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Open Interest Strategy And How To Use It

Open interest strategy is based on indicators that traders use to confirm trends and trend reversals for the stock futures and stock options markets.

Do you use an open interest strategy in trading options? What? No? Maybe that is the reason behind your losses. Well, you are not alone, to be honest. Many traders don’t use open interest strategy while trading options. Yes, if you want to be a profitable trader you have to analyze open interest. It is a very important momentum indicator. So, let’s see how you could have better chances to reach profitable trading by using an open interest strategy in trading options. But first, we have to understand open interest.

What is the open interest?

Open interest represents the number of active contracts. It shows how many contracts for options and futures are for the given market. This important indicator shows the strength of the market and measures how actively traded the market is. Someone could say we have the volume for that estimation. Wait! It isn’t the same as volume. There are some differences.

You can notice this data along with current prices, volume, and volatility. But still, so many options traders overlook active contracts, so that can lead to shocking results. They are losing too much money and have too many lost trades.

So, open interest shows the cumulative number of options or futures contracts that are currently traded but not yet cashed by an exercise, offsetting trade or assignment.

How to calculate?

There is simple math to do that when running an open interest strategy. The calculation is: add all contracts connected with opening trades and subtract all contracts connected with closing trades. For example, let’s assume we have 3 traders. Okay, we will give them the names: Anna, Bob, and Connie.

Assume they are trading the same futures contract, in our case study. When Anna buys one contract and enters the long trade, open interest will increase by 1. When Bob buys 5 contracts and goes long too, the open interest will increase to 6. Connie picks to short the market and decides to sell 4 contracts, open interest will increase to ten. Open interest will stay the same until one of them or all exit their positions. In such a case open interest will decline. For example, Anna sold 1 contract and open interest declined to 9. Also, Bob decided to exit his position, he buys back his five contracts, so open interest will be down to 4 and will remain at 4 until Connie decides to sell her 4 contracts.

Volume and open interest

And here is where the volume is different from open interest. While the volume counts all contracts traded, open interest shows how many contracts stay open in the market. So, we can say they are related concepts but different in what is taken into account. Open interest also shows how much money is in the futures or options market. When open interest rises, more money is flowing and when open interest decreases money is going out of the options or futures contracts.

It can be more complicated since the traders are buying or selling from other traders who are selling or buying. You will find that both sides can open their trades and increase open interest. If both sides close their trades, open interest will drop. But if one side of traders is opening the trades and the other is closing that will have no influence on open interest.

That is another difference from the volume. The volume will increase caused by both entries or exits, open interest will increase caused by entries and decrease caused by exits.

Analyze open interest strategy

Open Interest is relevant for both stock futures traders and stock options traders. It displays you where the traders are allocating their money. Therefore, you must have an open interest strategy. To be able to create an open interest strategy you have to analyze the open interest data. We can find a lot of option sellers in the market. It is due to the time decay of the premium of stock options.

Their profit is maximum the premium value of the sold option, but the possibility of losing is extremely big. The option sellers are generally very agile and ready to close their positions quickly in case of any unfavorable change. In the market, we can see the bullish traders selling their put options since they get premium if the price doesn’t run under the strike price. In the same sense, the bearish traders are selling their call options since they get premium if the price doesn’t run over the strike price.

If we notice a high open interest in any stock’s strike price of calls and puts, we should understand these levels as support or resistance areas. It will depend on if the option is put or call.

So, the open interest will confirm the strength of a trend. Rising open interest is a confirmation of the trend. On the other side, reducing open interest can be a signal of a failing trend. Traders are supporting the trend when they enter the market and that raises the open interest. Hence, when traders don’t believe or when they lose confidence in the trend open interest will decrease.

The importance of reports

At the end of each trading day, the open interest data report is published. This report includes all details about open interest from all market players, are they holding long or short positions. These reports provide important info about what all players are doing in the market for futures and options contracts. Traders use open interest strategy to support their decisions. For example, if a trader notices a big move in the open interest he or she knows that particular market players are entering or leaving the position. That may give hints to market direction.

Using open interest strategy

In trading futures, for example, the initial stage of a trend, post-breakout, is not started by trend followers. It is driven by traders who had to liquidate their positions because they were on the wrong side and had to catch the direction of the old trend. The more traders on the wrong side mean the more violent the move post-breakout. Well, you have to understand, if open interest increases during a range-bound action, the transit post-breakout in any direction will be violent. So, if the open interest falls at the start of a new trend, that is the sign that losers are covering their positions.

For example, the price is moving inside the 6 months average levels, but you notice that operating loss has started growing massively. What’s going on? Is the price still in the range? Oh, yes. Let’s examine this more. For example, the company’s average operating loss per share was $5, last week it reached $8 but the price is still in the same range. How is this possible? It is possible by creating new positions but buyers and sellers are in balance, there is no pressure from one or the other side. That’s how the price stays in the same range. For every long trade, there has to be one short trade. What will happen if the price breaks out on the upside?

Short-side traders will hurry to cover their short trades and start the rally. Before long-side traders start the rally. When uptrend is created, comes the trend-followers.

Bottom line

Indicators are important. They tell you what other market players are doing and can provide you to create your trading strategy. An open interest strategy can be used to recognize trading possibilities you might miss. It allows you quickly to enter and exit a trade at the best price. Many traders don’t use this profitable strategy because when they are looking at the whole open interest of an option, they cannot know if the option is sold or bought.

But they fail to catch really valuable information.

Trading means to have all the valuable data before you enter or exit the position. It isn’t gambling. There are some trading patterns and more about some profitable you can read in the “Two Fold Formula” book. Our suggestion is – test it with the our preferred trading platform.

6th April 2020
Stock Market Bottom And How To Recognize It

Nobody can with certainty predict a stock market bottom. Still, it’s worth at least thinking about different entry points to let your money work for you.

By Guy Avtalyon

The questions for the past several weeks mainly were all about the stock market bottom. Did the stock market hit the bottom? Will the stock prices stop dropping? Have stocks reached support levels? When will prices stop falling?

Stock traders have so many questions these days and weeks. But do they really know where to look?

Maybe one of the most terrifying jobs related to investing is about the stock market bottom and how to recognize it. The idea to predict when a given stock will hit the bottom is old as much as investing and trading. The point is to recognize the point where the stock will no longer drop. The rule of thumb is: buy low, sell high. The problem arises when we have some unpredictable events in the market such as this one, coronavirus pandemic. That has an influence on the global economy, almost all economic and political events, and decisions. So, with a high level of certainty, we can say finding the stock market bottom can be a discouraging job.

Well, this kind of question traders ask almost every day but are they looking in the right place to find the answer? For example, investors are looking at Dow Jones. Is it the right place? We are afraid that the value of DJIA isn’t able to alarm you when the stock market hits the bottom. Okay, it will tell you but after it happened.

So what to do?

How to recognize the stock market bottom?

If you want to find it, you’ll need some indicators. Indicators can tell you when is the stock market going to hit a bottom but also when it is going to recover. By using indicators you’ll not miss the beginning of the wave. When buying a stock you want to do so at the lowest possible price but you wouldn’t like to hold falling stocks. You would like them to start rising after you bought them, right? That’s why it is so important to recognize the stock market bottom. The point where the stock can find support.

That knowledge can give you huge profits and prevent huge losses. So, how can we know with certainty that a stock has touched a low point? To be honest, no one can do that with 100% certainty and consistency, but traders and investors have some tools, fundamental and technical trends, and indicators. They arise in stocks when they are about to tap the bottom.

The indicators of stock market bottoms

Some indicators can help us determine when the stock market is going to form a bottom. What we really need to have are indicators of the health of a global economy and what the main participants in the market are doing with their money. But keep in mind, there is no such thing as a magic indicator to identify a stock market bottom. We have to look at several indicators to have an idea of the economy’s and stock market’s health.

Second, we have to look at history because it will tell us that the average bear market persists about 17 months. Also, it corrects around 35% from the maximum. But keep in mind that you cannot find the two bear markets alike 100%. All we can do is to suppose that the next will be similar.

Further, we have to understand the valuation. For example, the S&P 500 has a P/E ratio and earnings. The P/E ratio will move up and down depending on the market period. It will be up when we have good earnings growth, all ratios including the P/E ratio will go up. But when the circumstances are changed, with rising pessimism the valuation is likely to go down.

For example, when the S&P Index was above 2.500 the P/E ratio was at 19.

Also, the higher the VIX is, the chances for the stock market to hit the bottom are growing. These first two days in April this year, VIX traded between 54 and 57. If we take a look at historical data we can see that in 2008, the VIX was somewhere between 70 and 95. During the March this year, VIX traded over 75.

Other indicators of the stock market bottom

The stock market fell over 25% in 3 weeks. This is the sharpest drop in history. The biggest decline occurred on March 12th, the biggest since the market crash in 1987. Many investors thought that a stock market hit a bottom.

If you want to recognize when the stock market bottom is, check out your emotions. Did you feel fear at that time? If yes, you were one of the millions with the same emotion. Fear was so obvious in the middle of March. To be honest, almost all were panicked.

But we have to try to be reasonable. Just take a look at the charts and the technical levels for those days. Can you notice the major pivot? Do you notice a bottoming tail and a huge volume?

Okay! A major pivot, bottoming tail, and a huge volume on the same day and combined with a market 3-weeks decline of 25%, are indicators there was some at least short-term bottom.

What to do when the stock market is near the bottom?

The most intelligent investors started to buy those days. Small chunks, nothing big. Smart investors are doing such a thing to accumulate their full positions. The point is to buy 25% or 30% even 50% of the total position. That will keep your potential stress down and provide you an all in all a better average. But remember, don’t buy some small-cap, go for the brands.

Where is the market bottom now?

That is the most frequently asked question since coronavirus appeared.

Market experts like to say that it’s impossible to time the market. Well, it isn’t the truth. If we can see the market tops, why shouldn’t we see the market bottoms? Institutional investors know that. Follow what they are doing. Their actions could be the key bottoming signal. Follow-through has been noticed at almost every stock market bottom. This signal is extremely important because it can provide you profits when the early stages of a new market uptrend is confirmed.

The quest for a stock market bottom

This signal works quite simply. When there is a sustained stock market downturn, the first rising day from the index low is most important. That could be the beginning of a rally attempt. No matter which index you are using S&P 500, Dow Jones or Nasdaq.

According to some experts, the gain expressed in percentages isn’t important at this point. Also, don’t pay attention to the trading volume. What you have to look at is a down session and the moment when the index bounces after a great drop and closes close to session highs. Some experts deem that closing in the top half of the day’s trading range is adequate also.

Further, find a bigger percentage gain in higher volume than the prior session several days in the rally attempt. This time period is making it possible for short covering to resolve and for a rally attempt to gain ground. The rally will be halted in place only if the index reaches a new low.

How will the market react after the pandemic?

It is good if the market supports the new buyings, but if it doesn’t, just be patient. Sometimes, breakouts are visible on the charts after a few weeks. This market crash caused by the coronavirus outbreak has a large supply of stocks making the new base. But a lot of them have yet to bottom.

If an index suffers a decline in higher volume shortly after the follow-through day, the signal will fail in most cases. If close below the low of the follow-through day, it is almost the same. It is more the sign to start selling the stocks you bought recently.

These signals don’t mean you should rashly jump into the market since they tend to fail after indexes have dropped clearly in a short time. That happened with the stock market correction in February. The more suitable is to buy a few stocks, maybe one or two, and test how they will work. If there is a real uptrend your stocks will rise.

Every investor wants to know when trends are going to make a significant change. Will they reach tops or bottoms. The truth is no one knows that for sure. Only the big volume spikes, and staying stick to the chosen sector, will give you some clue if the stock has reached the lowest level from which it will not decline more. We pointed just one of the numerous scenarios. There are many others.

3rd April 2020
Greeks In Trading Options As A Risk Measure

Using Greeks in trading options can confuse a trader but can be extremely helpful.

By Guy Avtalyon

Greeks in trading options can provide helpful information, but also they can add a bit of complexity that can confuse options traders. Greeks in trading are a measure of how some option’s price is sensitive to its basic parameters, volatility, or price of the underlying asset. This measure is important when you analyze the sensitivity of your options’ portfolio or single option. So many traders and investors think this is a vital measure for decision making in options trading.

The key Greeks are Delta, Gamma, Vega, Theta but some will include Rho too. Also, you’ll find some other Greeks derived from these four or five.

Greeks in trading options can indeed hide the most important part, the difference between the stock price and strike price and the value decrease with reducing time to expiration on the option. For these reasons some options traders never examine the Greeks at all when making trades. But they are important and we will show you why.

The importance of Greeks in trading options

It isn’t easy to have an accurate prediction of what is going to happen to the price of the option especially when the market is moving. Even more difficult can be to predict the options positions that efficiently couple multiple individual positions. That is the case with options spreads, for example.

The problem is that most options trading strategies require the spreads, anything that can help you to predict the option position is important and you have to know them better. These measures can be very useful when you have to predict the future of the option price since they measure the sensitivity of a price related to the price of the underlying assets, interest rates, volatility, and time decay. By having all this information you can be in a much better position because you will know when and which trades to make.

How is that possible?

The Greeks in trading options will provide you a hint of how the price of your options will run related to how the price of the underlying asset changes. Also, the Greeks will help you forecast how much time value an option is losing daily. Moreover, by using Greeks in trading options you will have a valuable tool for risk management. In other words, you can use these measures to understand the risk for each position and where the risk will appear. Greeks will help you to recognize which risk factors you have to remove from your position and your positions’ portfolio. Also, they can show you how much hedging you need for that.

Keep in mind, you can use Greeks as an indicator of how the price will go related to different factors but they are theoretical. To make this more clear, Greeks are actually values based on mathematical rules and can be accurate only if they are calculated according to the exact mathematical model.

How to calculate Greeks?

It is possible to do yourselves but, we have to warn you, the process is complex and you’ll need a lot of time for that. Usually, traders use some software to do that for them and get accurate calculations. The serious online broker will automatically present values for the Greeks in the options they display. That makes the use of Greeks in trading options a lot easier.

Anyway, we will show you how to calculate the four most popular Greeks.

Calculate Greek Delta

Delta, the sign is Δ, can measure the sensitivity of price changes related to the moves in the price of the underlying assets. So, for example, when the price of the underlying asset grows by some amount in money, the price of the option will change by Δ amount. Here is the formula to calculate that Δ amount

Δ = ∂V/∂S

∂ represents the first derivative
V represents the option’s price which is the theoretical value
S –represents the price of the underlying asset

Why did we take the first derivative of the option and price of the underlying asset? Because the first derivative is a measure of the rate change of the variable over a determined period.

The delta is visible as a decimal figure from -1 to 1. For example, call options will have a delta from 0 to 1, but puts will have a delta from -1 to 0. We have to point one important thing here, to give you a better perception of how to understand Delta numbers. When you see the option’s delta is close to 1 or -1, you will know the options are deep-in-the-money.

Also, you can calculate delta for your options’ portfolios. It is the weighted average of all deltas of options added to the portfolio. As one of the Greeks, delta can be a hedge ratio, also. When you know the amount of delta, you can hedge your position if you buy or short the number of underlying assets multiplied by delta. It’s quite simple, don’t you think?

Gamma as one of the Greeks in trading options

Gamma or Γ is a measure of the rate of change of its delta per 1-point move in the price of the underlying stock.

The formula to calculate is expressed as:

Γ = ∂Δ/∂S = ∂²V/∂²S

The gamma can be expressed as a percentage also. And as same as delta, gamma is changing even with very small moves of the underlying asset price. Gamma is at its peak when the asset price is near to strike price of the option. It drops when the options go deeper out of or into the money. When the option has gamma value close to 0 that means it means the option is very deep out of or into the money.

Long options will have positive gamma values. When the options strike price is equal to the price of the underlying stock gamma will have the maximum value.

One of the Greeks in trading options is Vega

Vega or ν is also an option Greek. It measures the influence of changes in the underlying volatility on the option price. In other words, it measures the sensitivity of the option price in comparison to the volatility of the underlying stock. Vega will show the change in the price of the option for each change in underlying volatility, for every 1% of it.

Here is the calculation:

ν = ∂V / ∂σ

∂ represents the first derivative
V represents the option’s price which is the theoretical value
σ represents the volatility of the underlying asset

The vega is shown as a money amount.

Options will be more costly when volatility is higher. So, when volatility rises, the price of the option will rise too. Consequently, when volatility decreases, the price of the option will drop also. Hence, when you want to calculate the new option price caused by volatility changes, you have to add the vega when volatility goes up. This means, to subtract it when the volatility decreases.

Theta

Theta symbol is θ. It is a measure of the sensitivity of the option price relative to the option’s time decay. If the date of expiry is closer by one day, the option’s price will change for the theta value. The theta is related to the option’s time to maturity.

The formula is:

θ = ∂V / ∂τ

∂ represents the first derivative
V is the option’s price in sense of theoretical value
τ represents the option’s time to maturity

Generally speaking, the theta is expressed as a negative figure and it is negative for the options. Well, for some European options it can be positive. This is possible because theta describes the most negative value when the asset is at-the-money and shows the value by which the option’s price will decrease every day.

Long-term options will have theta of near 0 because they do not lose value daily. Hence, theta is higher for short-term options, particularly at-the-money options. The reason is that short-term options have more premiums and a chance to lose every day. Theta will dramatically increase when the option is near to the date of expiry and time decay is greatest during those periods.

Rho

Rho or ρ. It measures the sensitivity of the option price related to interest rates. When a benchmark interest rate rises by 1%, the option price will switch by the rho value. The rho isn’t too important as other Greeks are. Interest rates don’t have such a big influence on option prices and they are less sensitive to interest rate changes.

Nevertheless, here is the formula to calculate:

ρ = ∂V / ∂r

∂ is the first derivative
V is the option’s price meaning the theoretical value
r is the interest rate

The call options will have a positive rho, but the rho for put options will be negative.

Why using Greeks in trading options?

In real trading, the Greeks will all change and develop their changes over the other variables. Every single change in the underlying asset’s price, interest rates, the expiry date may influence all variables simultaneously. So, it’s a smarter decision to use some software to calculate the final result.

But it is very important to know why and how the Greeks can help and provide you a measure of position’s risk and reward. When the Greeks in trading options become familiar to you, apply them to your trading strategies. It is necessary to use all types of risk-exposure measures. This may bring your options trading to a higher level.

Meanwhile, learn more about pattern trading from the “Two Fold Formula” book and check it with the our preferred trading platform.

2nd April 2020
Volatility Trading – How To Trade Volatility Profitably?

(Updated November 2021)

Volatility traders do not pay attention to which direction stock prices move, they are interested in the level of volatility itself.

Volatility trading describes trading the volatility of the price of an underlying asset. Make a note of the difference, it isn’t trading of the price itself. Or in other words, volatility trading indicates trading the assumed future volatility of the index. Hence, it is buying and selling the anticipated future volatility of the asset. Every single asset in which price changes, actually manifests price volatility. So, traders that trade volatility looks at how much change, in any direction, will happen. They don’t pay attention to the price, they don’t want to predict the price itself. Such traders just think about how much the price of some asset will move in the future, in the stock price, for example. No matter if it will go up or down. And it isn’t random trading. They have developed strategies which we’ll present to you.

But firstly, we would like to make clear what volatility trading is.

For example, options are a favorite tool for volatility trading. Why is that? Well, many factors can affect the value of the option but a crucial for its value is the expected future volatility of the underlying asset. Hence, options with higher expected volatility are more valuable than options on instruments with low expected volatility in the future.
Therefore, options represent an easy way to get exposure to the volatility of the underlying instruments. Basically, that expected future volatility of the underlying instrument of an option is a very important part when traders’ valuing the option.

Factors important to determine the volatility

We can recognize seven factors that determine the price of an option and they are also called variables. While all of them are variable only one is an estimate and represents the most important part. The known factors are the current price of an underlying asset, strike price, also the known part is calls and puts, meaning what is the type of an option. Further, we always know what is the risk-free interest rate, and the dividends on the underlying assets. But what we don’t know is volatility. The volatility is the most important variable to determine the price of an option. So we need to know what indicates volatility.

First of all, it is one of the “Greeks” – Vega.

It is the measure of an option’s price sensitivity to shifts in the volatility of the underlying instrument. Vega outlines the value that an option’s price changes as a response to a 1% move in the expected volatility of the underlying asset. This “greek” will show the change of an option for every 1% of the change in volatility.

Main points related to volatility trading

Traders should pay attention to two main points related to volatility.

One is relative volatility. It refers to the current volatility of the stock in comparison to its volatility over a given period. For example, ABC stock options that expire in one-month historically showed expected volatility of 15%, but current volatility is 25%. Let’s compare it with XYZ stock options that had expected volatility of 25% but now grown to 30%. If we want to estimate absolute volatility it is obvious that XYZ stock has a greater. But the stock ABC gained a greater change in relative volatility.

The volatility of the overall market is important too. The most used is VIX ( the CBOE Volatility Index) that measures the volatility of the S&P 500. VIX is also known as the investors’ fear gauge. When the S&P 500 experiences a sharp decline, the VIX increases sharply. Every time when the S&P 500 is rising gradually, the VIX will be pacified.

Strategies for volatility trading

Straddle strategy

As we said, traders who trade volatility are not interested in the direction of the price changes. They make money on high volatility, no matter whether the price goes up or down.

One of the most popular strategies for volatility trading is the Straddle strategy with pending orders. This strategy provides a profit when the price goes considerably in one direction, no matter if it is up or down. The best time to use this strategy is when the traders expect an extreme increase in volatility.

We said it has to be used with pending orders. The pending orders are orders that were not yet executed, hence not yet becoming a trade. They’ll become market orders when certain pre-specified conditions are met.
If you want to use this strategy, you’ll need to identify a market in consolidation before some significant market release. Further, set a buy stop pending order above the upper consolidation resistance. A sell stop pending order you should set below the lower consolidation support.

In Forex trading

For example, you are trading Forex and have a currency pair that entered a consolidation stage with low volatility. Just put buy stop orders a few pips above the upper resistance, so a sell stop order should be a few pips below the lower support. No matter in which direction the price will change, it will trigger one of these orders and when the volatility continues, the trade will end up in a profit.

The real trigger for pending orders is volatility. Volatility occurs a bit before important reports in the market and traders usually schedule this kind of trades before them.
In a straddle strategy, the traders write or sell a call and put at the same strike price wanting to receive the premiums on both positions. The reason behind this strategy is that the traders await expected volatility to decrease significantly by option expiry. That allows them to hold most of the premiums received on short put and short call positions.

Ratio Writing

Ratio writing is simply writing more options than are bought. Use a 2:1 ratio, just two options, sold or written for every option bought. The aim is to profit on a large fall in expected volatility before the date of expiry.

Iron Condors in volatility trading

In this strategy, the traders combine a bear call spread with a bull put spread of the same expiration. They hope to profit on a reversal in volatility. The result would be the stock trading in a tight range during the life of the options.
The iron condor strategy has a low payoff, but the potential loss also has a limitation.

Go long

During the high volatility, traders who are bearish on the stock can buy puts on it. Keep in mind the saying “the trend is your friend.”
“Go long” strategy or buy puts is expensive. It requires, from traders who want to lower the costs of long put positions, to buy more put out-of-the-money or, the other way is to add a short put position at a cheaper price to meet the cost of the long put position. You can find this strategy under the name a bear put spread.

Go Short

The other name for this strategy is “write calls”. The traders who are bearish on the stock but think the level of expected volatility for options could decrease may write naked calls to pocket a premium.
Writing or shorting a naked call is a very risky strategy, keep that in mind. There can be an unlimited risk if the underlying stock boosts in price before the expiry date of the naked call position. In such a case, you can end up with several hundred percent of the loss. To reduce this risk, just combine the short call position with a long call position at a higher price. This strategy you can find under the name “a bear call spread.”

Use VIX to predict the volatility

Yes, you can recognize market turns by using VIX. To be more specific, you’ll recognize the bottoms. Well, the stock market regularly rises gradually and the VIX will decrease in the same manner. So very low levels can occur. The investors don’t feel they need any protection. If these periods last longer, the VIX as a sell signal can be useless.

But, the nature of the S&P 500 is long-biased. If index declines investors start to buy protection (simple put options) fast. That pushes up the VIX. Can you see how great the “fear barometer” VIX is? When you notice a high VIX you can be sure the investors and traders are overreacting because the market drops. The VIX during times of market drops will behave as the spike. That is a good signal to discover when selling is overdone and the market is moving higher due to bounce or even bottom for a longer-term.

This strategy is suitable when the VIX ‘sign’ appears during a bullish trend in the S&P 500.

Bottom line

Volatility trading is an excellent way to get profitable trades even if you are wrong about the direction of the price. Volatility is the main interest of volatility traders. They are seeking big changes in any direction. Use the VIX index as a measurement for volatility in the stock market. A rising VIX index indicates fears in the market. But it is a good time to buy stocks. The most popular trading strategy to trade volatility is the Straddle strategy.
Also, traders use the Short Straddle strategy when they expect a lack of volatility, for example, the prices continuing with steady change.
No matter which of these strategies you want to use, just keep in mind that you can profit no matter what is the direction of the price movement.

30th March 2020
A Dead Cat Bounce – How To Trade It

Dead cat bounce appears when the markets are in free fall. Is it possible to profit from it?

A dead cat bounce is a phenomenon that occurs when a stock gap is lower by a remarkable percentage. For example, 5% represents that phenomenon. When the stock is always volatile within a continued period of downside this gap is over 5%. But when the stock isn’t volatile this gap of 5% must be taken into consideration.
The pattern occurs during bearish moves and it is visible on the charts. A dead cat bounce pattern is an expected correction of a bearish trend.

To put this simple

Assume we have a stock that is in a strong downtrend. When it happens we can notice a lot of short-sellers in that stock. But not all are short selling. Some traders will believe that the stock has touched its cheapest possible price, it reached the bottom. So, they would like to close their short trades but some will hold the position longer. And what we have here is increasing buying pressure. The consequence is that such a stock will find its bottom and a short bounce will occur. But the stock proceeds in the direction of its initial trend and that will lead to a quick sell-off.

So, we can say, a dead cat bounce is a short recovery of the stock price from a long dropping. But it is followed by the increase of the downtrend. This recovery in stock price is a short-living one. If you take a close look at such a stock’s chart, you will notice that the downtrend is broken by short periods of recovery. They are very small rallies and the stock price can rise for a short time.

Why is this phenomenon called a dead cat bounce? Well, there is a belief that even a dead cat would bounce if it falls fast and far sufficient.

How to identify a dead cat bounce pattern?

First of all, it is a price pattern and often a repeating pattern. Don’t be naive and think it is a reversal of the current trend because this first bounce will stop and the prior downtrend will continue so the stock price will continue to drop. It is important to understand that a dead cat bounce isn’t a reversal. It appears after a stock price drops below its previous low. When the price of such volatile stock temporarily rises you’ll see it as short periods of recovery. That is due to traders’ short-sellings, they are closing out short positions or maybe buying on the hope that the stock touched the bottom.

The problem is that we cannot identify this price action before it happens. We can recognize a dead cat bounce as a pattern after it occurs. We can try to predict if the recovery will be temporary by using some analytical tools as analysts do but there are no guarantees. Identifying the exact pattern before it happens is difficult even for experienced traders. We can see a dead cat bounce in the stock price for individual stock or for the group of stocks. Moreover, it can occur for the economy in general, for example, during the recession.

A real-life example of this pattern

We have it now, these days. The indexes had the greatest drops last week, three days in a row. The biggest drops after the Great Recession. Last month, February marked several days when the market has grown, but it fell under the pressure. The investors sold some of their positions when they noticed the market has risen after a long decrease. And they unloaded. But the downtrend continued so we have a typical dead cat bounce. During the first four days of last week, for example, Dow Jones declined by almost 18%. The indexes, in general, are oversold. The overall trend indicates further losses in the stock market. Coronavirus caused so much uncertainty.

The stock price fell, short traders started to look for a point to take profits. Some others started to buy at a discount. And the buying pressure occurred since both groups pushed the price back up. Well, buying pressure isn’t able to maintain the stock price at the current rate. When we have too many short selling in the market and no one left to buy, the downtrend is going to continue. The stock prices are going to drop more. This unbalanced relation in supply and demand causes a dead cat bounce.

How to recognize a dead cat bounce

First of all, a dead cat bounce is a retracement, it isn’t a reversal. So the rebound is short and unstable. Traders can notice in their chart the existence of intent bias coming amid a clear period of failing. That should help to identify a pattern. By using fundamental and technical analysis traders are able to discover if they are set for a leg lower or a broader recovery. This is an important issue for traders. Is a rebound going to form a significant bottom or it will be a short-living rebound? After a short rebound, the stock price will continue to decrease. As we said, if traders notice a sign of rapid selling and it lasts for a longer time, there will not be a bottom. It is a dead cat bounce.

How to trade a dead cat bounce?

A dead cat bounce is the reverse of a buy the dip thinking. While “buy the dip” means the traders are sure that the full uptrend is going to come back into play notwithstanding current losses, a dead cat bounce is different.
For example, your chart highlights the run-up to $100 and each fall is met by buyers. Well, they are taking advantage of drop thinking that history can repeat and produce further highs.

But markets recognize each leg lower as being a forerunner to further losses. Periods of selling are longer, the rebounds are short, they may not last. The use of Fibonacci retracement levels can give us a tool. A shallower retracement is characteristic of a market that is prepared for added dead cat bounce.
The sharp declines show that the market in free fall will see shallow retracements every time where there isn’t enough trust in any rebound. To notice a dead cat bounce, it is important to look for a breakthrough in the previous swing low, hence a continued downtrend.

Where to place a stop-loss order?

Traders can look onto these shallow retracements as a method to start risk-to-reward trades. Your stop loss should be sized smaller. That could provide you a greater chance for a high risk-to-reward profile. Timing is extremely important when you trade this pattern. You need to stick to the trading rules of this pattern. Otherwise, you are at risk to lose everything. So, as we said, short the stock only when the price move breaks the last bottom formed.

Use the previous swing low as an entry point to ensure the trade is opened upon verification that a dead cat bounce has happened. Then look at the dead cat bounce for a lead on where to place your stop loss. Stop-loss should be proportionately small due to the shallow nature of that rebound. Don’t place a stop loss at the peak of a dead cat bounce. It’s better to place it above. You will need a higher high to neutralize the bearish appearance.

If you don’t use a stop-loss order you’ll end up in pain. What if the pattern you think you notice isn’t a dead cat bounce pattern? Are you short selling a stock, which reached a significant bottom? So it was ready to make a big move higher. This means you made the wrong decision.

Don’t trade on margin and always set a protective stop-loss order when you want to trade this pattern.

Timing is important

When you see this pattern, you should intend for a minimum price move equal to the prior trend movement. Simply, if the price starts falling quickly and you verify a pattern, you should assume the price to fall at least with the same size. There you should take your profit.

It is important to highlight that timing is essential when trading this pattern. If you don’t enter the market at the right time, there is a big chance that you’ll miss an important part of the bearish move. You have to be sure you short the stock exactly at the moment when you notice a candle closing below the last low of the stock.

Bottom line

When the stock drops more than 5% from the prior closing price but soon the price is back close where it opened, and the price then falls again, we have a dead cat bounce. It isn’t a bargain at discount. But you can make money on it
The fundamental level in a dead cat bounce trade is near the open price of the initial gap down day. Usually, the price will retest this level during the same day. That will give traders the possibility to go short. This level will stay notable for days or weeks in the future. If you go short and the stock price falls more after that, the price can come back a week later again to test the same level. That would be a second dead cat bounce.

One single gap may have three cat bounce trades. It is risky to trade this pattern but may give you a high profit.

29th March 2020
How to Value a Company And Find The Best To Invest?

For investors, company valuation is a crucial part of determining the potential return on investment. Start by looking at the value of the company’s assets.

One of the most confusing questions for all beginners in the market is how to value a company. The worth of the companies is important for every investor. And the question of how to value a company has a sense for any investor, entrepreneur, employee, and for any size company. Thus, you have to find the best way to determine the worth of the company. Do you need to ask to see the company’s books or you can value a company based on the existing customers or news? How much time will it take to learn how to value a company? When you notice some interesting companies where to go first? Yes, you can ask in many ways how to value a company.

The first comes first.

For every investor, the value of a company is a crucial part of determining the potential returns on investment. Every investor should know if the company is fair valued, undervalued, or overvalued because it has a great impact on a company’s stock or stock options.

For example, a higher valuation might indicate the options will grow in value.

So, if you want to know how to value a company, be prepared to take into consideration a lot of the company’s attributes. This includes revenue and profitability growth, stage of growth, operating experience, technology, commodity, business plans. Yes, but the list isn’t full without market sentiment, growth rate, overall economic circumstances, etc.
To understand how to value a company in a simple way, you can take a few factors into account.

What metrics to use to value the companies?

Here is how to value a company and basic metrics you can use for that. You can use the P/B ratio and P/E ratio. These two metrics are important when you want to evaluate the company’s stock. These basic metrics you can apply to almost all types of companies. But it is important to know the other and often unique factors that can affect the process of how to value a company.

One of the variables in the valuation of a company’s health is debt. But a company’s debt is not continually easy to measure or define. So this metric can make the company’s value difficult to value.

When you want to value a company or stock, it is smart to use the market approach that includes a comparative analysis of precedent transactions and the discounted cash flow which is a form of intrinsic valuation since it is a detailed approach, and also uses an income approach.

How to value a company’s stock?

There are several methods that may give you insight into the value of companies’ stocks.

They are the market approach, the cost approach, and the income approach. The cost approach means that a buyer will buy a share of stock for no more than a stock of equal value. The market approach is based on the belief that in free markets, supply and demand will push the price of a stock to a point where the number of buyers and sellers match. The income approach defines value as the net current value of a company’s future free cash flows.

Market value as a method on how to value a company

The market value is simple. It represents the shares trade for but tells us nothing about stock’s intrinsic value. Thus, we have to know the stock’s true worth. This is a key part of value investing.
The stock value is shown in stock price. The P/E ratio is helpful to understand this value. To calculate the P/E ratio just divide the price of a stock by its earnings per share

When the P/E ratio is high it is a signal for higher earnings for investors. This ratio is helpful to use if you want to know how to value a company. The P/E ratio shows the company’s possible future growth rate. But you should be careful when using the P/E ratio to compare similar companies in the same sector.
Investors connect value to stocks with P/E ratios. If the average P/E ratio is, for example, 20 – 23 times any P/E ratio above 23 times earnings is classified as a company that investors keep in high

Investors and traders use the P/B ratio to compare the book value of a stock to stock’s market value. To calculate the P/B ratio use the most recent book value per share and divide the current closing price of a stock by it. If the P/B ratio is low you can be sure the company is undervalued. This metric is very useful if you want to have accurate data on the intrinsic value of the company.

But be aware, there are several P/E ratios and numerous variations, thus you have to know which one is in play. For more about this READ HERE

Cost approach or book value

Book value is the amount of all of a company’s tangible assets (for example equipment) after you deduct depreciation. So, when we are talking about the company’s “net capital value” it means the book value, estimated by the company’s book of net tangible assets over its book of liabilities. To calculate the book value you have to divide the net capital value by the number of outstanding shares. The result is a per-share value. The book value never takes into account the brand, keep that in mind.

Income as a method on how to value a company

Use the capitalized cash flow to calculate a company’s worth when future income is expected to stay the same as it was in the past. But if you expect the income is going to vary, use the discounted cash flow method.

Calculations are simple, divide the result from capitalized cash flow or discounted cash flow by the number of shares outstanding and the figure you get is the price per share.

Bottom line

By understanding how to value a company you’ll be able to understand the essence of making investment decisions. No matter if you want to sell, or buy, or hold the shares of stock in some company. Warren Buffett, for example, uses a discounted cash-flow analysis.
Sometimes, the company valuation is held as the market capitalization. So, to know the value of the company you have to multiply all shares outstanding by the price per share. For instance, a company’s price per share is $10 and the number of outstanding shares is 4 million. If we multiply the price per share by the number of shares outstanding we will find this company is 40 million worth.

To be honest, it isn’t too hard to value the public company. But when it comes to private companies it can be a bit harder. You can be faced with a lack of information. For example startups. They don’t have a financial track record and you have to value these companies based on the expectation of future growth. To value an early-stage company can be a great challenge.

Before you invest in any company, you’ll need to determine its value. This is important because you need to know if it is worth your time and money. Think about the company’s value as its selling price. Maybe it is the simplest way.

27th March 2020
Price Action Strategies For Profitable Trading

Experienced traders use price action strategies in trading to make more profitable trades. Price action strategies are one of the most used in current financial markets.

Price action strategies in trading are present for quite some time. They are here for good reason. That’s why these strategies are frequently used in the financial market. Price action strategies are used by both long-term and short-term traders. The point is that analyzing the price of a security is maybe the simplest but at the same time the most powerful approach to getting an edge over the market. And that is crucial for any trader. Having an edge means that you’ll not be found out by the market.

Okay, you might think you are a great trader because you had several winnings. Do you really think that having luck is the most important part of trading?

Anyone can do the same if the lucky is a matter of importance.

Relying on luck is the danger because the wheel of fortune is turning around. And eventually, your winning trades will become great losses. All the profits you made during your winning streak will vanish like a soap bubble. That’s because you don’t have an edge. Actually, in this case, your edge is with the market which is too risky because at some point that edge will play out in favor of the market securing that trader loss.

If you don’t have an edge and the edge is in the favor of the market, it is a matter of time until the edge starts to play out and you’ll become a loser.

Think about this as a casino, for example. All tools and machines in the casino have odds adjusted in favor of the casino. In any case, the casino is the winner. Yes, from time to time someone will make a lot of money, but there are many losing players, more than winning. So, the casino will be the winner in any case.

That is the casino’s edge. The exact comes with your trading if you are only considering your next trade and never think about trading inside the market’s overall edge.

Stay focused on the price action

Price action is a trading method that enables a trader to understand the market and make trading decisions based on current and real price actions. So, in price action strategies you are not relying only on technical indicators. As you can see, the action price strategies are dependent on technical analysis. Some traders use price action strategies to generate a profit in a short time.

If you want to be a price action trader, you must be focused on price action. This sounds like nonsense, you may think. But if you want to evaluate deeper, you will find the majority of traders think the price action strategies are the same as pattern trading. And that is a great mistake.

While pattern trading requires just staring at the last candles of the chart and making a trade based on them, for price action trading you’ll need more. Yes, in pattern trading the last one or two candles can be an excellent entry signal, in price action strategies they are just candles among many many other candles on the chart.

Every successful price action trader knows how to read a price action chart as a whole and knows how to force them to tell the entire price action story. Price action traders have to interpret the real order flow, support and resistance, traders’ behavior and trends through the live price action.

What is price action trading?

Price action trading is trading in which traders base their decisions on the price movements of an asset which can be stock, forex, bonds, etc. There is no need to use other indicators, your trade is based on price action solely. Of course, you can use other methods but it will have a very small impact on your decisions.

The price action traders believe that the only valid source of data flows from the price itself. For example, when the stock prices go up, the price action traders know that investors or other traders are buying. Based on the aggressiveness of that buying, price action traders estimate will the prices continue to rise. These traders don’t care why something occurs. Their all concern is to find the best possible entry point with lower risks but with greater profits. For that to know, they are using real-time data, for example, volume, bids, offers, magnitude and similar. Also, historical charts are very important.

In trading – what is that?

First of all, price action trading is the method where you make all your decisions from the so-called “naked” price chart. That means there are no other indicators. All we have is price action. That’s a lot of data because all markets generate data about the price changes over different periods. And that data is displayed on the price chart. What can you read there? For example, everything about the beliefs and behavior of other traders and investors, no matter if they are humans or computers. Data is for a specific time frame and all opinions, beliefs, all financial data, news that affects price change, and behavior are visible on the chart as price action.

The most important part, with knowing the price movements, you’ll be able to develop a really profitable trading system. All signals from the price action chart have a general name – price action trading strategies. These strategies can give you a chance to predict future movements with a high level of accuracy so you can make a profitable strategy.

Price action trading strategies can be used on a broad variety of securities including stocks, bonds, derivatives, forex, commodities, etc.

Price action strategies

Trendline strategy

One of them is the trendline strategy, very simple to use. The main point here is to know how to draw trendlines. This is an important part because only if you do it properly you’ll be able to predict where the price will bounce off the trendlines. Well, you’ll take a trade based on it so be consistent in how you draw trendlines.

Breakout strategy

The other price action strategy is a breakout. For example, a stock price is moving with a specific tendency. When it breaks the tendency, it is a signal for a new trading opportunity. To make this clearer, suppose a stock traded between $9 and $6 for the last two weeks. Suddenly, it moves above $9. So, the stock price changed the tendency. That is the signal for traders that the sideway moves are probably finished and the stock price is possible to go up to $10 or more.
Of course, you might be faced with a false breakout, but it is also an opportunity to trade in the opposite direction of the breakout.

Bars formation

Another price action strategies examine the price bars formation on a specific model of the chart. For example, candlestick charts. If traders use candlestick strategies, for example, the engulfing candle trend strategy. It is important to wait until the up candle engulfs a down candle during an uptrend. That should be your entry point, the moment when an up candle goes above the opening price of the down candle.

You can use price support and price resistance zones. That could give good trading chances. Support and resistance zones occur where the price has tended to reverse in the past and these points may be relevant in the future.

Bottom line

Price action strategies aren’t suitable for long term investments. They are aimed at short-term traders. So many traders don’t think that the markets never operate on consistent patterns. They believe the markets work randomly. The consequence is that they don’t think it isn’t possible to have a strategy that will work in any case. If you combine technical analysis with historical price data, price action strategies will allow you to make profitable trades.

These strategies are very popular today due to its advantages. They provide flexible trades, access to many asset classes, use of any software, apps or trading websites. Moreover, traders have a chance to backtest any strategy on historical data. Also, maybe the most important part of price action strategies is that the traders have an opportunity to choose their actions on their own. So, that creative approach to trading is important for many of them.

A lot of proponents on price action trading insist on high success rates. Trading has the potential for making great profits. Traders-Paradise suggests testing and acting after that. Just to be ready to meet your best possible profit chances.

25th March 2020
The Stock Price Pattern How To Identify It

The price pattern is a visual illustration of market psychology. It shows when traders are inspired and move, when they are taking a breath and when they are willing to move further.

The stock price pattern represents a form of price movement that is recognized by a set of trendlines and curves. Changes between rising and falling trends are usually shown by price patterns. The stock price pattern is important for technical analysis because it shows the current movement but also enables traders to predict future changes. For example, if the stock price pattern shows a change in trend direction, it is a reversal pattern. But if the pattern shows a continuation that means the trend proceeds in a direction following a shortstop.

To explain this a bit clearer, for example, you are driving your car and the traffic is heavy, and you have to drive and stop, and drive and stop. Every time when you see the brake lights in the car in front of you, you know that you have to slow down. Otherwise, you’ll crash into the other car. The unknown fact is will the car in front of you continue to move in the same direction, pull aside or stop after that slowdown.

The same is with the stock price pattern.

When you notice a stock price pattern beginning to develop on a chart that is the sign the stock is going to slow down or consolidate. At that moment you have to slow down too and estimate what may happen. Also, at that very moment, you cannot know if the stock price will breakout and continue to move in your direction or it will change direction.

Every trader must understand how important the stock pattern is. It is a really valuable tool that you need in your trader tool kit. Recognizing and understanding patterns isn’t easy but once you learn how to do that, you’ll be able to uncover the future price action with high probability.

Characteristics of the stock price pattern

So, we all understand that the price pattern is an evident picture of market psychology. It shows when traders are motivated and move, when they are taking a pause and when they are ready to move further. For some image in the stock chart to be a pattern, some conditions must be fulfilled.

Every single pattern is composed of four parts. Firstly, the pattern has to show an old trend. This means the trend of the stock price when it started to form the pattern. Also, the pattern must show the consolidation area. The consolidation area represents the zone where the trend is channeling or undefined. It is the area defined by set support and resistance levels. Further, the pattern must unveil the breakout point. That is the level where the stock price breaks the consolidation area. And, also as a part of an image on the chart to confirm it is a pattern, you must clearly see the new trend. The new trend represents the trend of the stock price when it starts coming out of the consolidation area. That’s how you can know that the stock price creates a pattern.

What types of stock price patterns do we have?

Chart patterns are an essential aspect of technical analysis. You’ll need to understand them. Stock price patterns are classified into two main categories: continuation patterns and reversal patterns.

Continuation pattern unveils you the new trend has the same direction as the old trend was going.

The reversal pattern shows you the new trend is in reverse directions and starts to move in the opposite direction from the old trend direction. And that is the main difference between them. – the direction in which the new trend is moving.

Both types of patterns have the characteristics we mentioned above.

Trendlines

Stock price patterns are recognized using a series of lines and curves, as we said. But how to guess trendlines and draw them? It is important to locate zones of support and resistance.
To draw trendlines just connect by straight lines the dots of highs or lows, meaning descending peaks or ascending troughs. When the stock prices have higher highs or higher lows we are speaking about an up trendline. The opposite occurs when we notice a down trendline. That means the stock price has lower highs and lower lows.

The body of the candle bar will show where the bulk of price activity happened. So, it is a better point where to draw the trendline.

To draw a trendline you can use closing prices instead of highs or lows. And it is maybe better because the closing prices express the traders’ decision to hold a position. But be careful, the trendline drawn with only two points may not be quite valid. Always try to find three or more points.

Uptrend happens where the price is making higher highs and higher lows. Up trendline connects at least two of the lows and registers support level below the price.

The downtrend is the point where the price is making lower highs and lower lows. Down trendline combines at least two of the highs and shows a resistance level above the price.

Consolidation happens where the price is swinging between an upper and lower span, which are shown as parallel and horizontal trendlines.

Continuation stock price pattern

A price pattern that signifies a brief break of a current trend is a continuation pattern. It is just a break, a short time for traders to take a breath when an uptrend occurs or to relax during the downtrend. The first is in connection to the bulls, and second to the bears.

While a stock price pattern is developing, we can’t know if the trend will continue or reverse. So, we have to take attention to the trendlines and realize if the price breaks above or below the continuation area. It is always better to suppose a trend will continue until it is verified that it has reversed. Keep in mind, if the pattern needs more time to develop and you see the large price movement inside the pattern, it is a stronger sign the price will significantly break below or above the continuation zone.

But if the price remains on its trend, it is a continuation pattern. Continuation patterns can be pennants, flags, wedges, triangles.

Pennants are created by using two converging trendlines.
Flags can be drawn with two parallel trendlines.
Wedges are created with two converging trendlines, but both have to be angled either up or down.
Cup and handles, which is a bullish continuation pattern. When having this pattern, you can be sure an upward trend has stopped for a short but will proceed after the pattern is confirmed.

Triangles are the most popular chart patterns in technical analysis and they occur more frequently than the other patterns since they can last from a few weeks to several months. There are three most typical types of triangles: symmetrical triangles, ascending triangles, and descending triangles.

Reversal pattern

It indicates a change in the current trend. This pattern indicates the period where the bulls or the bears have run out of money. This means the trend will pause and then continue in the same direction.

For example, an uptrend backed by enthusiasm from the bulls will pause. That means the influence of both the bulls and bears, so the result is a change in trend to the downside. The reversal that happens at market tops is a distribution pattern. That means more sold than bought assets. Opposite, a reversal that happens at market bottoms is an accumulation pattern, which means there are more bought than sold assets.

When the stock price reverses later, we are talking about the reversal pattern. Reversal patterns can be head ad and shoulders, double tops or bottoms, gaps.

Bottom line

You can identify the stock price pattern when the price makes a pause which indicates the zone of consolidation. Trendlines help in recognizing the price pattern that can develop in forms of flags, pennants, and double tops. The volume will decline during the pattern’s development, and increase when the price breaks out of the pattern. To have the better trading experience you can learn more in the Two Fold Formula book but first, try it with our preferred trading platform and check it.

22nd March 2020
A Bottom fishing As An Investment Strategy

The most popular bottom fishing strategy is value investing but traders also use technical analysis to identify oversold stocks that may be winning bottom fishing possibilities.

Bottom fishing as an investment strategy refers to the situation when investors are looking for securities whose prices have lately dropped. Also, that are assets considered undervalued.

Bottom fishing as an investment strategy means that investors are buying low-cost shares but they must have prospects of recovery. This strategy also refers to investing in stocks or other securities that dropped due to the overall market decline. But they are not randomly picked stocks, they have to be able to make a profit in the future. Well, it is general hope.

Buy low, sell high

We are sure you have had to hear about the old market saying “buy low, sell high” as the most pragmatic and most profitable strategy in the stock market. But, also, it isn’t as easy as many like to say. You have to take into consideration several things while implementing bottom fishing as an investing strategy. Firstly, you’ll be faced with some traders claiming that it is an insignificant strategy. The reason behind their opinion is if you are buying the stocks that are bottoming you do that near its lowest value.

The point is that almost every stock is a losing one. Usually, some momentum traders and trend followers will support this opinion. Where are they finding confirmation for this? Well, traders tend to sell to breakeven after they have been keeping a losing stock for a short time. They want to cut losses and that’s why they are selling, to take their money back and buy some other stock. Traders are moving on.

Overhead resistance will affect the way a stock trades but it is expected when using this strategy. Moreover, overhead resistance isn’t as inflexible as some investors believe.

Bottom fishing is an investment strategy that suggests finding bargains among low-priced stocks in the hope of making a profit later.

What to think about while creating this strategy

The most important thing is to know that you are not buying the stock just because it is low-cost. Lower than ever. The point is to recognize the stocks that have the best possibility for continued upsides.

Keep in mind that buying at the absolute low isn’t always the best time to do so. Your strategy has to be to buy stocks that have a chance of continued movement. Stock price change may occur on the news or a technical advancement like a higher high. A new all-time low can cause a sharp bounce if traders assume the selling is overdone. But it is different from bottom fishing. Bottom fishing as an investment strategy has to take you to bigger returns.

Not all low-cost stocks are good opportunities.

Some are low with reason, simply they are bad players. For example, some stock might look good at first glance but you noticed one small problem. Don’t buy! When there is one problem it is more likely that stock has numerous hidden problems. There is no guarantee that low stock will not drop further.

Further, for bottom fishing strategy, you will need more time to spend than it is the case with position trading, for example. You have to be patient with this strategy. You are buying a weak stock, and they became weak due to the lack of investors’ interest. Do you know when they will be interested again? Of course, you cannot know that nor anyone else can. When you want to use a bottom fishing as an investment strategy you must be patient and have a time frame of months, often years to see the stock is bouncing back

If you aren’t psychologically ready to stay with these trades for a long time you shouldn’t start them at all.

The bottom fishing strategy requires discipline

If you want to practice bottom fishing as an investment strategy you will need discipline. It requires extra effort. It isn’t easy for some aggressive traders to hold a stock for months and without any action. We know some of them that made a great mistake by cutting such stock just because they were bored. If you notice you are sitting in stocks that are dropping lower on the small volume you still can exit the position. The losses might add up quickly, so you’ll need to set a strong stop loss to avoid it. Even if you hold a stock paid $1. It can produce big losses over time if you don’t have at least basic risk management. Stop-loss and exit points are very important in this strategy.

The two main types of bottom fishing

There is the overreaction and the value. For example, the news of some company’s problems may cause a lot of traders eager to enter for a sharp recovery. The stock suddenly had a sharp decline but they may think the market overreacted and the stock will bounce quickly. That could be faulty thinking but what if the long-term bottom fishers start to buy that stock too? The company’s problems are temporary and as times go by, could be forgotten.

The point is that the bottom fishing on the news or even earnings is a good opportunity to trade a bit of volatility. But you have to be an aggressive trader and able to play the big fluctuations. These short term trades can easily become investments if you don’t pay attention to it. Before you enter the position you must have a solid trading plan with defined entry point, stop-loss, and exit point. Optimize your strategy before you jump in. There is one tricky part with cheap stocks – they can become cheaper.

The essence of bottom fishing as an investment strategy

Bottom fishing is when you try to find the bottom of a stock that has a higher price. Let’s say a stock was at $200 and now it is at $20. When you try to bottom the fish stock you’re actually trying to catch its bottom and buy it and provide it to go to the upside. In simple words, you want to get a good deal, to obtain the lowest possible price or bargain on the stock. But, if you want a good bottom fishing you must understand how it works. There are too many fresh traders starting bottom fishing but ending up with stock lower or never getting out from that low level. They are spending years stacking in bad investments. Also, their money becomes locked in such bad investments.

A real-life example

Nowadays, we have a big selloff in the stock market. It is a great opportunity to buy some stocks that were very expensive since they are much lower now. A high priced stock has the drawback. Everyone would like to buy but have insufficient capital. That’s why the trading volume of such stock can be small. And suddenly due to some unfortunate event, the price is going down. Buying these stocks is a very good opportunity because they have the chance to go back up to the top. But it is hard to catch the bottom for these stocks. So many investors push up the price in the hope to get out at a higher price.

Are they right or wrong? It is obvious they’ll have to sell these stocks when they start to come back up to reduce their losses. That is the main disadvantage of bottom fishing if you don’t do it accurately.

Bottom line

If you want a proper approach to the bottom fishing, you’ll have to watch for higher highs and higher lows. When you notice in the chart that a trend line is moving up off of a bounce you’ll see the real bottom. Well, you might not catch it at the lowest point, but you’ll catch it in a range of 5% or 10% which is a good deal for long-term investment. That can be a good strategy for investors willing to hold a stock for several years.

For example, the stock price had a sharp decline and fell from $300 to $100 per share over three days. You could determine it was due to market conditions. So, you are buying 10 shares for $1.000. Next week, the price returned to $300 per share. What are you going to do? Sell, of course. You can sell the share of stock that you purchased for $1.000 at $3.000 (10 shares at $300 each) and make a profit of $2.000. Really not bad.

Bottom fishing as an investment strategy is attractive for boosting portfolio value. Also, it is good for fast making profit while the volatility in the market is present. But, keep in mind, it can be risky because you can’t be 100% sure how the stock or market will go, how the price will run as a result of investors’ behavior, or how the particular company will survive the problems in the global economy.

16th March 2020
The Average Daily Trading Volume How to Calculate

(Updated October 2021)

A stock’s daily trading volume shows the number of shares that are traded per day. Traders have to calculate if the volume is high or low.

The average daily trading volume represents an average number of stocks or other assets and securities traded in one single day. Also, it is an average number of stocks traded over a particular time frame.

To calculate this you will need to know the number of shares traded over a particular time, for example, 20 days. The calculation is quite simple, just divide the number of shares by the number of trading in a specified period. Daily volume is the total number of shares traded in one day.

Trading activity is connected to a stock’s liquidity. When we say the average daily trading volume of a stock is high, that means the stock is easy to trade and has very high liquidity. Hence, the average daily trading volume has a great impact on the stock price. For example, if trading volume is low, the stock is cheaper because there are not too many traders or investors ready to buy it. Some traders and investors favor higher average daily trading volume because the higher volume provides them to easily enter the position. When the stock has a low average trading volume it is more difficult to enter or exit the position at the price you want.

How to calculate the average daily trading volume

As you expected, it is quite simple. All you have to do is to add up trading volumes during the past days for a particular period and divide that number by the number of days you observe. It is usual to calculate ADTV (Average Daily Trading Volume) for 20 or 30 days but you can calculate it for any period if you like. For example, sum the average daily trading volumes for the last 30 days and divide it by 30. The number you will get is a 30-day average daily trading volume.

Since the average daily trading volume has a great impact on the stock price it is important to know how many transactions were on a particular share. The same share can be traded many times, back and forth and the volume is counted on each trade, each transaction. For example, let’s say that 100 shares of a hypothetical company were purchased, and sold after a while, and re-purchased, and re-sold. What is the volume? We had 4 transactions on 100 shares, right? So, the volume in this particular case would be expressed as 400 shares, not 800 or 100. This is just a hypothetical example even though the same 100 shares could be traded many more times.

How to find the volume on a chart?

Thanks to existing trading platforms it is easy since each will display it. Just look at the bottom of the price chart and you’ll notice a vertical bar. That bar indicates a positive or negative change in quantity over the charting time period. That is the trading volume.
For example (if you don’t like too much noise in your charts), you will use 10-minutes charts. Hence, the vertical bar will display you the trading volume for every 10-minutes interval.

Also, you will notice that these bars are displayed in two colors, red and green. Red will show you net selling volume, and green bars will let you know the net buying volume.
You can measure the volume with a moving average, also. It will show you when the volume is approximately thin or heavy.

What is an average daily trading volume for a great stock?

Are you looking for the $2 stock with an average daily volume of 90,000 shares per day? It won’t be easy. Sorry!

The stocks that traded thinly are very risky and changeable. To put this simple, we have a limited number of shares in the market. Any large buying might influence the stock price skyrocketing. The same happens when traders and investors start to sell, the stock price will fall. Both scenarios are not beneficial for investors. So, you must be extremely careful when trading stocks with daily trading volume below 400.000 shares. You can be sure it is a thinly traded stock even if it is cheap as much as $2. The stocks with low prices carry higher risks. For example, penny stocks.

Here we came to the dollar volume. While the daily trading volume shows how many shares traded per day, the dollar volume shows the value of the shares traded. To calculate this you have to multiply the daily trading volume by the price per share.

For example, if our hypothetical company has a total trading volume of 300.000 shares at $2, what would be the dollar volume? The dollar volume would be $600.000. This is a good metric to uncover if some stock has sufficient liquidity to support a position.

To decrease the risks, it is better to trade stocks with a minimum dollar volume in the range from $20 million to $25 million. Look at the institutional traders, they prefer a stock with daily dollar volume in the millions.

Understanding Average Daily Trading Volume

Average daily trading volume can rise or drop enormously. These changes explain how traders value the stock. When the average daily trading is low you have to look at that stock as extremely volatile. But, the opposite is with higher volume. Such stock is better to trade because it has smaller spreads and it is less volatile. To repeat, the stock with higher trading volume is less volatile because traders have to make many and many trades to influence the price. Also, when the average trading volume is high, trades are executed easily.

This is a helpful tool if you want to analyze the price movement of any liquid stock. Increasing volume can verify the breakout. Hence, a decrease in volume means the breakout is going to fail.

The trading volume is a very important measure.

It will rise along with the stock price’s rise. So, you can use it to confirm the stock price changes, no matter if it goes up or down. When we notice that some stock is rising in volume but there are not enough traders to support that rise and push it more, the price will pullback.

Pullback with low volume may support the price finally move in the trend direction. How does it work? Let’s say the stock price is in the uptrend. So, it is normal the volume to rise along with a strong rising price. But if traders are not interested in that stock, the volume is low and the stock will pullback. In case the price begins to rise again, the volume will follow that rise. For smart traders, it is a good time to enter the position because they have confirmation of the uptrend from the price and the volume both. But be careful and do smart trading. If the volume goes a lot over average, that can unveil the maximum of the price progress. That usually means there will be no further rise in price. All interested in that stock already made as many trades as they wanted and there is no one more willing to push the stock price to go up further. That often causes price reversal.

Bottom line

The average daily trading volume shows the entire amount of stocks that change hands during one trading day. This can be applied to shares, options contracts, indexes or the whole stock market. Daily volume is related to the period of time. It is very important to understand that when counting volume per day or any other period each transaction has to be counted once, meaning each buy/sell execution. To clarify this, if we have a situation in which one trader is selling 500 shares and the other one is buying them, we cannot say the volume is 1.000, it is 500. Anyway, this is an important metric that will show you if some stock is easy or difficult to trade.

13th March 2020