Does the strategy of trading as per the previous day work?

Does a particular strategy from the previous day work successfully the next day also? Does such a replication work in practice? While there can be no clear answers, there are some conditions that should be adhered to.

Jul 08, 2018 04:07 IST India Infoline News Service

One of the approaches to the share market is to trade based on patterns. However, does a particular strategy from the previous day work successfully the next day also? Does such a replication work in practice? While there can be no clear answers, there are some conditions that should be adhered to. Let us look at them.

Strategy based on an underlying trend in the market

This is an underlying trend in the market which gives you the cue on which direction to trade. For example, if a sector or stock is structurally weak then any rise in the stock price should be used to sell the stock. Such stocks are called sell-on-rises stocks. As long as the underlying trend in the stock or sector remains the same, you can surely use this strategy. Then there are stocks that are structurally strong but the market volatility takes their price down. Such stocks are called buy-on-dips stocks or sectors. As long as the underlying trend is intact, you can repeat your trading strategy quite safely the next day. This strategy works very well in volatile markets. During such times, the market gives you opportunities even against the underlying strength or weakness in the stock.

Trading based on a proprietary strategy

This is another situation where you can try and replicate your strategy on the next day also.  Let us say, based on your own algorithm, you have started to trade a stock based on a combination of delivery volumes and MACDs. Ideally, such strategies should be appropriately back-tested before implementing the same. As long as such strategies are proprietary, you do not have much to worry. You can safely apply the strategy on the next day also and it is likely to work. Of course, the only condition, in this case, is that you continue to back-test the data and when you find that it is not working then you must shift your strategy.

Trading based on long-term and intermediate patterns

You will find that stocks have some distinct patterns and these patterns tend to repeat them. Most importantly, there are long-term patterns and then there are sub-patterns which can be short- to medium-term patterns. While long-term patterns are the broader trend, short-term patterns can even be converse to the long-term pattern. For example, the stock may be in a long-term uptrend, but within that larger pattern, the short-term trend over a week or a fortnight may be negative. If you have identified the trend in advance, then you can surely use that strategy as a replication on the next day also. Remember, today we are operating in a situation where patterns are not difficult to find so anybody with a basic reading of charts can read your patterns. When you find that the pattern is getting crowded, it is time to move out. In this case, don’t try to replicate the same strategy the next day also.

Trading based on a defensive approach

It is much easier to replicate a defensive approach to trading. What exactly is a defensive approach? Let’s say, if your view on a stock is that it will not cross a particular threshold, then the logical approach would be to sell options at that price. For example, if you believe that SBI will not go below Rs230, then you can sell 220 put options. Similarly, if your view is that SBI will not go above Rs270, then you can sell 275 call options. Remember, here you are not taking an aggressive view on the position but a defensive one. This is actually much easier to replicate the next day when your approach is defensive rather than aggressive.

But, beware the hand of God…

If you are a soccer fan (of course, there is FIFA 2018 going on right now), then you would be familiar with the famous ‘Hand of God’ which allegedly enabled Diego Maradona to score a crucial goal against England in the semi-finals in 1986. Of course, Argentina went on to win the cup but Maradona was quick to acknowledge it as the Hand of God. When you trade, quite often you make profits by the Hand of God. Don’t ever try to replicate such strategies the next day. Like Maradona, you must recognize that it was the Hand of God and leave it at that!

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