Stocks & Commodities V.

23:3 (64-71): Interview: Trading Diverences With Ashwani Gujral by Jayanthi Gopalakrishnan
INTERVIEW

Intraday Swings In Index Futures

Trading Divergences
With Ashwani Gujral
Ashwani Gujral first got acquainted with technical analysis when he was
studying for his masters degree in business administration in the US
during the mid-1990s and since then, theres been no turning back.
These days, Gujral is an India-based technical analyst, commentator,
author, and trainer who follows both Indian and US markets; hes also
an active short-term trader and a money manager. He is a frequent
contributor to various US trading magazines and makes regular weekly
appearances on Indian business television channels. Not only that, he
has an Internet presence, as he runs an index futures trading chatroom,
as well as a print presence, since he has just published a book called
How To Make Money Trading Derivatives: An Insiders Guide. He can
be found at www.ashwanigujral.com.
STOCKS & COMMODITIES Editor Jayanthi Gopalakrishnan conducted the interview with Gujral via instant messaging on the Internet,
starting on January 4, 2005.

ow did you get started in technical analysis?

I did my masters in business administration (MBA) in
the US in 1995, which was when I
became fascinated by the money management business. The first real gurus I
wanted to emulate were Warren Buffett,
George Soros, and Peter Lynch.

Not a bad place to start!

Being an engineer and having an MBA
in finance certainly helped. As an engineer, I was trained to build frameworks
and models to solve problems, and this
helped in developing a quantitative and
a logical approach to forecasting stock
price movements. As an MBA, I was
trained to understand business models,
so that helped me understand the business of companies whose charts I picked
for analysis. This is important because I
advise investing in only fundamentally
sound and pedigreed companies, even
if it is done on the basis of charts. In
addition, when I returned to India, I
found that technical data was much more
easily available than fundamental data.

This was one of the many

reasons I chose technical
analysis as my methodology
for analysis. Back in 1995, I
had a hard time just finding
annual reports, but of course
that has changed. And thats
how my fascination with
charting began, because that
put me on a par with large
investment banks with thousands of analysts making the
same forecasts.

Basically, one thing led to another,

and its become my lifes mission
to create successful traders.

How so?
I learned that I did not have
to decide the trend all I
had to do was to catch the
major part of the move. Meanwhile,
reforms in Indian capital markets took
place, so like the rest of the financial
markets around the world, we totally
turned away from physical delivery.
We had 100% electronic trading in India, followed by the big software boom
all over the world. Then, of course, the
subsequent bust also affected us.

Copyright (c) Technical Analysis Inc.

Again, like the rest of the financial

markets.
Earlier, the margin trading and cash
markets in India were interlinked, and
we had a local financing system called
BADLA for buying and selling securities. The problem with that was when
people used to build large positions on
the margin trading side, the cash also
used to come crashing down. Then in

Stocks & Commodities V. 23:3 (64-71): Interview: Trading Diverences With Ashwani Gujral by Jayanthi Gopalakrishnan

2001, the Indian market was hit with the

Ketan Parikh scam.
Can you tell the readers who that is and
what thats in reference to?
Ketan Parikh bought stocks in the
forward market margin trading
and used the proceeds as they got credited in his account every evening to
build huge positions. So he used proceeds of leverage to build even more
leverage. This was because, like in the
ordinary futures market, in this market
you also had mark-to-market, so gains
and losses were added or subtracted
from your account in the evening. In
addition, he took loans from cooperative banks and bought stocks on margin,
sending his favorite software stocks to
the stratosphere.
This game was a lot of fun, but when
the bust happened, it put a few regional
stock exchanges and banks under a payments crisis. Finally, the government
stepped in and scrapped the entire
BADLA financing system and introduced
derivatives. Today, all our derivatives
are cash settled. With all these reforms
happening, it was natural that trading
started taking a professional form.
And then?
As word of mouth grew about my
money management and technical analysis activities, I started making appearances on CNBC-TV18 [Editors note:
the Indian affiliate of CNBC] and other
channels, wrote a book and articles for
several US trading magazines, and began an index trading chatroom on the
Internet. Writing helped my technical
analysis and trading, because it internalized a lot of what I learned. Basically, one thing led to another, and its
become my lifes mission to create successful traders.
Did you start out by trading equities, or
did you jump into futures?
When I started trading in 1996, equities were the only thing out there. There
were no books to learn technical analysis from, just one or two software providers; most of the educational tools,
books and courses, came around after I
had started. Initially, it was a bit of

fundamentals as far as I was concerned,

but then I found out that markets predicted fundamentals before they happened. I couldnt have such in-depth
knowledge of the markets to analyze
them fundamentally, so I moved to technical analysis. I used fundamentals only
to the extent of making sure of the
company pedigree and used technical
analysis to buy and sell stocks.
This went on till 2001, and once derivatives were introduced into the market, that was it. I have not purchased a
stock since.
Is that because technicals work better
in derivatives?
Technical analysis works well with
anything that can be charted. The charts
I analyze are for equities, but since we
dont have margin trading, trading futures provides us with better leverage,
and hence a better risk/reward.
I use the index chart and trade its
futures. You can use the index futures
chart as well, but here in India, the
futures keep moving into discount or
premium, based on the bearishness or
bullishness. It made sense to use the
index chart itself. With derivatives, I
have more flexibility: When I am getting good signals, I trade the futures.
When the markets get choppy, I just sell
a straddle on index options and sit tight.
If markets are not showing strong trends
I tend to do lower volume and not add,
so I can book quicker profits.
How do you trade derivatives?
Almost all liquid derivatives instruments settle on the last Thursday of
every month. When markets consolidate, selling index straddles often works
better than getting chopped around taking marginal trades. These have a onemonth expiry so you end up making
money if the market is going into a
consolidation on the daily time frame or
the weekly time frame. Every month,
there are about 22 trading sessions, so
time is on the side of the option seller.
What type of money management strategies do you use?
I do not risk more than 2% of total
account equity on any one trade. I do not
Copyright (c) Technical Analysis Inc.

carry losses home. I also do not carry

marginal profits home unless there are
extraordinary circumstances involved,
such as when the market is closing at
highs. Once a position is deep in-themoney, I look for consolidations to
add. I use patterns like bull and bear
flags to add positions. The setups I
discuss here can also be used to add
positions, as they occur almost once a
day. [Editors note: See sidebar, Setups.] Once I am in a good position I try
to push it, on all time frames. But I
make sure that every time I add contracts, they are a fraction of the original
position, so my breakeven does not run
up too close to the current market price.
I take a lot of trades but really make
most of my money on a few big ones.
Tell us about your trading system using index futures.
Its for intraday traders who trade the
five-minute time frame, but it can be
used to time entries by longer time
frames as well. Lets start with momentum setups, which is what I call them. I
believe price follows momentum in general, but whenever the two diverge, you
get buy and sell signals. Now, the buy
setup means the momentum makes a
low for the day, whereas the price does
not. Even though momentum went to
oversold, the price had enough strength
to hold its lows.
So when this momentum turns, you
will get a stronger move to the upside
something like an a-b-c wave. We
believe all price moves take an ABC
form, where you have a move in a
direction called A, then a correction or
consolidation in the opposite direction
called B, and then a continuation of the
move A called C. So basically, we wait
until the market shows us its hand.
Now, the sell setup occurs when
momentum makes a high, while the price
does not. This means even though the
momentum went to its highest, the price
had such weakness that it could not
follow. So when the momentum turns
down, you get a larger move on the
downside. We use stochastics, both fast
and slow, as the measure of momentum.
Could you walk me through it using

Stocks & Commodities V. 23:3 (64-71): Interview: Trading Diverences With Ashwani Gujral by Jayanthi Gopalakrishnan

YAHOO!

tion. But if you strictly go by the slow

stochastics, you get fewer but better
percentage trades.

FIGURE 1: MOMENTUM SETUP. Here you see a setup on the S&P 500 index using fast and slow stochastics.

the chart in Figure 1 as an example?

In Figure 1, the market opened with
two up bars and then started coming
down. So it touched lows for the day, as
did the momentum from our system.
This tells us that the market is planning
to move down. Now, what you want to
do is make an entry into this downward
movement. The window directly below
the price chart displays the slow
stochastics. The window below that
shows the fast stochastics.
Why do you use both fast and slow
stochastics?
As you know, stochastics can be used
to define market momentum. I use fast
and slow stochastics because the fast one
hints at where the slow one may move
next. The red line you see on the Standard & Poors chart is the 20-period
exponential moving average (EMA). By
the way, the Yahoo! chart is a five-minute
chart, so once you form a bias based on the
initial move of the market to try to get a
better feel, you check out the market
breadth. This is available via Yahoo! and
updated throughout the trading day.
Can you tell our readers what happens
in India?
In India, what happens is that index
heavyweights sometimes skew the market. That problem may not exist in the

US because the S&P consists of 500

stocks. When youre looking at the
breadth of the market, you know whether
it is a narrow- or broad-based rally or a
decline. The broader the market in a
particular direction, the better the
chances of the trade succeeding. Still, it
gives you a feel for what is happening.
Now, coming back to Figure 1, which
shows a sell setup when the slow stochastic reaches oversold levels initially,
you get move A, in which you have to
wait for the market to react on the upside to look for a short entry. As you can
see, around 11 am the market started
reacting on the upside, starting the wave
B. Both the slow and fast stochastics
started moving.
Do you have a particular point at which
you like to trade?
Ideally, I trade only when the slow
stochastic is at extremes, because I find
that it gives the best trades on a percentage basis. But sometimes if the market
is showing a lot of weakness or strength,
the slow stochastic may not reach overbought or oversold levels. When that
happens, you can use some finesse. I
use the fast stochastic in conjunction
with the 20-period MA. The moment
the fast stochastic becomes overbought,
and price moves above the 20-period
EMA, you have a low-risk short situaCopyright (c) Technical Analysis Inc.

Why?
Say the momentum made a high but
the market did not, so you have an a
wave down, a b wave up, and then you
ride a c wave down. This also gives the
closest stop you use the high of the
day as your stop, for the sell setup.
Similarly, use the low of the day as a
stop for buy setups. The triggers can be
set according to each trader, which we
will discuss shortly. All you really need
is just one entry like that in a day, so
instead of beating around the bush
which is what daytraders usually do
you get a clear way of taking a trade
once the market shows its hand. I will
introduce qualifications to this as well,
but this is the basic trend.
What is the essence of this system?
You know, I work with traders all the
time, and these guys basically go around
chasing the market like a chicken with
its head cut off. The beauty of this
technique is that whichever way the
market goes, this system forces you to
buy dips after an intraday uptrend and
sell rallies after an intraday downtrend.
That is what youre supposed to do.
Because if you sell dips in an intraday
uptrend and buy rallies in an intraday
downtrend, you will be stopped out
several times a day, even before the
trade works out.
In addition, my system makes you
sell momentum overbought and
oversold which means if and when
the momentum does turn downward,
even if the trade is not working out, you
will get a decent exit because the reversal in momentum will pull it in its
direction to some degree.
What are some other benefits?
You also get to trade divergence in
price and momentum. I discuss only
two types of divergence between momentum and price, because they work
the best. Through testing, I have found
that other types of divergences do not
work as well. The classic dilemma
that traders face is whether a certain

Stocks & Commodities V. 23:3 (64-71): Interview: Trading Diverences With Ashwani Gujral by Jayanthi Gopalakrishnan

But sometimes something that looks

like a strong momentum move is only
short-lived.
Yes, that is the reason were not chasing momentum, but trying to trade divergences. Were trying to trade the
exception to the rule that price follows
momentum.
Do you find yourself out of the market
often when you use this system?
Yes. When a trend starts stalling, I
get out of there. I know I will always get
an entry in the next day or two. When
the market is chopping around in a narrow range, the system either does not
give signals or at least gives very few, as
the slow stochastics dont reach overbought levels as often.
Now Ill write a few words on how to
filter signals. I wrote an article on average directional movement index (ADX)
for STOCKS & COMMODITIES, if youll
remember. Now, as with all technical
analysis methods, if the market is in a
strong trend, techniques work much
better. These techniques are no exception, so a key parameter to watch is the
daily ADX. If its above 30, these setups
work very well. When the ADX is not
showing a strong trend, you should keep
volume low and take profits quickly.
Another filter mechanism is the 30minute chart (Figure 2). When slow
stochastics on the 30-minute chart is
overbought and starts weakening, the
chances of getting a good five-minute
sell setup are much higher. Similarly,
when slow stochastics on the 30-minute
chart is oversold and starts strengthening, the chances of getting a good fiveminute buy setup are higher.
If the market on the 30-minute time
frame is showing slow stochastics at
overbought levels [above 80], I try to
take only the five-minute sell setups. If
the market on the 30-minute chart is
showing slow stochastics as oversold, I

eSIGNAL

support or resistance will hold or break

down or out. This can help solve that
dilemma to some degree. The best part
of this system is when the market is just
chopping around, it does not go to
extremes as often. So youre kept out
of impulsive trades.

FIGURE 2: FILTERING MECHANISM. Here is an example of using a 30-minute chart as a filtering mechanism.
Note the favorable points to take five-minute buy and sell setups.

FIGURE 3: AN IDEAL SETUP. If the stochastics moves up and the price makes a new high, you would stop
looking for a setup. In this case, the stochastics moves drastically, but price doesnt.

will take only the buy setups. The trade

preferably is taken as the slow stochastics
comes down from the 80 level or moves
up above the 20 level. If I am trading a
range-bound market, I keep my volume
60% of those during trending markets
and take profits quickly.
This can be used as a profit booking
mechanism as well. Say you take a trade
using this method and it works well.
How do you book a profit? You wait
until the next opposite setup occurs
again. This means if you traded the buy
setup, you would use the next sell setup
to book profits. If you traded the sell
Copyright (c) Technical Analysis Inc.

setup, you would use the next buy setup

to book profits. This is particularly useful if you are carrying overnight positions and want to get out at a good exit.
That will make sure either you book
your profit near the high on a buy trade
or near the low on a sell trade.
Its important to note that if you use
slow stochastic overbought/oversold levels, you get fewer trades, but large moves.
What about triggers?
For the triggers I have spoken about,
I think you can use the previous twobar low, or the previous two-bar high

Stocks & Commodities V. 23:3 (64-71): Interview: Trading Diverences With Ashwani Gujral by Jayanthi Gopalakrishnan

SETUPS
Key points about momentum setup
Buy setup Slow stochastics makes a low for the day,
but the market does not make a new low for the day
Sell setup Slow stochastics makes a high for the day,
but the market does not make a new high for the day
If, because of a strong trend, the slow stochastics is not
reaching extremes, the fast stochastics can also be used.
Things that this setup forces traders to do
Buying on dips, selling on rallies
Buying when momentum is oversold, selling when
momentum is overbought
Divergence between momentum and price
Even if the trade does not work, it considerably
reduces risk as the trade is taken on a momentum
extreme and a good exit is provided
Key framework to apply these setups in
In a trending market, when ADX>30, take trades only in
the direction of the trend
In a range-bound market, when the ADX is declining
below 30, define daily support and resistance, buy on
support and sell at resistance

on the five-minute chart, or when the

price goes through the 20-period EMA
in the direction of the trade.
I just use the oversold and overbought levels on the slow stochastic
and use a stop of the high or the low.
Now we move to the stuff below the
triggers. Check out Halliburton (Figure 3).
From that chart, you can see that the
stock prices corrected upward slightly
after trending down for most of the
day. This prompts you to short as the
slow stochastic reaches overbought
levels. Scenarios like this do happen.
Note that stochastics moves drastically, but price doesnt. If the stochastic moves up and the prices also make
a new high, then we quit looking for a
sell setup. Its the same with lows, so
basically this setup keeps you out of
trouble a number of times.
What else do you look at?
I look at the high and low of the given
day. If you look below when you bring
them up on Yahoo! charts, youll see a
table that displays the highs and lows
that you can use as your reference.
Lets move along to the CISCO chart

Take quicker profits in a range-bound market, preferably

as the slow stochastics reaches the other end
Use 60% of trending volume in a rangebound market
Triggers
Previous 10-minute lows
Breakdown/breakout below the 20-period moving average
Just reaching extreme areas and then keeping a standard stop because the momentum moves the other
way at some point
Setup conditions
The following information, which is available on Yahoo!, sets
up the conditions for the trade:
Strong positive breadth facilitates buy trades
Strong negative breadth facilitates sell trades
Marginal breadth usually discourages trading, as it
means a consolidation day
Reversal of breadth from one extreme to another serves
as confirmation of a larger move in the direction of
breadth reversal
A.G.

FIGURE 4: CHOPPY MARKET. Even when the setup does not work well, you still get a decent exit.

(Figure 4). Now, this is where the setup

kind of diddles around. But you still
dont get chopped, and if youre not
comfortable, you can exit at a decent
price again. The slow stochastic made
new highs. Prices did not see their previous prices because everything closed
lower. I could not find a buy setup, but
I guess on an up day, you will find
Copyright (c) Technical Analysis Inc.

plenty of that.
Now, right below the chart [not
shown] you have breadth. Believe it or
not, I refresh the breadth every five
minutes that really tells me the odds
of my trade working. If I have an open
position and the breadth strengthens, I
am confident that this move has more to
go. If the breadth weakens while I am

Stocks & Commodities V. 23:3 (64-71): Interview: Trading Diverences With Ashwani Gujral by Jayanthi Gopalakrishnan

long, I tighten the stops. Its the same

with sells. If the breadth is iffy, meaning very close to a 1-to-1 ratio, its a
sign that you need to take profits quickly,
as the market is not overly bullish or
bearish. The best trades, of course, occur when breadth moves from one extreme to the other.
The best thing this system has done
for me is that it allows me to watch the
market action and take in whats going
on while I wait for the setup to occur.
And you do this with just an Internet
connection?
Yes, this is probably the most inexpensive way to trade the US markets,
although you may need a 30-minute
datafeed for filtering purposes.

I must stress again that having a

perspective of the daily trend is important. I place a lot of emphasis on support
and resistance, which I draw on my
charts before planning the days trade.
Since I have been using this technique,
I have not had a stop that was hit because the entries are always on the
opposite extreme. In my earlier days, I
used to sell bottoms and buy tops. Using this system reduced all that, even if
I was wrong. You get a decent burial
and dont get shot. You can make four
points a day on the S&P. Most people
will take that, and sometimes this lands
you in large moves. If you understand
the essence, it just makes you do the
right things.

Thank you for your time, Ashwani.

SUGGESTED READING
Gujral, Ashwani [2005]. How To Make
Money Trading Derivatives, Vision
Books India.
_____ [2004]. Candlestick Filtering,
Technical Analysis of STOCKS &
COMMODITIES, Volume 22: April.
_____ [2004]. ADX: An Indicator And
Trading System, Technical Analysis of STOCKS & COMMODITIES,
Volume 22: May.
_____ [2004]. The Shark Attack Strategy And Fibonacci Levels, Technical Analysis of STOCKS & COMMODITIES, Volume 22: June.
See Traders Glossary for definition

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