There are 2 types of traders:-
- Discretionary traders
- Algo based system traders
Discretionary traders are people who believe in their gut to take the trades. Most of the time, they would be right as well. They let their intuition win all the time. These veterans may be trading for more than 2 to 3 decades and they can simply look at a chart pattern and say — yes, the markets are going up and quickly take on a long position.
The second category of traders depends on a system to punch the orders. Yes, they have the same logic and reasoning as the discretionary traders, but they prefer a computer to take the trades instead. It could be because they know, their emotions will spoil the party or it could be for faster speeds and accuracy.
For someone starting in this domain, algo traders are like — wow! They are usually considered at the apex or the pinnacle of all trading activity. The computer itself is a fancy object, so imagine getting to know someone who codes on a computer to extract money from the stock markets. The next time you go to a party, introduce yourselves as an algo trader — the reaction from people would be like “wow”.
Today, I am showing you an interesting path — a combination of discretion and algo. Something that you can set up and run easily. The idea is to guess the direction via discretion and then outsource the trades to an algorithm. It may sound complicated, but it is not, I will break it down into easy steps.
Step 1: Market Moves
You know for sure that there are only 3 market moves that could happen on any possible day.
- Bullish (up move)
- Bearish (down move)
- Non-directional (flat move)
Yes, that’s it. No other type of moves are possible. Even if we have a V, W or M type pattern intraday, at the end of the day markets are either up, down or flat.
Step 2: Type of Trade
I) If you know the markets are going to go up, what trade will you deploy? Most likely you will be doing one of these :-
- Buy a call option (unlimited profit, limited loss)
- Sell a put option (limited profit, unlimited loss)
- Bullish debit spread (Buy ATM call option and sell OTM1 call option)
- Bullish credit spread (Sell ATM put option and buy OTM1 put option)
- Bullish ratio spreads, ladders or any multi-leg strategies.
I am not planning to discuss option5 as it may sound complicated for a newbie, but the others are easy to comprehend. Try searching online or use a free options strategy builder to try out the various multi legged strategies.
II) Similarly, if the markets are going down, you need the opposite strategies i.e.
- Buy a put option (unlimited profit, limited loss)
- Sell a call option (limited profit, unlimited loss)
- Bearish debit spread (Buy ATM put option and sell OTM1 put option)
- Bearish credit spread (Sell ATM call option and buy OTM1 call option)
III) If the markets are staying range bound, these strategies could be used
- Short Iron Condor
- Short Iron Butterfly
- Credit spreads (will explain shortly)
Step 3: Creating the Algos
You just need to create 3 algo strategies, one each for bullish, bearish and non-directional. Use any popular Algo service provider to do the same. I run my trades on AlgoTest, because it was easy to get started.
You just need to save these 3 separate strategies into a portfolio and keep them ready.
I hope you know how to create the algos, if not just contact the customer care section of these service providers and they will guide you. You need to have a logic and they will surely codify it for you.
Due to regulatory restrictions, I am not revealing my code/logic in the open forum, but I guess you can figure it out.
Step 4: Combining Discretion and Algos
The fourth and final step is to marry both the discretionary mind and the algo-execution. Before the trading day starts, make up your mind whether it is going to be a bull-day or a bear-day.
If you think it is going to be a bull-day then activate the bull-algo. If you think it’s a bear-day, then run the bear-algo. If your discretion was correct, the algo will make money and vice versa.
The profits you make are directly dependent on your sense of direction. The probability of guessing the direction correctly is 50% in a day. If you can bring that up to 65% over a 200 day period, you can create wealth.
So finally, it all boils down to whether you can guess the market’s character daily. Trust me, all professional traders take this bet (knowingly or unknowingly). And believe me, no one has 100% accuracy, so need not be afraid to lose.
Professionals, just manage to keep their losses under control. Even if they lose 50% of the time, the money made during their win period usually will be double the loss incurred from the other day. Yes, that’s how you plan your trades.
For non-directional markets, I continue to use the credit spreads instead of iron-fly or condor. The reason is obvious, Nifty has a weekly expiry and the time decay (theta) will erode the premium if markets remain flat.
Indeed, the winnings might not be as much as a favorable directional trend, but the good thing is that the charges are minimal when compared to a 4 legged strategy.
On the profit part, it is a narrow line. The charges, taxes and brokerage are so high that there is a minimum lot size that you need to deploy before it breaks even. You can find that magic number by using the algotest’s backtest feature.
PS: I do not recommend running naked option buy/sell strategies, even in an algo, it is because they have an unlimited loss possibility. It may wipe out your capital.
