Strategy

Trading

Up until now 75% of my time has been spent researching the fundamentals of companies I am looking to hold shares in, the rest of the time has been spent timing my entries and exits on my shares. I will carry on doing this in the back ground as this is sound practice for my longer term investments. I will attempt to expand on this in the future, and I may give a few insights depending on what’s happening but for now I would like to explore another way.

Technical Analysis as it is known is often used for shorter time strategies. has been widely used for years, only since the explosion of the internet and computing power has this area become more and more crowded with dozens of ideas, oscillators, indicators etc. if your not careful it can be completely mind blowing and sometimes contradictory. Also a lot of these indicators are lagging, for example moving averages only tend to cross over after a significant move has been made. Therefore reducing your risk/reward.

This is an example that completely baffles me. What on earth is going on here!? way to much noise and clutter…

The simple principle is to forecast the direction of future prices studying past market data. Sounds simple, but it really isn’t. Trouble is the market makers and the big institutions are the ones who are mostly moving the prices, so it shouldn’t come as a surprise then that these prices can be manipulated.

Its these moves created by the bigger players that I intend to effectively piggy back on and capture as much of the moves as possible. But I believe there is a much simpler way to anticipate future price moves based purely on Volume and price, this is not new, a principle that is well documented by Anna Coulling. I can honestly say from all of the books I have read, hers have made the biggest impact on my performance and I have a completely different way of reading the market than I used to.

The £1000 challenge

Its not a lot of capital, but enough to prove a strategy. Is it possible then to generate a real income from the market on a short term using a strategy based on volume and price? that alone most people wouldn’t take it seriously, after months of reading the market learning this new principle, it seems there are plenty of opportunities out there to capture these moves. I genuinely have no idea how this idea will work out but I thought it would be a fun process. Seeing as I would always keep notes on this I thought why don’t I ‘blog’ it. Whilst encouraging input from others, otherwise I will be trading blind in my own little bubble. So this will be real money using a spread betting instrument for execution. Please see my warning below on the risks associated with spread betting.

Theory on Volume

Its worth going over the basic principles what drives market prices because at the end of the day that is all we are interested in. To put it simply if a company put out a trading statement where revenue and profits were ahead of expectations and smashing all consensus forecasts, you will naturally find a lot of volume traded on that particular day. Traders, investors all want a piece of the action. The investors are in it for the long game and if they believe the fundamental reasons are strong they will use any opportunity such as a trading update to accumulate that stock. The flip side of that is if the investors feel the stock is overvalued and want to off load their holdings, again they will use any opportunity to sell their stock. But the market is a beautiful thing, not everyone agrees which is why we have a market in the first place. My job is to makes sense of all this volume and find out where the sentiment lies, is there significant buying or selling? The goal is simple, but the noise and manipulation that takes place makes in incredibly difficult cipher through.

As Anna Coulling points out in her books, studying this is not an exact science, neither is it a holy grail so don’t try and find it. But more of an art form which needs to be interpreted appropriately. She also mentions how this same methodology can be used in any financial instrument as the theory behind moving prices is all the same, volume moves prices. So to break it down I will be looking closely at the volume traded at the end of the day within the price action that was created using daily candles.

Choosing a market to trade

I would like to try and stack the cards in my favor a little bit more here by focusing on UK stocks. As this is where I have always put my time and effort into researching and there are many companies that I am already familiar with. Out of curiosity this will drive me to research a bit further into these companies to find out what is causing a sudden increase in volume, or a price move. This will allow me to focus on a very specific area that I am comfortable with and understand.

The other main reason is that volume traded through equities is a lot easier to interpret than something like forex, or commodities. The same principles can be applied but they appear in different forms. Equities will show physical shares traded through the market. Where Forex will show tick volume, and I cant explain that one so I will just stop there! Stick to what you know.

The Tools I’ll be using

I will be using spread betting as my instrument to trade with but first…

A WARNING

Please read this to understand the risks involved with spread betting, its recommended if you don’t understand leverage or don’t know what you are doing, then either do some reading on it or steer clear completely. Its pretty much like trading with a credit card and it can become a double edged sword losing you more money than you initially put in.

The £1000 though is real money. That will effectively be used as my deposit for my trades. But I will have to manage this accordingly as some stocks may require a bigger deposit than others. The goal is to grow this within the account and size up positions accordingly, this will be explained further down.

Given the recent chaos surrounding GameStop, this has created bit of a pain point with the spread betting providers as margins required for 1000’s of stocks have increased to 100% overnight. To put it another way, if you were going to use 100% of your capital to open a spread bet, you might as well just buy the stock instead. For this reason I may end up stumping up more trading capital depending on if the rules tighten.

IG Index will be my provider for this, I have used them for years and never really had any problems. In fact their strengths were highlighted during the Covid market meltdown as many stock brokers were struggling to keep up with the volumes, with clients unable to trade and many applicants switching to IG in the process.

The charting package that comes with IG is absolutely fine but In addition I will also be using the charting provided by Trading View. The reason for this is because spread bet prices can differ slightly from the underlying prices, and for that reason I double check the price action and volume against the underlying market to make sure there are no anomalies. Also its a great layout, really easy to use with great tools to make annotations.

Indicators, this is where many of you will run a mile, I will only be using volume traded, 10 day volume average on a daily candlestick chart sometimes in comparison with a smaller timeframe. That is it, no Bollinger head stands or draconian channels here thanks. Keep it simple. My charts tend to look something like this…

Boohoo group performance during 2020

Many eagle eyed traders will have noticed the volume bars are all the same color. There is a genuine reason I have changed this…

If you select the volume indicator with most charting packages by default they will be denoted red and green to match the green and red price candles. which looks something like this …

Angle PLC – Green volume on up days, Red Volume on down days

Took me a while to realize how misleading this actually was. When you initially look at this you start to believe the red volume bars are all sellers, and all green volumes are all buys which is crazy when you think about it, there has to be someone on the other side of the trade. Look at the small arrow I placed on this red down candle, selling huh? why did the stock rebound then? ah the plot thickens. its these little anomalies I will be exploring.

There is a huge amount of information that can be gained from candlesticks. For those not familiar, I suggest you check out this page which is a great insight. For the record no I do not recognize all of these patterns and neither do I solely rely on them, they are used to help me make me decision, not the final say. its an art remember.

Screening for opportunities

I will be screening UK stocks with Trading View based with a market cap between £50m and £10bn. This is to filter out the small illiquid stocks that can create some wild volatility in their prices for no apparent reason.

I have set a parameters for end of day volume to hit between a certain range. So a minimum of 750k traded to anything over 50m. This was with the intention of trading an equity with decent liquidity, which in turn should give a more stable price action associated with it. What I want to avoid is setting the minimum so low the screener ends up picking up on all sorts of penny shares making pointless wild swings. I may adjust this though over time, as I could be missing some decent opportunities.

Relative Volume, this is an interesting one which picks up on the opportunities I am looking for, I want to see some volume going through the stocks which have a higher relative volume traded than the day before. This is displayed as a ratio, I have set this at 2 meaning I want to see the volume 2 times higher than the normal average volume. This should highlight action and interest in the stock, the hard bit is working out in which direction.

Its this unusual volume I am hunting for here, and you may be surprised to learn that some of the best opportunities may lie within a prolonged period of consolidation, or sideways price action. Over time these consolidation periods can be used by the market makers to accumulate or distribute stock whilst there is plenty of volume to absorb. At some point though this price action has no option to break out of these trading ranges as the supply effectively dry’s up, therefore finding new ground outside of this range to fill the underlying orders in the market.

Managing risk

If this was in order of importance it should be at the top of the page, either way this is the backbone of this strategy.

I will be treating this as seriously as possible, and without capital I cannot trade. Therefore managing risk is absolutely essential to stay in this game for the long term.

There is plenty of research out there which shows how you can be profitable with only 40% winning trades versus 60% losing. Purely by managing risk. If the winners trades are greater than those which lose, then you can have a positive outcome. Running your profits and cutting your winners is has always been at the forefront of my trading and investing.

Cutting the losers is absolute key. If you had bought a stock at 100p but it fell to 50p, then it needs to climb 100% to get you back to break even, and big fallers rarely recover that quickly.

Using Volume price analysis I believe I can skew the winning number of trades in my favor, combine this with running the winners and this should prove a positive outcome.

Stop Losses will always be used. This will be determined by a monetary value based on a percentage of the total capital. I will be risking 3.5% loss on each trade. This amount will always be adjusted according to the account value.

3.5% of £1000 = £35

This is actually quite a conservative risk factor. Technically I would need 28 trades in a row to wipe me out completely.

The stop level will most of the time be set just underneath a support level, preferably a level where volume plays a significant role as the stock reverses.

Here is an example.

Risk parameters determined before the trade has entered

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Because i don’t have the time to be glued to the screen all day, I will be entering my trades at the end of the day placing a market order, mainly to grab an attractive price.

Before a trade is entered, I reckon about 70% of my effort is goes into finding the opportunity, and 30% is managing the risk. Psychology plays an important role here, if you spend to much time searching for something you can end up with confirmation bias. Entering into a trade and justifying it by the time spent searching for it.

Finally once the trade has opened this is all about constantly managing the risk and reward factor. I hate to enter profit targets on trades as that can limit any potential huge moves. But from time to time I may do this to exit at a favorable price if I think the stock is turning against me.

So I will do my best to let them run and trail the stop behind accordingly. hoping to gain as much as possible in the process.

I have no idea how this will go or the time I will be able to dedicate to this, so keep checking on the home pages for the latest updates. Feel free to contribute as it can be rewarding bouncing around ideas time to time.