Rank Based Trading

There is an adage that says two heads are better than one. In trading also, two indicators are better than one to confirm a trading bias. But if it is multiple indicators, it doesn't mean too many cooks spoiled the broth. It is the merrier in technical trading. If many indicators point in the same direction, then the probability increases.

The daily dilemma of a trader is which stock to trade in. Stock selection can be a tedious process. To address this quandary, multiple indicators are used and applied to a watchlist and then rank them based on their bullish or bearish indication. The ranking system is just a simple system where if the bullish biases outweigh the bearish bias, the stock is bullish, and if the bearish biases outweigh the bullish, then the stock is bearish. If they are equal, then the bias is neutral. Basic data analysis using a spreadsheet can throw the results of stock to trade.

Process of ranking

The process of ranking begins with the selection of stocks or the watchlist of choice. The next step is the selection of indicators that are to be used for ranking. One can take as many indicators as one likes. The indicators have to be then interpreted for biases. For example, if the price is above a 5-period exponential moving average (EMA) it is bullish, and if it is below, it is bearish. Similarly, if the relative strength index (RSI) is above 50, it is bullish, and below 50, it is bearish. If the biases of all the indicators are bullish, then it is a strong buy, and if the biases of all the indicators are bearish, then it is a sell. If the biases of the indicators are equal, then it is neutral. We shall understand this better with an example; Let us say we are using a combination of EMAs, RSI, MACD and Stochastics for identifying trades. The parameters in our example are set at the default values. We shall restrict this to daily analysis for simplicity and understanding.

An example to drive home

The EMAs can be grouped into one. If anyone of the EMA condition is not satisfied, then the trade will be avoided. Now for a bullish trade, the EMA group, i.e., EMAs 50 should be greater than EMA 100, and EMA 100 should be greater than EMA 200. The price should be greater than the EMA group, and the RSI, MACD and Stochastic should also be bullish. And for a bearish trade, it is the opposite. Given below are the data table and the action table. The action table is derived from the data table based on the parameters defined.

Data Table

Action table

In the table above the trend or rank for each indicator is arrived at based on the parameters, and the final trend or rank arrives only if all the indicators are either bullish or bearish. Even if a single indicator against the stock throws an opposite trend or a different rank, then the stock is avoided. For example, Tata Steel and PI industries have indicators that are different, and hence the final trend is blank as the trend is uncertain as per our parameters. In our example, we have used the words bullish or bearish for ranking. Many traders use numbers that add up to form a cumulative rank. However, the idea remains the same - select stocks that are trending.

Conclusion

The ranking-based trading is like highway driving, unlike city driving. Highway driving has less of speed breakers and signals that break the momentum of the drive. City driving, on the other hand, has too many impediments for a smooth drive, like speed breakers signals, traffic jams etc. The ranking-based trading is, therefore, like highway driving, where all the indicators give the go-ahead for a smooth ride. The above ranking-based example is only indicative to explain the basic concept. One can add as many indicators and parameters as they want and also set their own rules for arriving at the ranks.