Getting Started with Options Backtesting on PHI 1

Before you use a trading strategy, be it an options trading strategy or otherwise, to work, it is important to test it. The fundamental ways to evaluate options trading strategies include backtesting and forward testing.

Backtesting trading strategies refers to testing your strategy using historical data sets.

Forward testing refers to evaluating your trading strategy using simulated environments.

As a trader, testing your options trading strategy is of utmost importance, as it will not only help you avoid huge losses but also help you trade stress-free.

With backtesting, you can understand how viable your trading strategy is without the need to risk your money. Yes! It’s basically testing how good your trading strategy is when tested with real market data.

You can test both – simple and complex options trading strategies requiring multiple parameters and inputs with backtesting using options backtesting software on an algorithmic trading platform.

The analysis that you get from backtesting can help you optimize your trading strategy.

Here’s how you can perform these backtest options strategy with ease on PHI 1:

Step 1: Open the Option Leg Builder on PHI 1.

Step 2: Select the index or stock, expiry, and the strike price whose options you want to trade to create your desired strategy.

Step 3: You can save this strategy for future use as a template by clicking ‘save strategy.’ Read how you can create the straddle strategy with PHI 1 here.

Step 4: This strategy is saved.

Step 5: Select Create Options Backtest.

Step 6: Select strategy to backtest, select symbol or stock on which you want to backtest the strategy, select test parameters like expiry date, period, etc. and run the backtest.

Step 7: Voila! You can see the result on the next screen within a minute or two!

Step 8: You can check monthly trades, equity charts, and logs for your strategy

Kudos! You have successfully backtested the strategy created by you.

You can backtest any other options trading strategy in the same way.

Watch our webinar on “How to backtest your options trading strategy using PHI 1.”

In this webinar, you will learn to create popular options strategies like an iron corridor, straddle and strangle and deploy it too!

And hey! Before you watch the video, one more thing.

There’s a lot of automated trading tools available in the market which offer the backtesting option.

But, what if you could see payoff charts, Greeks, and more along with robust screening and deployment on a single automated trading platform?

That’s PHI 1 for you!

Avail of the free trial to experience trading automation in full throttle.

Try for free today!

Getting Started with Options Trading on PHI 1

Options trading can be tricky, especially if you don’t use the right trading platform. Algo trading software can make it simpler and quicker to trade options.

Here’s a guide on how you can start options trading with ease using PHI 1.

 

Access comprehensive charts:

Using PHI 1 for options trading will give you uninhibited access to detailed charts and data sets. You have the choice of displaying any chart, symbol, price-related data across various time frequencies. This means minute-to-minute trading actions and movement will be available at your fingertips.

For displaying charts, you need to click on the graph symbol on the left side of PHI 1. All NSE instruments are available here. You can choose any scrip you want.
Choose Script for Option Trading
For Options, you would need to click the F&O selector in the header and choose your desired scrip, expiry, strike price, and whether it is a call or a put option. Once that is done, click generate.
F&O selector in the header
With PHI 1, you can get access to data across various time periods. Whether it is daily swings or market ticks by the second, you can generate data for any time you want.
time periods for daily swings or market ticks
There is no restriction on the number of indicators you can apply here. You can use multiple indicators at a time.

Another useful feature that needs to be highlighted is the ease of transactions.

If you have connected your broker to your account, you can place a buy or sell order directly from PHI 1’s interface.
multiple indicators
There are two ways to select the option instrument on PHI 1:

A. One is by directly inputting the precise strike and expiration date, or

B. You can choose from the dynamic monthly and weekly options available. You can choose any strike price like at the money (ATM), and the software generates various options that get updated daily.

option instrument on PHI 1
In case you want to come back to the charts in the future, you can do so by saving the chart. Just click on ‘Save’ in the header with the name you want.

Your chart template is now saved and you can continue your technical analysis whenever you want.
chart template for technical analysis

Built-in strategy templates

For viewing the various strategy templates available at hand, click on the menu options on the right-hand side, and select strategy.

Under the strategy, you have two options to choose from. You can either start with the form mode or code mode.

With form mode, you have basic strategy templates available with various indicators so you can algorithmic trading without coding.
Built-in strategy templates
You just need to select the strategy template that you require (SMA, EMA, etc). You get a basic buy and sell condition on which you can add a stop loss and take profit.

If you have your own entry and exit rules, you can enter them using either the form mode or code mode. Also, if you need any coding help, just contact PHI 1 support and they will help you out.

Once your strategy is ready, all you need to do now is click on ‘Run and Save’.
SMA and EMA strategy template
When the run completes at the day frequency, you get the default run for the entire year.

There are other trading performance metrics that you get access to at this stage such as your overall returns, long-short trades, profitable trades, loss-making ones, each entry, each exit, and overall return.

It’s super easy to get started with the form mode. You can add as many indicators as you want to experiment with in order to get the results you require.
Set day frequency
Even with code mode, you have access to 10 templates, to begin with.
Inbuild templates
Let us understand code mode with an example.

When we choose the first strategy template – Bollinger, it gives you an initial indication for you to calculate and take buy and sell orders based on where your current price is in terms of the Bollinger band with default parameters.

You can change the parameters and buy/ sell orders based on the metrics you want to analyze.
understand code mode
If your current strategy isn’t working, and you want to include an additional trading indicator of your own, you can introduce the code under initialize code here.

In the screengrab below, the code for MACD is added in the box.
code for MACD
Next, you will need to add the set of conditions under step code.

The first condition is that, from the top, MACD should be < zero.
set conditions
And on the opposite side, before the uptrend, we want the MACD to be >zero.
opposite side uptrend
This added indicator helps filter out unfavorable trades and allows you to focus on trades that may work in your direction.
filter out unfavourable trades
The code mode is not limited to only the 10 indicators visible in the drop box.

You can access nearly 119 indicators available in the learn section on the left-hand side to add to your strategy.

You also have the option of using multiple indicators at one go, to analyze market trends, and review the metrics you need.

You can experiment with trading strategies, time frequencies, add stop-loss conditions, and different instruments.
visible indicators
When building a trading strategy for options, the process is exactly the same.

You just need to choose your desired option and strike price and run the strategy.

You can choose different time frames from hourly to monthly, visually inspect all trades to see how the premiums have changed over time, etc.
trading strategy for options
With PHI 1, options trading gets bigger and better.

You can not only try out tested and experimental strategies but also see payoffs, backtest, and simulate trades.

Finally, you can deploy your trades with the broker of your choice using the multi-broker integration.

In a nutshell, PHI 1 offers total freedom for the trader to exploit market opportunities while trading options by managing mundane tasks that take away time and effort.

Try PHI 1 for free!

 

Watch our webinar on ‘Getting Started Options Trading with PHI 1’ here.

Stay tuned for more.

Creating a Straddle Strategy with PHI 1

What is the Straddle strategy in options?

Straddle strategy is an options trading strategy in which the trader buys both a call option as well as a put option of the same underlying asset or stock having the same expiry date and strike price.

Usually, traders use the straddle strategy when they are sure of a significant movement of the underlying stock’s price, but are unsure of the direction, i.e. whether the price will rise or fall significantly.

Thus, in this strategy, the trader will make a profit when the price or the underlying stock rises or falls by an amount that is more than the premium paid to buy call and put options.

The profit potential is unlimited as long as the price of the underlying stock moves significantly in either direction.

For example, consider a stock whose price is Rs. 10.

The trader is expecting a significant movement in the stock’s price within 15 days post its result on 1st February.

But, he/she is not sure if the market will take the result positively or negatively.

So, the trader goes for a straddle strategy, i.e., he/she buys call options and put options with expiry of 15th February and bets the price to rise above Rs. 12 or fall below Rs. 8.

Thus, in this way he/she will make a profit on any movement of the stock price beyond Rs. 2.

Looking at a straddle, a trader can know two things about the sentiment of the options market towards a particular stock. The first is that the market is expecting volatility in the price of the stock, and the second is the expected trading range of the stock’s price.

You can easily try this strategy on PHI 1 as shown below:

Step 1:
Open the Option Leg Builder on PHI 1.

Step 2:
Select the index or stock whose options you want to trade.


Step 3:
Select the expiry.


Step 4:
Select the option strike price.


Step 5:
Select PE (put option) in option type.


Step 6:
Add this position by clicking Add Position.


Step 7:
Keeping all other parameters the same, select CE (call option) in option type.


Step 8
Add this position by clicking ADD POSITION.

Voila! You have created the straddle strategy with the payoff chart.

You can save this strategy for the future as a template by clicking ‘Save strategy’.

Now, prior to deployment you may want to perform backtesting for your options strategies. You can avail free options backtesting with PHI 1.

You can also deploy your options strategy easily when your predefined criteria are met. This means no more staying glued to the screens for the right trading opportunity to come!

Make the most of automation with PHI 1!

Try for free today!

 

Watch our demo of how to test straddle strategy using PHI 1’s Options Trading feature: Watch Now!

An Introductory Guide to Options Trading

Learn Basics, Strategies, Risk Evaluation, & Risk Management in Options Trading

Options can be great instruments for hedging and risk management. Options also open up a whole new world of trading strategies you can explore and use to make profits.

We’ve put together an options trading guide to help you get started.

Here’s what you will learn in this guide:

1. What are Options?
2. What are Call Options & Put Options?
3. What are the uses of Options?
4. How do Options work?
5. What are some Options Trading Strategies?
6. What is risk in Options and how is it measured?
7. What are some risk management strategies using Options?
8. How to effectively use leverage in Options Trading?
9. What are the pros and cons of options trading?

 

1. What are Options?

An option is a contract that gives the buyer the right (without the obligation) to buy or sell the underlying security or asset at a predetermined price (strike price) by a predetermined date (expiry).

Options belong to the derivatives segment, as their price is derived from the price of something else, which is the underlying asset or security.

 

2. What are Call and Put Options?

There are two types of Options – Call option and Put option

A call option means that the buyer of the call option has the right but not an obligation to buy the underlying security at the strike price.

A put option means that the buyer has the right but not an obligation to sell the underlying security at the strike price.

The four main actions traders can take with options are:

1. Buy call

2. Sell call

3. Buy put

4. Sell put

Similar to buying a stock, buying a call option gives a long position to the trader on the underlying security.

And similar to short selling a stock, selling a call option gives the trader a short position in the underlying security.

Buying a put option means the trader is taking a short position in the underlying security.

Selling a put means the trader is taking a long position in the underlying security.

These four scenarios are crucial to understanding Options Trading.

Buyers of options are known as holders and sellers are known as writers of options. The difference between holders and writers is:

1. Call holders and put holders do not have the obligation to buy or sell the underlying security/options. They have the choice whether they want to exercise their right. This limits the risk of holders to losing the premium spent to buy the options if the markets do not go their way.

2. Conversely, call writers and put writers must buy or sell if the option expires in the money. This is because the writers need to make good their promise to buy or sell. This shows us that writers usually are exposed to more risk, as they can lose much more than the premium paid for the options. Sometimes, the risk to writers is unlimited.

 

3. What are the uses of Options?

A. Speculation

Speculation is essentially betting on where the price of a security will go in the future.

If a trader thinks that the price of a security will go up within the next one month based on his analysis, he/she will either buy the stock or a call option to benefit from the price rise.

An option is a more attractive instrument, as it provides leverage (one only has to pay option premium and not the price of the underlying security) and costs significantly lesser than the stock.

B. Hedging

Options were invented for hedging.

Using options to hedge helps traders reduce risk at a lower cost.

For instance, if a trader invests in a security assuming that its price will increase, they can hedge their position by buying put options of the same underlying security.

Thus, if the price increases, they will earn as the security price rises. And if the price falls, they will minimize their losses by making money on the put options.

 

4. How do Options work?

Here are 3 factors you need to know to understand how options work:

Relative Value:

Options are used by traders to profit from determining the probability of future events.

If the probability of an event is high, the option that makes bets on the event happening is more expensive than that of an option of an event less likely to occur, i.e., an event whose probability is low.

Thus, for example, the call option’s price goes up as and when the underlying security’s price goes up. Thus, one must understand the relative value of options to trade in it.

Time Value:

The price of options depends on time.

Therefore, if the option would expire soon, its price would be lower than the option whose expiry is after a longer time period.

This is also because determining the probability of an event (in this case – price rise or price fall) becomes easier as the expiry date comes closer.

This means that options are a time-diminishing asset.

For instance, if one buys an option with a one-month expiry, and the price of the stock does not move, then the option’s value decreases with each passing day.

So, a one-month expiry option is cheaper than a three-month expiry option.

This is because the probability of a price move in your favor increases if the time available increases.

Volatility:

The more volatile the underlying stock’s price, the more is the price of the option.

This is because more volatility implies that the price can go either way with larger swings, thus making the possibility of price movement in either direction greater.

Here’s an illustration of how option pricing works:

Most of the time, traders choose to make money by trading their positions, so the option holders usually sell their options in the market.

Only ~10% of options are exercised, 60% are traded, and 30% expire.

 

5. How do traders use options? (Basic Options Strategies)

As we know, traders use options to either speculate, hedge their trades or simply trade to make profits. To make maximum profits, option traders use some strategies while trading.

Let us look at some strategies here:

1. Long Call

In this strategy, the trader goes long on a call, i.e., the trader buys call options expecting that the price of the underlying security will go up.

For instance, a trader buys a contract with 100 call options for an underlying security whose current price is Rs. 10.

The option price, say, is Rs. 2.

Therefore, the trader spends Rs. 200 for the contract.

The trader will be at a no-profit no loss position (at the money) when the security price reaches Rs. 12 (strike price).

As the security price increases over Rs.12, the trader will start making profits.

Thus, a long call can give unlimited profits to the trader, as the price of the underlying stock can increase infinitely.

If the stock price falls below Rs.12, then the trader may sell it off at a loss or let the option expire and lose Rs. 200 only.

Thus, this strategy has an unlimited upside and limited downside, which traders use when they are fairly certain of the increase in the underlying stock’s price.

Long call

2. Short Call

In this strategy, the trader sells a call option, expecting that the price of the underlying stock will decrease over a predetermined time frame.

Thus, the trader can make unlimited profits if the price of the underlying stock decreases.

However, the trader may face significant losses if the price of the underlying stock increases, as in that case, he/ she would have to purchase the stock at higher prices and deliver.

Short call

3. Covered Call

To protect against such losses, the trader goes for the covered call strategy.

This involves holding a long position in the underlying while shorting a call.

Here, since the trader already buys the underlying stock, they gain on the stock price if it increases and gain on the call option if it falls.

This strategy limits the losses and profits of the trader. Experienced traders usually use this strategy of covered calls to generate income from their stock holdings.

Covered_call

4. Long Put

This strategy is like that of a long call except that the trader buys put options instead of call options when they are fairly certain that the price of the underlying stock will fall below a certain level in a fixed time frame.

For example, if a trader buys a contract with 100 put options for an underlying stock whose price is Rs. 10 at a strike price of Rs. 8, they will be at a no profit no loss position (at the money) if the stock price falls to Rs. 8.

Thereafter, as the stock price falls further, the trader will be in the money, till the stock price reaches 0.

As the price of the underlying security cannot fall below zero, gains as well as losses are capped.

This is because if the price moves in the opposite direction, the trader can choose to let the options expire and suffer a loss of Rs. 200.

This strategy is used when the traders are fairly confident of the stock price falling below a certain level.

Long Put

5. Short Put

In this strategy, the trader will write/ sell a put option, i.e., bet that the price of the underlying security will increase over a fixed time period.

Here, the maximum profit for the trader is limited to the premium amount collected.

But, the maximum losses can be unlimited because they will have to buy the underlying stock to fulfill their obligations to buyers if they decide to exercise their option.

This can be an effective strategy if the trader is fairly certain that the price of the underlying stock will increase.

The trader can also buy back the option when its price is close to being in the money and generate income through the premium collected.

Short put

These strategies would have seemed vague if you wouldn’t be able to see payoffs, right?

Well, here you go!

Now, let’s move on to understanding risk measurement in options and risk management strategies.

 

6. Risk Measurement in Options Trading

An option’s price can be influenced by several factors that can either help or hurt traders depending on the type of positions they have taken.

We need to understand the factors that influence options pricing, which are known as “Greeks”—a set of risk measures named after the Greek letters that denote them.

Greeks show how sensitive an option is to time-value decay, changes in volatility, and movements in the price of its underlying security.

These four primary Greek risk measures are known as an option’s Delta, Theta, Gamma and Vega.

An option’s “Greeks” describe its various risk parameters.

1. Delta is the measure of the change in an option’s price or premium resulting from a change in the underlying asset.

2. Theta measures its price decay as time passes.

3 Gamma measures the Delta’s rate of change over time as well as the rate of change in the underlying asset. Gamma helps forecast price moves in the underlying asset.

4. Vega measures the risk of changes in implied volatility or the expected volatility of the underlying asset price in the future.

 

7. Risk Management using Options

Options are used to offset risk when trading in the market. Using options to hedge helps traders reduce market risk at a lower cost.

Here, we will look at a few option trading strategies that traders use to minimize their risks:

1. Protective put or Married Put

In a protective put, the trader invests in a security assuming that its price will increase.

They also hedge their position by buying put options of the same underlying security.

Thus, if the price increases, they will earn as the security price rises. And if the price falls, they will minimize their losses by making money on the put options. This strategy limits the losses and profits of the trader.

The only downside to this strategy is that the trader has to let go of some gains as risk mitigation.

protective put

2. Covered call:

A covered call is used by traders who intend to hold the underlying stock for a long time, but do not expect a considerable rise in price in the near term.

Selling a call (covered call) protects against a fall in the stock price and thus hedges their position.

The maximum profit from a covered call is if the stock price rises to the strike price that has been sold. Thus, this strategy is not meant for very bearish or very bullish expectations.
covered call
These are the simple strategies for risk management in options. There are more complex option spreads too, which traders use to mitigate risk.

 

8. Using Leverage effectively in Options Trading:

Let us first understand what is leverage and how it relates to options trading.

There are two ways leverage is used in options trading.

A. Avoid: Using the same amount of capital to bet on a larger position

This means that 1 rupee invested in a stock and the same 1 rupee invested in an option does not equal the same risk.

Consider the following example. You’re planning to invest Rs.10,000 in an Rs.50 stock, but also have the option to buy options contracts worth Rs.10 as an alternative. After all, investing Rs.10,000 in a Rs. 10 option allows you to buy 10 contracts (one contract is worth 100 shares of stock) and control 1,000 shares. Meanwhile, Rs.10,000 in an Rs.50 stock will only buy 200 shares.

In this example, the options trade is riskier than the stock trade. With the stock trade, your entire investment can be lost, but only if the stock price falls 100% from Rs.50 to Rs.0.

However, you stand to lose your entire investment in the options trade if the stock drops to the strike price.

So, if the option strike price is Rs.40 (for an in-the-money option), the stock only needs to drop below by 20%, i.e., below Rs.40 by expiration for the entire investment to be lost.

B. Better: Maintaining the same position by spending less money

This is the definition of leverage that a consistently successful trader incorporates into his/her trades. Understanding the risk in this way of leverage is as explained below:

There is a huge risk disparity between owning the same amount of stocks and options. To understand this, let us examine two ways to balance risk disparity while keeping the positions equally profitable.

i. Conventional Risk Calculation

The first method to balance risk disparity is the standard and most popular way.

Let’s go back to our example to see how this works:

If you were going to invest Rs.10,000 in a Rs.50 stock, you would receive 200 shares. Instead of purchasing the 200 shares, you could also buy two call option contracts of 100 shares each at a considerably lower cost. By purchasing the options, you spend less money, but still control the same number of shares.

This excess money which you saved when buying an option can be used in other trading opportunities with greater diversification. Thus, this leveraging strategy can free up your funds for other trades.

ii. Alternative Risk Calculation

In this alternative risk strategy, the trader balances cost and quantity based on risk.

For example, if you buy a stock at Rs. 50, keeping a stop loss at Rs. 40.

You are ready to lose Rs. 10 in case the stock does not behave according to your expectations.

So, for these Rs. 10 you can buy a put option of the same underlying security with strike price Rs. 40.

What you can achieve with this strategy is that you can limit your loss to Rs. 10 in this trade. All other price movements, like above Rs.50 and below Rs. 40 will generate profits for the trader.

Thus, the trader needs to determine the right amount of money to invest in an options position, which allows the investor to unlock the power of leverage.

The key is managing risk while maintaining your exposure and profit probability.

Before we conclude, here are some advantages and disadvantages of option trading:

 

9. Pros and Cons of Options Trading:

 

Pros of Options Trading:

Options trading can be very helpful for traders. Some of them are listed below

1. Leveraging potential:

Options come with huge leveraging power. A trader can get an options position equal to a stock position at a much lower cost and margin, or at the same investment cost, the trader can control a much greater number of securities using options.

2. High Return Potential:

The returns on options trading would be much higher than buying shares on cash. This is because the trader can get options on lower margin and get the same profitability, hence, the percentage return on investment would be much higher comparatively.

3. Lowering Risk of Holding Underlying:

Options are surely riskier than owning equities, however; there are also times when options are used to mitigate risk. Options are used widely to hedge positions. The risk in options is pre-defined as the losing the premium paid to buy the option.

4. Risk Management in Options Trading:

There are more strategies which are used by regular traders to trade options along with trading equity. The trades can be combined to create a strategic position with the help of a call and put options to mitigate and control risk when trading in the market.

 

Cons of options trading:

As we have seen above, options can be highly rewarding. However, there are some drawbacks to options trading.

1. Less Liquidity:

Some stock options have lower liquidity, which makes it very difficult for a trader to enter and exit trades.

2. High Trading Costs:

Option trading is typically more expensive as compared to stock trading, as most full-service brokers charge higher fees for trading in options.

3. Time Decay:

The value of your option premium decreases by some percentages each day irrespective of movement in the underlying.

4. Non Availability of All Stock Options:

All the stocks registered with exchanges do not have options contracts. This makes it difficult for a trader to hedge his position with options strategies.

Wow! Looks like you’ve got it all ‘covered’!

Which platform would you prefer to try out these learnings?

We’d say a platform that offers not just free and accurate F&O data but also allows you to see payoffs, try out any options trading strategy, backtest and simulate it, and all this while placing your trade with a broker of your choice!

Option Leg Builder

Image caption: Here’s a married put example while the trader is holding Axis Bank shares and how easy PHI 1 makes trading options.

Add to this, our robust support and resources section!

Get more from Option Trading with PHI 1.

Simply visit app.phi1.io for a free trial and choose a plan that suits you if you like us.

8 Indicator-based Trading Strategies you can try right away on PHI 1

Traders usually combine a variety of technical indicators to come up with trading ideas and strategies to execute a trade profitably. That said, some tried and tested trading strategies can always be deployed to make some quick trades.

All you need to do is insert the parameters into an automated trading system like PHI 1.

You can even paper test these strategies before you actually start placing trades with real money.

Let us look at some popular trading strategies you can use now on PHI 1:

 

I. Moving average strategies

1. Price Crossover – Whenever the price of security crosses the moving average line, traders take it as a signal of a change in trend.

For example, if the price crosses above the moving average line, it depicts a positive trend and when the price crosses below the moving average line, it depicts a negative trend.

Using MA in Form Based Strategy Creator On PHI 1-min

Using MA in Form-based Strategy Creator on PHI 1

MA Strategy Testing Results on PHI 1

MA Strategy Testing Results on PHI 1

MA Charts on PHI 1

MA Charts on PHI 1

2. Two moving averages – In this strategy, 2 moving average lines are plotted on the chart, one longer moving average and another shorter moving average.

The traders recognize it as a positive trend or a buy signal when the shorter moving average line crosses above the longer moving average line. This is the golden cross.

For example, when the short-term moving average (50 SMA) passes above the long-term moving average (100 SMA).

After the formation of the golden cross, the price of stock has increased gradually. Therefore, we can say that it is a good time for the trader to buy the stock.

When the shorter moving average line crosses below the longer moving average line, traders recognize it as a negative trend or a sell signal. This is the death cross.

For example, the death cross forms when the short-term moving average (50 SMA) crosses below the long-term moving average (100 SMA).

After the formation of the death cross, the price of the stock declines sharply. Therefore, we can say that most of the time, the death cross shows that there is the potential of a massive sell-off.

Using 2 MA in Form-based Strategy Creator on PHI1

Using 2 MA in Form-based Strategy Creator on PHI 1

Strategy with 2 MA Testing Results on PHI 1

Strategy with 2 MA Testing Results on PHI 1

 

II. Average Directional Index strategies

The strength and direction of a trend is measured by the average directional index or ADX. It consists of 3 lines on the indicator – ADX, +DI and –DI.

It is considered that when the +DI line crosses the –DI line while the ADX is above 25, traders see it as a signal that an uptrend is about to start, and they could consider entering a long position.

On the other hand, if the –DI line crosses the +DI line while the ADX is above 25, traders can take it as a signal that a downtrend is imminent, and there is an opportunity to enter a short position.

 

III. On-Balance Volume strategies

As is well-known, on-balance volume indicators are used to depict the positive or negative flow of volume in the traded security over a fixed period.

Up volume is the volume of a security traded on the day when the price of the security has rallied, and down volume is the volume of security traded on the day when the price of the security has fallen.

We get the on-balance volume of the day by adding or subtracting the day’s volume from the indicator if the price goes higher or lower, respectively.

When on-balance volume rises, it depicts that there are more buyers and pricing is being pushed higher, whereas if on-balance volume falls, it shows that there are more sellers than buyers, thus pricing will be pushed down.

In case the price and the on-balance volume indicator go in different directions like the price rising but the on-balance indicator falling, the rising prices are not supported by buyers in the market, and the upward trend could reverse.

 

IV. Accumulation/Distribution Line strategies

A/D line considers the closing price of the security as well as the trading range for the trading period.

Traders view the A/D line trending upwards as buying interest in the security, and thus, infer an uptrend in the security’s price. And if the A/D line is falling, it depicts a fall in volume and thus infer a downtrend.

Also, if the A/D line and the price of the security moves in different directions, it signals a reversal of trend.

 

V. Relative Strength Index (RSI) strategies

The relative strength index (RSI) moves between 0 and 100, as per price gain or price loss of the security. The traders could thus understand the momentum and strength of the trend using RSI.

Also, some traders consider RSI above 70 as an indicator of the security being overbought and thus expect a negative trend. This indicates an exit point.

An RSI below 30 is understood as the security being oversold and thus signaling an upward trend and an entry point for a long position.

When RSI is moving in the opposite direction of the price, it signals a weakening of the price trend which could reverse, eventually.

Using RSI in Code Mode Strategy Creator on PHI 1

Using RSI in Code Mode Strategy Creator on PHI 1

8-min

RSI Strategy Testing Results on PHI 1

RSI Strategy Testing Results on PHI 1

RSI Strategy Testing Results on PHI 1

 

VI. Aroon Oscillator strategies

This indicator is used to determine if the price of the security is reaching new highs or lows over the time for which it is calculated.

There are 2 lines in this indicator – Aroon up line and Aroon down line.

When the Aroon up line crosses above the Aroon down line and the up line reaches near the 100 level and the down line remains near 0 levels, traders infer a positive uptrend and vice versa.

 

VII. Moving Average Convergence Divergence (MACD)

The moving average convergence divergence (MACD) is used by traders to ascertain the trend direction and the trend momentum.

When the MACD rises over zero, the price is believed to be in an upward trend and as the MACD goes below zero; the price is in a downward trend.

Also, if the MACD line crosses above the signal line, traders depict a price uptrend, and vice versa.

Both these methods are used together by traders.

Thus, if the MACD is below zero and MACD crosses below the signal line, one may enter a short trade and vice versa.

 

VIII. Stochastic Oscillator strategies

A stochastic oscillator is used to measure the current price of a security relative to a price range over other periods. It is plotted between 0 and 100.

It shows that when an uptrend is on; the price makes new highs and in case of a downtrend; the price makes new lows.

Also, when the stochastic oscillator is above 80, the security is overbought and if it is below 20, then it is considered being oversold.

You can easily try these strategies on PHI 1.

PHI 1’s Form-Based Strategy Creator is super easy to use. All you need to do is choose the indicator, add criteria and values, and hit Run and Save. Your trade is executed when the requisite criteria are met.

PHI 1’s automated trading aims to make life easy so you can trade better. Explore its unique features on app.phi1.io.

Try these strategies on PHI 1 for free.

 

Disclaimer: The purpose of sharing these strategies is purely educational. Please do not consider these for investment purposes.

8 Popular Chart Trading Patterns You Must Know

We’ve discussed indicators and trends as well as popular trading strategies using technical indicators in our previous articles. In this blog, we discuss the most popular stock chart patterns for trading.

Chart patterns are essentially shapes formed on trading charts, which may help identify price action signals like reversals and breakouts.

Over the years, several stock chart patterns have been widely recognized. Using these chart patterns can give your trading an edge by allowing you to confirm a specific signal or trend.

Whether or not you’re new to stock patterns, it’s time to familiarize and refresh yourself with these 8 popular chart patterns.

1. Head and shoulders pattern:

This pattern forms when a stock’s price increases and reaches a certain level and then comes back to the base from where it started earlier.

After this, it again starts rising and crosses the previous peak, reaches a new high price, and then declines to reach the base.

Finally, the stock price again rises but goes only to the level of the first peak. Then, it falls, and while declining, if it breaks the established baseline with a reasonable volume, the bearish reversal occurs.

Source: https://traders-paradise.com/magazine/2020/05/head-and-shoulders-pattern-how-to-trade/

2. Double Top:

This is a bearish reversal chart pattern that is formed when a stock is on an uptrend for some time.

The stock’s price increases and reaches a level and declines to the support after creating a peak.

This support level is called the neckline.

It rises after getting to the neckline, reaches the previous level, and forms a peak.

Finally, the formation of this pattern completes when the price comes back to the neckline after creating the second peak. If the price breaks through the neckline while retracing back, it confirms a bearish trend reversal. 

Source: https://howtotradeblog.com/what-is-double-top-pattern/

3. Double Bottom:

This is a bullish reversal trading pattern comprising two lows below a resistance level referred to as the neckline.

The price will hit the first low just after the bearish trend. However, it stops at this level and retraces back to the neckline.

After hitting the neckline, the price rebounds and enters a bearish trend, reaching a price almost the same as the previous low.

Finally, the price again starts increasing and comes to the neckline. Further, if this bullish trend breaks the neckline and continues moving upwards, it confirms the uptrend.

Source: https://dailypriceaction.com/forex-beginners/double-bottom-pattern/

4. Rounding bottom:

This pattern shows a bullish upward trend and can be divided into three parts.

First, excess supply forces the stock price to go down, thus forming the declining slope of a rounding bottom.

The transition to an upward trend occurs when buyers enter the trade after seeing the stock at a low price, thus increasing the demand for the stock.

After completing the rounding bottom, the stock’s price breaks the resistance line and continues the uptrend. The trading volume is less at the lowest point of the chart and high at the decline and when the stock price reaches its previous high.

Source: https://www.centralcharts.com/en/gm/1-learn/7-technical-analysis/27-chart-patterns/518-rounding-bottom

5. Cup and handle pattern

This pattern shows a bullish market trend after a pullback.

It features a rounding bottom followed by a handle-like consolidation, which might look like a pennant, wedge, or a smaller rounding bottom followed by a solid upward trend after that.

The breakout towards the upward trend must be confirmed by a substantial volume above the handle’s resistance, or it might come out to be a fake breakout.

The limitation of this pattern is that it takes a longer duration to form, leading to late decisions. Further, sometimes a very shallow cup can be a signal, whereas other times, even a deep cup can be a false signal.

Source: https://www.elearnmarkets.com/school/units/chart-patterns/cup-and-handle

6. Wedges:

This pattern is formed by converging trend lines on the chart.

Two trend lines are generated by connecting the highs and lows of the price of a stock over a period.

Highs and lows either rise or fall at a different rate, resulting in a wedge-like appearance.

Wedge patterns are primarily used for forecasting price reversals and can signal both bullish or bearish price reversals.

There are three standard features in both cases: converging trend lines, a decline in volume with the price progression, and finally, a breakout from one of the trend lines.

The two types of wedge patterns that form are the rising wedge and the falling wedge.

Rising wedge patterns result in a decline in stock prices after the breakout at the lower trend line.

This offers an opportunity for short-selling.

In the case of falling wedges, price breaks the upper trend line, and the stock price reverses and trends higher. This provides an opportunity for entering a long position.

Source: https://www.dailyfx.com/education/technical-analysis-chart-patterns/rising-wedge.html

Source: https://www.dailyfx.com/education/technical-analysis-chart-patterns/rising-wedge.html

7. Pennants and flags:

Flags are consolidation phases where the trend lines are parallel to each other.

This pattern is formed by a sharp counter-trend (flag), which is succeeded by a short-lived trend (flag’s pole).

This pattern is primarily used in combination with volume indicators and signifies trend reversal or breakouts after consolidation.

Pennants are identical to flags in their implications, but the trend lines converge instead of being parallel in pennants. Further, it’s crucial to observe the volume in a pennant. Volume should be low during consolidation, whereas during the breakouts, it should be on the higher side.

Source: https://www.dailyfx.com/education/technical-analysis-chart-patterns/pennant-pattern.htm

Source: https://forextraininggroup.com/trade-bearish-bullish-flag-patterns-like-pro/

8. Triangles:

Perhaps one of the most commonly used patterns is triangles – ascending, descending, and symmetrical. Go to our blog post to read up on the triangle pattern.

You may have seen above how easy it is to spot patterns on PHI 1.

Why don’t you try it for yourself?

PHI 1 is not just a technical analysis charting software but also offers strategy creation, testing, and order execution. It is a unique algo trading software that allows you to trade using a single tool.

Plus, there’s no need to download or install anything. You can also explore the new automated options trading feature.

Give it a go: Try PHI 1 for free today!

Bollinger Bands – A Starter Guide – Part 2

If you’ve read through Part – I of our Bollinger Band series, it’s time to look into some applications of Bollinger Bands and trading strategies you can build around them.

1. Following Trends using Bollinger Bands

Bollinger bands are used for measuring deviation, and therefore, this indicator can be very beneficial in recognizing a trend. We can generate two sets of Bollinger bands, one set with the help of “0.5 standard deviation” and the other using “3 standard deviations”.

In the chart of Tata Consultancy Services shown below, we can observe that whenever the price holds between the upper Bollinger Bands +0.5 SD and +3 SD away from the mean, the trend is in the upward direction, and therefore, this channel is known as the “buy zone.”

Contrarily, if the price is within the Bollinger Bands –0.5 SD and –3 SD, it is referred to as the “sell zone.” Finally, if the price moves between the +0.5 SD band and –0.5 SD band, then it is in a “neutral zone.”

Bollinger Bands keep on adapting to the expansions and contractions in price, because of the increase and decrease in volatility. Because of this, bands widen and narrow down in sync with price action, creating a highly accurate trending envelope.

Coming back to the chart again, the trader may take a long position when the price enters the “buy zone”. The trader’s target should be able to stay with the move for most of the uptrend and exit only when the price starts to consolidate at the top of the new range. An exit from this trade should be made when a red candle is formed and more than 75% of the candle’s body is below the “buy zone”.

2. Squeeze and Breakout Strategy using Bollinger Bands

This trading strategy is based on predicting price breakouts using volatility.

The volatility of the market is constantly changing from low to high and vice versa. This implies that if the market is in a low volatility phase, eventually, volatility will pick up in the future, leading to large price movements and breakouts.

Bollinger Bands can be used both for intraday and swing trading, depending upon the time frame which the trader wants to use.

For using this strategy, we need to find conditions of low volatility or specific less volatile markets and predict when a breakout might happen and in which direction it will be.

For this purpose, we need to find a market that is moving in a range. We can quickly identify this by looking at the middle SMA line. The line needs to be relatively flat, as shown in the chart of Nazara Technologies Ltd., and the two bands must be close to each other.

This task can be made easier by using an indicator called the BBW or Bollinger Bands Width. You can easily get this on a trading platform. This tool shows the distance between the two bands.

If the BBW is low, it means the gap between the two lines is close, and if it is high, it means that the gap is set further apart. The two indicators need to have the same settings for them to work.

Further, to predict the price breakout, we need to wait for the standard deviation lines to start expanding, which can be easily identified by the rise of the BBW. This means that there’s an increase in volatility and a breakout is likely to occur.

The direction of the breakout depends upon whether the candle is breaking the upper line or the lower line. Accordingly, selling or buying of stocks is done.

In this chart of Nazara Technologies Limited, we are using a 15-min time frame. We can observe a flat SMA, meaning that the market is in a range and the two bands are contracting, which a low BBW confirms.

After some time, the bands start to expand, which is also confirmed by the rise in BBW. Then, a red candle breaks out of the lower line, which is an excellent opportunity to take a sell position and make an entry. The lowest point of this same candle is taken as “Stop Loss.”

As shown in the figure, the exit should be made when the price breaks the middle SMA line.

Let’s look at another example.

In this chart, we are analyzing Wipro Limited with a time frame of 1 day.

We can observe that the market is in a range as shown by the flat SMA, and the gap between the two bands is close, which is also represented by a low BBW.

Next, we can see that the bands are starting to expand, confirmed by the rising BBW. Then, a green candle breaks out of the upper line, and this is an excellent opportunity to take a buy position and make an entry.

The lowest point of this same candle can be set as stop loss. As shown in the figure, the exit should be made when the price breaks the middle SMA line.

As you can see, Bollinger Bands can be one of the best trading indicators to use. On an Algo trading platform like PHI 1, you can use over 120 technical analysis indicators and customize them as per your trading strategy.

In fact, PHI 1 offers charting, screening, back testing and forward testing as well as strategy grading and deployment – all on a single automated trading platform.

You can explore Bollinger Bands and a lot more by availing a free trial!

Experience the power of automated trading at full throttle!

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Bollinger Bands – A Starter Guide – Part 1

Among the many trading indicators used for technical analysis, Bollinger bands are a popular technical indicator. Bollinger bands are a momentum indicator used to characterize price and volatility.

What are Bollinger Bands?

Bollinger Bands are a technical analysis tool defined by a set of 3 lines.

The middle line depicts a simple moving average of a stock’s price while the upper and lower lines depict positive and negative standard deviations, respectively, which the user can adjust to one’s preference using a technical analysis charting software.

Bollinger Bands were introduced by John Bollinger, and no prize for guessing, they have been named after him.

How to calculate Bollinger Bands?

As seen in the picture above, Bollinger Bands consist of 3 lines.

The first one in the middle is a simple moving average line usually calculated using the 20-day simple moving average or SMA of the security we are analyzing.

The next two lines, i.e. the upper and lower lines depict the standard deviation of the security’s price we are analyzing.

The upper line denotes positive standard deviation and the lower line shows negative standard deviation. Typically, the upper and lower lines are 2 standard deviations higher and lower from the simple moving average line, respectively.

In the PHI 1 image above, the red line signifies the 20-day moving average and the standard deviations are +/-2, which is the default setting on a trading platform.

Standard deviation is a method to measure the average variance, i.e., how spread out the numbers plotted on a chart are from an average value.

You have the option to change the gap between the SMA line and the positive and negative standard deviation lines on a technical analysis charting software. We skip the formula for calculating Bollinger Bands as they are available easily on the charting tool you may use.

What do Bollinger Bands tell you?

Bollinger Bands are used by traders to identify when a security is oversold or overbought.

As mentioned above, standard deviation shows the price variance of the security from the simple moving average.

So, as the lower and upper line gap widens, it shows more price volatility, and as the lower and upper line gap contracts, it depicts less volatility.

Bollinger Bands can also be used for trend following and to identify breakouts.

Identifying overbought and oversold conditions with Bollinger Bands

The rule is simple:

When the security’s price breaks below the lower band, it may be oversold and due for a bounce-back.

When the security’s price breaks above the upper band, it could be overbought and due for a pullback.

Thus, the closer the price of a security goes to the upper standard deviation line, the more overbought security is believed to be, and the closer the price moves to the lower standard deviation line, the more oversold the security could be.

This rule is based on the premise of mean reversion, which assumes that if a price moves too far away from the average, it will eventually return to the mean.

(Watch this space for more trading strategies using Bollinger Bands. Subscribe to our blog.)

Limitations of Bollinger Bands

1. It should be noted that Bollinger Bands are not a standalone trading indicator.

They only provide insights regarding price volatility to traders. It is always advisable to use them in combination with other technical trading indicators.

2. Bollinger Bands don’t always give the correct buy and sell signals.

For instance, with a strong trend, you may risk placing trades on the wrong side, as the indicator may give overbought or oversold signals too early.
You can avoid this by considering the overall direction of price.

3. They are calculated using a 20-day SMA.

Here, the weightage given to older data is the same as more recent data, which may cause the older data diluting the newer and more relevant data.

Also, the 20-day SMA setting with +/- 2 standard deviation may not be suited for each security in all market conditions. Traders need to use their discretion to adjust the SMA and standard deviation as per their assumptions.

All said and done, Bollinger Bands are still the rockstars of trading indicators.

You can access them along with over 120 other indicators on a trading software like PHI 1, which lets you customize them based on your needs.

You can accomplish charting, screening, strategy creation and testing, simulation, and order execution all in one unified trading software.

Try PHI 1 for free today!

Popular Momentum Indicators You Should Know

Momentum means how strong the movement is.

Momentum is an important concept in trading.

What are momentum indicators?

Momentum indicators or MOM indicators are tools that measure momentum of securities. Momentum trading indicators are popular technical analysis tools that measure the rate at which the price of a security changes.

Momentum indicators are readily available on intraday trading software platforms.

These trading indicators are used with other indicators as they mainly help determine the time frame in which the price change occurs and not the direction.

Advantages of momentum indicators:

Momentum indicators show the change in the price of a stock over time and how strong the movement is and will be. They are particularly useful for traders to identify points when the price direction can reverse.

Given that momentum indicators only show strength of movement, they are used with indicators such as moving averages which show the direction of price movement.

Concept of divergence in trading

Divergence typically indicates that the momentum of the price movement will stop soon or is about to reverse.

It occurs when the stock price is moving downward continuously along with the momentum indicator, however, later, the momentum indicator stops following the downward price movement or turns upward.

Thus, it is essentially a divergence of the indicator from the actual price movement, showing that the momentum of the current price movement is dropping.

Popular momentum indicators

1. Relative Strength Index (RSI):

RSI is a popular momentum indicator in technical analysis that measures the magnitude or extent of recent fluctuations in the security’s price.

It evaluates whether the stock is overbought or oversold. Showed as a momentum oscillator, RSI can have values from 0 to 100.

Typically, RSI values over 70 indicate overvalued or overbought and below 30 indicate undervalued or oversold.

RSI can be calculated using a formula involving the use of 14-period data of average gain and loss. However, we can easily access this on a trading platform.

So, let’s dive straight away into how to use RSI for trading.

As you can see, in the Wipro chart above, RSI values crossing 70 may indicate that it is becoming overvalued and may generate a sell signal, indicating the possibility of a trend reversal soon.

An RSI of 30 or below indicates an undervalued condition and may indicate the start of uptrend soon.

If RSI remains in a range, it denotes a trend.

For example, between Oct 2020-Jan 2021, the stock was in a steady uptrend. An uptrend may also be indicated when the RSI remains above 40 and frequently hits 70 or above like between April-July 2021. The opposite is true for Jul-Oct 2019.

A bullish divergence occurs when the RSI is in the oversold region followed by a higher low that corresponds to lower lows in the price. This is when bullish momentum is indicated. Any break above the oversold region can be taken as a signal for taking a long position.

A bearish divergence is when the RSI generates an overbought signal followed by a lower high corresponding with higher highs on the price.

Divergence Cheatsheet
Source: Image by Marvin Chebbi, CryptoTrendy 2018

Limitations: True reversal signals are rare, and false signals could lead to false alarms. A false positive, for example, would be a bullish crossover followed by a sudden decline in a stock.

RSI is suitable in a market where the stock price is alternating between bullish and bearish movements.

2. Average Directional Index (ADX):

ADX indicates trend strength. It does not show the direction of the trend but only its strength. Hence, it would need to be used with another indicator.

PHI 1 Momentum ADX

The red line indicates ADX.

When the ADX rises above the threshold (generally 25), it means that the stock price trend is showing strength. Combined with an indicator like Moving Average, it can help general buy/sell signals.

For example, in the figure above, the price crosses the 50-SMA and ADX crosses 25, which generates a ‘buy’ signal.

On the other hand, a flattish ADX indicates a weak trend, i.e., the stock price moves in no particular direction or is range bound.

ADX is an excellent trading tool to use to identify strong trends for trend trading.

A common mistake traders make is considering a falling ADX line for a trend reversal. That’s not true! A declining ADX line generally implies that the trend strength is reducing and not reversing.

3. MACD:

Moving Average Convergence Divergence (MACD) is a trend-following momentum indicator that shows the relationship between two moving averages of a stock’s price.

Primarily, the 26-period exponential moving average (EMA) is subtracted from the 12-period EMA to get the MACD line. The signal line is the 9-day EMA.

MACD is presented using a histogram that plots the difference between the MACD line and the signal line. When the MACD line is above the signal line, the histogram will be on the top of MACD’s baseline.

MACD can be used to identify points to enter or exit trades when they form divergences and crossovers.

You can check out an example of a MACD crossover from our previous blog

As mentioned earlier, you do not have to manually calculate these momentum indicators. You can get them easily on an algo trading platform.

PHI 1 is a unique algo trading platform that offers 120+ technical indicators that are completely customizable to suit your trading analysis.

PHI 1 is not just any intraday trading software. It offers stock screeners, technical analysis charting software, option trading, backtesting trading software, simulations, and order execution – all on one single platform.

No download or installation is necessary.

Simply sit back, relax, and upgrade your trading process. You deserve it!

Enjoy a free stock trading trial on PHI 1 today!

Strategy Sessions from Mr. Krishna Rawal (Senior Trader) – A PHI 1 Initiative

About Mr. Krishna Rawal

Mr. Krishna Rawal is a senior trader with over 20 years of experience across various instruments – Stocks, Futures, Commodities and Currencies.

He is a professional algo trader and helped brokers and traders in designing their algo trading strategies and system for futures and hedging. He is a multiple time winner of trading challenges and has trained 100s of professional traders.

Currently, he plays multiple roles in trading-related institutions as Managing Partner at Commodities Trade Services and as CEO at STAT Institute – an institute that conducts advance courses in AI ML and Algo Trading.

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Some of his famous algo trading speaker sessions:

Disclaimer: The User/ Licensee agrees and declares that the training that may be received by the User/ Licensee is not intended to provide, and should not be considered to be any investment advice from the Licensor and/ or the said trainer. No decisions should be taken by the User/ Licensee on the basis of any such training. It is agreed that the training that may be provided is only for the purpose of educating the User/ Licensee as to how the Software may be used.