation 

 Wholesale Price Index (WPI) 

WPI is the index that is used to measure the change in the average price level of goods traded in wholesale market. In India, a total of 435 commodities data on price level is tracked through WPI which is an indicator of movement in prices of commodities in all trade and transactions. It is also the price index which is available on a weekly basis with the shortest possible time lag only two weeks. The Indian government has taken WPI as an indicator of the rate of inflation in the economy In India, Reserve Bank of India, announce the Price Index on weekly, monthly basis. 

 How the inflation can be controlled ? 

 There are broadly two ways of controlling inflation in an economy – Monetary measures and fiscal measures 1) Monetary measures 

2) Fiscal measure 

Monetary measures are the common method used to control inflation. In this method Govt makes some monetary policy changes like interest rates, CRR etc to control the money flow in the economy. All these policies are to control the money flow in the economy and hence reduced the inflation 

Fiscal measures are that , in which Govt makes some policy changes like reducing its own expenditure, reduces the public borrowings. Govt can also make some policy changes like banning export of some of the essential items like pulses, cereals and oil etc. 

Controlling the money supply is very important to keep the inflation on check. How does money supply works ? 

To understand this, let us consider an example 

Consider an economy where there are only two people A & B doing business. Money supplied is Rs 100/-. 

A and B do business with each other. A produces some goods and sell to B and B makes some goods and sell it to A. This cycle goes on. Money in circulation is only Rs 100/- 

In a month, “A” produced some goods and sold it to “B” for Rs 100/-. Money comes to “A”. Same way “B” also produced some goods and sold to A for Rs 100/-. Now the money change hand and comes to “B”.  

As a result, both A & B together made a business of Rs 200/- thus contributed Rs 200/- to the GDP in that month. Which means with a money supply of Rs 100, the GDP of the country in that month is Rs 200/-

If this cycle continues for 12 months, then the GDP will be 12 x 200 = Rs 2400. That is with a money supply of Rs 100/-, made a GDP of Rs 2400/- in a year. Money in circulation is only Rs 100/- but money keep changing hands. 

 Now les us consider little bigger example : 

Assume that there is a village with 10 people doing 10 different businesses and the money supplied is Rs 10 lacs. Each one of them produce something and sell it to one another. Each one of them does a business of approx 1 lakh per month. 

So the GDP is Rs 10 lakhs per month ( |Rs 1 Lakh business each ) which amounts to a GDP of Rs 1,20,00,000 a year. 

That means that, Rs 10 lakhs money supplied in to the economy, generated a GDP of Rs 1,20,00,000 ( Rs. One crore twenty lakhs). 

In both the examples above, we assume that all the parties BUY and SELL same amount every month.. All are earning approximately same amount In this village there were 10 businesses and money supplied Rs 10 lakhs and each one of them does Rs 1 lakh business per month. So there is no winner or looser. Money was changing hands at a particular speed and economy was running smoothly so far. 

If some more people start doing business, then what happens ? 

Assume that 2 more people of that village start doing business and their product being good, they become famous immediately and started doing Rs 1 lakh business per month same as other 10 business men who were doing business originally. Money supplied is still the same Rs 10 lakhs and there are 12 businesses now in that village. 

Now, if the money changes hand little more quickly than before, then everyone can make Rs 1 lakh business per month and eventually the GDP should grow to Rs 1,44,00,000 in a year ( 12 business men doing 12 lakhs business each in a year). 

But, if the money doesn’t change hands at the required speed ( velocity of money doesn’t change), then each one of the business men will be buying and selling less quantity than before and as a result each one of them would be doing a business of Rs 80,000 instead of Rs 1 lakh per month which they were doing earlier.

 Assuming that each one would be doing a business of Rs 80,000, then the business per year will be Rs 80,000 x 12 = 9,60,000 ( approx 10 lakhs) a year which is 2 lakhs less compared to the business they were doing earlier. 

Since there are 12 businesses in that village now, total GDP would be 12 x 10,00,000 (approx) = 1,20,00,000. ( which should have been 1 Crore 44 lakhs if the money as changed hands quickly). Here, though the GDP is still the same as before but divided among 12 people instead of 10 earlier and hence everyone feels like that the business is down or recession has started. 

What we found just now is there is a mismatch in the “demand and supply” of money here. So the central bank (Reserve Bank) now should take some action ( increase the supply of money or some other action) and bring the money flow into normalcy. This is just a simple example of how the money flow works. 

 What are the various ways RESERVE BANK adopt to control the money flow ? 

Reserve bank controls the money flow in the economy through various meausures like, interest rates, repo rates, reverse repo rate, CRR, SLR etc. 

bps 

bps stands for basis point and used to indicate changes in rate of interest and other financial instruments. 1 basis point is equal to 0.01%. So when we say that repo rate has been increased by 25 bps, it means that the rate has been increased by 0.25%. 

 Repo Rate and Bank Rate 

Repo rate or repurchase rate is the rate at which banks borrow money from the central bank (read RBI for India) for short period by selling their securities (financial assets) to the central bank with an agreement to repurchase it at a future date at predetermined price. It is similar to borrowing money from a money-lender by selling him something, and later buying it back at a pre-fixed price. 

Bank rate is the rate at which banks borrow money from the central bank without any sale of securities. It is generally for a longer period of time. This is similar to borrowing money from someone and paying interest on that amount. Both these rates are determined by the central bank of the country to control the demand & supply of money in the economy. 

 Reverse Repo Rate 

Reverse repo rate is the rate of interest at which the central bank borrows funds from other banks for a short duration. The banks deposit their short term excess funds with the central bank and earn interest on it. 

Reverse Repo Rate is used by the central bank to absorb liquidity from the economy. When it feels that there is too much money floating in the market, it increases the reverse repo rate, meaning that the central bank will pay a higher rate of interest to the banks for depositing money with it. 

CRR (Cash Reserve Ratio) 

All the Banks are required to maintain a percentage of their deposits as cash. Eg: If you deposit Rs. 100/- in your bank, then bank can’t use the entire Rs. 100/- for lending or investment purpose. They have to maintain a portion of the deposit as cash and can use only the remaining amount for lending/investment. This minimum percentage which is determined by the central bank is known as Cash Reserve Ratio. 

If CRR is 6% then it means for every Rs. 100/- deposited in bank, it has to maintain a minimum of Rs. 6/- as cash. However banks do not keep this cash with them, but are required to deposit it with the central bank, so that it can help them with cash at the time of need. 

 SLR (Statutory Liquidity Ratio) 

Apart from keeping a portion of deposits with the RBI as cash, banks are also required to maintain a minimum percentage of deposits with them at the end of every business day, in the form of gold, cash, government bonds or other approved securities. This minimum percentage is called Statutory Liquidity Ratio. Example If you deposit Rs. 100/- in bank, CRR being 6% and SLR being 8%, then bank can use 100-6-8= Rs. 86/- for giving loan or for investment purpose. 

 What is a Mortgage? 

A mortgage is the transfer of an interest in property (or the equivalent in law – a charge) to a lender as a security for a debt – usually a loan of money. A mortgage represents a loan or lien on a property/house that has to be paid over a specified period of time. Think of it as your personal guarantee that you’ll repay the money you’ve borrowed to buy your home. Mortgages come in many different shapes and sizes, each with its own advantages and disadvantages. Make sure you select the mortgage that is right for you, your future plans, and your financial picture.While a mortgage in itself is not a debt, it is the lender’s security for a debt. It is a transfer of an interest in land (or the equivalent) from the owner to the mortgage lender, on the condition that this interest will be returned to the owner when the terms of the mortgage have been satisfied or performed. In other words, the mortgage is a security for the loan that the lender makes to the borrower. 

Mortgages come in two primary forms, fixed rate and adjustable rate, with some hybrid combinations and multiple derivatives of each. A basic understanding of interest rates and the economic influences that determine the future course of interest rates can help consumers make financially sound mortgage decisions, such as making the choice between a fixed-rate mortgage or adjustable-rate mortgage (ARM) or deciding whether to refinance out of an adjustable-rate mortgage. 

 The Mortgage Production Line 

The mortgage industry has three primary parts or businesses: the mortgage originator, the aggregator and the investor. The mortgage originator is the lender. Mortgage originators introduce and market loans to consumers. They sell loans. They compete with each other based on the interest rates, fees and service levels that they offer to consumers. The interest rates and fees they charge consumers determine their profit margins. The aggregator buys newly originated mortgages from other institutions. They are part of the secondary mortgage market. Most aggregators are also mortgage originators. Mortgage-backed securities are sold to investors. 

Fixed Interest Rate Mortgages 

The interest rate on a fixed-rate mortgage is fixed for the life of the mortgage. However, on average, 30-year fixed-rate mortgages have a lifespan of only about seven years. This is because homeowners frequently move or refinance their mortgages. The Federal Reserve plays a large role in inflation expectations. This is because the bond market’s perception of how well the Federal Reserve is controlling inflation through the administration of short-term interest rates determines longer-term interest rates, such as the yield of the U.S. 

Concluding Tips 

An understanding of what influences current and future fixed- and adjustable-rate mortgage rates can help you make financially sound mortgage decisions. This knowledge can help you make a decision about choosing an adjustable-rate mortgage over a fixed-rate mortgage and can help you decide when it makes sense to refinance out of an adjustable rate mortgage. 

 BLUE PRINT OF INDIA 

 The man at the midst of all the action insists that the inspiration behind the National Manufacturing Policy which aims to achieve enviable growth figures in the next few years is not inspired by our northern neighbour, China, which has sustained rapid growth as it successfully scaled up its manufacturing capabilities over the past years. Leaving the ‘inspiration’ debate aside, what’s important here is that as the man of the moment, Commerce and Industry Minister Mr Anand Sharma, gears to introduce the first ever National Manufacturing Policy to the nation, we caught up with him to bring you some exclusive insights as to what’s going on in the power corridors. 

The pace is hectic and feverish as he gets into last minute troubleshooting before the National Manufacturing Policy is unveiled. The journey from draft to blueprint is proving to be an uphill task with steep challenges. The draft manufacturing policy, which has been in the making for 18 months and aims to attract overseas investments besides increasing the share of manufacturing in the GDP, has been stuck due to inter-ministerial differences with opposition coming mainly from the labour and environment ministries. These ministries are seen to be blocking the policy, which proposes to simplify the procedure in designated areas. The draft policy had suggested that the procedures be simplified in several ministries, including Labour and Environment, where inspector raj and a plethora of approvals make life difficult for companies. 

Apparently, the Indian industry had objected to the Environment Ministry’s intervention in some of the big-ticket projects that had halted the government’s development agenda and also resulted in declining foreign direct investments. The government is also concerned about an impending slowdown in the manufacturing sector and industrial production. While the industry raised concerns on the high cost of credit, investment slowdown, skill shortage, high input cost, hurdles in getting various clearances, environmental issues and debottlenecking of logistics, the ‘tool of change’ that this new policy is slated to be, promises to act like a magic wand. 

To start with, the draft policy promises to create 100 million new jobs and take the share of manufacturing to 25 per cent in the country’s GDP by 2025. At present, manufacturing contributes 15-16 per cent to the economy. And there are actions already being taken towards achieving this national dream. States like Rajasthan, Maharashtra and Gujarat have already initiated the land acquisition process for the super manufacturing zones, known as national manufacturing and investment zones, proposed in the new manufacturing policy. 

While the prospects are plum post this policy, it remains to be seen how it is implemented and practiced…therein lies the key to our fortunes.

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World Investment Report 2012

World Investment Report 2012

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E.A.S.Y method!

E.A.S.Y method!

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Market Profile Basic Introduction

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The Hidden Strengths of Volume Analysis - Part 2

In part 1, I discussed two examples of how and why volume can show the changing face of supply and demand. When the order of supply and demand is change we will get a change in market direction, sometimes a significant change in trend or otherwise some degree of retracement of the prior move. We will now continue on from that discussion and show larger periods of transition which can lead to quite substantial turning points in the major trends. These can be easy to identify, but do require some patience. If you did not read the prior article it would now be worth reviewing that before going on.

Let’s firstly take a look at AWB Limited.

Since early 2006, the price of AWB had been in a downward spiral. The story that eventually came out suggested AWB was doing some bad business against the UN sanction in Iraq. The initial shock sent the shares plunging by 18% in a single week. 

This is a sure sign of a change in sentiment and it’s not exactly rocket science to know there must have been some kind of bad news that changes the outlook.

But what is important here is that this significant sell off is actually the first sign that strength may start to appear in the near future. As I discussed in part 1, demand strength actually starts in price weakness and here is a sign of capitulation. A wide ranging bar on increased volume is a sign of panic and when we see panic we can usually expect that a bargain could be in the offering, but this is where the patience is required. What we usually start to see after capitulation is a transition from sellers to buyers. This transition has two important characteristics; firstly it takes some time and secondly prices do tend to drift lower. Let’s zoom into the AWB chart at Area 1 and also add our volume indicators.

Bar 1 is the capitulation; a very wide ranging bar and ultra high volume. Remember that ultra high volume is signaled when the volume histogram penetrates the volume Bollinger band. Bar 2 gaps lower but closes on the weeks high and does so on high volume. This is a sign that the Smart Money is interested in buying. There is no other way that prices can close higher on increased volume if buyers were not involved. Bar 3 however shows sellers returning; a push lower, a low close and another increase in volume. Bar 4 is the turning point and is a sure sign that buying interest is occurring. This is the time to start thinking that this market will turn higher soon. This bar shows a move to new lows but a complete rejection, i.e. a high close and very high volume. We’re seeing the Smart Money taking positions, even though the stock is drifting lower. Now take a close look at bars 5 and 6. What happens? Essentially they are inside days with a slight downward bias but look at the volume? There is none. Volume has dried right up. This means that sellers are done; they’re exhausted. Those that wanted to sell have either been fulfilled or do not wish to chase prices any lower. Bar 7 sees another probe lower, another high close and yet again a rapid increase in volume. Combined with bars 2 and 4, both of which show background strength, this is continued evidence that the stock is being accumulated. It’s only a matter of time before enough of the supply has been accumulated that prices will start to rise again. 

For the next 2 months AWB rallied 34% off that exact low. The first signs of upward price momentum would be the signal to initiate longs. We have the Smart Money footprints in the volume so we just need to time the entry for our own comfort. Take a look at the bars from that low. All down bars had low volume; all up bars had high volume. There was a specific transition from sellers to buyers which led to a reasonable, albeit unsustainable, price rise.

The following chart shows that advance in more detail. Bar 8 was a very promising bar indeed; a wide range higher, a high close and a good increase in volume. With the high close we can deduce that buyers had the control. Bar 9 is an important bar for current longs. It shows an attempted push higher, a reasonably tight range but more importantly a weak close and solid increase in volume. This is the first time that sellers had come back to the market. Now these sellers can originate from two sources; either profit takers that bought at lower levels, after all, it was a rapid rise in quick time which will always create profit taking; or it is very old longs who were waiting for the evitable bounce to get out of their positions. We’re not to know which, but what we do know is that selling has emerged and that caution is required.

Bar 10 shows a rise into new recent highs but a close on the absolute lows. This is of paramount importance – what does it mean? Bar 9 identifies sellers because we had a weak close on high volume. Immediately following, Bar 10 shows a low close on low volume, which suggests buyers have disappeared. If buyers have gone, who is going to support the market if those sellers from Bar 9 decide to chase prices lower? Nobody. If there is no buyer demand or buyer support then prices have the risk of falling until buyer demand comes back again. And that is exactly what has occurred. 

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The Hidden Strengths of Volume Analysis - Part 1

The power of correct volume analysis cannot be overlooked. Unfortunately the ability to read volume correctly is not readily discussed or freely available. Off-the-cuff remarks such as, “increased volume on advances is bullish and increased volume on declines is bearish” are bantered around but that’s as far as it goes. The correct use and application of volume can make for some quite startling insights into price action, especially when one is swing trading or leaning against support and resistance points or zones of confluence.

I set up my charts with a couple of extra volume measures. I use a normal volume histogram that can be found with almost all software packages. However, if there is a larger volume spike skewing the ability to read the volume properly I will edit the data accordingly. Next, I add a 10-day moving average of the volume. This gives me a guide as to what is below average or above average volume on any given day. Lastly, I add in a 2- standard deviation of the 20-day volume average. Essentially this is like the upper Bollinger band of the volume average. This shows me when ultra-high volume occurs

Figure 1: Chart Setup for Volume Analysis

With these added extras we can quickly gauge the personality of the day’s volume as well as benchmark it against the surrounding volume. The exact volume reading is not important. The concept of relative volume is the key.

I’m going to make reference to The Smart Money throughout this article. The definition I use for the Smart Money is:

A group of professional users that act in unison at very specific levels and points of time to change the order of supply and demand.

The Smart Money are the one’s who constantly buy the lows and sell the highs. Let me say that this is not a bunch of traders ringing around attempting to manipulate the price. We don’t need to know who or why but these are the people we wish to follow. We do so by watching their footprints, and their footprints are shown within the daily volume. The Smart Money will show their hands by selling into strength and buying into weakness. As the Smart Money can change the order of supply and demand we can therefore ascertain that strong price action may in fact contain weakness and weak price action may in fact contain strength. I appreciate this may go against most things you’ve learnt about volume but it’s important to keep that thought in the back of your mind. Increased supply, and therefore weakness, may occur during price strength. Increased demand, and therefore strength, may occur in price weakness.

                                                                           

The first thing to understand about volume is that it’s not just the volume by itself we’re interested in. At any particular price a major misconception is to think that for every buyer there is a seller and in turn volume is null and void. If that were really the case then prices would simply not move. What drives prices is the fear and greed of the buyers and sellers. It’s therefore the relationship and interaction between volume and price that shows us what is really occurring in the market. Think of volume as the effort of one side and the price activity as the result of those efforts. If sellers are desperate to exit then they will be more inclined to sell at the bid rather than sit back on the offer. If there is not much buying demand below the market then prices are going to be driven lower until those sellers are fulfilled or are unwilling to pursue prices any lower. Conversely, if buyers are desperate they will buy the offer and not sit on the bid. If buyers are desperate and there is not much supply above the market then you’re going to see prices move up until those buyers are fulfilled or unwilling to pursue prices any higher.

The mantra of volume analysis is:

“What is the result of the effort?”

The most basic example of a volume/price relationship pattern is a straightforward blow-off top or bottom. As technicians we all know what these are and we also know what they tend to mean. Figure 2 shows a perfect recent example of a blow-off bottom in Lihir Gold (LHG).

Figure 2: Typical blow-off low in LHG

The gap opening on that low day means sellers were indeed desperate. There is no other way to account for that gap except simple selling pressure. They over-ran all buyer demand until they were fulfilled. They even managed to keep pushing prices lower. But remember, previously I suggested that demand strength occurs in price weakness. LHG had certainly been declining up until that point. So, if there was no demand strength, how could prices rise from thereon?

The demand strength is shown by the effort and the result. Effort was certainly very high because volume was very high, in fact ultra high. This means a substantial number of transactions took place between buyers and sellers. But, what is the result of that effort? The result of that effort is that the market closed on its highs for that day which means that buyers have clearly over-powered the desperate sellers. When a lot of effort or a lot of volume takes place we know the Smart Money is involved because they are the big players and they are the one’s that can change the course of supply and demand. This is a prime example where the Smart Money has decided that LHG is a value buying proposition and they move into the market to absorb the selling volume. They are the stronger party. It’s the weaker hands capitulating. This is why I said that demand strength will appear on weakness. If the Smart Money have absorbed all the selling volume and the sellers are fulfilled, how can prices go any lower? They can’t, is the answer. And if prices can’t go lower then they will tend to go back up because now there is no overhanging supply capping the market.

Let’s look at the exact same concept but without the blow-off. Remember the core thinking; increased supply and therefore weakness may occur during price strength and what is the result of the effort?

Again we’ll use LHG but note this time the absolute high bar is a very small tight range and not the standard blow-off that we’re normally used to seeing.

Figure 3: The Smart Money appears at the absolute high

Firstly, the volume is extremely high, almost ultra high. We therefore know there are a lot of transactions taking place and in turn a lot of effort being put into the day. So what is the result of that effort? A very tight range with the close on the lows and below the open. What does it suggest? Clearly the sellers have overpowered the buyers. The buyers must have been desperate because prices have been gapping higher and they were most likely desperate from probable good news.

Ever heard the saying, “buy the rumour, sell the fact”? Do you ever wonder why prices go down after a positive announcement? Do you think the Smart Money knew the facts or the good news beforehand and the reason why they’re already long? I think so. So when the good news is announced to the market all the weaker hands jump in and start buying and the Smart Money take the opportunity to offload their positions into the demand strength.

Look at that LHG chart again in Figure 3. Prices were already trending higher. The Smart Money has already bought because they knew what was coming. When the announcement came they took their profits and sold their positions to all the latecomers. The force of buying from all the latecomers was large. We know this because the volume was high. But the force of the Smart Money selling and standing firm in the face of large buying was even larger and is why the days range was so small. If the Smart Money thought prices were going to travel higher, then they would not be selling and we would’ve had a wide ranging up day on light volume. But because the Smart Money knew that prices would most likely not go any higher, they stood their ground and simply offered their supply into the buying from the weaker hands.

Let’s think about what all those weaker hands are thinking at the close of that session. Good news has been announced. I bought the stock accordingly but it’s now closed below where I purchased it so I’m wearing a loss immediately. You can see them almost scratching their heads! Because the Smart Money had absorbed all the buying demand there is now no follow through buying demand. All the weaker hands are all of a sudden slightly nervous. Any slight weakness will see them exit their positions. They wait a day or so in wonderment but look at what occurred on the 3rd day after the high. A down day on increasing volume. Those weaker hands that bought the highs have had enough and are getting out whilst they can. They walk away with yet another loss but none the wiser as to why prices didn’t go higher on the good news.

So whenever you see a very tight range at new highs or lows that is accompanied with ultra high volume, you know the Smart Money is trading the other way. They are large enough to change the trend so you’d better listen. These are two simple examples of reading volume correctly. There are many more to be aware of, but remember the mantra, “what is the result of the effort?”

The best book on volume/price analysis is Master the Markets by Tom Williams who is the Richard Wyckoff of the modern era. Its 190-pages packed with volume and price characteristics and I rank it as one of my top-5 trading books ever.

Nick Radge can be contacted at The Chartist

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A 10-Day Trading System

Life is really simple, but we insist on making it complicated. -- Confucius

There are many different systems and techniques that traders can learn to help themselves gain an edge in their trading. Some of these are complex, but they do not have to be complex to be good. The 10-day System is probably the simplest one you will ever learn, yet it can be very helpful, especially during choppy markets.

The 10-day System works on the simple principle that when the markets (especially the S&P 500 index) are at 10-day relative highs or lows, the trend will change direction temporarily. A 10-day low happens when the closing price of a certain day is lower than the close of the last 10 days. This usually results in a strong bounce in price within 5 days. A 10-day high happens when the close is higher than the close of the last 10 days. The 10-day high's results are a little more erratic, but often the results are downward or at least flat movement for the next 5 days.

Here is the 10-day System chart from the first few months of 2006.

The blue arrows indicate a buy according to the system, which is the morning after a 10-day low is reached, while the red arrows indicate a sell signal the morning after at 10-day high is reached. This chart is a good demonstration of how accurate it can be at times. During strongly trending markets, the results are not quite as good, but it is still usually pretty good for predicting short pauses, at least, in the trend.

The 10-day lows are, by far, more useful then the 10-day highs. Since 1980, the 10-day lows have been an accurate predictor of short-term gains on the SPX index about 62% percent of the time. Simply buying the morning after a low signal and holding for exactly 5 days each time, as described above, would have yielded a gain of around 120% for the 26 year time period, and that is without reinvesting profits.

While that, in itself, is impressive, it is definitely not the only way that you can use the system. The 10-day System is probably best used to direct your other trades. For example, if you swing trade stocks or options and notice that the 10-day System hits a high signal, you might avoid or cut back on your bullish trades for a few days.

Price Headley is the founder and chief analyst of BigTrends.com.

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The Trend is your Friend TRADERS’ BIGGEST PROBLEM Trading is an great way to make a living and/or accumulate large sums of wealth. As a trader you alone are responsible for all your decisions that you may take to make profits and/or losses in the course of your trading career. As a trader you alone will be responsible for all or any loss that you may make and on the other hand you do not have to thank anyone for your profits. You are the boss and you are not obligated to anyone expect yourself.  However there is a problem that most traders do not understand and that is that most of the time the market does not move in trends. The market only trends only 30-50% of the time. The rest of the time the market is sleeping or it does not have a discernable trend from which traders can make money. Professional traders make most of their profits in a trending market. By following trends over different time frames, traders can increase their profit making opportunity in trending markets and stay away from markets when they are not trending. The Trend is your Friend TREND AND TRADING RANGE  Traders try to profit from changes in prices: Buy low and sell high or sell short high and cover low. Even a quick look at a chart reveals that markets spend most of their time in trading ranges. They spend less time in trends. A trend exits when prices keep rising or falling over time. In an uptrend, each rally reaches a higher high than the preceding rally and each decline stops at a higher level than the preceding decline. In a downtrend each decline falls to a lower low than the preceding decline and each rally stops at a lower level than the preceding decline and each rally stops at a lower level than the preceding rally. In trading range most rallies stop at about the same high and declines peter out at about the low. A trader needs to identify trends and trading ranges. It is easier to trade during trends than in trading ranges. PSYCHOLOGY OF TRENDS AND TRADING RANGE An uptrend emerges when bulls are stronger than bears and their buying forces prices up. If bears manage to push prices down, bulls return in force, break the decline, and force prices to a new high. Downtrends occur when bears are stronger and their selling pushes markets down. When a flurry of buying lifts prices, bears sell short into that rally, stop it, and send prices to new lows. When bulls or bears are equally strong or weak, prices stay in a trading range. When bulls manage to push prices up, bears sell short into that rally and prices fall. Bargain hunters step in and break the decline, bears cover shorts, their buying fuels a minor rally, and the cycle repeats. Prices in trading ranges go nowhere, just as crowds spend most of their time in aimless mulling. Markets spend most of their time in trading ranges than trends because aimlessness is more common among people than purposeful action. When a crowd becomes agitated or excited, it surges and creates a trend. THE HARD RIGHT EDGE Identifying trends and trading ranges is one of the hardest tasks in technical analysis. It is easy to find them in the middle of the chart, but the closer you get to the right edge, the harder it gets. Trends and trading ranges clearly stand out on old charts. Experts show those charts on seminars and make it seem easy to catch trends. Trouble is your broker does not allow you to trade in the middle of the chart. He says you must make your trading decisions at the hard right edge of the chart! The past is fixed and easy to analyze. The future is fluid and uncertain. By the time you identify a trend, a good chunk of it is already gone. Nobody rings a bell when a trend dissolves into a trading range. By the time you recognize the change, you will lose some money trying to trade as if the market was still trending. Most people cannot accept uncertainty. They have a strong emotional need to be right. They hang on to losing positions, waiting for the market to turn and make them whole. Trying to be right in the market is very expensive. Professional traders get out of losing trades fast. When the market deviates from your analysis, you have to cut losses without fuss or emotions. THREE IMPORTANT TRENDS You may be asking yourself the question, "What is a trend and how long does it last?" There are countless numbers of trends, but before the advent of intraday charts, there were three generally accepted durations: primary, intermediate and short-term. The main or primary trend, is often referred to as a bull or bear market. Bulls go up and bears go down. They typically last about nine months to two years with bear market troughs separated by just under four years. These trends revolve around the business cycle and tend to repeat whether the weak phase of the cycle is an actual recession, or if there is no recession and just slow growth. Primary Trend Primary trends are not straight-line affairs, but are a series of rallies and reactions. These series of rallies and reactions are known as intermediate or medium term trends. The intermediate or medium term trend can vary in length from as little as six weeks to as much as nine months, or the length of a very short primary trend. Intermediate trends typically develop as a result of changing perceptions concerning economic, financial, or political events. It is important to have some understanding of the direction of the main or primary trend because rallies in bull markets are strong and reactions are weak. On the other hand, reactions in bear markets are strong and rallies are short, sharp, and generally, unpredictable. If you have a fix on the underlying primary trend, you will be better prepared for the nature of the intermediate rallies and the reactions that will unfold. In turn, intermediate trends can be broken down into short-term trends, which last from as little as two weeks to as much as five or six weeks. Market Cycle Model As an investor, it is best to accumulate when the primary trend is in the early stages of reversing from down to up, and liquidate when the trend is reversing from up to down. Second, as traders, we are better off if we position ourselves with the long side in a bull market since that is when short-term uptrends tend to have the greatest magnitude. By the same token, it does not usually pay to short in a bull market because declines can be quite brief and reversals to the upside unexpectedly sharp. If you are going to make a mistake, it is more likely to come from a counter-cyclical trade. If you're an intraday trader, you may think all of this does not apply to you, but really, it does. It is important to remember that even on intraday charts, the predominant trend determines the magnitude and duration of the shorter moves. You may not feel a three-hour rally is closely related to a two-year primary bull market move, but it is just as related as a five or six-day trend. Charles Dow, the author of the venerable Dow theory, stated at the turn of the century that the stock market had three trends. The long term trend lasted several years, the intermediate trend lasted several months and anything shorter than that was a minor trend. Robert Rhea, the great market technician of the 1930s, compared the three market trends to a tide, a wave and a ripple. He believed that traders should trade in the direction of the market tide and take advantage of the waves and the ripples to time your entry and exit. CONFLICTING TIMEFRAMES Most traders ignore the fact that markets usually are both in a trend and in a trading range at the same time! They pick one time frame such as daily or hourly and look for trades on the daily charts. With their attention fixed on daily or hourly charts, trends from other time frames, such as weekly or 10 minute trend keep sneaking up on them and wrecking havoc with their plans. Markets exist in several time frames simultaneously. They exist on a 10 minute chart, an hourly chart, a daily chart, a weekly chart, and any other chart. Traders often feel confused when they look at charts in different time frames and they see the markets going in several directions at once. The market may look for a buy on a daily chart and a sell on the weekly chart, and vice versa. The signals in different time frames of the same market often contradict one another. Which of them will you follow? Most traders pick one time frame and close their eyes to others – until a sudden move outside of “their” time frame hits them. A FACTOR OF FIVE When you are in doubt of a trend, step back and examine the charts in a timeframe that is larger than the one you are trying to trade. A factor of 5 links all timeframes. If you start with the weekly charts and proceed to the dailies, you will notice that there are five trading days to a week. As your timeframe narrows, you will look at hourly charts – and there are approximately 5 to 6 trading hours to a trading day. Intra day traders can proceed even further and look at 10 minute charts, followed by 2 minute charts. All are related by a factor of five. The proper way to analyze any market is to analyze it in at least two time frames. If you analyze daily charts, you must first examine the weekly charts and so on. This search for greater perspective is one of the key principles of the Traders Edge Multiple Time Frame Trading System. METHOD AND TECHNIQUES There is no single magic method to identifying trends and trading ranges. There are several methods and it pays to combine them. When they confirm one another, their message is reinforced. When they contradict one another, it is better to pass up the trade. Analyze the pattern of highs and lows. When rallies keep reaching higher levels and declines keep stopping at higher levels they identify an uptrend. The pattern of lower lows and lower highs identifies a downtrend, and the pattern of irregular highs and lows points to a trading range.   Draw an uptrendline connecting significant recent lows and a downtrendline connecting significant recent highs. The slope of the latest trendline identifies the current trend A significant high or low on a daily chart is the highest high or lowest low for at least a week. As you study charts, you become better at identifying those points. Technical analysis is partly a science and partly an art.   The direction of a slope of a moving average identifies the trend. If a moving average has not reached a new high or low in a month, then the market is in a trading range.   Several market indicators, such as MACD and the Directional system help identify trends. The Directional system is especially good at catching early stages of new trends. CONCLUSION When you trade in the direction of this long a trend, you are truly following the markets rather than predicting them. However trading with the trend is hard to do because a logical give-up exit point will be farther away, potentially causing a larger loss if you are wrong. This is a good example of why so few traders are successful. They can't bring themselves to trade in a psychologically difficult way. This article contains content from New Trading Dimensions, written by Bill Williams and Trading for a Living, written by Alexander Elder.

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