Forward and Futures

MBA, FDRM
  Background, Forward and Futures Market in Nepal
2  Specification of Futures Contracts
 Daily Settlement and Margin
 Website and Newspaper Quotes
 Cash and Physical Delivery
 Forward Vs. Futures contracts
 Economic purpose of forward and futures
 Basis Risk and its consequences
 Forward/Future Pricing Principles
 Trading mechanism of forward and future contracts
 Use of margin in future trading
 Trading platform for future contracts and its uses
 Using Forwards and Futures for Hedging
 Application of Forwards and Futures in Nepal
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 Future market is for:
3
• Both Raw or Primary products and
Financial Products

• Generally, raw products (e.g. Crude oil,

coffee, wheat etc.) are traded in regulated
exchanges with standardized contracts.

• Apart from commodities; Equity, Index

& Currencies are also traded in the
Future market.

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 Why do we need the Future Markets?
4
 Risk management:“Hedging”- One can lock-in the price for
future, against unfavorable price movements.
Situation Risk Action
You will need it in the future Price may increase Long in the future market

You want to sell it now Price may increase Long in the Future market

You just bought Price may decrease Short in the future market

You will sell it in the future Price may decrease Short in the future market

 All above situations are useful to manage the risk through

hedging.
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 Cond.
5  Price Discovery and Market efficiency: The exchange works as a
vehicle for “price discovery”. So, there exists transparency for price -
All participants in the market have access to authoritative price
levels.
 Income generation: The government, the exchange, clearing & non
clearing members and the traders can generate income.
 Leverage: Commodity futures operates on margin. That is why
trader has to keep only a fraction of the total value in cash in trading
account. Not possible in spot trading.

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 Cond.
6
Ability to go short: ‘Gain from decline in the price’ - In the future
market one can easily take an advantages from going short which is
almost impossible in the spot market.

Reduction in overall cost: It reduces the transaction cost due to the

Concentration of buyers and sellers in one place (i.e., the costs of
looking for counterparty). Similarly, cost of insurance and other
carrying cost will also be reduced.

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 Who are the participants?
7
Bank

Warehouse End-users

Traders
Facilitators
Speculators, & Market
Hedgers & Regulators Makers
Arbitrageurs

Quality
Farmers & Certification
Producers Agencies

Others
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 Brief History of Future Market
8
 Aristotle’s book – “Politics”-Financial Device of Thales

 DOJIMA RICE EXCHANGE in Osaka, Japan -1710

 Chicago board of trade (CBOT); the world’s first modern future

exchange-1848

 Chicago produce exchange - 1874, renamed the Chicago butter and egg
board in 1898 and then reorganized into the Chicago mercantile
exchange (CME) in 1919.

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 Cond.
9  Minneapolis grain exchange-1881, the only exchange for hard red spring
wheat futures and options.

 The biggest increase in futures trading activity occurred in the 1970s when
futures on financial instruments started trading in Chicago.

 In Nepal, commodities and metal exchange Nepal (COMEN) started the

trading from 16 Dec., 2006.

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 Some big name of future exchanges
10
CBOT - Chicago Board of Trade

CME – Chicago Mercantile Exchange

NYBOT – New York Board of Trade

NYMEX – New York Mercantile Exchange •TOCOM – Tokyo Commodity Exchange

LME – London Metal Exchange •SICOM – Singapore Commodity Exchange

LIFFE – London International Financial Futures •Dalian Commodity Exchange

Exchange
• NSE- National Stock Exchange of India
ICE – Intercontinental Exchange
•SFE – Sydney Futures Exchange
DGCX – Dubai Gold & Commodities Exchange
•MCX- Multi Commodity Exchange
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 Future Market in Nepal
11
 After establishment of commodity and metal exchange Nepal (COMEN) in December
16, 2006;

 Eight exchanges are trading currently

 More than 200 registered brokerage firms are trading actively in Nepalese future
market.

 The total number of trader are more than 20000 but only 5000 are supposed to become
active traders.

 Gold, silver, copper, crude oil etc are in its product list and most of trading is occupied
by futures of gold.
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 Regulation Status
12
 The SEBON has drafted the regulations and it is in the process of
execution.
 The rule regarding tax is clear which charges 10% on all profit
settled trade and no tax saving on loss settled trade.
 13% VAT on all trade is being charged till now.
 Other rules regarding the warehousing and mechanism of control
are drafted but yet to be formalized and may take some months for
implementations.

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 Evolution of commodity futures in Nepal

13 Commodities & Metal Exchange Nepal limited (COMEN) www.comen.com.np

 This is the first exchange in Nepal.
 Established in 2006 and real trade started from 2007.
 The first products they launched were textiles, wheat flour, rice etc in their trading pit.

Mercantile exchange Nepal limited (MEX) www.mexnepal.com

 MEX Nepal started its operation from 2008.
 Small trade pit changed into national level online trade platform.
 The largest TWS till date.

Nepal derivative exchange ltd. (NDEX) www.ndex.com.np

 In the early phase it had six commodities and 11 contracts.
 After two months it added six agro commodities and two precious metal for online trading
 This is the first exchange which facilitates intraday contract to traders.
 Now it has listed 13 commodities and 25 contracts in a month.

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 cond.
14 Nepal spot exchange (NSE) : www.nsenepal.com
 A subsidiary of MEX.
 Focus on agro products.
 Established in 2010 and trading started from 2011.

Wealth exchange Nepal (WEX) www.wexnepal.com

 Trying to focus on spot market.
 Established in 2010 and trading started from 2011.
 Trying to provide trade facility in mobile phone.

Commodity Future Exchange Ltd.(CFX) www.cfxnepal.com

 Registered on June,2011 but started its trade from Jan,2012
 They claim to provide additional 50% return on floating profit.

 RCDEX & ECX have also launched their trading pit with reduction in Commission, Margin and Spread.
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Market operation hierarchy

• Launches the Future Contracts

The Exchanges

• Maintains the records of all trade

Clearing house

Bank
• Facilitates the trade
Brokers and sub-
brokers

Traders • Trades to meet their objectives

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 Overall status
16
 Regulation – Recently framed
 Market standard – very poor
 Investors awareness – very poor
 True competition – poor
 Quality standard – May begin soon
 Transparency – very poor
 Analysis based investment – nearly zero
 Government support – nearly zero
 Motivation to potential traders – very poor
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 Future Contract
17
 A futures contract is a binding agreement between a
seller and a buyer to make (sell) and to take (buy)
delivery of the underlying commodity (or financial
instrument) at a specified future date with agreed upon
payment terms.

 Most futures contracts don’t actually result in

delivery of the underlying.

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 Cond.
18
 Futures contracts are standardized with respect to the delivery
month; the quantity, quality, delivery location; and the payment
terms.

 Guaranteed settlement.

 Consistency : All the contracts are identical.

 Prices are reflected by true information.

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 An example
19
 An investor takes a long position in 2 October gold futures contracts
on August 21

 Contract size is 1Kg.

 futures price is NPR 42000/10gram

 initial margin requirement is NPR 75,000/contract (NPR 1,50,000

in total)

 maintenance margin is NPR50,000/contract (NPR 1,00,000 in total)

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20
Special Characteristics of Future Contract
 Marking to Market

 Floor Trading

 Margin Deposit

 Physical Delivery

 Standardized and identical

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 Positions in the future contracts
21

Long Position:
A long future position is the party that agrees to buy underlying assets in
the future at specific price. But the long position holder can settle the
transaction before the maturity.

Short Position:
A short future position is the party that agrees to sell underlying assets in
future at specific price. But the settlement can be done before the maturity.

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 Specification of Future contracts
22
 In the future market, Specification is prepared for all the products to be traded.
It includes:
what product?
The quality?
The quantity?
The settlement mechanism?
Trading time?
Maturity period?
Commission chargeable?
The price is quoted at?
The symbols etc.

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 Daily settlement and margins
23
The future contracts can be settled at any time till the maturity period. Similarly, the clearing member
is responsible to mark the market every day to facilitate smooth trading.

An example:
 long position in one gold future contract with the contract size of 500 grams.
 The initial margin in Rs. 45,000 per contract and the maintenance margin is Rs. 30,000 per
contract.
 The contract is entered into on December 11 at 10 am. When the price is 42,000 per 10 gram of gold
and closed in December 20 at a price of Rs, 43,200.
 The long position speculator opened account with Rs.50, 000.

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 A table to show daily settlement and marking to market
24
Date Settlement Price (Rs.) Marked to Market Additional Margin Final equity
Cash Flows

December 11 42,000 - - 50,000

Dec 12 42,400 20,000 - 70,000

Dec 13 42,200 -10,000 - 60,000

Dec 14 42,100 -5,000 - 55,000

Dec 15 42,300 +10,000 - 65,000

Dec 16 41,500 -40,000 - 25,000

Dec 17 41,300 -10,000 5000 20,000

Dec 18 41,700 20,000 20000 60,000

Dec 19 42,400 +35,000 - 95,000

Dec 20 43,200 +40,000 - 1,35,000

 Explanation
25  On December 12, the price of the gold per 10 grams rises by Rs. 400. So, total gain for the
long position speculator will be Rs. 20,000. So this final equity position on December 12,
[(500/10)*400 + 50000] = 70000 and so on. On December 26 the price of gold decreased
by Rs. 800 per 10gram. So the speculator looses Rs. 40,000 in a day and next day the trader
must deposit at least Rs.5, 000 to re-open the contract because the equity 25000 is lower
than the maintenance margin required. The trader deposits Rs.5,000 on 17 th of Dec. Again
the price declines on 17th as well and requires depositing at least 10,000 but the trader
deposits 20,000 this time.

 On December 20, the speculator of long position holder earn (1, 35,000 - 50,000 - 5,000-
20,000) = Rs. 60,000. The speculator can terminate the contract at any time before the
contract expires.
 Note: In case of Nepal, the Initial Margin and the Maintenance Margin are same.

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 What determines the future price?
26
 Supply and demand

 Production and consumption

 Import and export

 Transportation & Storage

 Custom and insurance

 War, invasion, looting etc.

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 International Market Timings
27
Winter Timing Summer Timing

Market Name Opening Time Closing Time Market Name Opening Time Closing Time

Sydney 2.45 AM 11.45 AM Sydney 2.45 AM 11.45 AM

Tokyo 5.45 AM 1.45 PM Tokyo 5.45 AM 1.45 PM

London 1.45 PM 10.45 PM London 12.45 PM 9.45 PM

New York 6.45 PM 2.45 AM New York 5.45 PM 2.45 AM

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28 Basis Risk
 The Basis : It is the difference between spot price and future price.The
Basis helps to understand the process of hedging.
 Basis(B) = Spot price(S) – Future price(F)
 Let, t = time in future(t=0 implies ‘today’)
 So = Spot price today
 Fo = Future price today
 St = Spot price at time t
 Ft = Future price at time t
 ∏ = Profit(loss) from a strategy

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29 Computation of profit(loss)
 Short Hedge:
 ∏= Spot market profit + Future market profit
 Or, ∏ = (St-So) + (Fo-Ft)

 Long Hedge:
 ∏= Spot market profit + Future market profit
 Or, ∏ = (So-St) + (Ft-Fo)

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 Since the basis is defined as the spot price minus future
price, we can write
30
Bo = So - Fo ( Basis today)
B1 = S1 - F1 (Basis at time 1)
Bt = St – Ft (Basis at time t)

Hence,
For positions closed out at time t;
Short hedge

∏ = (St-Ft) – (So-Fo)
Or, ∏ = Bt-Bo

Long Hedge
∏ = (So-Fo) – (St-Ft)
[email protected] Or, ∏ = Bo - Bt
 Spot Future Basis(Spot price-
Profit(loss)
Price Price Future price)
31
Situations
Spot price & future price Today 50 52 Bo= -2 Short Hedge
1 remains same but future Long Hedge (Bo-Bt) 0 0
In the future 50 52 Bt= -2 (Bt-Bo)
prices are higher
Spot price & future price Today 50 48 Bo= 2 Short Hedge
2 remains same but future Long Hedge (Bo-Bt) 0 0
In the future 50 48 Bt= 2 (Bt-Bo)
prices are lower
Spot price & future price Today 50 50 Bo= 0 Short Hedge
3 changes with same Long Hedge (Bo-Bt) 0 0
In the future 53 53 Bt= 0 (Bt-Bo)
amount
Spot price rises more than Today 50 50 Bo= 0 Short Hedge
4 Long Hedge (Bo-Bt) -1 1
the future price In the future 53 52 Bt= 1 (Bt-Bo)
Spot price falls less than Today 50 50 Bo= 0 Short Hedge
5 Long Hedge (Bo-Bt) -1 1
the future price In the future 48 47 Bt= 1 (Bt-Bo)
Spot price rises and the Today 50 50 Bo= 0 Short Hedge
6 Long Hedge (Bo-Bt) -3 3
future price falls In the future 52 49 Bt= 3 (Bt-Bo)
Spot price rises less than Today 50 50 Bo= 0 Short Hedge
7 Long Hedge (Bo-Bt) 1 -1
the future price In the future 52 53 Bt= -1 (Bt-Bo)
Spot price falls more than Today 50 50 Bo= 0 Short Hedge
8 Long Hedge (Bo-Bt) 1 -1
the future price In the future 47 48 Bt= -1 (Bt-Bo)
Spot price falls and future Today 50 50 Bo= 0 Short Hedge
9 Long Hedge (Bo-Bt) 4 -4
price rises In the future
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32
Hedging Profitability & the Basis
Types of Benefits from Which occurs if
Hedge
Spot price rises more than future prices

Short Hedge Strengthening basis Spot price falls less than future price

Spot price rises and future price falls

Spot price rises less than future prices

Weakning basis Spot price falls more than future price

Longe Hedge
Spot price falls and future price rises

Note: Short hedge means long spot,short future and long hedge means short spot,long future.
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 The Forward Contract
33
 An agreement where one party agrees to buy (or sell) the
underlying assets to a specific future date and a price is set at the
time, the contract is entered into forward contract.

 The forward contract cannot be settled before the maturity

period of the contract.

 The seller sells the assets and purchaser needs to purchase them.

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 The forward contract has certain characteristics:

34  Flexibility : The forward contract is not flexible in the sense that this contract cannot be
terminated before the maturity. This type of contract has fixed term of Maturity. So seller
and buyer of contract can have right to sell or purchase the assets at the end of maturity
only.

 Default Risk : The forward contract per formed only at the end of maturity. So this
contract may have default risk from the purchaser’s side or seller’s side.

 Liquidity: The forward contract is not liquid in the sense that it cannot be resold in the
market. The buyer and seller performed the contract only at the end of maturity.

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 An example
35
Computer parts Inc. has ordered memory chips from its supplier in USA.

 The $5 million must be paid in January 30. The company can arrange with its bank
today to buy the no. of Dollar for delivery on January 30 at a forward price of Rs. 100
per dollar.

 Therefore, on January 30, computer parts pays the bank $5 million  Rs 100 = Rs.
500 million and receive $5 million, which it can use to pay its supplier from USA. By
committing forward to exchange Rs. 500 million for $5 million are locked in dollar
term.

 Exchange Rate Risk - Nil

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 Another example
36
 Suppose, today on Dec 25, 2015, an agreement is made between Mr. Prashant and Mr.
Sashank to deliver one tola gold a year from today i.e. Dec 25, 2016 at a price of Rs.
50,000. Mr. Prashant will take the delivery and Mr. Sashank will make delivery of one tola
gold at a given price of Rs. 50,000.

Here,
 Mr. Prashant is in long position – Receives the delivery in Future
 Mr. Sashank is in short position – Who delivers in Future

 Price Risk - Nil

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 Forward Vs Future Contracts
37

FORWARDS FUTURES

Private contract between 2 parties Exchange traded

Non-standard contract Standard contract

Usually 1 specified delivery date Range of delivery dates

Settled at the end of contract Settled daily

Delivery or final cash

settlement usually occurs prior to maturity

Some credit risk Virtually no credit risk

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 Forward Vs Option
Today USD Ra te NPR
38 Import price CIF Ca lcutta USD 10 per KG 100.00 120.00 12,000.00
Insura nce, Freight (Ca lcutta to Ka thma ndu) 125.00
Custom Duty (8% on CIF Ca lcutta price) 100.00 120.00 960.00
Cost Price 13,085.00
Sa les Price 14,000.00
Gross Ma rgin 915.00
Without Forward Or, Options
After 30 days USD Ra te NPR C-1
Import price CIF Ca lcutta USD 10 per KG 100.00 126.00 12,600.00 USD Rate 126 at the time of retirement of LC Document
Insura nce, Freight (Ca lcutta to Ka thma ndu) 125.00
Custom Duty (8% on CIF Ca lcutta price) 100.00 127.00 1,016.00 USD Rate 127 at the time of Custom clearance
Cost Price 13,741.00
Sa les Price 14,000.00
Gross Ma rgin 259.00

After 30 days USD Ra te NPR C-2

Import price CIF Ca lcutta USD 10 per KG 100.00 117.00 11,700.00 USD Rate 117 at the time of retirement of LC Document
Insura nce, Freight (Ca lcutta to Ka thma ndu) 125.00
Custom Duty (8% on CIF Ca lcutta price) 100.00 116.00 928.00 USD Rate 116 at the time of Custom clearance
Cost Price [email protected]
12,753.00
Sa les Price 14,000.00
Gross Ma rgin 1,247.00
39
Forward Vs Option
With Forward
USD Ra te a t the time of LC Opening 120
1 month Rupee Ra te 10%
1 month USD Ra te 2%
Forwa rd Premium for 1 month 0.8
Forwa rd Ra te for 1 month 120.8
After 30 days USD Ra te NPR C-1
Import price CIF Ca lcutta USD 10 per KG 100.00 120.80 12,080.00 USD Rate 126 at the time of retirement of LC Document
Insura nce, Freight (Ca lcutta to Ka thma ndu) 125.00
Custom Duty (8% on CIF Ca lcutta price) 100.00 127.00 1,016.00 USD Rate 127 at the time of Custom clearance
Cost Price 13,221.00
Sa les Price 14,000.00
Gross Ma rgin 779.00
After 30 days USD Ra te NPR C-2
Import price CIF Ca lcutta USD 10 per KG 100.00 120.80 12,080.00 USD Rate 117 at the time of retirement of LC Document
Insura nce, Freight (Ca lcutta to Ka thma ndu) 125.00
Custom Duty (8% on CIF Ca lcutta price) 100.00 116.00 928.00 USD Rate 116 at the time of Custom clearance
Cost Price 13,133.00
Sa les Price [email protected] 14,000.00
Gross Ma rgin 867.00
 Forward Vs Option
40 With Option
USD Ra te a t the time of LC Opening 120.00
1 month Rupee Ra te 10%
1 month USD Ra te 2%
Option Premium for 1 month 0.50
Right to buy 121.00
After 30 days USD Ra te NPR C-1
Import price CIF Ca lcutta USD 10 per KG 100.00 121.00 12,100.00 USD Rate 126 at the time of retirement of LC Document
Option Premium 100.00 0.50 50.00
Insura nce, Freight (Ca lcutta to Ka thma ndu) 125.00
Custom Duty (8% on CIF Ca lcutta price) 100.00 127.00 1,016.00 USD Rate 127 at the time of Custom clearance
Cost Price 13,291.00
Sa les Price 14,000.00
Gross Ma rgin 709.00
After 30 days USD Ra te NPR C-2
Import price CIF Ca lcutta USD 10 per KG 100.00 117.00 11,700.00 USD Rate 117 at the time of retirement of LC Document
Option Premium 100.00 0.50 50.00
Insura nce, Freight (Ca lcutta to Ka thma ndu) 125.00
Custom Duty (8% on CIF Ca lcutta price) 100.00 116.00 928.00 USD Rate 116 at the time of Custom clearance
Cost Price 12,803.00
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Sa les Price 14,000.00
Gross Ma rgin 1,197.00
41

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 Cash Vs Physical delivery
42

In Future Market

What may be the reasons that most of the trades are settled at cash rather than delivered physically???

 More than 90% of the future contracts are settled at cash due to following reasons:

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 Cash Vs Physical delivery
43
1. Convenient to both parties:

 In physical settlement the seller/short position holder would have to buy each of the underlying stocks
in the correct proportion in order to deliver.

 This would not only be tedious but cause complications of having to buy in odd lot sizes.

 On delivery, the long position will have to get all these stocks registered or sell them in the odd lot
received, again a tedious and time consuming process.

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 2. Cost reduction
44

 No need for the short to buy the underlying stock and the
long position to sell the received stock, both parties save
substantial transaction costs.
 An example of Malaysia: brokerage commission is equivalent to
one percent of value for either buying or selling. Cash settlement
saves two percent of contract value which typically is a few
thousand ringgits. In this case, the only ones who would benefit
from requiring physical settlement would be stock brokers.

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 3. When physical delivery is not needed
45
 A hedger who had taken a position to lock in a price regardless of whether the
contract is cash or physically settled.
 Let’s talk about a jeweler who just bough 1 million worth of gold bars for
inventory.
 These are to be used as raw materials for jewelry he intends to produce over
the next six months.
 Since jewelry prices are dependent of the spot price of gold, the jeweler
clearly has exposure.
 If the spot price of gold falls subsequently, he would be hurt since not only
the value of remaining gold bars in his inventory will fall but also the finished
jewelry and jewelry to be produced in the near future would all be worth less.

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46

 How can the jeweler hedge such a risk?

 Is he not a Genuine Hedger??

 Can he deliver after 6 months???

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 Cond.

47  An easy way would be for him to use gold futures contracts that is
short 1 million worth of 6 month gold contracts.
 By doing so, he neutralizes subsequent gold price declines since the
losses resulting from diminution in value of inventory will be offset by
the profit he makes on the short position in the futures contract.
 The opposite will happen if gold prices rise. Notice that even though
the jeweler is a genuine hedger and not a speculator, he has no
intention and will be in no position to deliver the gold. In 6 months the
gold in his inventory would be just about finished.
 He cannot deliver and had not intended too. All he needed was
insurance against price falls for 6 months and he received that
protection. Just before maturity the jeweler simply calls his futures
brokers to reverse out his position.
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 An interesting apocryphal
48
 Live cattle future contracts trade on
CME and each contract is on 40,000
pounds of cattle.

 Would you expect it to be settled @

cash or delivered physically?

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 Website and newspaper quotes
49
Symbols Bid Ask High Low

372.26 368.69
COFJUNE14 370.53 370.65

691 671
COPJUNE14 687.0 688.5

18.910 17.210
CORJUNE14 18.210 18.240

17590 17400
PALJUNE14 17431 17460

49950 49372
GOLJUNE14 49685 45699
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50

NDEX Trading Work

Station-TWS

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51 Technical Analysis

 Technical analysis assumes that market psychology

influences trading in a way that enables predicting
when the price will rise or fall.

 Technical analysts believe that they can accurately

predict the future price of a stock or commodity by
looking at its historical prices and other trading
variables.
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52
Types of Charts

The most popular types of charts are:

 Line chart
 Bar chart
 Candlestick chart

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 Line Charts
53

A simple line chart draws a line from one closing price to the
next closing price.

Bar Charts
A bar chart also shows closing prices, while
simultaneously showing opening prices, as well
as the highs and lows.

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 Candlestick
54  Japanese Candlestick charting and analysis is one of the most effective
methodologies in the universe of technical analysis. Japanese Candlestick
analysis is a highly effective, but under-used investment decision-making
technique. Yet few people understand the ramifications or significance of the
signals that are clearly and reliably displayed.

 Popularized by Sokuta Honma, Japanese Rice Trader during mid 1700s.

 Developed over 400-year period

 Steve Neson is credited with introducing them into the US markets

 There are over 100 Candlestick patterns

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 The Candlestick
55

The purpose of candlestick charting is strictly to serve as a

visual aid. The advantages of candlestick charting are:

• Candlesticks are easy to interpret, and are a good place

for a beginner to start figuring out chart analysis.

• Candlesticks are easy to use.

• Candlesticks and candlestick patterns have cool names

such as the shooting star, which helps you to remember what
the pattern means.

• Candlesticks are good at identifying market turning points

– reversals from an uptrend to a downtrend or a downtrend
to an uptrend.

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 Formation of Candlestick
56

There are two types of Candlestick, Bullish & Bearish

 Bullish Candlestick formed when market close above the

opening price.

 Bearish Candlestick formed when market close below the

opening price.

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57
Some Technical Terms Used

 Bullish
 Bearish
 Bullish continuation pattern
 Bearish continuation pattern
 Bullish reversal
 Bearish reversal
 Support
 Resistance

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 Long Day & Short Day
58

A long day represents a large price

move from open to close. Long
represents the length of the candle body.

Short days can be interpreted by the

same analytical process of the long
candles.

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 Marubozu
59

White Marubozu

In Japanese, Marubozu means close cropped or close-cut. This is

an extremely strong pattern. It opens on the low and
immediately heads up. It continues upward until it closes, on its
high. it is often the first part of a bullish continuation pattern.

Black Marubozu

It is often identified in a bearish continuation A long black

candle could represent the final sell off, making it an "alert" to a
bullish reversal.

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60
Closing Marubozu

A Closing Marubozu has no shadow at it's closing end. A white body

will not have a shadow at the top. A black body will not have a
shadow at the bottom. In both cases, these are strong signals
corresponding to the direction that they each represent.

Opening Marubozu

The Opening Marubozu has no shadows extending from the open

price of the body. A white body would not have a shadow at the
bottom end , the black candle would not have a shadow at it's top
end. Though these are strong signals, they are not as strong as the
Closing Marubozu.

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61
Spinning Top
Spinning Tops are depicted with small bodies relative to the
shadows. This demonstrates some indecision on the part of
the bulls and the bears. They are considered neutral when
trading in a sideways market.

Doji

The Doji is one of the most important signals in

candlestick analysis. It is formed when the open and the
close are the same or very near the same.
Interpretation is that the bulls and the bears are conflicting.

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 Morning Star
62
The Morning Star is a bottom reversal signal. Like the morning star,
the planet Mercury, it foretells the sunrise, or the rising prices. The
pattern consists of a three day signal.

Evening Star

The Evening Star is the exact opposite of the morning star. The
evening star, the planet Venus, occurs just before the darkness sets
in. The evening star is found at the end of the uptrend.

Shooting Star

A Shooting Star sends a warning that the top is near. It got its name
by looking like a shooting star.
The Shooting Star Formation, at the bottom of a trend, is a bullish
signal. It is known as an inverted hammer. It is important to wait for
the bullish verification.
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63
Hammer

The hammer is a bullish reversal pattern that forms

during a downtrend.

It is named because the market is hammering out a

bottom.

When price is falling, hammers signal that the bottom

is near and price will start rising again.

The long lower shadow indicates that sellers pushed

prices lower, but buyers were able to overcome this
selling pressure and closed near the open.
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 Support and Resistance
64

 Support and resistance is one of the most widely used concepts in trading.
Strangely enough, everyone seems to have their own idea on how you
should measure support and resistance.

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 Leading VS. Lagging Indicators
65

 A leading indicator gives a buy signal before the new trend or reversal
occurs (oscillators are leading indicators.) Example:
Stochastic, parabolic SAR, and the Relative Strength Index(RSI)

 A lagging indicator gives a signal after the trend has started and
basically informs you “ hey buddy”. Pay attention, the trend has
started, you’re missing the boat.” (momentum
indicators are lagging indicators also called Trend following Indicators)
Example: Moving Average, MACD

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 Moving Average
A “simple moving average is calculated by adding the instrument
prices for the most recent “n” time periods and then dividing by “n”

Crossover trading-two SMAs are plotted and the shorter period is

used as the signal line. If is shorter period crosses over the longer
period from below to above, then it is considered bullish and a buy
opportunity. Conversely, if shorter period crosses over the longer
period form above, then it is considered bearish and a sell
opportunity.

Effective period are 5.10.20,50 and for support and resistance

50,200
 MACD
Moving average convergence/divergence is trend-following indicator.

This tool is used to identify moving averages that are a new trend, whether
it’s bullish or bearish. MACD parameters “12,26,9”

Used to identify buy and sell signal. When MACD crosses above the signal
line, it may be time for the longs to enter the market, whereas when a cross
below the signal line occurs, it may be time for the shorts to enter the
market.

If you look at our original chart, you can see that as the two moving
averages separate, the histogram, gets bigger. This is called divergence,
because the faster moving average is diverging or moving away from the
slower moving average.

As the moving averages get closer to each other, the histogram gets
smaller. This is called convergence because the faster moving average or
getting closer to the slower moving average.
68

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 RSI
Relative Strength index ( RSI) identifies
overbought and oversold conditions in the
oscillator

Is a price - following oscillator

Scaled from 0 to 100- readings over 70

indicate overbought and below 30 indicates
underbought.

Period-9 days and 14 days

 Parabolic SAR

Parabolic Stop And Reversal (SAR)

A Parabolic SAR places dots, or points, on a chart that indicate potential reversals in price
movement

Basically, when the dots are below the candles, it is a buy signal; and when the dots are above the
candles, it is a sell signal.

You DON’T want to use this tool in a choppy market where the price movement is sideways.

It only gives bullish and bearish diagonals

 Stochastic

Measures overbought and oversold conditions in the market.

2 lines are similar to the MACD lines in the sense that one line is scaled from 0
to 100

When the stochastic lines are above 80. The red dotted line in the chart above),
then it means the market is overbought . When the stochastic lines are below 20(
the blue dotted line), then it means that the market is oversold.
 Bollinger Bands
Bollinger bands are used to measure a market’s volatility.

When the market is quiet, the bands squeez; and when

the market is LOUD, the bands expand

The Bollinger Bounce:

A strategy that relies on the notion that price tends to
always return to the middle of the Bollinger Bands

You buy when the price hits the lower Bollinger band

You sell the price hits the upper Bollinger band

Best used in raging markets

73

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 Pivot Point
74  Pivot point is used to determine entry and exit points of the trading day based on the previous day’s
trading activity.

 Support and Resistance levels are areas at which the direction of price movement can possibly
change.

 Pivot points are especially useful to short-term trader who are looking to take advantages of small
price movements.

 Calculated by using last trading session’s open , high, low, and close
Pivot point= [open+high+close]/3
 The calculation for a support and resistance is shown below.
first support (S1)=2*pp-high
first resistance(R1)=2*pp-low
Second level of support and resistance:
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support (S2) =pp-(high-low)
Second resistance (R2)=pp+ (high-low)
 Which Time Frame Should I Trade?
75

Trading time frames are usually categorized into

three types:

 Long-term
 Short-term or swing
 Intraday or day-trading

Which one is better?

It depends on your personality!

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 Time frame Description Advantages Disadvantages
76 Long-term Long-term traders will usually Don’t have to watch markets Large swings which require large stops
refer to daily and weekly charts. intraday Usually 1 or 2 good trades a year so
The weekly charts will establish Fewer transactions means less patience is required
the longer term perspective and paying of spreads Bigger account needed to ride longer
assist in placing entries in the   term swings
shorter term daily. Trades usually Frequent losing months
from a few weeks to many months,
sometimes years.

Short-term Short-term traders use hourly More opportunities for trades Transaction costs will be higher (more
time frames and hold trades for Less chance of losing months spreads to pay)
several hours to a week. Less reliance on one or two trades Overnight risk becomes a factor
a year to make money  

Intraday Intraday traders use minute Lots of trading opportunities Transaction costs will be much higher
charts such as 1-minute or 5- Less chance of losing months (more spreads to pay)
minute. No overnight risk Mentally more difficult due to
Trades are held intraday and frequency of trading
exited by market close. Profits are limited by needing to exit at
the end of the day.

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 Reasons for several traders suffering from losses
77
 No planning
 No patience(investors’psychology)
 Not following the trends
 Hot news
 Lack of time
 Not using money management technique (investors’ psychology)
 Not using stops (investors’psychology)
 Overtrading (investors’psychology)
 Continuous buy/sell

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 Best guidelines for trading
78
 Robert Deel’s 16 Rules of Investology (A successful trader, 20 years of
experience ; He is an internationally recognized trading expert, and has trained groups of traders
Throughout the U.S., Europe, Asia, and Canada. He is the author of Trading the Plan and The Strategic
Electronic Day Trader. He is also the President and CEO of Tradingschool.com, a school that trains
Individual and professional traders from all over the world.)

 Trade with a Plan

 Screen your trade
 Always Look at a Chart
 Stay With a Trend
 Use Money Management Techniques

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 Buy and Sell on Confidence
Buy only Liquid Stocks and in Liquid Markets
 79
 Don’t buy or sell on Hot Tips
 Do not Average Dollar Cost
 No one wins 100 % of the Time
 Always use Stops
 I don’t have Time
 Be patient and let time be your Friend
 Learn from your Mistakes
 Know how to short Stocks
 Follow the Rules
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80 Any Questions???

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81

Thank You 
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