Article Written on: Thursday, 08 June 2017

Learn how volume in stock or derivative trading can help traders set up their winning trades.

What Is Volume?

Volume is a count of total trading done at a given period of time.

See today’s highest volume in Bank Nifty:

Source: https://www.nseindia.com/live_market/dynaContent/live_analysis/most_active_contracts.htm

You can find historical contract-wise price volume data of NSE here:
https://www1.nseindia.com/products/content/derivatives/equities/historical_fo.htm

As you can see as on June 08, 2017, 11:31:22 Indian Standard Time:

Most volume of trading can be seen in BANK NIFTY of strike 24,000 CE.
Volume: 2,74,121
Turnover in lacs: Rs. 26,31,617.52
Open Interest: 15,83,280
Value of Underlying: 23,631.30

Bank Nifty at the time of writing is currently at 23,610.45:

Source: https://www.google.co.in/search?q=banknifty+share+price

Today – Thursday, 08-06-2017, is Bank Nifty weekly expiry. As you can see since strike CE 24000 is Out of The Money Call Option, a lot of traders are trying to make money here there.

Read The Reality Of Very Far OTM Out Of Money Options, to know why Out of The Money options are highly traded on expiry day.

I that article I had written – They get attracted by low premium and low risk options.

This you can see comes true in every expiry day.

Volume is overlooked because not many trades know how to utilize it.

Volume is created because for every buyer there has to be a seller, and for every seller there has to be a buyer. When in a certain stock or derivative too much volume is created, there is definitely something going on.

In stocks with high volumes the ask and bid prices are very close. In low volume stocks the ask and bid prices are far.

Especially in stock options, the out of the money options have very low volume. Sometimes are volume are so low that there are buyers but no sellers, and the trade cannot take place.

Volumes can be great indicator to trade a stock.

How To Use Volume as an Indicator of Direction?

Before reading I need to add a disclaimer: Volume itself is not the only indicator of the direction of the move. It is just one part of the indicator of the direction.

Most traded stocks, option strikes and futures can be found in many websites. One link I have already given above, but there are many brokers who show the high volume stocks for their clients to take a decision to trade. Here is another link to see the volume, most active stocks traded during the day, last 5 day performance, Gain Percentage, SMA, Deliverables, live when the markets are open:

http://www.moneycontrol.com/stocks/marketstats/nse-mostactive-stocks/nifty-50-9/

As traders it is better to participate in stocks with more volume than stocks with less volumes. This is better for a short term trading not long term investing in stocks.

Long term investing can sometimes produce stellar returns, I offer a course on selecting stocks for long term investing. For long term investing volume is not important.

However for short term trades, volume is a strong indicator of trading though it is not a strong indicator of success of trading.

Indicators to help you take a trading decision

If the price of a stock is decreasing, but its trading volume is increasing then there is a chance of the stock price rising. Reason – good interest by trades. This is signal of an uptrend.

Possibility of success is high if the volume in the above situation is very high. In low volumes it may be a wrong signal as in low volume trading the volume can change any time.

Example:

When a company comes out with great quarterly result, there is a very high chance of high volume and rising stock price of that company. Similarly when a company comes out with bad quarterly result, there is a very high chance of lack of interest, low volume and falling stock price of that company.

What is the problem with the above volume based trading?

Volume has to be constantly monitored. This is a serious drawback as within seconds volumes can change. This is the reason we see a high volume stock suddenly falling, or a high volume stock suddenly rising.

Have a look at Yes Bank trading chart on 09-June-2017:

At 1.41 pm the stock suddenly started moving up from a intraday low of 1475.20. Exactly here the volume must have increased.

This is where is the problem with volume based trading. Seeing the decreasing volume some intraday traders must have shorted the stock at 1.40 pm only to see the stock going up from 1.41 pm and must have exited in loss.

In extraordinary volumes some stocks become very volatile. They move up and down in a rapid way leaving the traders in a frenzy mode. When volume increases it goes up, when volume decreases it goes down. This happens intraday.

It is seen that most intraday traders get caught in the market tops seeing the volume and vice versa.

Is Historic Volume is Of Any Help?

No. Historic volume will produce irrelevant data. If traders need to compare volumes then maximum they can go back to 14 trading days.

Conclusion:

Lots of traders trade only out of the money options. Read to know the reality of trading Out of The Money OTM options.

There are two types of speculative option traders:

1. Those who trade only ATM (At The Money) options, and
2. Those who trade only OTM (Out of The Money) options.

Very few trade In The Money ITM options.

Most traders start with At The Money options then move to Out of The Money Options to try their luck.

Buyers when they lose become sellers and sellers when they lose become buyers. And most option traders start trading with Index options. In India Nifty Options is the most traded options.

Therefore there is rarely low liquidity in Nifty Options trading.

Option Buying or Selling is a Game of Probability

NSE spot price is 9,642.15 as on 01.01 pm, 06-June-2017.

Today NSE is falling, so for most traders probability of success of selling Call Options is more than that of probability of success of selling Put Options.

Tomorrow the story may change.

To avoid taking chances traders try to sell very far Out Of The Money options, especially near expiry. This is more fun oriented than logic oriented.

One plunge down on expiry day can even push far out of the money options into at the money options and it may take away years of profits of the far out of the money option sellers.

Story is same with far out of the money option buyers.

They get attracted by low premium and low risk options. On expiry day or a few days before expiry when option premiums are low, these traders buy very far out of the money options hoping the stock may take a drastic move and they can make a lot of money.

Most of the times it does not happen and they end up losing money.

When move actually comes they are either not trading that side, or they exit in a small profit.

Buying low premiums out of the money options is like buying a lottery. At least if they win a lottery, they end up making a few lakhs or even crore, but in options trading maximum profit also has a limit. One trade cannot make lakhs of profits.

Unfortunately by the time a trader understands it’s too late.

Once they realize they are doing a mistake they look for tips – again a huge mistake and they lose more.

Then they start looking to educate themselves or do a course. Some of my clients have been though the above hell then did my course.

Conclusion:

Educated yourself before trading options and getting into the game of speculative trading or playing the game of probability.

Date: Monday, 05-June-2017

Nifty has rallied from 8000 levels to the highest in history today: 9685.15

Today highest:

Learn why you should avoid temptation to buy stocks in a bull rally, wait for a fall and then buy stocks as per your choice.

In a bull rally most investors get lured by temptation to participate in the rally and make quick money and end up getting caught at the peak.

In the history of stock markets which bull rally ran permanently? None. What goes up has to come down and what comes down has to go up. This is the nature of stock markets.

Mistakes To Avoid In a Stock Rally

1. Temptation to Buy Stocks – Too many investors are now in a buying frenzy mode as if stocks will never fall. This is a huge mistake. This is the time to sell not to buy. Of course to sell you must have stocks in your portfolio that are making good profits. If you did not buy earlier when the stocks were at attractive prices, you did a mistake. If you buy now you will do a double mistake. Avoid your temptation to buy stocks now.

2. It is A Very Costly Market Now You are getting a deal but its very costly. Will you go for this deal? Yes there is a feeling that Nifty may touch 10,000 who knows but the deal is costly and the risk is too much. It is better to leave a costly deal and wait for a better deal.

3. Chance of a Bubble – Agreed now government across the world have taken considerable steps to avoid the recession like situation in 2007-08, but who knows what is happening? Why risk your money when it can be avoided. There is little chance of a bubble, but its better to sit sideways.

4. Aggressive Shorting – There are a lot of contrarian traders. They always short the markets whenever they see a bull market. Positional shorting cannot be done on stocks so they take aggressive bets on options shorting. I am sure a lot of traders are now shorting at the money options or just out of the money ones trying to capture the maximum profit. They forget that in a bull market option premiums are very low so the risk reward ratio is very bad. See India VIX on 05-June-2017. It is less that 11. Range of 9-12 is considered low for VIX. VIX or Volatility Index has a big role to play in deciding option premiums. It forces trader to come near the money to short options to make more money. They do not even hedge and if the rally continues they end up making huge losses.

India VIX as on 05-June-2017:

Learn proper option hedging methods in my conservative options trading course.

5. Depending on Trading Software – I am sure all trading software must be giving a buy signal. A software does not have a brain. When it sees no downfall for days it will obviously make a straight line up. The software cannot predict a fall. No software ever predicted a bull run or a great fall and they will never do. I have never traded based on any software because I believe business is done by humans not machines. The article you are reading now is written by me not a machine. Similarly, the money you will keep to trade will be yours, the profit and losses will be yours – then why follow a software? Like your place in your job/business cannot be replaced by a robot or a machine, what makes you think software can trade?

Read this how automated trading systems can fail big time. Here are the disadvantages as per the wiki article:

Disadvantages of Automated Trading System:

An algorithm that performs very well on backtesting could end up performing very poorly in the live market. This point is very important for traders who backtest a strategy, get great results and think the strategy will work in future as well. This is simply not true. Good performance on backtesting could lead to overly optimistic expectations from the traders which could lead to big failures.

The following text has been taken from Futuresmag.com:

The system wins only 38% of its trades. The average winning trade lasts 153 days, whereas the average loser lasts only 55 days. If we look at monthly returns, however, six out of 10 months make money. Our winning months average $7,028, and our average losing month is –$5,805. At first glance, this may seem like a paradox—how can only 38% of the traders make money, while 60% of the months are winners? The answer lies in the role of time. This is a trend-following system; as such, a large percentage of trades shows an interim profit at some point even though (per the rules of the system) only 38% are closed out as winners.

Because the average winning trade lasts 153 days, we can assume we must trade for at least 600 days before we make money. That would be just four winning trade periods. Even though it may seem like a long time (almost two years), it is still a short period measured in terms of trade time frame.

The following text has been taken from https://en.wikipedia.org/wiki/Automated_trading_system:

On May 6, 2010, the Dow Jones Industrial Average declined about 1,000 points (about 9 percent) and recovered those losses within minutes. It was the second-largest point swing (1,010.14 points) and the largest one-day point decline (998.5 points) on an intraday basis in the Average’s history. This market disruption became known as the Flash Crash and resulted in U.S. regulators issuing new regulations to control market access achieved through automated trading.

On August 1, 2012, between 9:30 a.m. and 10:00 a.m. EDT, Knight Capital Group lost four times its 2011 net income.[14] Knight’s CEO Thomas Joyce stated, on the day after the market disruption, that the firm had “all hands on deck” to fix a bug in one of Knight’s trading algorithms that submitted erroneous orders to exchanges for nearly 150 different stocks. Trading volumes soared in so many issues, that the SPDR S&P 500 ETF (SYMBOL: SPY), which is generally the most heavily traded U.S. security, became the 52nd-most traded stock on that day, according to Eric Hunsader, CEO of market data service Nanex. Knight shares closed down 62 percent as a result of the trading error and Knight Capital nearly collapsed. Knight ultimately reached an agreement to merge with Getco, a Chicago-based high-speed trading firm.

One small mistake by the software and the trader loses his shirt or may have to sell his home to at least put food on the table.

Never do these mistakes in your trading life especially in a Bull Run which attracts most investors to stock markets.

Conclusion:

Do not let Automated Systems take ownership of your trading money – if they do mistakes you will pay the price not automated systems. Take control of your money yourself. God has given you a brain and two hands to take control of your future so do not let anyone else either a machine or an unsolicited advisor or tip provider take control of your finances.

Today on Saturday, 03-June-2017, at 7.07 am morning I received an SMS which was quite shocking.

Here is the screen shot:

Here is the text (spelling mistakes corrected):

Good morning Sir, I am from Telangana. I lost so much amount know, I am in Suicide condition sir please help me, I am coming to Kolkata. Please give me your address.

Please train me as yours brother and I will message through what’s up is showing yours, can I talk for 10 minutes on phone call when I call after yours time please tell me and help me sir.

Imagine seeing this first message as soon as you get up on your phone.

There are a lot of things which are clear:

1. Emotional blackmail: Well I keep getting such messages and calls. But such emotional messages are mostly from South India (please do not take it personally if you are from south India, I am just telling a fact). 60% of my customers are from South India. Yesterday I got a call from someone speaking in very good English. He said. “Sir I am a farmer selling vegetables. It is very hard to survive, please help me. I will pay Rs.1000/- please send me your strategies.”

Speaking English like well educated person, but giving an excuse to save 4000. Obviously I said, “No rules is same for all, when you sell vegetables to a poor man, do you give him 80% discount?” He kept down the phone.

But this morning SMS was shocking. Not even once he said he will pay the course fee, but he is willing to come to Kolkata from Telangana and learn personally from me.

Lets calculate the approximate cost to some to Kolkata from Telangana and learn the strategies personally from me without paying the course fees:

1. Travel cost by Airplane: Rs.7000/- or more approx (2000 more than the cost of my course)
2. Stay at a hotel for 2 days: Rs.4000/-
3. Food for 2 days: Rs.2000/-
4. If he decides sightseeing in Kolkata: Rs.3000/-
5. If he decides sightseeing near Kolkata like Darjeeling and Gangtok: Rs.12000/-
6. Course Fees he is not willing to pay: Rs.0/-

Total cost: 7000+4000+2000+3000+12000+0 = Rs.28,000/-

This guy has lost lot of money in stock trading so much so that you know what. He needs my personal coaching to learn my course strategies. For that he is willing to spend Rs.28,000/-, but is not willing to pay the fees of the course. Strange.

After taking the screen shot, I deleted the message. I did not reply, nor called him.

2. What is the truth behind the SMS? May be he is a crorepati who knows?

3. Giving a shot to emotionally blackmail to get the course for free.

A few months back one person called me. He was crying and said he is retired, aged 65, and lost 80% of his retirement money trading stock markets and he needs my help. Read – he wanted the course for free.

For 6-7 months, end 2013 to mid 2014, I gave a lot of advise for free, but no one bothered. Then I realized I am wasting my time, no one cares for free knowledge. Here is some proof. Only 13.1% read my absolutely free emails. This data is since 03-Aug-2013, when I started helping people for free. Paid course started in May 2014 only after I realized free is not valued. See this image:

Well I have more than 10,000+ mobile numbers in my database and I can easily keep one marketing guy to call people to do my course. I NEVER do it and will NEVER do it. Did you ever got a call from me after filing the form in my site? No, you will never get a call from me ever.

The email is taken to send you free emails that is all that too if you are interested and filled the form, and the phone number is taken to help you save money on brokerage, there is no other reason.

Both are to help you. But everything is your choice.

– You can unsubscribe from my emails anytime,
– You can reject the offer to save money on brokerage, though you will be doing a mistake. Saving money is making money, and,
– And you can enroll for my paid course or not enroll – it’s your choice.

In fact all of the above is your choice.

Frankly at least 70% of my customers have done my course after 1 or more year of being my free subscriber and am sure after losing money trading, then thinking ok let me try to recover the lost money by doing this course. Most of them do my course as a “Last Chance” to recover lost money from stock markets.

And then this happens.

Any new and young aspiring investor or trader while opening a demat and trading account dreams big of making at least 10% return a month from stock trading. Almost all of them think they will double their money in one year, and then compound it.

Well same here, that’s the reason I lost money heavily when I started trading in 2007.

At that time people were not that smart or educated (though I am an MBA in Finance), I thought maybe this is the reason people think this way. Later India developed, our education system developed and I thought now people might have changed in ten years time in 2017.

But hey I was wrong.

Last week end May 2017 I received an email from one of my site followers. Here is the email:

=====
Subject: Inquiry for the option course from a very serious professional

Hi Dilip,

I am an entrepreneur and the founder of (company name hidden for privacy).

Since the last 2 months I have invested in learning and practicing charts, technical analysis in international forex trading. Later I found that Indian trading platforms are not suited for forex.

My note not in email: Forex, also known as foreign exchange, FX or currency trading, is a global market where all the world’s currencies trade. The forex market is the largest, most liquid market in the world with an average daily trading volume exceeding $5 trillion. In India forex trading is done mostly in USD (United State Dollars).

I am interested in your course, but here are the issues:

I have been practicing charts and trading a nominal amount, using this brokerage firm, but lack the basics. Like after every successful trade, still why I am losing money?

I need to understand the basics – money management, commission, ideal trading platform, etc. Also, though I have read a lot, I really don’t understand the difference between options and futures and I have not traded Nifty etc.

My question are:

1. Will you be able to start training from basics? I am a very diligent and fast learner, and will catch up really fast, as my technical understanding is good. I am willing to invest in education.

2. I am not looking to ‘get rich quick scheme’ and willing to learn and put the hard work just like I have did for my digital agency which is among the fastest growing now. I have 75000 capital to invest and looking at a decent 15000-20000 profit per month.

Waiting for your reply.

Name Withheld

This e-mail was sent from a contact form on http://www.theoptioncourse.com.
=====

Everything seemed fine but what surprised me was the last paragraph – I have 75000 capital to invest and looking at a decent 15000-20000 profit per month.

Please note that he is an entrepreneur which means he is highly educated, on top of that he has read technical charts etc.

Calculating the returns he is expecting every month.

(20000/75000) * 100 = 26.66% a month.

In that way he is expecting 26.66*12 = 319.92% return a year from stock markets. IMPOSSIBLE.

Let is see what 319.92% a year return can do to Rs.75,000 if compounded for 10 years.

Rs.127,857,692,121.36 that is Rupees 12 Thousand 7 Hundred & 85 CRORES and 692,121.36.

In ten years time this will make him the RICHEST person on Earth, probably much before.

In our times most people used to dream of 10% return a month, but look at this 26.66% a month.

I was like scratching my head after reading this. Now what to reply? Anyway I did reply. Here is the reply:

=====
Hi,

The course does not deal with basics as it is assumed that the person knows options and futures trading basics, like what is Call, Put and Future. What is the difference between buy call, sell call, buy put, sell put, buy future and sell future. If you know these things you can do the course. If you do not know still, the basic is very easy to learn.

I can send you basic course on options but support is not given in basic course. Support is given in the paid course only. If I start giving support on basic option course for free I will not be able to sleep.

>> I have 75000 capital to invest and looking at a decent 15000-20000 profit per month.

This is NOT decent. You are expecting something that is impossible to achieve. Max is 3-5% return a month. You are targeting 25% return a month. Sorry to say but from your point of view Mukesh Ambani is a fool. He should immediately close Reliance Ltd and start trading.

Dilip
=====

I could have lied telling some months its possible or something like that, like most tips provider lie to take your money. But the problem with me is that I cannot tell a lie to take your money.

Do my course if you are satisfied with 3% return a month, otherwise there are many people ready to take your money away by telling you a lie or sending SMS that 1 lac a day is possible by options trading. Hey even I get these SMS everyday. I delete them immediately.

Beware of them.

Anyway he replied again:

=====
Hi Dilip,

Please pardon if some of my questions are too naive, as I am a newcomer and trying to explore the scenario.

I have 3 points to highlight:

I am willing to invest more if you help me to learn basics as well.

5% return is fine. Does that mean if I invest 5 lakhs , I would be generate a profit of 25,000 return monthly ?

I am really willing to learn. Please help me. I would always remain a newcomer if no one handheld me in the initial days.

Regards,
Name Withheld
=====

My reply:

=====
>> I am willing to invest more if you help me to learn basics as well.
I can just give you a document on option basics but no support on that. Support is only in the course strategies.

>>5% return is fine. Does that mean if I invest 5 lakhs, I would be generate a profit of 25,000 return monthly?
No 3% is average, which means 15000 monthly.

It is not your fault. Too many people think it’s easy to make 10% return a month from stock markets. When they lose lakhs then realize even 2% a month is good enough.

You are in the first zone.

Best Regards,
Dilip Shaw
=====

I am sure a lot of you are in the first zone dreaming to make 10% or more return a month. Let me tell you bluntly if you trade aggressively to make 10% return a month, may be one month you will make, but next month you may end up losing 20% or more.

Over a year you will be in loss.

I get phone 5-6 calls daily inquiring about my course and 100% of them are losing money trading options.

If you are also one of them do my course and learn something. Lots of traders have benefited from it since 2014. My first client paid on 12-May-2014, for the course – the very first day I updated a paid service. Before that I was helping traders for free but no one cared or listened. Then I realized that free is not valued in this world.

It is three years now and you can see the results yourself:

What traders say about my course
Latest testimonials
Testimonial page 2
Testimonial page 3
Testimonial page 4
Testimonial page 5
What people say just after reading my course

The above are real testimonials not fake Photoshop generated random images or a fake made excel sheet uploaded as monthly performance in many websites that you see online.

It took me three years and three lakhs to research and make these strategies that is why there is a charge.

If you think you will be happy with small profits trading options you can pay for my course here.

Read to know why many option sellers sell options on expiry day and try to make money.

A few months back I got an interesting email from one of my subscribers:

Dear Dilip ji,

Hi Sir,

I am your follower, though I am new to your course joined some days back, also familiar with market.

I wish to know from your vast experience, about:

1) Why bears/shorter select the expiry date or day before/near expiry only, for heavy selling?

Last time, on some expiry day only, the reason was Bank of Japan’s rate policy & on today’s expiry, reason is India’s surgical attack on LOC, whereas these reasons were already known for these bear community.

2) Why Long straddle / strangle is useful in the expiry week?

3) Can one go for Long straddle/strangle in this type of vertical fall?

Request your expertise comments, at your convenient.

Thanks.

I replied him the reasons, but I want to share with you as well.

It is true that on derivative expiry day a lot of selling / shorting of options (not futures) takes place.

But why on Expiry Day?

The reason is pretty simple. This is the day ALL the out of the money options will expire worthless. If they expire worthless all the buyers money will be eaten by sellers.

But there is a condition – it has to expire worthless. If it does not then there can be heavy losses for the sellers.

The problem with greedy sellers is that they forget what if they lose.

If you observe India VIX, on the expiry day, you will see that it almost always increases on expiry day. VIX is directly associated with panic in the markets. On expiry day most sellers and buyers are in a panic mood until the trade is closed. Biggest mistakes by option and future traders are done on expiry day.

These are some of the mistakes done on expiry day by option traders

Sellers hope that the option they sell will expire worthless and they can keep all the money they got for selling. On top of that they know if it expires worthless they will not have to even close the trade as when the option expires worthless there is no need to close. Though if they do not expire worthless you must close them.

Basically this trade is on hope. But the sellers forget that if there is even slight jump in the last minutes of the market closing they may lose years of profits in a jiffy.

On last day of trading even 200 points OTM out of the money options open at very low premium like 2 or less. Not worth selling.

100 points out of the money will be approx 3-5, again not worth selling.

So the only option left is to sell ATM at the money options. Now this gets a bit risky. This opens at around 15-20 to attract trading. Please understand that if option prices are not worth to sell, the sellers will not sell and trading cannot take place.

Therefore to make sure trading does takes place, market makers keep some attractive premiums in only at the money options.

Here is Historical Contract-wise Price Volume Data of Index Options, Index Futures, Stock Options, Stock Futures and Volatility Futures (very low volume here in india).

https://www1.nseindia.com/products/content/derivatives/equities/historical_fo.htm

You will see that volume of trading in ATM options is always high on most trading days, but exceptionally high on the expiry days.

One reason is obvious that traders are closing their positions. But the biggest reason why trading is done in ATM options on the expiry day is the most traders close their positions in other strikes and try their luck in ATM options depending on their view. Some become buyers and some sellers.

Recommended Reading:

Close Futures And Options Before Expiry Day to Save Securities Transaction Tax STT

Why Expiry Day Trading Is Not Good

Date: 26-May-2017

Sir John Templeton (1912-2008), one of the greatest investors and mutual fund managers of all time founded the Templeton Growth Fund in 1954. It started in US but was one of the first mutual funds in US to invest in many countries globally. India is also one of them. In India it is the Franklin Templeton India Mutual Fund.

Sir John Templeton once said, “bull markets are born on pessimism, grow on skepticism, mature on optimism, and die on euphoria.”

Nifty from 8000 levels has now today as on 26-May-2017, has reached 9500+ level. This is an increase of 19% in a five months.

NSE Nifty 50 as on 26-Dec-2016, 7908.25:

NSE Nifty 50 as on 26-Dec-2016, 7908.25

NSE Nifty 50 as on 17-May-2017, 9525.75:

NSE Nifty 50 as on 17-May-2017, 9525.75

There are four stages of a bull market – pessimism, skepticism, optimism, euphoria.

I may be correct or wrong but my perception is we are in the third stage – Optimism.

US is in a very dicey stage. There are talks going on for impeachment of US president.

Frankly there is no big news in India and US or any other country of great economic revolution. Is the world or Indian economy 19% better than it was in December 2016? No. It might be better but nowhere near 19%.

It is just optimism or hopefulness and confidence about the future or the success of something that has brought Nifty from 8000 to 9500+ levels.

If you look at history every bull market ended up with a bubble. Especially the stock market crash of 2008, the world bubble after an euphoria. Stock markets all over world tumbled 50%.

Well that will not happen for sure as the world has adopted strict measure to make sure recession does not happen again. Even if recession has not happened this is a place where we can expect some kind of reversal if not bubble.

Here are some important points:

Every time there is a strong bull run, hedge fund positioning and investments becomes a major headache for stock markets.

Before the stock bubble or 2008, hedge funds had overbought tech and banking stocks. Once the bubble hit, both the tech and banking stocks tumbled bringing the stock markets the world over down 50%.

A recent Goldman Sachs report on hedge funds is showing similar pattern now in 2017. Hedge funds have invested most of the their money in small stocks on top of that they have not invested too much in hedging there portfolios. This is seriously bad news if a bubble hits in.

Since hedge funds invest in billions of dollars, if they start losing money and if not properly hedged the first thing they will so is start taking stop loss. Do not forget that to close their position they will have to sell their stocks.

Basically Sell will overpower Buy. Bears overpowering Bull is a signal of stocks going down.

Once hedge funds crack they have the power to bring stock markets down.

Another problem with hedge funds is that they use leverage to borrow and increase the size of their bet on stocks they hold. Some hedge fund managers are over confident of their investment decisions therefore leverage too much without hedging their bets. As hedging takes money to hedge they do not hedge due to overconfidence.

Once they see any sign on weakness in the markets they sell off all their holdings at once. Here is where is the problem. If all hedge funds sell off then there will be a bubble just like the bubble of 2008. However if the sell off is a few days apart, the markets will come down slowly.

It is well know that hedge fund managers are smartest people in the investing world, but if they do a mistake, everyone suffers.

What I have written above is what hedge funds are doing in the US markets. But do not forget that if US markets fall, Indian markets too follow through.

Disclaimer: This article is based on what is happening in the world of stocks markets especially US. There is no guarantee that we are near bubble or the stock markets will fall. It is based on pure research done by me. I am in no way responsible if based on my articles anyone takes an investment or trading decision. No one can predict the future, but everyone has the right to research. This article is based on my research.

Hedging is sort of Insurance. Like when we buy a car we also buy an insurance. Similarly other insurance products like life insurance, loan insurance etc. These are basically hedge against certain problems in our lives.

Hedging is the same. If take a trade and hedge it properly rest assured that the loss will be limited because hedge will make sure the losses are limited.

Hedge reduces or eliminates fear, one of the worst enemies of trading. It reduces fear because the trader knows that his loss is going to be limited. In that case hedging allows him to take a bigger trade.

Imagine a trader trading 10 future lots without hedging vs a trader trading 10 futures lots with hedge – both taking a long buy call. And if this is an overnight position the trader trading without hedge will not be able to sleep.

Hedging is not just an insurance as written everywhere, its most important feature is it reduces fear of trading.

What Exactly Is Hedging?

It is an investment or trade with negative correlations. It is like becoming a broker. Take money from one trade and give back money on another – the difference is the profit of the trader.

It is obvious that if the trader is reducing risk in the trade, then profits will also reduce. However, if the original trade makes a loss then the insurance pay off a lot which in turn reduces the losses.
Which type of traders are big hedgers?

Portfolio managers, high net worth individuals, conservative retail traders, and corporations trading in millions of dollars almost always hedge their positions.

Just like insurance hedging comes at a cost. But the benefit far surpasses the cost of hedging especially when the trade goes against their bet.

Instead of losing millions of dollars or rupees, they lose only a few lakhs. But when they make money, it’s only a small price they pay for hedge. All in all over a long period of time they make good money.

Even if it is 30 crores profit made on 100 crores of rupees this is a great return.

It is due to hedge that they are able to risk 100 crores, otherwise it is impossible to trade with 100 crores naked trading.

Do High Net worth Investors Hedge?

Yes they do. They trade with a lot at stake. Sometimes they also trade with borrowed money. When they are trading with millions of dollars they cannot even think of taking a big risk. Naked trading is winner takes all and loser loses all.

Winner takes all is fine, but when it comes to losers lose all, they have a problem.

HNIs mostly buy stocks worth crores and they hedge it with derivatives. When they feel stocks may fall they buy Put to protect the losses from the fall.

How many puts to buy and the strike price to buy puts depends on the pricing of the puts and the risk they feel on the stock’s fall.

If their data suggest there can be a huge fall they buy more puts and if they feel the stock may not fall too much they buy less insurance or hedge. This strategy is known as Married Put mostly done by high net worth individuals.

As soon as a trader enters the world of Options the first thing that comes in their mind is to buy options.

These are the reasons they start off by buying options as told by brokers, or friends or reading in websites:

1. Option buy has low risk – It is a myth. Agreed you can buy an option for less than 100 rupees but do not forget that it does not guarantee that it will make money. That 100 rupees can become ZERO. There is no business in the world where you buy something then there is a possibility of losing 100% of the money on it. Low risk if combined for one year can be very high risk. Ask any three year experienced option buyer how much he lost. I bet the average will be more than 1 lakh rupees.

Low risk is to lure option buyers to buy options.

2. Option buy has unlimited profits – This is only in theory. Have you ever heard of an option buyer who started with 500 rupees and went on to make 5 crores. Unlimited profit right? so why stop at 5 crore, why not 10 crore or even 100 crore?

Nobody has ever done that, no one will ever do that.

In reality option buyers book profit at some stage. This they call as target. There is nothing wrong in keeping a target for stop loss and profit because this is how this business is done, but then when there is a target to book profits and exit where does the word unlimited come from.

Beware of this myth of limited loss unlimited profits of buying options.

3. Best option trade in the world is to buy both at the money call and put because if the stock moves down out will make money and if the stock goes up call will make money – This is actually one of the worst option trades in the trading history.

In that case why not every option buyer does that? I mean buy both calls and puts of the same stock and keep laughing all the way to the bank every month?

Why this does not make money?

Do not forget that options do not come for free. What an option buyer pay for is the premium built inside the options.

Options are made up of Delta, Gamma, Theta, Vega and Rho. The worst of them is the Theta – the time value and Vega – the implied volatility which depends on India VIX.

At The Money options have the maximum time value built in them. And statistics suggest that most trading is done in ATM – at the money options, which has the maximum time value.

Last 10 days time value of options evaporates like melting ice. Time value evaporation means money getting evaporated in the sky. This is like throwing money.

Greedy traders who want to take advantage of movement in last 10 days actually buy options during last few days only. Imagine the kind of risk they are taking. It is like putting their money on fire.

Sure sometimes option buyers get lucky here and there, but long term they lose money. The real reason is written above – options slightly overpriced compared to the expected move of a stock. Overpriced means Theta and Vega is added to their pricing.

I hope now it is clear why most of the times option buyers lose money even if they buy both long calls and puts.