Can yesterday influence today?

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Prices have memory

This is the eternal truth of the market (in Gujrati we use to say, “ભાવ ભગવાન છે!”). Prices tell some kind of story, story of buyers and sellers and their aggression. As a trader if we can interpret it, then our trades can directly be in sync with the market and not in sync with our emotions. Here is one such analysis that I have done to validate the hypothesis.

Before we jump to data, I think we all may agree that if let’s say Virat Kohli scored 35 runs then probability of him scoring fifty runs is higher. If he has scored 80 runs then the probability of century shoot up drastically. But wait, what is Virat Kohli doing here? IMO This is the simplest way of understanding volatility in the market. How? What is the probability of BANKNIFTY moving 500 points up if it is already up 300 points in the morning session versus it is only up 100 points in the morning session? Definitely higher in the first case, right? Making some sense now?

But we can’t trade above logic as it is very subjective. So let’s quantify the above concepts to find out real statistics.

The Test

Years: 2013 to September, 2020

  1. First calculate the absolute range(call it previous day range {PDR}) by subtracting yesterday’s High from yesterday’s Low price of BANK NIFTY spot.
  2. Now if today’s price moves above X% of PDR then buy BANKNIFTY at market price.
  3. Same way, Sell if price moves below X% of PDR.
  4. Close all open positions at 3:29 pm.

I have not considered Stop-loss in it because it is just a test not a strategy.

Case 1: X is 50%, means if PDR is 100 point then today if BANKNIFTY moves above 50 point then buy or sell if it drops 50 point.

Here I have reduced 3 point commission and 10 points slippages in every trade. And results is based on the point generated.

Case 2: X=100%

We can clearly see the difference. Now can this result further get enhanced if we try X=200%? It should be if our hypothesis is true. So, let’s find out.

Case 3: X=200%

That’s it! Only 98 trades and average 36 point profit per trade! But total points captured is only 3600 points so better to go with the X=100% option for now. But this option comes with higher and steep Drawdowns.

When I further discussed this idea with Vishal Mehta, he suggested one good tweak in this approach. His rationale is that the market sometimes drops just to short squeeze(basically to trap short seller) then may reverse from there. So, giving us the wrong signal. To minimize this false signal, he suggested below criteria:

For buying X=100% and for selling X=125%, basically making it a bit harder to short.

Edge is almost the same but it has captured almost 3x(X=200%) point then above setup. And drawdown reduced to half than X=100% option

So, there are shining edges by following this type of setup. One can further furnish it by adding stop-loss logic and risk management parameters. We can also conclude that, it is always better idea to let price move somewhat or let machines get heat before directly jumping into trades any day.

Until then, Happy Trading!

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Kevin Kukadiya

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