Introduction to Moving Averages, Oscillators and how they works

All oscillators essentially tell us the same thing; how price has performed over a specific time. At first, oscillators appear to be the perfect stock or index trading tool because so often they give excellent buy and sell signals. But, the more you use oscillators, the more you realize that oscillators give an equal number of false signals. An oscillator actually measures the momentum of data, whether it is price, volume, or opens interest. An oscillator will help show the speed at which the information is changing. Thus, it can also define over-bought or over-sold areas. The reason people have continued interest using oscillators is that they have the capability to give indications in advance of market turning points.. oscillators lead, sometimes they lead far too early and instead of buying a bottom, you are buying falling daggers and getting sliced up. Even the best oscillators consistently give premature buy and sell signals…The largest failure of oscillators is their inability to deal correctly with the time cycles involved…. If you use a 7-day average, you will quickly find that the maximum move you are going to catch is one that lasts somewhere in the area of 3 1/2 to 9 days. In other words, the type of moves the oscillator catches cannot, by definition, be much longer than the time period measured in the oscillator.

One thing noticed is that the traditional short term oscillators, such as those featured in most trading and investing books, will turn very positive at the start of a major upmove in the market but quickly show divergence and overbought readings, causing most traders to sell short somewhere after the first leg of a bull market. They then take a short position on the market and hold that short position in one form or another, actual outright short or afraid to purchase, for the next three or four legs of the bull market. That can be a costly experience. This happens because the time measurements in the oscillators they are following are too short-term in nature to catch a major move. Time is one of the most critical elements.. three time cycles that generally have been the most dominant time cycles in the market short term 7days/medium term 14 days/ longterm time 28days .

There will be two requirements for a buy and sell signal to execute a market position using the oscillator.  first requirement is that we have a price divergence from the oscillator. In the case of a buy we must have had a lower low in price that was not matched by a lower low in the oscillator. In the case of a sell we must have had a higher high in price that was not matched by the oscillator. Second requirement is, await a trend break in the Oscillator to produce the actual signal.

A moving average is a line drawn on a stock chart representing the average price of a stock over a given period. They smooth out the gyrations in the stock price so that the trend becomes more obvious. The most common types of moving averages are the SMA (Simple Moving Average) and the EMA (Exponential Moving Average).The SMA takes a stock’s prices over a given period and averages those prices. A line is then drawn to represent the average price over time. Simple Moving Averages are slow to react to recent price changes. An Exponential Moving Average is calculated in a similar manner to the SMA except that the EMA places more weight on recent prices. This means that they react more quickly than SMAs to recent price action.

Two important things to realize about moving averages, no matter what type you are considering, they are lagging indicators. They show you where the price has been. They don’t predict future price movements. They only work in trending markets where there is a clear and distinct trend. They don’t work in ranging markets where the price is bouncing up and down between support and resistance levels.

Regarding “trending” and “ranging” stocks: Some traders use an indicator called ADX (Average Directional Index) to determine if a stock is “trending” or “ranging”. Moving averages help you to identify the direction of the trend. Stock prices can only move three ways – up, down, or sideways. We are only interested in stock prices that are going up for “long trades”, or down for “short trades”. Trend strength can be indicated with moving averages according to the angle of the slope. A steeper slope means a stronger trend.If you use two moving averages on the same chart, one slow and the other one fast, you can get an idea of the strength of the trend by observing how far apart the two moving averages spread as they rise. Two very common MAs are the 50-day and 200-day. The 50-day (the faster MA) represents the intermediate-term trend and the 200-day (the slower MA) represents the long-term trend. If both MAs are rising and pulling apart then the trend is strong.

The intermediate- and long-term trends are the most important. 50-day and 200-day MAs are adequate for determining the state of the market. Before buying/trading a particular stock, part of your trading plan might insist on the overall market that you’re investing/trading in be above rising 50-day and 200-day MAs. You may also want to see that the two MAs are spreading apart (indicating trend strength).Trading in the direction of the overall market increases your chances of a successful trade. Monitoring the dominant market trends is part of a trader’s due diligence.

Data need to be observed by every trader

Global Financial markets are interlinked and observing various data released by various government bodies to represent country financial conditions give better picture on where country is heading. Observing below indexes help trader while taking positions

• ·         US non-farm payroll data (US job data) comes every month.
•                This report gives unemployment rate, sectors which are adding jobs etc.
• ·         The Consumer Price Index (CPI) in US for inflation rate
• ·         US Manufacturing data
• ·         US and Europe Banks stress test results
• ·         US home sales data
• ·         WPI based inflation in India
• ·         Index of Industrial Production (IIP) (in India)
• ·         CBOE VIX
• ·         Baltic Dry Index
• ·         Monetary reviews by various countries
• ·         Federal bank meetings to discuss various stimulus packages like QE3 etc.

IIP and its importance

Index of Industrial Production (IIP) (Used in India)

IIP or the index of industrial production is the number denoting the condition of industrial production during a certain period. These figures are calculated in reference to the figures that existed in the past. Currently the base used for calculating IIP is 1993-1994.

Importance of IIP

As IIP shows the status of industrial activity, you can find out if the industrial activity has increased, decreased or remained same. Today it is important because with the news of recession hovering over the horizon, better IIP figures indicate increase in industrial production. It makes investors and stock markets become more optimistic.

Its relation with stock markets

The optimism amongst the stock markets and investors translates into the markets going up. This is because the markets expect the companies' performance to increase. This ultimately leads to the growth in the country's GDP. It implies improvement in country's economy, thus making it an attractive investment destination to foreign investors.

Computation of IIP

The first time IIP used the year 1937 as its reference point. It contained only 15 products. Since then, the criteria for the base year as well as the number of products have been revamped 7 times.

They are segregated into 3 sections: manufacturing, mining and electricity. They are also classified on the basis of usage: capital goods, basic goods, non-basic goods, consumer durables and consumer non-durables.

The numbers for IIP are released within 6 weeks after the end of the month. This data is collated from 15 different agencies like Department of Industrial Policy and Promotion, Indian Bureau of Mines, Central Statistical Organisation and Central Electricity Authority. But at times, the entire data may not be easily available.

Hence some estimates are done to generate provisional data, which is then used to calculate provisional index. Once the actual data is available, this index is updated subsequently.

Though IIP does indicate the condition of the country's economy, it should not be taken as the sole basis for investment. This is because some sectors may show higher performance as compared to others. So you need to check the reason behind the increase/decrease in IIP figures before investing.

What are CBOE VIX and Baltic Dry index? What they indicate?

CBOE VIX is Chicago Board Options Exchange Market Volatility Index, a popular measure of the implied volatility of S&P 500 index options. It is constructed using the implied volatilities of a wide range of S&P 500 index options. This volatility is meant to be forward looking and is calculated from both calls and puts often referred to as the fear index or the fear gauge, it represents one measure of the market's expectation of stock market volatility over the next 30 day period.

     VIX values greater than 30 are generally associated with a large amount of volatility as a result of investor fear or uncertainty, while values below 20 generally correspond to less stressful, even complacent, times in the markets.

Although the VIX is often called the "fear index", a high VIX is not necessarily bearish for stocks. Instead, the VIX is a measure of market perceived volatility in either direction, including to the upside. In practical terms, when investors anticipate large upside volatility, they are unwilling to sell upside call stock options unless they receive a large premium. Option buyers will be willing to pay such high premiums only if similarly anticipating a large upside move. The resulting aggregate of increases in upside stock option call prices raises the VIX just as does the aggregate growth in downside stock put option premiums that occurs when option buyers and sellers anticipate a likely sharp move to the downside. When the market is believed as likely to soar as to plummet, writing any option that will cost the writer in the event of a sudden large move in either direction may look equally risky. Hence high VIX readings mean investors see significant risk that the market will move sharply, whether downward or upward. The highest VIX readings occur when investors anticipate that huge moves in either direction are likely. Only when investors perceive neither significant downside risk nor significant upside potential if VIX is low.

What Does Baltic Dry Index - BDI Mean?

The Baltic Dry Index (BDI) is a number issued daily by the Londan-based Baltaic Exchange. Not restricted to Baltic Sea countries, the index tracks worldwide international shipping prices of various dry bulk cargoes. The index provides "an assessment of the price of moving the major raw materials by sea. Taking in 26 shipping routes measured on a timecharter and voyage basis, the index covers Handymax, Panamax, and Capesize dry bulk carriers carrying a range of commodities including coal, iron ore and grain."

Every working day, a panel of international ship brokers submits their view of current freight cost on various routes to the Baltic Exchange. The routes are meant to be representative, i.e. large enough in volume to matter for the overall market.

Why many economists read this?
Most directly, the index measures the demand for shipping capacity versus the supply of dry bulk carriers. Changes in the Baltic Dry Index can give investors insight into global supply and demand trends. This change is often considered a leading indicator of future economic growth (if the index is rising) or contraction (index is falling) because the goods shipped are raw, pre-production material, which is typically an area with very low levels of speculation. The index can experience high levels of volatility if global demand increases or drops off suddenly. The Baltic Exchange also operates forward freight agreements (FFA’s) in freight derivatives, which are traded over-the-counter.

NSE launches new instrument to trade on Dow Jones and S&P 500 index

NSE recently launched futures trading on S&P 500 and Dow Jones index with rupee denominated contracts. These contracts shall be traded during Indian time and under the domestic regulatory. These instruments comes under existing equity derivatives segment. This facility of foreign index trading is first of its kind in world.

Various details on these contracts are as below

	S&P 500 index futures	Dow Jones industrial average (DJIA) index futures
Symbol	S&P500	DJIA
Contract size	250	25
Contract value	=Contract size*Current value. For example if S&P 500 is at 1100 , then contract value = 250*1100=2,75,000 Rs.	=Contract size*Current value. For example if DJIA is at 11000 , then contract value = 25*11000=2,75,000 Rs.
Tick Size	0.25	2.50
Trading hours	Normal trading hours ( IST 9 AM to 3.30 AM)
Expiry date	3rd Friday of respective month. If 3rd Friday is holiday in USA or in India expiry shall be on previous business day
Contract months	Three serial month contracts and following three quarterly expiry contracts in Mar-Jun-Sep-Dec cycle
Daily Settlement price	Last half hour’s weighted average price
Final settlement price	All open positions at close of last day of trading shall be settled to the special opening quotation ( SOQ) of the S & P 500 and DJIA index on the date of expiry
Final settlement day	All open positions on expiry date shall be settled on next working day of the expiry day ( T+1 )

QE3 and its impact on financial markets

With this round of quantitative easing QE3, the Federal Reserve will look at providing extended assistance and stimulus for economic activity in the US by keeping the interest yields on bonds low, and thereby forcing investors to spend money . The idea is that these investments in the economy will in turn create a wealth effect and result in more consumers spends. This will increase the wheel speed of the US economy

Fed can consider QE3 for following reasons.

·  The high rate of unemployment:

·   Low inflation rate

·  The U.S. debt ceiling raise: following the House of Representative’s decision to raise the U.S Debt ceiling by $2.1 trillion earlier this month, the deal between Obama and Republicans included budget cuts, which may eventually further slowdown the economic progress (this budget cuts will try to slowdown the growth in deficit, which will reach nearly $1.2 trillion in 2011 fiscal year. But in any case, by launching a stimulus plan to purchase treasury bills, it could help finance some of the growing debt of US government.

·   U.S. housing market: the recent reports show that the current real estate market is slightly better than last year, but isn’t doing well or growing. In order to jumpstart the economy it needs to build and sell housing. This stimulus plan might push more funds towards housing, even though many commercial banks are still reluctant to provide credit for obvious reasons;

·  The current stock market and Treasury bills: following the downgrade of US credit rating from AAA to AA+ by S&P, the US stock markets sharply declined; on the other hand, the US Treasury bills yields sharply declined as well due to higher demand for US Treasury bills; e.g. the 10 year T-bills yield fell by 0.72 percent point during August – the sharpest monthly fall in 2011. The QE3 program could bring back some stability to the US stock market and the US Treasury bills market.

On the other hand Fed can avoid another stimulus plan for following reasons

• The previous two QE programs didn’t work
• Low interest rates:
• Weaker US dollar: even though the US dollar held its grounds against the Euro, it did fall against the “safe currencies” such as CAD and AUD. This QE3 might further weaken the US dollar, QE3 could push inflation in emerging markets

Impact on dollar

The dollar is expected to weaken against major world currencies. The Fed will expect a weaker dollar to have a positive impact on the current trade imbalances. However, the cross currency movements will depend on several other global factors too such as developments around the sovereign debt crisis in Europe.

Impact on global inflation

The QE3 is expected to increase liquidity in the markets. It can, hence, aggravate the inflation rate further. The inflation rate is manageable in the developed countries due to slow the economic activity. However, it will hurt emerging markets like India which are already facing a high rate of inflation.

Impact on commodities

The prices of global commodities went up quite a bit during the last QE phases. The main reasons for the are weakness in the US dollar and sharp cross currency movements.

The commodity prices have corrected over the last couple of months as the QE2 effect faded off. Analysts believe another round of quantitative easing will trigger another cycle of high commodity prices in the global markets. In fact, there have already been some in global commodities over the last few days over speculations on the QE3 package announcement.

Impact on domestic markets

Because of dollar weakening QE3 is good for importers and bad exporters especially IT industry.The QE will increase inflow of funds to emerging markets from foreign institutional investors. The fund inflows here have slowed down considerably since the beginning of this year due to signs of economic recovery in the developed countries.

Impact of CRR hike on stock market

Cash reserve Ratio (CRR) in India is the amount of funds that the banks have to keep with RBI. If RBI decides to increase the percent of this, the available amount with the banks comes down. RBI is using this method (increase of CRR rate), to drain out the excessive money from the banks.

For example if bank A collects 10000/- deposit from you then out of the 10000/- he has to keep Rs 500 at the rate of 5% with the RBI. The net amount left with the bank will be 9500/- . if the CRR is getting hiked then RBI will suck the money from the system in order to meet the trade deficit. Same time the bank will have money supply deficit to meet all the loan demand. To fill this money supply deficit banks will increase interest rates on Fixed deposits to get more deposits from customers, increase home loan, Auto, other loans to industries to pass its burden to borrowers.

The increase in CRR rate will directly impact the housing, experts, banks, automobile sell figure etc in the short term. Since market is more sensitive towards the short term reactions it can lead to the fall in the above sectors. The real jerk will be felt in the monthly sales figure  and turnover of the above mentioned sectors. Continuous increase in the CRR may impact the quarterly profitability of the above sectors. Second point is if it is inline with the increase in the interest rate in the cash deposits then it will directly impact the stock market since the big money will flow out from the high risk sector to the low risk sector resulting low participation in the market.

Repo Rate: Repo rate is the rate at which our banks borrow rupees from RBI. This facility is for short term measure and to fill gaps between demand and supply of money in a bank .when a bank is short of funds they borrow from bank at repo rate and if bank has a surplus fund then the deposit the funds with RBI and earn at Reverse repo rate .

Reverse Reporate: is the rate which is paid by RBI to banks on Deposit of funds with RBI.A reduction in the repo rate will help banks to get money at a cheaper rate. When the repo rate increases borrowing from RBI becomes more expensive. To borrow from RBI bank have to submit liquid bonds /Govt Bonds as collateral security ,so this facility is a short term gap filling facility and bank does not use this facility to lend more to their customers

Are ULIPs good investment option?

ULIPs are a category of goal-based financial solutions that combine the safety of insurance protection with wealth creation opportunities. In ULIPs, a part of the investment goes towards providing you life cover. The residual portion is invested in a fund which in turn invests in stocks or bonds. The value of investments alters with the performance of the underlying fund opted by you.

ULIPs are wrongly messaged to public by funds as this particular investment type will give both insurance as well as gives good returns over the period of time. But historical data proves it as wrong.

 With the premium you are paying to buy these ULIP units if you buy Term policy for insurance coverage and remaining investing in SIP( Systematic Investment plan ) in any good performing mutual fund you would be getting much higher returns than what ULIPs give you. Also you get good insurance coverage with less premium towards term policies

DTC effect on ULIPS:

The first point is exiting before 10 yrs will badly hurt ULIPs holders  from cost point, as all the Ulip’s are heavily front loaded and exiting before 10 yrs means the total cost is (commissions) turns out to be too much for you. Only if your total premium per year is less than 5% of the Sum assured, you can save yourself from getting taxed. But most of the ULIP plans in the country will not meet that criteria as majority of the policyholder’s pay much more than 5% of sum assured as premiums. A big number of policies have sum assured as 5 times of the premium, as it’s the minimum requirement of a ULIP policy