SK Biswal Chief Engineer at ONGC. Interested in Stock option trading ,Technical Analysis of Stocks & Commodities

Greedy For Risk? Contrarian Approach a Good Rational Strategy

3 min read

UNINTENDED CONSEQUENCES

Its an example .At the outset I don’t endorse betting and gambling. Take one example of one of IPL matches of last season.In a match of Mumbai Indians Vs Pune warriors ,outcome is mostly certain and predictable. Betting for Mumbai Indians is no brainer.Our minds responds to reward only and a passion called greed surges and grips us.Well we are greedy for Rewards. We dislike and Fear Risk.Obviously no one or very few are going to bet for Pune warriors –A palpable Risk. However our greed in case of Mumbai Indians comes with fear of loss also when stakes are very high.We have to Hedge automatically. Depending on our Safety factor ,we have to bet on pune warriors also.So the demand for Risk is automatically created. Demand for Reward is voluntary and driven by strong force of greed. But demand for Risk is involuntary and is created by equally strong forces of Fear.Rewards sell and Risk also does. They go hand in hand.Trading Risk is compulsory and one has to spend money on this accessories to fulfill your greed.In our desire to make profit for ourself ,we tend to create profit for others.This is called Risk –Reward trade off or simply RISK –REWARD Ratio.

Trade offs that exist between Reward and Risk  is not recognized easily. This is because two opposing view points such as Greed and Fear can not coexist in mind without paying attention to each other. Like two protons in a Nucleus makes it unstable.In mind we can have either Greed or Fear .We can not have both at the same time. We tend to assume that we can be hypocritical depending on situation .Hypocritical is our tendency towards selfish  convenience. But our practice or faith in hypocrisy fails when it comes to trade. Therefore we rely on charts or systems not only for buy and sell signals but to identify Risk /Reward  involved.Hedging does not come naturally. Rewards and Risks can be separated in charts and can not be kept separate in mind.Trade we enter has two wings like a butterfly.we tend to ignore one of them.When you buy rewards ,you have to buy Risk.So demand for Risk always exists and trading risk as against trading rewards can not be impulsive but has to be based on objective parameters in the chart.This is beauty of trading risk.

 

PUT FOR EVERY CALL

So rewards and risks ,both sell.Coming to options, CALLS are rewards in bull market and PUTS are the risks exactly the way it is explained above.When you buy Calls ,automatic demand of Puts are created in the market.Therfore as we all know in bull market both Calls and Puts sell.-calls as our natural demand and Puts as compulsory accessories.So at any point of time whether rising,falling or sideways market ,demand for rewards and risk instruments exist simultaneously.Buying and selling Puts makes equal sense in bull market as it does for Calls.Demand for Puts rises proportionately with that for Calls.Of course it depends on Risk and Reward ratio at the moment.

SAFETY RATIO IS RISK UPON REWARD.

Reward shopping is voluntary action and driven by cognizable or tangible price action.Mind is simply responding to reward embedded in Price action.Once buying over ,Incognisable or intangible part of price action called Risk arises in mind and appears in charts too.Our demand for reward tend to involuntarily create demand for Risk.This is unintended consequence.This incognisable  part is byproduct and is Risk-Reward trade off.This intangible price action is in fact non cognisable offence of price action.

This largely Incognisable part of Price action is captured by Safety ratios.Safety ratios can be customized or STO orTRIN or RSI and many other momentum indicators can be used to track dynamic safety ratios.Safety ratios tells you the extent of incognisable Risk built in Price action at the moment and gives clues as to future risk.Like momentum ,safety ratio tend to deteriorate at certain levels in chart.Higher the Risk, less is the safety, then demand for risk instrument rises.This approach shifts our focus from highly emotional event called price action to more rational safety ratio.One tend to get excited about expected rewards not with estimating safety factor.Risk sells and it is important to know to what extent it sells at the moment to take a contrarian approach. Safety ratio indicators helps us to take contrarian bets or trading risks.

Take example of STO .It is trusted and respected momentum indicator.When STO  is 70 and above we call it overbought condition or a top. From the perspective of safety ratio ,it equals to 70/30.Risk is twice of Reward.Potential demand for RISK instrument is going to be high.Possibly Right time to trade puts or short calls.My idea is not about buying put or call options but having closer look at risk side as it is popularly perceived.

RISK PERSPECTIVE

Buying calls is buying reward when we are bullish.But from sellers perspective you are transferring your risk to the call seller.You pay the kind of Risk parking charge. Call seller merely receive parking charge. Now why would somebody park your risk? Only if there exists the expectation of Trade offs Or if one expects parkings going to be available cheaper in future. When supply of risk instruments goes up ,you have cheaper parkings available in market.This happens when Risk and rewards ratio becomes very high.In the absence of cognigible rewards in price action,seller sees no incognigible risk in parking and parking fees tend to be less.Yes options are more complex than this.So momentum indicators play important role in our trading decisions. Most of us know this already and in more simpler form.But its my attempt to give another perspective.

Greedy for Risk is turning things on head.But it is rational and works better.Yeah ,out of box.Instead of focusing on rewards ,focusing on risk trade when time is right tend to be more profitable.

SK Biswal Chief Engineer at ONGC. Interested in Stock option trading ,Technical Analysis of Stocks & Commodities

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