IST Theory - What is IST & why the NIFTY?

Ok, I think it is time to explain what IST stands
for.

IST = I Sell Time

When I first thought of this blog, I had decided
to call it ISellTime. It is only later that a
better name occured to me. However, my technique,
which I intend to polish into a theory, retains
the original monicker.

Why the NIFTY? Why not the E-Mini S&P 500, which
I actually use? Two reasons -

1. I want to demonstrate how the theory works for
any liquid, broad market index.

2. It keeps me focused on the theoretical aspects,
which is difficult to do with something I trade
every day.

There is also a third reason, which is that I dont
want to give too much away. I depend on this for
a living, and I make no bones about the fact that
I have had and still have apprehensions about
writing this blog.

Thanks for your viewership!

IST Theory - The NIFTY one month later

Please refer to my post of 4/29/08 titled
"The NIFTY is approaching 200dma resistance".

Here is last weekend's summation -

4875 rsi 33.41, 50/200 4909f/5205uf
low 4448 Jan 22 4468 Mar 18, hi 5298 May 2
weekly uptrending 50wma at 5075, line lost again!
wrsi 47.04, must rise and take out 50 else trouble
fib levels 6357 - 4468 = 5189 hit! 5412 5635
DB breakdown 5/26 bearish po 4600

Let me quote what I wrote in the previous post-
"This first approach will ALWAYS fail, though
one does not know WHEN it will fail". I was
referring to the 200dma resistance.

Let me draw the latest weekly chart. Remember,
about 4 weeks have elapsed.



Ah, one can see that it went up to about 5298
before turning around. Thats roughly 100 points
above the 200dma ( not shown in these weekly
charts but you can take my word for it! ). Since,
it has fallen to just below its 50dma at about
4900.

Let me explain the cryptic lines in the analysis
above-

1. price, rsi, 50dma, 200dma.
4909f means 4909 flat.
5205uf means 5205 sloping up but flattening.
The 200dma line, which slopes healthily up in
a nice bull market, is flattening! If it curves
down, it will form a strong downward sloping
resistance, or that unhappy word DOWNTREND!

2. some recent significant highs and lows

3. the 50 weekly simple moving average line ( see
chart ) which had held the nice move all these
months, and the nifty jittering around it.
Still nothing too bad.

4. a comment on the weekly 14-RSI, as can be seen
from the chart. Back in March 2007 and July 2006,
this indicator plunged the depths of March 2008,
then picked up and didnt look back. We need the
same to happen, so the 50 line becomes important.

5. fibonacci retracement levels of the move down from
6357 to 4468. We have claimed the 1st level at 5189,
which unhappily was close to the 200dma. Thus double
trouble!

6. a p&f chart comment- on 5/26 we had a double bottom
breakdown and the bearish price objective, 4600.

So, the approach to 200dma did fail, and this time
the 1st fib retracement level was also sitting there
to make it more difficult. But we could not know
WHEN it would fail.

I wont bother you with classical trading analysis
of the nifty, since I am doing that with the Euro.
I just wanted to say that one way to play this
would be as follows -

Sell a CALL option above the resistance zone
For symmetry, sell a PUT option below the support zone

That, my friends, is a short strangle. Its what
I do for a living!

Questions -

1. Which months options to sell?
2. Exactly which strikes to sell?
3. What happens if my strikes are approached?

The answer to those questions, is my speciality.
I do not need to be able to predict where the
nifty will go - I have already collected my
cash by selling the strangle. All I need to do
is to be able to protect my money. I need to
react if it looks like I may be exercised on
my short options.

"Do not predict; react!"

Thanks for your viewership!

The Euro story - Recovery

Something has finally happened in the Euro. Lets
first look at what we were doing before. We traded
the Euro short on the classic trendline break,
got a 200 pip reward and closed our position
after reaching the reward level.

We then said we will wait to see if it goes further
down or goes back up. I am showing the annotated
chart below to explain all this in a simple picture.



This is the daily chart with the Fibonacci levels
and annotations of what we were doing. The Euro
held support at the March 23 swing low on May 4
and has since been going up on mild volume. We
will now switch to the hourly chart.

Remember, we said that when it does start to go up,
it will encounter resistance at the inflection point,
which was the point where it did the classic trendline
break and which also, once the swing low support
held, was close to the 50% retracement level of
the fall to the swing low. The next annotated chart
shows this.



Please follow the datewise comments boxes till you
come to 5/16. Everything should be clear. Please note
the lack of volume since 5/16 as we await confirmation
of whether the inflection point, which I mentioned
in a previous post would be strong resistance, has
now become support.

When will we know it ( in the sense that of course
one never really knows anything but when can we be
sanguine about it ) ? Remember what happened when
we went short. Here it is -

1. A significant chart action takes place with volume.
2. Our attention is drawn.
3. We wait to see if it is a head fake.
4. We get confirmation that the action is not a fake.
5. We take action, with a suitable risk-reward ratio.

For the above 5 steps to play out now, following will
have to take place -

1. The inflection point must hold on a test, with volume

Once that happens, where will we go long and what will
be the risk-reward? For that, we need a different chart.
Here it is -



The chart clearly shows how the rising trendline and
the inflection point will intersect to form a strong
test area. If this area is tested with volume, we
will have to surmise that the trendline break on
4/24 is now history and we will at least be going
back to the 4/23 high and maybe beyond.

If the trendline/inflection point is not tested,
we will be in watch mode. One possible situation
could be that it will move up on low volume to
the 4/23-4/24 highs where there is the strongest
resistance.

In the next post on the Euro, we will avoid these
number crunching exercises and try to distill exactly
what we have been trying to do. This will lead to
our 3rd law of trading - "Support becomes resistance;
resistance becomes support".

Thanks for your viewership!

Delusions - Why technical analysis works - 1

A few posts back I alluded to the "self-fulfilling nature
of technical analysis". I will start the series with this
post. I couldnt think of a clever name for it!

Please look at the chart of the S&P500 below and read my
comments in the right margin.



The S&P 500 has been in an uptrending channel since the
"Bear Stearns bottom" on March 17. Thats when the Fed
made a signal statement of the kind they rarely have in
the past, viz, "We will NOT allow the market to collapse".

Of course, what impact that will have on inflation, and
whether inflation will ultimately destroy whatever
little gain can be had from the Fed-supported stock
market, is a whole different story!

Anyway, I have a few points to make, and here they are.

1. Do you think the index has been supported by the
uptrend line or the 20-DMA ?

2. Was the index turned back at the start of May from
the 200-DMA or the top of the uptrend channel ?

3. Is the RSI holding above 50 for the last month or
so a sign of strength?

4. Is it time to rejoice now that the MACD has crossed
above the ZERO line?

I will give you the answer to these questions. The
answer is "Your guess is as good as mine". But thats
not the whole point of the story.

The point of the story is that these technical
parameters and events are what is used by the majority
of program trading systems which have such a huge
impact on the market these days.

And thus, the reason why technical analysis works
is not some inherent magic in moving averages, channels
or anything like that. It works because of the same
principle which would have allowed you to double
your money many times over if you had bought the
Dow 50 years ago and sat back and done nothing
since - the "herd principle".

You will go only so far with the "herd principle",
and that too when you are good enough to be on the
side of the majority herd more often that not,
which is no easy task. Maybe you will make 10%
annually with some consistency, and pat yourself
on the back for you would have beaten most overpaid
money managers on Wall Street. You will most assuredly
NOT make the kind of returns I do on a regular basis.

Times are changing. Events of great significance are
taking place. There is more money in the swap market
than in the stock market. Commodities are no longer
the playfield of commercials and speculators, but
of investment-minded pension funds! The "herd" which
ran things are finding themselves out of their depth!
Will you be able to choose the correct herd?

There will always be a place for technical analysis.
We need to understand what the herd is thinking.
But we certainly do not need to trade like them!

Thanks for your viewership!

Delusions - The kind of analysis you dont want to read - 2

Here we go again.

"JUNE JAPANESE YEN -- The market posted the lower close
of the downward trend on the projected reversal date and
the 161.8% Fib extension. Since then, the market has
drifted away from the centerline and appears to be forming
a bullish TR pattern. Friday's session closed above the
20-day SMA, while Monday's session pulled back and closed
slightly below the SMA. This is typical market action and
provides a buying opportunity. -- Buy the Japanese yen at
9775 stop, with a protective stop at 9600."

Out of sheer kindness, I am keeping the attributions out
of these posts. I want to draw your attention to the
175-pip risk, with no reward mentioned anywhere. I call
this kind of analysis the worst word I can think of
calling it - "daily wage literature".

By the by, at the bottom of the page where this analysis
is from is the following legend -

*Due to the volatility of the markets, all trade
recommendations are subject to change without notice."

Talk of covering your backside!

What I will reveal to you as this blog unfolds, and
which I will back up with every monthly statement
from my account, is how to make money irrespective
of market volatility. I will not make a recommendation
with the proviso that it may be defunct tomorrow.

A few articles back, I had mentioned the 2nd principle
of my trading - "Do not predict; react!". That is just
the opposite of this stuff, which can be summed up
by "Predict away; but I may be wrong!".

Thanks for your viewership.

Primer - A simple lesson on the MACD and RSI

The MACD ( moving average convergence divergence ) and
the RSI ( relative strength index ) are two of the most
widely known technical indicators. But I am certain
most people do not know when to use one or the other.

Here is a simple explanation. You can read a lot about
these indicators at sites like stockcharts school. But
you will not know what I will write here, which is more
important than blindly digesting technical details.

The simple rule of thumb is, use the RSI in a ranging
market and MACD in a trending market. A ranging market
is one where the price keeps oscillating between two
levels, and this happens often, sometimes lasting for
months and even years. A trending market is like
the one of the Euro futures I showed in the post
on the classic trendline break.

In either market, use the respective indicator only
to time trades. The primary trade setup should still
be based on the technicals of the price/volume action
and a well-grounded fundamental knowledge on the time
period being considered for the trade. Within this
framework, you can use the RSI or MACD to tighten
your entry point.

Here is an example of the MACD in a trending market.



I suggest you look up charts of the Euro, Yen or
S&P500 for other RSI and MACD setups that have occured,
while keeping firmly in mind that if technical
indicators indicated oversold or overbought conditions
or trend changes correctly, then everyone in the world
would have been a successful trader!

Why did I say the above, after seeming to endorse the
use of the indicators in some capacity? The reason
will be clear as I expand on another subplot of this
blog, the self-fulfilling nature of technical analysis.
I am still thinking of a good name for it!

Thanks for your viewship.

Delusions - The kind of analysis you dont want to read - 1

I am thinking of various different themes for this blog.
If every post is like every other post, it gets dreary.
I know, because I have read tons of stuff over the years
and if I start naming names, it will prove what I am
talking about.

One of the things I feel very strongly about is advising
people who read these kind of sites and blogs to think
carefully why they are reading them. It is alright to
read them to gain knowledge of facts. For instance,
I may not always have every fact in my head, and sometimes
something somewhere just jumps out and grabs my attention.
Happens about once in 2/3 days, and it is necessary to
read a lot for this alone.

What one should NEVER read trading sites for is to trade
the ideas therein. There is just so much rubbish out there
that you will not make a profit doing so. To highlight
this, I will periodically post samples of what one should
avoid ( or pay no heed to ). Also, one should carefully
rethink whether one wants to continue reading a site
or author who writes stuff like this.

You know why? Because he is getting paid to write this
stuff, while you will lose your shirt if you take him
seriously.

So here is sample #1 of the kind of analysis
you dont want to read.

" Oil has had one record high after another. Still there
are signs that this run is coming to an end. China demand
fell sharply in April and the dollar is showing signs of
firming. The Dollar has been a major driver of oil and if
it firms oil will not be able to hang on to these gains.
Oil should correct. Sell June crude at 12700 stop 12750."

The above, my friends, is a hot potato. DROP IT!
Thanks for your viewership.

Primer - A quick introduction to speculative sentiment analysis with the Euro

We are waiting on the Euro, with Trichet coming out with
a very hawkish outlook yesterday which probably saved it
from the fall which would have triggered our short trade.

Please note that I do not make these trades, but I am using
the Euro to teach how I would trade if I was like the
majority of traders who buy and sell futures trying
to capture swings. I will come back to my trading techniques
featuring my 2nd principle of trading "Do not predict; react!"
that I first introduced in my post on the Perils of Price
Prediction. But a few things must happen before that,
and I am taking the time to do some more conventional
analysis.

Anyway, in this article I will briefly introduce the concept
of speculative sentiment and its contrarian signals.
The futures market participants are divided into two
main classes, the commercials and speculators. The
commercials are actually interested in buying or selling
the underlying commodity or currency, while the speculators
are only interested in making money off the movements
in price. An example of a commercial is a gold mining
company. An example of a speculator is me.

There are two classes of speculators, or specs for short.
The large specs and the small specs. The differentiation
is based on how many contracts a spec holds, long or short.
It is not very important for our topic.

Speculative sentiment measures the current ratio of
longs to shorts among the speculators. Remember that
for every future contract in existence, there is someone
who sold it and someone who bought it. It is a zero
sum game. But the zero sum is across the entire market,
including commercials and specs. Within each class,
however, the sum is not necessarily zero. In fact,
it very rarely is.

As an example, lets look at the Euro June 2008 futures
which we have been following. It so happens that at
the moment, 52% of specs are long ( thus 48% are short ).
The longs are those who are bullish, of course. The
shorts are bearish. Sentiment is 1.10, which is 52
divided by 48. If 52% of the specs would have been short,
the number would be -1.10. This is just a convenience;
what it means is that positive numbers are bullish and
negative numbers are bearish, and the absolute value
of the number is the ratio by which the majority exceeds
the minority.

Now I will show the chart of the Euro nearest futures
plotted against the SSI ( speculative sentiment index,
which is what we call it ) over the last 5 years.



You will notice that since late 2006, sentiment has
been consistently bearish while the Euro has made an
uninterrupted run upwards. Why is this important ?
Because with the latest SSI numbers finally turning
positive ( bullish ) this increases the chances that
there will be a correction in the Euro, which makes
me a little more confident if and when my short entries
are triggered.

Thanks for your viewership!

The Euro story - Swing low reached

Continuing the Euro story, we show the latest daily
chart with the swing low of March 23 marked;
notice the level has been broken down to 1.5255
in the small box at top left which gives current
day's numbers.



The Euro did not make it up to the 1.5650 resistance zone.
As I had posted, the other alternative was that it would
go down to the March 23 swing low of 1.5273. Well, with
the ECB President Trichet ( a renowned hawk and a market
mover ) due to take an interest rate decision today, the
markets are getting a little jumpy. For long Trichet has
highlighted inflation as the primary concern, and the
rate bias as hawkish. It seems the bank may change its
dialog today, though the rate itself will likely remain
at 4%. If it does, and there is some concern expressed
towards growth, then the Euro may be sold off across the
board.

Lets see how we may be able to trade this. As I had
mentioned earlier, a break of the March 23 swing low would
set up a short trade which will be taken when the 50%
Fibonacci level at 1.52 is broken for the 2nd time.
What seems likely is that the nervous markets will
trade the Euro down thru that level post the ECB decision.
We will then wait for a bounce, and see if it fails.
If it does, and trades back down below 1.52, we will
go short.

Since this is some distance away, we will enumerate
stops and targets when ( and if ) it happens.

Thanks for your viewership.

The Euro story - Inflection Points

The Euro June 2008 futures broke the 38.2% retracement level of 1.54
on Friday. We are out of this hypothetical trade at the moment,
since it hit our profit target. But we will continue to monitor
the charts. Here is the 30-day hourly chart with Fibonacci
retracement levels for the fall from the peak of 1.5988 on
4/22 to the low of 1.5324 on 5/2.



If the Euro did put in a short-term low on 5/2, which I
think happened due to the volume spike similar to the
one on 4/18, then we may see it retrace according to
the levels shown in the picture. But that is not my
point here. I want to show what the inflection point is.

In this example, the inflection point or pivot is quite
clearly the 50% orange Fibonacci line. This does not always
happen, but when it does, it is a VERY STRONG resistance
level. Our next hypothetical Euro trade will start forming
when it tries to come close to this inflection point.
Remember this is the same point where we placed our
original stop ( we placed it just above it to be safe
from noise ). It is at 1.5650-1.5700. That is the resistance
zone.

Of course it is entirely likely that the Euro will continue
its descent. If it does, we will wait to see what happens
when it approaches 1.5273, a swing low from March 23.
If it breaks this swing low on volume, we will be back
in the trade aiming for the 61.8% retracement level of
1.50. We will make that trade when it dips below the
50% retracement level of 1.52 for the 2nd time, similarly
to the way we did our trade on the break of the 1.5604
low.

Here is the chart showing the swing low of March 23.



Thanks for your viewership!

IST Theory - April 2008 MTM performance summary

I would like to show you my MTM performance for April 2008.
An internal rate of return of 6.46%! This follows 5.63%,
1.76% and 12.64% for the 3 previous months. I have attached
proof of the earlier months before. Here is the proof
for April, from my IB account.



Thanks for your viewership!

IST Theory - The perils of price prediction

We will now look at my 2nd principle of trading -

"Do not predict; react!"

Now this is something most people do not understand,
and I think that includes most of the so-called expert
traders. I will try to explain it over time, and in this
post I will give an example of what I call the perils
of price prediction. I will use the Euro June 2008
futures, which is why I posted the previous article
on the trendline break and suggested a trading idea.
I also made it clear I would not make the trade myself.

If you look back at the post "A classic trendline break"
I said to short it below the low of the break day which
was 1.5604. My target was the 1st Fib retracement level
of 61.8% at 1.54; the stop was the closing price on the
break day at 1.5651. What happened since then ?

Here is what -



Above is an hourly chart of the Euro covering the last
2 weeks. Notice 4/24 and then look what happened
thereafter. We would have gone short on 4/25 when it broke
the 4/24 low. The target 1.54 was reached on 5/1. A good
200 pip 1 week trade, the classic swing trade!

WAIT A MINUTE! No! Look at what happened on 4/28 ( the
dashed line ). The high ? 1.5663! I was stopped out for
a 60 pip loss!!

But wait! I actually was foreseeing some of this
due to the FOMC / end of month volatility. I had said
right at the end of my post that I would raise the
stop to where the 9-DMA stalls at 1.5672. So I was
ok after all.

Now the point is, does the fact that my first stop
failed but my second stop succeeded make me a trader
who could earn his living from trading?

The answer, my friends, is a resounding NO.

In investing, one can do certain things with price
prediction. In trading, it is a LOSING game. This is
why almost all traders fail.

I hope you have learned the perils of price prediction.
Its a coin-toss, no matter how good a technical analyst
or fundamental analyst you are. And I am a very good
one!

I will expand on this in various posts as I lead up
to the idea of reacting rather than predicting. It
forms the core of my trading concept utilising the
half-life of time.

Btw, what about that NIFTY? I had said it is approaching
200DMA resistance which always fails on the first try.
But we do NOT know when! Below is the latest chart. We
shall see what lessons we can learn from this particular
struggle as it unfolds over the next few days! For the
moment, look closely at the Wilders DMX, a very
valuable indicator for longer-term or trend traders.
It is congesting. You can study Wilders at Stockcharts
or any other good charting school.



Thanks for your viewership!