Saturday, August 18, 2012

Decision Point Nifty Future Trading Setup

This discretionary trading setup is used by Smart Trader. I have formally decided to give it a name and try to define it in one blog article. The below information would be available in Smart Trader’s market updates and comments section. I have added my thoughts and perspective to it where ever required. I feel the frequently asked questions format would explain this concept nicely.
What is price action and how does it unfold?
Price action is simply how prices change. The actions and reactions of market participants impact the direction, speed of movement, duration and intensity of the market.

Are markets truly random in Behavior?
The Bad news is market are random most of the time. The good news is when markets are not random it gives the trader a edge. This edge will not endure for long and markets will return to their random behavior.

How can you figure out when market behavior is not random and when market behavior is random?
The market behavior is not random when there is a imbalance in supply and demand. When the supply and demand is in balance the random behavior continues.

How do you figure out  that there is a imbalance in supply and demand?
When ever price gets rejected at a level and forms an extreme it is a sign of imbalance. Price acceptance is when price keeps moving above and below price levels aimlessly this is a sign of random behavior.

How can a trader assess or predict price action when he observes that the market behavior is not random?
A trader cannot predict price action but he can figure out if the market is in trending mode or mean reverting mode.

How can a trader figure out the market mode?
When market is making higher high and higher low it is in an uptrend. When market is making lower high and lower low its is in a down trend. When market is trading in a channel it is in mean reverting mode.

Now that the Trader has understood the market mode what tactics will he use to profit out of this understanding?
If market is in trending mode a trader should look for Breakout Pullback at Decision Points and when the market is in mean reverting mode a trader should look for Break out failure at Decision Points. There are subtle variations of both these setups which is listed in the back tested data on Smart Trader website.

What is a Decision Point?
Decision points are price levels where the market strongly reacted earlier. Most of the time they are proven price levels.But market will always create  new Decision Point levels.  Traders are creatures of habit and you can expect them to react at these price levels again.

What are proven price levels?
Proven price levels are price levels in the past where price have moved violently away from due to supply – demand imbalance. An example of this would be
Big Round Number like 5400, 5300
Day Open
Double bottom
Double Top
High of the day
Low of the day
Major Swing point a price point before which there was consolidation. Like 5180 was a level before which Nifty Spot stopped and consolidated and then after break out it moved away from it.
Previous Day Close
Previous Day High
Previous Day Low
Previous Day Open

Is there any other Decision Points other than those mentioned above that could be important?
After market opens at some point in time it creates its first balance area where price trade in a range for a minimum duration of 30 minutes. This is an initial range and the high and low of this initial range is a Decision Point.

How can one track price action around so many Decision Points?
When the market price action unfolds not all Decision Point behave like a Decision Point. Only those Decision Points are important where price is rejected immediately. Where price forms a barbed wire type formation around a Decision point is no longer a valid Decision Point. Please look at the below example
In this price chart there were three Decision Points
PDH: Previous Day High this behaved like a Decision Point as a move towards it was rejected. When price moved above it then there was no pullback.
PDC: Previous Day Close this did not behave like a Decision Point and price was accepted and moved like a Barbed wire around it.
PDL: Previous Day Low this also behaves like a Decision Point there was a break out above this level and price moved away from it. And every pullback to it was rejected and price moved in the opposite direction.
What is the first step in a trade setup?
The first step is always to find the bias of the market as the price action unfolds. A big body green candle with volume higher than usual is an indication of bullish bias. Similarly a big body red candle with volume higher than usual is an indication of bearish bias. A bunch of small body candles with low volume signifies no trend. There are many other ways to determine the bias of the day. Listing it out here is beyond the scope of this article.

What is the second step in Trade Setup?
The second step is to find price rejection at Decision Points. The Key element of a price level at a Decision Point is price rejection. It appears that the market does not want to stay at the Decision Point. You could set a rule that not more than two 3-min candle stick bars should be present at the Decision Point. Or whatever you feel is right.

After finding out the bias of the market and the price rejection of a Decision Point what next?
When the Bias is Bullish and the price moves above a decision point and pulls back to it. This is a Break out pullback setup. The pullback to the Decision Point is a long trade. The stop loss would be behind the Decision Point. The target would be the first trouble area which could be the next Decision Point. Break out pullback is a “With Trend Trade”.

Are there any Decision Point setups to trade in non trending markets?
When market is trading in tight trading range for a duration of more than one hour and with low volumes. The Break out failure trade leads to a powerful move in the opposite direction. But very important when price moves away from a tight trading range. One must position for a trade entry after first break out in the direction of the break out. If this trade fails and market moves below the other side of the range. Reverse the trade without hesitation. The Reward to Risk ratio of this setup is very high. The stop loss is limited to the width of the range but target would be multiples of this. Break out failure is a “Counter Trend Trade”.

Is Break out pullback in a trending market and Break out failure in a non trending market the only Decision point trading setup?
Not exactly there are countless variations on how to accurately identify and locate trade entries. Please go through the Smart Trader website to figure out different possibilities.

How to do we figure out when to close the trade?
Decision Point setup is a discretionary setup and the closure of a trade would depend on how price action unfolds. Let us consider a few scenario’s to clarify this
1. Market opens with a bullish bias moves above a Decision point and moves in a brisk pace till the next decision point. Let us play out some probable scenario’s. We are long at the first decision point.
a) Market moves till the second decision point and makes an attempt to break out but fails. Market settles in a range with low volumes. The range low is at some distance away from the first Decision Point.
b) Market moves till the second decision point and makes a shallow pullback and breaks out above the second decision point.
c) Market moves till the second decision point and attempts a break out which fails with a deep pullback with low volumes close to the first decision point.
d) Same as (c) but volumes are high during the pullback
In each of the scenario’s the closure of the trade is different.
a) Market has reached the first trouble area and the bias of the market has changed from uptrend to mean reverting. The trade has to be closed immediately close to the range high. Any new trade entry would be after a re assessment of market structure
b) This scenario is very bullish and keep moving stops closer and ride the up move.
c) There is a high probability of market re testing the second decision point. There is a low probability of market moving above the second decision point. The up move is coming to an end but it could still have one last break out. Do not move stops closer but exit at the next sign of strength.
d) Pullback with high volumes is a sign of start of down move. Exit immediately at the market. Generally a sudden change from Bullish bias to Bearish Bias will blow your stops.
Decision Point trading is just a setup. A trader will have to define his trading strategy for trade management.

Why Decision Point Trading is a setup and not a strategy?
A Set-Up is the condition or set of conditions that are necessary prior to considering taking a position in the market or closing a position in the market. Traders have to be aware that the set-ups are only part of the equation. The strategy that one uses on these setups define the extent of your profit and loss. To create a trading strategy, many things must be considered like return, risk, volatility, timeframe, style, correlation with the markets, methods, etc.

Could an example of a popular trading strategy be provided?
VWAP is Volume Weighted Average Price.VWAP trading strategy and different variations of it are used by traders. One trade that has worked very well is If there is a move in the last hour of trade which continues to move away from the VWAP with high volumes then the market will continue to move in a direction that increases the gap between the VWAP and current market price.

Is it possible that on some trading day’s Decision Points prove to be in-effective?
It is definitely possible for example in a soft trend day where the market moves only in one direction and there is no price rejection. The market could have made a big move but as there was no price rejection. This setup will not give any trade entries. Also in a price spike and channel type of pattern will give plenty of false signals.

How to hone trading skills and increase the probability of success using Decision Point trading setup?
There is a tremendous difference understanding patterns and execution. Only through repeated exposure will one develop the subtleties of the price action. Practice with at least 100 charts bar by bar. Amibroker has bar by bar re play of previous intraday price action. Make elaborate notes while observing this. I am not recommending that you buy Amibroker but a replay feature is good feature to hone your skills.

Why is this titled as a Decision Point Trading Setup for Nifty Future?
The reason for this is that Smart Trader has provided the back tested results for this setup on Nifty Future from January 2012 in his blog.

Why is it not possible to automate the Decision Point setup?
This is a discretionary trade setup and is not bound by rules other than trade entry should be close to Decision Point and stop loss behind the Decision Point. The trade closure is based on how the market action unfolds. The next Decision Point may be a first trouble area but if it does not behave as a first trouble area. Then you hold the trade. After the trade entry one has to closely monitor the trade. As a thumb rule any target that gives twenty points is a good exit.

How Long have I been using this Decision Point Trading Setup?
I have been using it for a week and it has helped me locate good trading setups. I have not back tested it beyond a week but I am clear about the concept.

If this is not my trading setup then why am I promoting it?
I was a software programmer prior to trading and It gave me great satisfaction to contribute to open source software projects that had helped me. In keeping with this tradition I am updating my blog with my perspective on Decision Point Trading setup.

What role do Technical Analysis indicators and price pattern signals play when using the Decision point setup for intraday trading?
My Personal opinion is that Technical Indicators are not to be used in Intraday trading time frame. Adopt minimalism and keep your trading screen clutter free. Also price pattern of less than 30 min duration are completely meaningless. The longer the price pattern plays out stronger is the signal.

What would be the single important thing that a trader should do?
A trader should position himself in the direction of the net order flow. This is the imbalance between supply and demand. Once a news based event has occurred. Ignore the news and focus on the price action.  News flow may be good or bad but more important is how the market reacts to it.


  1. Rameshji

    Thanks. Nice summary.
    You have understood the core concepts well.
    Everything else is tactics.feel free to find out what suits your personality and stick with it.
    Nice blog. liked it.
    All the best


  2. Nice Article All the best ramesh

  3. Excellent Article Sir...


  4. Very good briefing of the whole concept.. thanx..