Manage Risk in the Stock Market

What is Risk Management? 

Risk management is the process of measuring, or assessing risk and then developing strategies to manage the risk while attempting to maximize returns. Typically involves utilizing a variety of trading techniques, models and financial analyses.

The potential return from any investment is generally depending to the amount of risk the investor is willing to assume.

Investors will not take on greater risks without the possibility of higher earnings. This is called the risk premium.
 

Common types of Risk 

There are two common risks that investors should notice them well:

Market Risk: The possibility that the value of financial markets rise or fall.

Inflation Risk: The risk that rising prices of goods and services over time, Inflation risk is also known as 'purchasing-power risk' and it is one of the most important factors for long-term investing.

You can't control the inflation risk, but with a good strategy you can manage and control the affect of market risk on your stocks.

A professional trader always tries to understand and control portfolio risk. Before entering into any trade, good traders first think about how much risk to take and how much risk exposure comes with a particular trade selection. Only then do they allow themselves to think about how much profit they stand to make.

Prudent investors always close their position and exposure if they determine that a portfolio carries too much risk.
 

Risk Management for a Trade 

1- Before you decide to trade consider to these fundamental principles:

2- Before you trade a stock, know how much you are willing to lose.

3- Check the stock to be sufficiently liquid, can you buy or sell promptly?

4- Determine the cut-loss level before trading.

5- Determine your profit target (take-profit-level).

6- Buy the stock only at an acceptable price level. Use a limit order when you buy a stock.

7- Immediately after the trade has been confirmed, enter the stop-loss-at- market order at your predetermined stop-loss level.

8- Take profit when the trade reaches your profit target.

For example: so many traders determine their cut-loss level 2% of their capital and they call it 2% rule. If you own 1000 shares of X at $100 with a $2 stop loss order in place, your risk is: $2 * 1000 = $2,000. So long as you have capital amounting to at least $100,000 on hand, you would not be considered to be in breach of this "rule".
 

Portfolio Risk Management 

Whit managing the risk of each trade your portfolio risk will be well under control and you manage your portfolio risk actively, but to control your portfolio risk management better notice to this points: 
1- Determine your overall cut-loss level. Usually your portfolio should not lose more than 10% of your capital. 
2- Diversify your investment in at least six or more different stocks. 
3- Know your overall risk tolerance before building up the portfolio. 
4- Act quickly when you see your risk limits exceeded. 
5- Close out the entire portfolio if it loses to your overall stop-loss level. 

12 Basic Stock Investing Rules Every Successful Investor Should Follow

There are many important things you need to know to trade and invest successfully in the stock market or any other market. 12 of the most important things that I can share with you based on many years of trading experience are enumerated below.

1. Buy low-sell high. As simple as this concept appears to be, the vast majority of investors do the exact opposite. Your ability to consistently buy low and sell high, will determine the success, or failure, of your investments. Your rate of return is determined 100% by when you enter the stock market.

2. The stock market is always right and price is the only reality in trading. If you want to make money in any market, you need to mirror what the market is doing. If the market is going down and you are long, the market is right and you are wrong. If the stock market is going up and you are short, the market is right and you are wrong.

Other things being equal, the longer you stay right with the stock market, the more money you will make. The longer you stay wrong with the stock market, the more money you will lose.

3. Every market or stock that goes up will go down and most markets or stocks that have gone down, will go up. The more extreme the move up or down, the more extreme the movement in the opposite direction once the trend changes. This is also known as "the trend always changes rule."

4. If you are looking for "reasons" that stocks or markets make large directional moves, you will probably never know for certain. Since we are dealing with perception of markets-not necessarily reality, you are wasting your time looking for the many reasons markets move.

A huge mistake most investors make is assuming that stock markets are rational or that they are capable of ascertaining why markets do anything. To make a profit trading, it is only necessary to know that markets are moving - not why they are moving. Stock market winners only care about direction and duration, while market losers are obsessed with the whys.

5. Stock markets generally move in advance of news or supportive fundamentals - sometimes months in advance. If you wait to invest until it is totally clear to you why a stock or a market is moving, you have to assume that others have done the same thing and you may be too late.

You need to get positioned before the largest directional trend move takes place. The market reaction to good or bad news in a bull market will be positive more often than not. The market reaction to good or bad news in a bear market will be negative more often than not.

6. The trend is your friend. Since the trend is the basis of all profit, we need long term trends to make sizable money. The key is to know when to get aboard a trend and stick with it for a long period of time to maximize profits. Contrary to the short term perspective of most investors today, all the big money is made by catching large market moves - not by day trading or short term stock investing.

7. You must let your profits run and cut your losses quickly if you are to have any chance of being successful. Trading discipline is not a sufficient condition to make money in the markets, but it is a necessary condition. If you do not practice highly disciplined trading, you will not make money over the long term. This is a stock trading “system” in itself.

8. The Efficient Market Hypothesis is fallacious and is actually a derivative of the perfect competition model of capitalism. The Efficient Market Hypothesis at root shares many of the same false premises as the perfect competition paradigm as described by a well known economist.

The perfect competition model is not based on anything that exists on this earth. Consistently profitable professional traders simply have better information - and they act on it. Most non-professionals trade strictly on emotion, and lose much more money than they earn.

The combination of superior information for some investors and the usual panic as losses mount caused by buying high and selling low for others, creates inefficient markets.

9. Traditional technical and fundamental analysis alone may not enable you to consistently make money in the markets. Successful market timing is possible but not with the tools of analysis that most people employ.

If you eliminate optimization, data mining, subjectivity, and other such statistical tricks and data manipulation, most trading ideas are losers.

10. Never trust the advice and/or ideas of trading software vendors, stock trading system sellers, market commentators, financial analysts, brokers, newsletter publishers, trading authors, etc., unless they trade their own money and have traded successfully for years.

Note those that have traded successfully over very long periods of time are very few in number. Keep in mind that Wall Street and other financial firms make money by selling you something - not instilling wisdom in you. You should make your own trading decisions based on a rational analysis of all the facts.

11. The worst thing an investor can do is take a large loss on their position or portfolio. Market timing can help avert this much too common experience.

You can avoid making that huge mistake by avoiding buying things when they are high. It should be obvious that you should only buy when stocks are low and only sell when stocks are high.

Since your starting point is critical in determining your total return, if you buy low, your long term investment results are irrefutably better than someone that bought high.

12. The most successful investing methods should take most individuals no more than four or five hours per week and, for the majority of us, only one or two hours per week with little to no stress involved.

8 Ways to Reduce Stock Market Stress

=Do not watch Bloomberg, CNN, CNBC, or any stock news channel for a lengthy time. All the news will disrupt your rythm. Remember that the stock market is all about demand and supply, simply put. You do not need to listen to all those reporters, who themselves, I bet, are not even investors or traders. Being informed is good but being too paranoid with news data is not needed.

=Do listen only to yourself. There will be a lot of rumors in the grapevine regarding inside information on certain stocks. Take these with a grain of salt. In fact, treat these as humor only. You are the only one who controls your investments so you should do your own homework. You will be responsible for all the sound decisions you make so you have prepare yourself very well and not follow rumors floating.

=Get enough sleep every night. Sleeping 6 - 8 hours a night would give you a big advantage on how you respond and react to market changes during the day compared to sleeping less than 5 hours a day. Having a good night's rest allows you to be fresh and gives you a sharp mind to face not only the market challenges but everyday life as well.

=Have a plan. Have an investment methodology that caters to your emotional, spiritual and risk appetite. Develop a methodology that works for you. Investing and trading according to your working methodically will help you generate wealth and minimize your losses, thus reducing prolonged stress. Many people get stuck with bad stocks because they are confident with themselves, do not let this happen to you.

=Eat healthy foods. Trading makes use a lot of mental energy and puts stress on your body. Keep your body well balanced with what you eat. I always eat fresh fruits everyday usually apple, orange, or kiwi. Try not to make a habit of eating junk foods and replace it with healthy alternatives like fruits or oat crackers. Why not even make your favorite fresh fruit juice/shake while the market is open, it gives you a break from the mental concentration and allows your brain to soothe itself.

=Surround yourself with optimistic individuals. Being with people who are stressed and/or negative vibes would just give you more stress to deal with. Instead, talk to your trader/investor friends who are optimistic and give sound advice where you can even learn with.

=Learn to accept your losses. No trader can win all the time in the stock market. If you can maximize your profits and minimize greatly your losses then you will find yourself generating wealth in no time. One of the hardest to learn and one of the biggest stress inducing aspect are the losses from the stock market. Set on your methodology an acceptable loss percentage rate and follow it. I set mine at 5%. Whenever I already lost 5% in a stock that I bought, I immediately accept the loss and sell it. Protecting capital should be the priority. In the stock market, you should accept humility in what you do as the price is king and you are just following it.

=Do not jump the gun. Stop, think, then act. Three simple things you should remember to avoid stock market stress in the first place. Before you do anything, stop what your instinct and emotions are telling you. Think about the situation on the possible risks and rewards you are entering into. Then act upon your best judgment what you have to do in order to minimize loss and maximize gain.

GOLDEN RULES FOR TRADING

Divide your Risk Capital in 10 Equal Parts.

As part of the Successful money management, it is always advised to divide your Risk Capital (which you can afford to lose) into 10 equal Parts and at any given time none of your Single Trade should have more than 3 parts of your capital in it even if you are in a winning position. At the same time always keep some spare money for any Buying Opportunity, which may come any time.
 

Trade ONLY in active & high Volume Stocks/ Futures.

Many Traders get stuck with stocks for want of liquidity. Always rely upon Stocks which have reasonably high volume over a period of time. High Volume are always advised for easy Entry, Exit and Stop Loss. In low volume stocks the spread is too high and chance of Stop Loss limit getting failed is too high as there would be no Buyer or seller at your Stop Loss Level.
 

Come Prepared with a Trading Plan

Successful traders always keep their Trading Plans ready before entering into any transactions. One must prepare a Watch List or Probable candidates for Day's trading and remain focused on the movement of those stocks only. For example a Stock 'X' is on verge of a Bullish Breakout from any pattern or stock 'Y' has declined substantially after an initial sharp upmove or stock 'Z' is close to an important support level. Successful trader would concentrate on the movement of those stocks only and enter the trade as soon as stock 'X' gives the anticipated breakout or stock 'Y' starts an upmove or stock 'Z' breaks the support level to initiate a trade for quick gains.
 

Never Over Trade

This is the most common mistake committed by Traders, particularly after a Streak of winning Trades. This mistake Generally not only wipes off all the profits, but puts traders in heavy losses. In order to remain in market while making consistent Profits, under no circumstances, traders should go beyond their Risk Capital.
 

Trade in 2 to 4 Stocks at a time with strict Stop Loss.

In a Bull move, most of the stocks move up and similarly in any Bear Move, most of the stock moves southwards. As a Trader you know this fact but can you Buy 20 Stocks and try to make profit in all the 20 stocks just because all are moving up or vice versa in a Down trend? What will happen if market reverses without any indication on any bad news? Would you be able to monitor all your trades in such situation? Smart and Successful trader would trade in 2 to 4 stocks with strict Stop Loss and keep a strict vigil to avoid any misfortune in case of any eventuality.
 

Sell Short as often as you go Long.

More than 90% of common investors/ Traders are 'Bulls' by nature. Because they love to see prices going up only. Stocks are bought by anybody/ corporate/ financial institutions/ Mutual Funds to make profit on rise. They have large holdings and mentally they wish and pray for the market to rise only. But facts are different. History shows that Bull Phases have shorter duration that Bear phases. So every stock that moves up will retrace back to 38%-50%-66%. Since 90% investors are Bulls by heart they normally do not book profit at higher levels to re-enter later at lower levels instead they prefer to increase their portfolio at lower levels. Successful Traders know how to capitalize such correction. They are always prepared to go 'Short' as often as they trade on 'Long' side.
 

Don't Trade if you are not Clear.

Many Traders, because of their daily habits trade even when there are no signals to buy or short. Normally such situation arrives after a sharp rise or decline when stocks are adjusting their values. While some stocks attempt to move up, few may be taking breather before next move. Such situation are often confusing. There is no harm in taking rest for a day or two or short period if the trend is choppy, unclear or doubtful, instead of putting your money at higher risk.
 

Don't expect Profit on Every Trade.

If you consider you are a smart trader who can make profit on every trade, you are 100% wrong. Always be flexible and accept the fact as soon as you realize that you are on wrong side of the trade. Simply get out of the trade without changing your strategy during the market; it may cause you double losses.
 

Withdraw portion of your profits.

The business of Trading is excellent as long as you are making profits. Unlike other business your losses can be unlimited and rapid if market does not move as per your expectations. While in other businesses you may have other remedial measures available but in trading it is you only who has to control it. Traders have large egos particularly after series of successful trades and their tendency to enlarge commitments in overconfidence may cause major financial set back. There fore it is must that trader must take a portion of the profit and put it in separate account. This is absolutely must for long term stability in the market.

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Trading Psychology

 

Just as markets go through cycles, so do the emotions of a binary options trader. Regardless of how well traders try to control their emotions during trading, it is impossible to push them aside completely. What many do not realize is that the emotions associated with trading often cycle through, repeating themselves over and over again. Before a cycle can be broken, it must first be recognized.

The following stages and cycle tend to be most common in trading. Consider each and what it will mean in terms of trading activity.

Optimism

Nearly all trades are initiated with a feeling of optimism serving as the driving force. This makes perfect sense, as no experienced trader would make an investment based on a feeling of negativity.

Excitement

This feeling will be generated when the trade goes live. It can be further enhanced by the asset price moving in the predicted direction.

Thrill

Should the asset price continue to move along with the prediction and the expiry time period ending draw near, thrill will be the next emotion.

Euphoria

The point at which maximum risks amounts to maximum reward. Profits may seem to be coming easily, telling our brain that any investment we make will surely be a good one.

Anxiety

The feeling that comes when the binary options trader realizes that not every investment will be profitable, regardless of recent successes. The feeling of anxiety may still not be strong enough to halt investing temporarily, as the euphoric feeling continues to linger.

Denial

At this point traders simply do not want to accept that there was some flaw in the binary options strategy used. Surely, there is a problem with the system and not the trader, right?

Fear

Reality hits hard in the form of realizing that unwise investments have been made. Some will close trades and retain some profit when feeling fear. Others may linger in confusion and continue to accumulate losses for a period of time.

Desperation

With the gains gone, desperation may cause the trader to begin considering any number of investments which may restore some of the profits which have been lost.

Panic

A powerful feeling associated with the brain telling the trader that they have absolutely no control over the market and therefore cannot control losses. This is of course an irrational line of thinking.

Capitulation

This will be the breaking point that comes just after panic. This emotion may prompt the trader to close trades early or take any other action to avoid larger loss amounts.

Despondency

A feeling that binary options trading is simply not a good idea and should be avoided at all costs. Oddly enough, those who reach this phase rarely realize that it presents real financial opportunity.

Depression

A time for reflection, looking back upon the trading mistakes that were made and led us to this point. Many will try to pinpoint the exact moment where things went wrong. This emotion can actually be a valuable learning tool.

Hope

With depression waning, hope of being able to actually profit from binary options trading will re-emerge. With mistakes in the past, most will realize than a few adjustments can make a world of difference.

Relief

The feeling that comes from seeing that all is not lost, and yes, you do have the skills required to profit from binary options trading.

Being able to recognize these stages and emotions for what they are can allow a higher level of control over them. It may even be possible to skip past the emotion stages which are least beneficial. Much focus is placed on learning the mechanics of trading. By placing at least some focus on the emotional aspects, traders will be less likely to make costly mistakes.

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Teach Your Kids About Money

Teaching kids about money is a controversial thing — no one argues that you should teach them, but the how is a tougher question. In general,  four guiding principles:

1. Educate yourself. You can’t teach something you don’t know about yourself. Learn as much as possible about budgeting, about saving, about investing, about cutting expenses, about reducing debt. Armed with knowledge, you’ll be a good teacher.
2. Set a good example yourself. It’s one thing to tell your kids something, but if you are doing the complete opposite, they’ll learn more from your actions than your words. To teach them about controlling spending, you have to do so yourself. Lead by example.
3. Teach them one habit at a time. Your kids are not going to become skilled financial planners overnight, or in one month, or even in a year. Your goal should be to teach them these lessons over the course of their childhood and adolescence. So teach one thing at a time, until they’ve learned the skill, and then move on to the next. There’s no rush.
4. Let them learn by doing. You can’t teach by telling. You have to tell (briefly), then show, then let them do. Let them make mistakes. And then talk about those mistakes. Soon enough, they’ll learn why those mistakes were actually mistakes, and if you set it up right, they’ll learn better habits on their own, by doing.

So with those principles to guide you, here are 10 valuable lessons you can teach your kids about money:

1. Give them control of money. If kids don’t have control of money before adulthood, they learn that money will always be provided for them, that they don’t have to be responsible for their spending or their future. And when they finally get control of their own money, they apply those lessons, by spending liberally and not worrying about the future.

Instead, give your kids control of money. I suggest taking some money that you already have in your budget, and giving them control of it. For example, if you currently spend $200 a month on eating out (to use a random figure), perhaps give your child control over $50 of that. And do the same for clothing and toy spending — don’t add to your budget, but allocate portions of your budget to them. Give them complete control over that money.

The result will probably be that they spend too much on frivolous stuff. At first. But when they want other things, they’ll have to learn to save for them, and cut back on other areas. Eventually, they’ll learn how to make decisions, through trial and error. It could take awhile, but it’s better they learn now than when they’re adults.

2. Teach them to save for money goals. Once they realize that there’s more to money than just spending on whatever their latest impulse is, they’ll want to buy something larger than the amount they have on hand. That’s when you teach them about savings goals.

“You want to buy an Xbox 360? Well, let’s find out how much that costs. Now that’s how much you’ll need to save. If you take $40 from your monthly budget, you could have that in 5 months. If you take $60 from your monthly budget, you could have it in a little over 3 months. But either way, that will mean cutting back on McDonald’s and buying little toys every weekend.”

You might also create a chart on the computer, that shows their goal, and little savings milestones along the way. That way they can get excited about watching their savings grow.

3. Teach them that reducing expenses makes goals come faster. This goes hand-in-hand with the above lesson, and if you teach them about savings goals, they’ll probably learn this lesson on their own. It’s common sense, and kids are smart enough to figure it out: if I want to get to a goal faster, I have to save more … which means spending less on other stuff.

But it’s worth reinforcing with a discussion about spending and saving, and by talking to them about the decision they’re making every time they spend money.

4. Teach them how your money can make money. This is the lesson on investing, and it’s a lesson many of us can learn. It’s one thing to save, where you get perhaps 5% interest. But if your kids are going for short-term goals, they probably won’t see much compound interest happening. You’ll need them to make a longer-term goal, such as a trip once they graduate, if you have a teen-ager, or a down payment on a car, or even something a little smaller. Whatever the goal, teach them about how they can put their money in certain investments, and how those investments will grow over time.

That growth is their money earning money for them. It’s free money, almost, but the cost is not spending on other stuff in the meantime, and getting into the habit of investing the money. And it’ll help them get to their goals faster.

5. Teach them about creating a budget. It doesn’t have to be a complicated budget, but what you really want to teach them is how to plan their spending, instead of having a big wad of cash that keeps getting smaller with every impulse buy. Something simple, like $30 for savings for a bike, $30 investing for a longer-term goal, $20 for a birthday gift for mom, and $30 for spending. Then teach them how to split the money up and how to keep within those planned amounts.

Make it simple and easy, so they don’t grow up thinking that budgets are hard and onerous (like many of us grew up thinking). If they get into the habit now, it’ll pay off huge when they grow up.

6. Teach them to pay bills. Does your teen-ager have a cell phone? Who pays the bill? Give them the amount in their monthly budget, and allow them to pay the bill each month. If they’re late, the service will be cut off. They’ll learn to pay the bill on time. Other bills could include a car (when they’re of driving age), cable TV, Internet. If you let them pay any of these bills, you’ll probably want to monitor them to make sure they’re actually making the bills.

7. Teach them about the dangers of debt. This probably isn’t a lesson they can understand when they’re 6 years old, but when they’re teen-agers, they can grasp the concept. You’ll need to discuss things like loans, credit cards and other debts. If you want them to learn by doing, you can have them take out a car loan or get a very limited credit card (that they pay for). They’ll soon learn that paying debt payments reduces how much they have to pay for other stuff, and how the debt payments can get to be overwhelming.

8. Teach them that earning more money gets them closer to their goals. If you have a savings goal, you can reduce your expenses to get there faster … and you can also earn more money. They can start learning this lesson at a young age, by earning extra money (not from chores, as they need to learn to contribute to the household without expecting pay), but from extra projects, such as doing yard work or babysitting for the neighbors, washing people’s cars, etc. Later, they can get a part-time job to pay for a car or any other goals.

9. Teach them about advertising and consumerism. This is something that should be taught at home and in the school, because most of us grow up without really being aware of the effects that advertising, marketing and consumerism has on us, and on our spending. This is often the root of our financial problems, whether we’re young or old. Teach them about the goal of advertising: to get us to buy their products or services, and to get us to spend our money. And show how advertising affects us, and gets us to do that. And talk about consumerism, and how it hurts us financially, how it’s not good for the environment, and how it leads to a cluttered house full of expensive and wasted stuff.

10. Teach them about impulse buying. Closely related to #9 above, of course, impulse buying is the effect of advertising and consumerism. Teach them about pausing before buying, recognizing the signs of impulse buying (increased heart rate, heavy breathing, other similar body signs), using a 30-day list before buying anything that’s not completely necessary, avoiding shopping malls and online shopping sites, and reducing your need to keep up with others and buy prestige things (cars, clothes, shoes, gadgets, etc.) to look good in the eyes of others.

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Basics of Options Shorting/Writing

Option writing/shorting is the act of selling either calls or puts first, hoping that the value goes to zero or buy it back at a lower price to earn a profit.

Trading in index options has been surging over the last few years, accounting for almost 75% of the total derivative market turnover on NSE in 2012-13. Most retail traders usually buy options, i.e., buy calls if the bet is that the market will go up or buy puts if going down. The idea behind this post is to explain the basics on option writing/shorting, and  how including them in trading can improve the odds of winning.

We use  the words option writing/shorting and not option selling, to signify that the options were sold first before being bought. Selling options is used when exiting options that were already bought.

Why Short/Write Options

Here is some food for thought, between 70 to 95% of all options usually expire worthless. What this means is that by buying an option (calls or puts) the odds of losing are significantly more. Now the question is if options buyers are inherently taking a higher risk, who is on the other side of the trade with better odds of winning? The answer is “Option Writers”.  Let me explain with a basic introduction to what comprises option premium, different types of options, open interest and an example showing how most options expire worthless.

Option Premium

Option premium, the value of calls or puts that you see on your trading screens has two components, Intrinsic value, and time value.

Premium = Intrinsic Value + Time value 

Intrinsic value

Intrinsic value is how much the option is in the money, or simply how much you would get if the options were to expire right now.

1. If Nifty is at 6100, Intrinsic value of 6000 Nifty calls is 100 (6100 – 6000) which is how much you would get if the option expired right now.
2. If Nifty is at 6100, Intrinsic value of 6200 Nifty calls is 0, since it is out of the money which is how much you would get if the option expired right now.
3. Similarly if Nifty is at 5900, Intrinsic value of 6000 puts is 100 and 5800 puts is 0.

Time value

Time value is the portion of premium which is over and above the intrinsic value of an option, i.e., Time Value = Premium – Intrinsic value

Say if Nifty is at 6240,

1.  Nifty 6200 call is at Rs 100. This premium of Rs 100 = Rs 40 (Intrinsic value)+ Rs 60 (Time value)
2. Nifty 6300 call is at Rs 40. This premium of Rs 40 = Rs 0 (Intrinsic value) + Rs 40 (Time Value)
3. Nifty 6200 put is at Rs 60, This premium of Rs 60 = Rs 0 (Intrinsic value) + Rs 60 (Time Value)
4. Nifty 6300 put is at Rs 140, This premium of Rs 140 = Rs 60 (Intrinsic value) + Rs 80 (Time Value)

Different types of options

• ITM (In the money), all options which have some intrinsic value. So if Nifty is at 6240, 6100 calls, 6300 puts, 6400 puts, etc. are ITM.
• OTM (Out of the money), all options which have no intrinsic value and only time value. So if Nifty is at 6240, 6300 calls, 6400 calls, 6100 puts, etc. are OTM.
• ATM (At the money), all options with strike price very close to the market price. So if Nifty is at 6210, 6200 calls and 6200 puts are ATM.

Open Interest (OI)

The total number of open contracts for any option is called its Open Interest. So if  Nifty 6200 Jan 2014 calls have OI of 30 lakh, that means all buyers of 6200 calls together hold 30 lakh contracts sold to them by option writers.

Example

Here is  OI data collected  for 8th Jan 2014 from the NSE website for both calls and puts for 9 most active strike prices on Nifty.

Nifty OI data for 8th Jan 2014

In the example above if Nifty were to expire today at 6200, the total options that would expire worthless would be : 39295000 (15102150 + 3150000 + 4235750 + 16807100) which is around 83% of the total OI of all calls and puts combined.

Yes, an option buyer can take quick intraday trades for a profit, or be on the right side of the market and have the potential of making unlimited profits, but the odds of winning are always in favor of an option writer who benefits with majority of options expiring worthless.

The underlying reason for this is because of the time value component of the option premium (Premium = Intrinsic Value + Time Value). A buyer of an option is continuously fighting time because if the trade doesn’t go in his favor immediately, the time to expiry keeps reducing(time value), and hence the premium itself. An option writer on the other side has time as his advantage, once in a trade as long as the market (intrinsic value) doesn’t move against him the time value keeps reducing, increasing his odds of winning over an option buyer.

Option Writing – Risks

An option buyer has limited risk and unlimited profit potential, so if 1 lot of 6300 Nifty call was bought at Rs 100, the maximum loss on this trade is the Rs 5000 (Rs 100 x 50), and if Nifty went to 7300 the call would make a profit of Rs 45,000.

An option writer has unlimited risk and limited profit potential.

When you write an option, say 1 lot of 6300 calls at Rs 100, Rs 5000 (Rs 100 x 50) which is the premium paid by the buyer is credited to your trading account and this Rs 100 on the premium is your maximum profit potential.  After taking this trade if

1. Nifty is 6200 on expiry, value of 6300 calls on expiry is 0, and you get to keep the entire Rs 5000.
2. Nifty is 6300 on expiry, value of 6300 calls is still 0, and you get to keep the entire Rs 5000.
3. Nifty is 6350 on expiry, value of 6300 calls would be 50, you have to give back Rs 2500( Rs 50 x 50) on expiry, but still earning you a profit of Rs 2500.
4. Nifty is 6400 on expiry, value of 6300 calls would be 100, you would have to give the entire Rs 5000, no profit no loss.
5. Nifty is 6500 on expiry, Value of 6300 calls would be 200, you would have to give back Rs 10,000 whereas you had received only Rs 5000, causing you a net loss of Rs 5000.
6. Nifty is 7500 on expiry, Value of 6300 calls would be 1200, you would have to give back Rs 60,000 whereas you had received only Rs 5000, a net loss of Rs 55000.

Since the potential losses are unlimited, it is best as a beginner option writer to be conservative, and allocate only a small portion of your trading capital when starting off.

Option Writing – Margins

Since the risk is unlimited for an option writer, the exchange blocks margin and similar to futures is marked to market at the end of every day. So to buy an option at Rs 100, you need to have only Rs 5000 ( Rs 100 x 50), but to write an option you will need around Rs 25,000 which is marked to market daily, which means that if there is a loss you are asked to bring in those funds to your trading account by end of the day.

Option writing margin requirement varies for every contract, and as on today Zerodha is the only brokerage in India to offer a web based SPAN tool that lets you calculate this.

Example

You have a bearish view of the market and Nifty is presently at 6172. You decide to write/short 6200 Jan 2014 calls at 90 expecting to profit if the value comes down below 90 on the premium.

Check the SPAN calculator for the margin required as shown below:

Option Margin calculation

This is just an introduction for traders looking to start off on option writing, exercise caution, and once you are clear with the concepts look at combining short options with stocks, futures, or other long options, to create positions that can increase the odds of winning while trading considerably.

Happy Trading,

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Top tips for trader : Do & Don't

 

Do: If You Want To Be Great…Don’t: If You Want To Be Average.

You shouldn’t want to get rich quickly

Novice traders sometimes make the mistake of seeing Stock-Commodity-Forex Market as a simple way to become rich in a short period of time. You should consider the risks and effort that must be put in to achieve such a goal.

Placing very large trades in proportion to your account balance in an attempt to make a huge profit is unlikely to be successful in the long term because eventually a trade is likely to go against you and that can lead to severe losses.

You shouldn’t make decisions randomly

You should know where you intend to open and close a position before entering any market, based on a particular system you are following. Setting this ahead of time helps you focus on your system and eliminate second-guessing.

You can also reduce losses by having stop loss orders in place. It's important to know that the market may not always agree with where you place an order.

Be careful not to use too much leverage

One aspect of the Stock-Commodity-Forex Market that attracts many traders is the opportunity to trade on margin, in other words, leveraged trading. Trading with a small initial deposit can still make it possible for you to open relatively large positions, so it is important not to overdo it when selecting a trade size.

Stock-Commodity-Forex  Market is usually traded with a high degree of leverage, which means you are able to provide just a small percentage of the actual amount you are investing while sustaining profit/losses as if you had invested the whole nominal amount yourself. This can work for you as well as against you.

There is a possibility that you could sustain a loss equaling to some or even all of your initial investment. It is also possible to lose more than you initially invested in your trading account.

We do offer you risk management systems that are designed to help prevent unmanageable losses. But please know that these measures still require a responsible approach to trading.

You should use stop loss orders

Some traders hold on to losing positions far too long thinking, or hoping, that the market will turn around. They also tend to get out of winning positions far too quickly to lock in an immediate profit, which eliminates the chance for greater gains.

Although it may be tempting for you to have this mind frame, you must have the patience to enter only those trades which you think are opportunistic and follow this up with the discipline to either cut this trade quickly if it turns against you or run with it because you believe in the trade.

When you open a trade, you can set a stop loss order – this is a point where the trade will automatically close if the market moves to that position.

You should take emotion out of your trading

Keeping calm and maintaining a balanced state of mind is crucial when trading in order to remain focused on relevant events. You should always remember that the market's actions are not personal.

We realize it’s quite easy to say but very difficult to do, especially in the heat of the moment when you have to make a split second decision. Try not to trade with emotions and remember all the things that you've learnt.

Discipline helps you make the most of trading

If you’re disciplined and stick with a tested trading plan consistently, you will, more often than not, profit over those who trade inconsistently. Constant second-guessing can ruin the profitability and may eliminate the benefits of having a trading plan in the first place.

You should plan your trades and trade your plan rather than randomly pick out trades on a whim. The latter is no more than punting with only the hope of winning as opposed to having an edge in the markets through the use of a solid, consistent trading system.

You should maintain consistency with your trading system and follow it up with good analysis of your own processes in order to have a better idea of where you are going wrong.

You should manage your money

The main difference between an amateur and an experienced trader is their approach to money management.

Experienced traders recommend risking a set percentage of capital and never altering that percentage. Risking a set percentage of your total capital on each trade is an advantage in times of repeated losses because it reduces their impact.

Amateur traders often disregard this and increase their stakes as they begin to lose more. This type of scenario inevitably leads to loss after loss.

 

You should learn your market

Some novice Stock-Commodity Market traders begin trading without having sufficient knowledge of their chosen currency pair(s) and how currencies are influenced by global events. You should learn as much as you can about how different financial markets impact each other and how they intercorrelate, i.e. stocks, bonds, commodities and forex.

This knowledge will help you to make better-informed trading decisions when various economic figures are released. It is also important to identify the type of market that is prevailing to allow you to adjust your strategy accordingly and thus avoid entering into losing trades.

The more informed you are, the better your chances of trading successfully. Please know that some market participants have different intentions from the ones you have; for example, hedgers will sell into a market that is rising because hedgers often look for good average prices on large orders in order to risk manage their portfolios. This is in contrast to individual traders who seek to maximize profit on each trade.

You should monitor your positions

It is crucial that you monitor any exposure you have in the Stock-Commodity- forex market. Having a close eye on how your trades are doing will help you maintain control and follow market movements as they happen.

You should stay up to date with market developments. It is a good way to maintain and expand your level of knowledge and understanding of the forex market. You should be aware that the forex market trades 24 hours a day, so making use of pending orders will be crucial if you want to leave your PC.

You should develop a trading strategy

You should spend a significant amount of time on deciding on your strategy before you place your first trade. This will make it easier for you to concentrate on market events.

Some novice forex traders begin trading without having sufficient knowledge of their chosen currency pair(s), how currencies are influenced by global events and how they plan to take advantage of price movements. It is crucial that you observe the market price action and try to identify trading patterns before risking your capital, with your observations helping you formulate a trading plan and a trading style.

Your trading strategy should take the following into account:

• Planned frequency of trading
• Time of day when you plan to trade
• Technical indicators you plan to use
• Buy/sell signals you plan to use
• Estimated risk and reward for each trade
• A daily stop limit to protect your total capital base

Your motivation to trade is a key aspect. The most successful traders do not have profit in mind when trading because thinking about the potential future profit or potential future losses will cloud your decisions in the present. Instead, experienced traders focus on the process of trading rather than worrying about the amount they could win or lose in a trade.

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