See... this is how you can make money?

Here's one very very basic example to show the power of technical analysis and the discipline and patience required to make sure shot profits. This example is aimed at individual and small investors who want to invest for long term and have very little time to do exhaustive equity research.

This is the weekly candlestick chart of ONGC over last two years. For beginners, all the green and red bars represents open, high, low and closing price of the stock and the red lines above and below such bars are called Parabolic SAR (it is a technical indicator to make a buy or sell transaction). As a thumb-rule, whenever the red line or arc is above the candles then buy and vice-versa. For example, at the beginning of the chart, red line is below the candles, thus buy the stock at around 170. This red line continues till 15th July, then it moved above the candles signalling a strong sell.

I think, this is a very simple rule to start with. For individual investors, who doesn't know anything about the Parabolic SAR and any other technical indicator, this would serve as a very effective 101. If you trade by following the rules mentioned above, then you will make the following transactions over two years.

This means, if you trade just by following one technical indicator, however with discipline and patience, you can get a return of ~35% per annum.

I'll explain first two trades to make things simpler for you.

Trade 1- buy the stock at 172 as the red line is below the candles. sell the stock at 281 on 24th July when the red line moved above the candles. And simply book profits. But don't stop here, make another trade on the same day i.e. trade 2

Trade 2 - sell the stock at 281 (carry this position in futures) and buy it again at 305 on 14th Aug. book a loss of 24 and make another trade i.e. trade 3. And so on.

I think you must be amazed to see the returns and I am sure your mind will be filled with n number of questions. Is it that simple? And I must say its not.

Have you observed, of all the eight trades that you made, only three were profitable while five of them end up hitting you with a loss. This is a very big concern. One must understand the fact that technical analysis is not an exact science and it can not always give you the correct signal. In fact, there can be more whipsaws than accurate signals, thus experienced traders use a mix of more than three signals to confirm a trade direction.

However, I have shown you the power of using just one indicator. One most important thing that you would notice here, its the discipline and patience that paid off. After the profit in first trade, next five trades resulted in losses that too for more than one year. This can easily frustrate anybody and force him to stop believing in technical analysis. But one must not forget, all the loss making trades resulted in 3-12% of losses while profit making trades resulted in whopping 16-63% profits. This shows that TA (technical analysis) helps you reducing your losses and increasing your profits.

I hope, this post would be insightful for the learners of TA and would increase their self confidence. I know you will have a lots of questions now. Do let me know and I'll try to answer them in subsequent posts.