The term ‘volatility’ is often used loosely. Sometimes, it simply describes a session (or a month or a week) which sees a wide difference between the high and the low. This ignores cases of one-way trends. Sometimes, it describes a session with choppy characteristics, when the actual difference between the high and the low isn’t much, but the price line swings randomly.
Let’s define volatility as the difference between the high and the low as a percentage of the opening price. Applying this definition to trading since January 2010, the Nifty has moved about 1.4 (median) to 1.5 per cent (mean) a session on an average, with a standard deviation of 0.65 per cent.
Let’s see the sort of returns likely for day-traders. A day-trader may reasonably hope to be correct about 50 per cent of the time. He would never pick up the entire trend from the low to the high (or vice-versa, if he’s short). Say, he picks up about 50 per cent of the trend — about 0.75 per cent— when he’s right. To keep a net surplus, he must set stop-losses at about 0.5 per cent.
On a given day, at a normal futures leverage of 10:1, a disciplined day-trader could record gains of about seven per cent, or losses of about 5.5 per cent, after brokerage and slippages. On days when trading is choppy, stop-losses might be hit and trades closed, almost before these are initiated. The odds cannot be improved significantly with a mechanical system. Once in a while, a big session would come along. Then, the trader must hope he’s on the right side of the market.
The statistics help explain why most day-traders (perhaps as many as 90 per cent) are losers in the long run. Though some day-traders are serious winners, it’s difficult to replicate their performances. It requires extreme discipline and quite a lot of luck to win regularly at day-trading, since likely net returns per trade are low.
Extending the timeframe improves the odds. This is simply because the Nifty can fluctuate more in a week, or a month, than in a single session. Wider stop-losses can also be set, ensuring a single choppy session doesn’t disturb the trading system. In an average week for instance, the Nifty swings between 3.6 per cent and 3.9 per cent, with a standard deviation of about 1.5 per cent. In an average month, the Nifty moves about 8.3-8.4 per cent, with a standard deviation of 2.9 per cent. In both cases, the trader can set a more generous stop-loss and still generate ample returns.
The author is a technical and equity analyst