Candlestick Patterns

Sorry for my long absence from here. As you might be knowing already, been keeping busy with Options Blog (Trade for the Week posts). Hope you have enjoyed the trade as much as I did including the Trading Holiday gaffe. I also made a offbeat post about Europe Crisis and thanks for your mails about it. Will keep on writing such off the track posts in between.

Been also writing lot of posts on Equity Blog. Wrote lot of them about Candlestick Patterns like single candlestick patterns (Doji, Hammer, Marubozu and so on) and just today started with candlestick patterns formed by multiple candles. These are very useful basics whether you want to trade Options, Futures or Equities. Hope you have been enjoying them too.

Will write next post here very soon.

Happy Trading.

Margins Concluded

We have seen Margins, Margins for Options, Margin Calculations and so on. Let's tie any loose end.

Regarding payment of the Margin... I mentioned various ways of paying Margins which will differ from Broker to Broker in terms of acceptable instruments and limits against each instrument. However NSE has its own guidelines for that which can be read here.

As for the SPAN Margins... NSE releases SPAN Margin file six times a day. Once before start of the trading, 4 times during the day and once after the end of trading. You can download SPAN file here. Honestly, I have never downloaded this file and also it seems that it needs some kind of software to open it. Many brokers give SPAN data in Excel or XML formats and you can check with yours if you are enthu about it. Frankly I was never bothered about it.

Finally it will be a good idea to read through NSE Faq on Margins... it can clear lot of doubts about Volatility and it's calculation. You can take a look at this file here.

If you have any more questions about Margins which are not answered in above links... God save me. Just kidding, do let me know and I will try my best to dig out more information for you. Stay tunes for more.

Margin Calculations

Welcome back. Hope you had great time during Diwali.

Well, I am back with more on Margins. Have already put one on Options Blog regarding Margin for Options. Hope you will like it. Coming back here, we have seen how margin call can be very confusing for newbee traders and they may feel that their broker is somehow taking them for a ride. An apparently modest move can create substantial margin shortfall and broker has all the rights to square-off positions if you do not fulfill margin requirements. Unfortunately such square-off almost always happens when the markets are at their worst positions and thus adding to the mayhem.

But what do we do? Simple, do not trade on margins. Trade at the actual face value of the trade or reduce the leverage. Let us revisit trade in our last post; You take position worth 250000 for a margin of 25000 which means a leverage of 10. It is ok if you have another sum ready to fill in any margin void.. But what if you have only 25000 and cannot furnish further margin... It's simple, do not trade in Futures. Really, I am not joking.

Usually I will not advice anyone trading in Futures if you do not have 200000 to trade and that too risk money (which you can afford to loose) and not in any case if you do not have 100000 at least. With such money also, keep in mind that you need to start with a trade needing initial margin which is 25% of your risk money and not more.

Now, you must have already lost appetite for further reading. Who has that kind of money... particularly risk money. well, don't loose heart.

It's not always hard cash that you need to provide as margin. You can provide securities, fixed deposits, Government Bonds, etc. Each broker will have their own rules of what is acceptable as collateral for margin and what is not. Obviously, stocks are not taken as collateral for full value and a percent of their market value is acceptable as margin.

Also if you have multiple trades then your margin calculation can vary as it is calculated for an entire portfolio... so a simultaneous buy/sell (hedged) positions may have lesser margin requirement than a single position. But then, there may be some variation in this depending on the broker you are using.

Recently SEBI has been very active on margin requirement and it's fulfillment. They have sent a circular (read here) to all brokers regarding strict adherence to it and heavily penalized few of them for not meeting it. This in turn has made brokers very strict about collecting margins (earlier they were lax in doing so for the big players). Life for you and I... remains same.

Will cover anything remaining and worth knowing about margins in the next post.

Margin Calculations

In an earlier post, I mentioned that during future trading you will not pay any premium and seller (sugar cane farmer) will not receive any. In spite of that the future contract will be binding on both the parties. So how does exchange ensure that both the parties maintain their side of the bargain and not run away?

It is done by charging ‘Margin’.

Margin is a percentage amount of the trade value which exchange takes from both; the buyer and the seller as good faith money. Let’s take an example; if you were to buy NIFTY future, one lot at 5000 price you would be needed to pay 250000 in normal case. However you do not have to pay full 250000 for the lot, you pay a percentage of it. This percentage varies from Index to Index, Stock to Stock and Time to Time and it depends on Underlying as well as Volatility.

This Margin is consisting of two parts. There is an initial margin which depends on price and volatility and another is exposure margin. Margin calculation is done by SPAN technology used around the globe. Its origins are credited to oldest derivative exchange CME (Chicago Mercantile Exchange). It does a complex set of calculation involving price, volatility and GOK (God only Knows) what else and arrives at a percentage number which you have to pay. Exposure margin is a fixed percentage like 3% to 5%. Both these margins are adjusted every day and you are required to pay any margin shortfall at the end of the day (EOD).

Let us illustrate this whole concept with an example.

Let’s say we buy one lot of NIFTY at 5000. Trade value is (50x5000) 250000 and SPAN margin requirement is 10% so you pay 25000 as margin. You are happy and exchange is happy. However cosmological forces conspire against you and NIFTY fall 3% (150) points during the day. At the EOD, exchange carries out following activities;

It calculates you MTM (Mark to Market) loss which is 150x50 = 7500 which you obviously have to pay. The conspiracy does not end here… Exchange also calculates new SPAN margin. This calculation takes in to account the 3% fall (which is a comparatively large move) and it increases the volatility number for NIFTY. So it increased SPAN margin to a ball park 15% now. Your margin shortfall becomes 5% of 250000 (10% you have already paid) and the amount it 12500.

So exchange, through your broker makes a margin call of SPAN Shortfall 12500 + MTM 7500 = 20000 on you which you have to pay. This payment is just for staying in your position. What bamboozles a trader is that he has to pay 80% of his initial margin (20000 on initial 25000) for a small 3% move in NIFTY. Hence your total margin becomes 45000 for the lot.

This is just about Margin calculation. I will post about how to pay the margin, can it be offered through collaterals, what happens for multiple positions (buy/sell together), what happens if you do not pay the margin and how to avoid nasty surprises. Taking cue from here, I will also write about Margins for Options on the Options Blog.

Before closing, I wish all of you and your loved ones a Very Happy, Joyous, Prosperous and Safe Diwali. Have a rocking time.

Future Contract Settlements

Thanks guys for your support messages.

Getting back to the point... let us continue our discussion. In the last post, we discussed Hedgers and Speculators and how they help in Price Discovery and Stability of business environment. Now as promised, let us see how Future Contracts are settled.

Future Contracts these days do not see meeting between two people and a paper contract now. These contracts are highly standardized today and are traded on exchanges around the world with buyers and sellers from across the world participating. Not just because geographical diversity of market players but also because various types of players and many other complications, contracts are not settled through physical delivery anymore (at least not on most exchanges and for most underlying).

Just like option contracts, Futures Contracts are also cash settled. So at the end of the two months (or duration of contract) if the sugar cane price is in your favor, you will get the money from the exchange. Or in case unfavorable price, farmer will get the difference from exchange. Keep in mind that exchange is not playing Santa Claus here and it recovers (actually it keeps it in advance from both you as well as the farmer) this payout from the loosing party. The amount which exchanges takes from you as a deposit is known as margin and there is a tremendous mechanism behind calculation of this and believe me most people who lose money in Futures... loose it because they do not understand this mechanism.

It is almost criminal not to understand margin calculation before even thinking of Futures trading. And as you all are good friends of mine, I will definitely not want any of you serving sentences for this... so hold on, next post on Margins.

Hedgers and Speculators

Well, there is once again delay in posting here and it is for the same reasons which I explained on Options blog. Nevertheless we will try to make up for the lost time.

First let us try to understand meaning and functions of Hedgers and Speculators. In the classical futures market explained in the earlier post the role of the farmer and buyer would be that of a producer and trader. Every producer will like to make sure that there is no price risk for his products in the future. Similarly trader (who can be again a manufacturer for something else using product of first manufacturer as raw material) would also like to make sure that there is no price risk for the items he/she wants to buy. So producer hedges his position against a possible drop in price by entering in to a futures contract while trader hedges his position against a possible rise in the input cost. Both of them want to sleep well without worrying about volatility and making sure that they know the price they will get or pay for the particular underlying. In short, they want to cut their risk i.e. nothing but they want to hedge their positions. They are hedgers.

On the other hand, speculators want to make use of this inherent risk (that is always present) in the futures market to make money. These guys are (most of the time) neither producers nor traders and in fact have nothing to do with the underlying. All they are interested in making some money betting against the producers and/or traders for a short duration. When speculators buy a position hoping that price would increase they are usually buying it from hedgers who wants to cut downside risk of their produce.

As I said in previous post too, this is not necessarily a bad thing. In fact, it is these guys who have made futures market one of the largest traded markets in the world and they help it in many ways. These guys want to remain updated of all current and likely events in the immediate future and factor in developments in every thing like RBI meet, FED meet, Euro Zone meet, Tsunamis and what not in to the price of the contract. This act of them helps a lot in real Price Discovery of the underlying.

Another important advantage of futures market is Risk Reduction. Hedgers try to secure a price for their product (as a producer or as a buyer) and know their margins beforehand. This provides a lot of stability to the general business environment.

In the next post, which I promise won't be far, we will talk about settlements of Future contracts.

Future Basics

My apologies for delay in posting on this blog. Navratri and Garba took a toll on my plans to write more. Nevertheless, I believe you all would also be busy in the same so it is about time that we play catch up.

Let us consider the example of Sugarcane farmer that we used on the NSE Options Trader for explaining options. In case of options, you would recall (In case you have not read options basic at NSE Options Trader, I would request you to kindly do so) that while the seller of the option had the obligation to fulfil his side of the contract, buyer had the right or choice to exercise the option contract. For this, seller would receive a premium for the risk he is taking. Now what happens when both buyer as well as seller has the obligation to come true to their side of bargain; well you have a futures contract.

In futures contract, both buyer as well as seller has the obligation to buy or sell the prescribed amount of underlying at the prescribed time. So you will have to buy from the sugarcane farmer and he has to deliver 10 Tonnes of sugarcane to you in two months’ time exactly. You do not pay any premium and he does not receive any. So how do the things work out and why can’t you run away.

This is where the exchange comes in to play. But before we get to the mechanism of futures trading and settlement, a little history about futures would be apt.

In North America, farmers used to produce whatever they could and bring it to the market place in anticipation of securing good price for it. However, neither they had any idea about demand for their crop nor traders (or buyers) had any idea of the supply they will get. This often led to mismatch between the two and uneven loss/profit to the parties involved. This need became the mother of modern futures contract. Farmers and traders started to tie up the contract beforehand which mentioned underlying, quality, quantity, time, etc. This led to a better regulated market with stable demand-supply equation and less volatility. That was the origin of the one of financial world’s greatest invention.

Farmers and traders were true to their business and used to settle future contracts as per terms. Not anymore, today, farmers and traders have been replaced by hedgers and we have speculators. This is not necessarily a bad thing and in fact much of the dynamics of derivatives market is a result of these entities.

In future posts, we will see explanation of all these future terms and also future margin and future settlement mechanism in futures.

All I can say is future is bright.

Coming Soon...

Friends, my posts on basics of Options at NSE Options Trader are coming to a intermediate close. I intend to start writing on basics of Futures immediately after that. In all likelihood you will see posts starting on this blog as early as this weekend. Thereafter I will take up writing on India Equity Trader.

Stay tuned for more.

About Myself...

I am a typical investor who is not satisfied with copy book 9 to 6 job and want to dabble with being an active trader. My lust for investment does not stop at Mutual Funds or Shares as in other 90% cases and I graduated (read: want to graduate) to a derivative trader.

I have started by getting in to options first. You may want to visit NSE Options Trader to check out how am I doing.

Surprisingly enough, but since you are anyway on this page, wish me luck.