Thursday, July 31, 2008

Inflation, the Hidden Tax

Inflation numbers released today (Thursday) evening are not comforting. The rate of inflation has one up again reaching 11.98%. Worse, food articles have become more expensive, causing discomfort to the poor and the middle class.
From: http://www.drlwilson.com/Articles/INFLATON.htm
Quote
In his classic book, The Economic Consequences of the Peace (1920), John Maynard Keynes observed:
“Lenin (the founder of the former communist Soviet Union) was certainly right. There is no subtler, no surer means of overturning the existing basis of society than to debauch the currency. The process engages all the hidden forces of economic law on the side of destruction, and does it in a manner which not one man in a million is able to diagnose”.
Many people do not realize that inflation is with us, and it is an extremely destructive hidden tax, especially on the poor and middle classes. Inflation reduces the buying power of your money.
UnQuote
Inflation in fact is a transfer of money from the poor and the middle class to the rich. The transfer of wealth comes as savers and fixed-income families lose purchasing power, and big companies benefit from increased government spending and higher finished product prices. Savers and those living on fixed or low incomes are hardest hit as the cost of living rises. Low- and middle-incomes families suffer the most as they struggle to make ends meet while wealth is literally transferred from the middle class to the wealthy.
Can the economy prosper in times when the country as represented by the middle class gets poorer ? The answer is NO. Then, higher inflation should slowly translate into lower share prices.

This is the second of today's blog entries. The first entry is below: titled "Cycles of contraction and expansion".

Cycles of Contraction and Expansion

The Stock and Futures Markets go through cycles of expanding and contracting volatility. Periods of narrowing volatility suggest uncertainty among market paricipants. Bulls and Bears, both are confused on the direction of the market. This state of indecision does not last long. One of these two groups is likely to get an upper hand. When this happens, volatility expands in the direction of the stronger hand. If the bulls are stronger, they will push the markets up, while if the bears get stronger, the market should see a sharp down move. The narrowing volatilty then is an indicator of an expansion in price range in any one direction. It is a setup where the trader can take a position in anticipation of an increase in volatility and a directional move.
On Thursday, the Nifty remained lock in a narrow range. This was the narrowest range in seven days. Just two days ago, the Nifty had a similar narrow range day. Two days of low volatility tell us that the market is ready for a period of expanding volatility. This should take place soon enough, with the Nifty likely to move sharply in one direction - up or down.

How to trade such cycles of contraction and expansion ? Two ways.
First, Using Options, buy a Call and a Put, then wait patiently for the expected increase in volaatility. When the market gives a clear directional break out, sell the losing leg and continue with the profitable option.
Second, wait for the actual process of expansion to begin. When the market does show its hand, moving decisively in up or down, then take a trading position.
Specifically, the Nifty is in a period of contracting volatility. We can identify 4350 as resistance and 4300 as support. A move beyond these levels will be the first sign that the Index is moving towards a directional move. When this happens, take a position in the direction of the breakdown / breakout.

Wednesday, July 30, 2008

A Dip, A Test and now a time to take decisions

When the Nifty first started its rally from 3800, I had made these points:
1. There is support at 3800, so swing traders / short term traders should buy with 3800 as stop.
2. Investors should stay away since this is a bear market rally.
3. Is a bottom coming in place ? The first sign of this will be when the Nifty corrects after its rally and the correction stops before touching 3800.
The third statement is now coming out to be valid. The Nifty went through a decent correction retracing 400 points from 4550 to 4150. The lows at 4150 have been above the previous 3800 bottom.
The Nifty has made a pattern of higher highs (confirmed) and higher lows(probably).
The question then is: Should Investors buy now ?
We have to give a clear, actionable answer to this question. Let us answer this question as traders - straightforward, and not as analysts (if this happens, maybe, on the other hand....).
Before an answer, here is a more significant question: How do you decide the amount you invest? if you are surprised at this question, let me tell you that this is much more important than a decision on buy or not. The correct term for deciding how much to invest is called 'Position Sizing' so we will use this term.
Position sizing is that part of your system that tells you “how much” throughout the course of the trade. The terms trade also refers to investments. Position Sizing, along with your personal psychology, controls about 90% of your performance in trading / investing. That's how important it is!
It is possible that a rally in a bear market may be the start of a new bull move. When we have a possibility of such an event, investors should start testing the waters, by buying small lots of blue chips. If the rally fizzles out, they can (a) hold on to their positions, or, exit with small losses.
When the Market has started on what is a confirmed bull market, investors should increase their positions, commit more funds to equity.
Now, to our original question: Should Investors buy now ? Well, what do you think the answer is ? Yes, with careful position sizing. Use, say, 10% - ten percent of your available capital to buy blue chips - Reliance, Tata Steel, TCS, Maruti, HDFC Bank, Cipla, Grasim, Sterlite, ONGC, Cairn, ---- the list is longer than this. (I own shares in some of these names). If the Nifty falls and closes below 4150 - the current low, then stop buying. You can either hold on to these shares, or, sell them for a small loss - your choice.
If the Nifty continues to rally, then wait for a new high above 4550. Once this level is broken, add more on dips.

In the short term, I assume this market remains in a trading range, with support at 3800, and resistance at 4550. A support has now been defined at 4150. if this level breaks, keeping long positions may not be a good idea.

Tuesday, July 29, 2008

A Trading Range Market ?

The Nifty fell by 150 points today, bringing it down to 4175. This is almost 400 points down from the rally highs recorded last week.
Below 4200, the intermediate trend is down, the short term trend is down while the primary trend has been down for a long time. It is likely that the Nifty may fall down to test the 3800 lows again. But when ? Before a decline occurs, we can easily see a see-saw market in which the Nifty falls and rises alternately. This means we can see a rally tomorrow, then maybe a follow through again on the next day, and then a sudden dip (after inflation numbers?).
This is the sign of a trading range market. The Index may have defined a low at 3800, while it may also have defined a high at 4550. Between these two limits, the Index could move up and down alternately, giving the impression of activity and trend, but essentially remaining in a trading range.
How do we trade such a market? By identifying extremes on the charts. When a rally is 'over-bought' consider selling while an 'oversold' condition deserves a buy.
The broad trend of the market remains down. Thus, a short position is likely to reward better, as compared to a long position.

Monday, July 28, 2008

How much is a Trillion Dollars ?

Well let us understand some numbers. India's population is 100 crores. With a per capita income of Rs 30,000/- the GDP is Rs 30 lakh crores. This is Rs 30 trillion.
(One Trillion = 1000 billion = 1000 times 100 crores = 1 lakh crores).
Phew! Finally got the maths through!
Now, in today's news, the IMF says that sub-prime / financial sector losses are likely to reach one trillion US $.
This is equal to 42 lakh crore Rupees, or, more than the GDP of India.
Who did it ?
A few hundred (or thousand ?) financial sector smart guys, receiving millions of dollars in salary and bonuses, driven by greed have almost managed to destroy the American Financial Sector.
Reforms or retrograde step ?
In India, we want to hand over our Banks and Insurance Companies and Hard earned provident Fund money to these fellows. And this is called 'reforms' ?

Market in Narrow range, ready for a big move

The Nifty moved in a narrow range today, a suggestion that the contraction will soon lead to an expansion in any one direction.
Today was the narrowest range in the last seven days, a day on which neither the bulls nor the bears gained an upper hand. Such range contraction days are unlikely to continue. Soon enough , one of the two groups (bulls and Bears) overcome the other.
This question comes again: Where will the market go: up or down. The answer lies in the future. Wait for the market to begin a movement, the chances are that the momentum will continue in the same direction.
For the Nifty, a move above today's high - 4360 could suggest strength, while a move below today's low - 4285 may result in more downside pressure. This is as simple as it gets. Traders should wait pateintly for the move to begin, then go with it. By tomorrow morning, if world markets develop a strong direction, the Nifty could simply follow it. If world markets remain flat, then the Index will probably remain choppy for a day or two till either the bulls or the bears win this skirmish.
This is not the first time that I have discussed the narrow range day. It will not be the last either. These cycles of contraction and expansion occur frequently. They are usually easy to trade. Just follow the market.

Sunday, July 27, 2008

Nifty on a Watch

The Stock market as represented by the NSE50 (close:4318) has seen volatile movements over the past two weeks. First, we saw a decline to 3800, then support coming in at this decline. Smart Money probably sensed a political victory for the govt in the confidence vote. The Index was up almost 20% this week, before Friday's decline cooled down the gains to 15% from the 3800 lows.
Wise Traders follow the Markets
The markets go through three phases - up, down and sideways. When the market is changing from up / down to sideways, there is confusion since the trader is no longer confident about the current momentum. Then what should he follow ?
The primary trend is down, the Nifty is in a bear market.
The intermediate trend is UP. The trend changed to Up when the Nifty crossed above its previous minor high at 4215. This is the number we will watch for. A close below 4215 will change the trend to down.
The minor trend is also UP. This trend will change to down if the Nifty were to close below 4300. How did I get this number? The low on Friday was 4297 so I rounded this to 4300.
A trader should be following the minor trend. When the minor and intermediate trends are aligned together trading is easy, volumes can be increased.
If Monday opens below 4300, there will be a chance that the minor trend may change to down. Or, a strong open could suggest that 4300 may well be supported. If this happens, traders can buy on an intra day dip with 4300 as stop. There are many ways of trading this scenario. The key is to accept when you are wrong, keep protective stops to ensure that your losses are limited.
I have a software that provides projections in the near future. This software is suggesting a down swing with a target between 4290 and 4180. Now, the Nifty has already touched 4297 so it is anybody's guess on what the market could do now. I do not use such predictive tools since I prefer to use chart patterns that tell us what is happening now rather than the future. When such support levels are identified, a much wiser trade is to buy the support near 4180, and if the support breaks to sell the breakdown.
Earlier in this column, i had suggested that trading is not easy when markets lack direction. Now is such a situation. Trade less, with low volumes.

Friday, July 25, 2008

Inflation, Stocks & Gold

For Investors who have savings, this is a difficult time. Inflation is raging at 12% (11.89% to be exact). With Banks paying 9% on long term deposits, real returns have turned negative. The stock market is in a bear phase, offering little prospects of capital appreciation. One area where investors can put money is commodities. In India, Gold is the only commodity where investments can be made easily, both in physical form and as a security through ETF's (Exchange traded funds). We are not dsicussing property since it requires a different level of investment.
For investments, we then have - Fixed Deposits with banks, Stocks, Gold. Now, just like stocks, Gold is not risk free. In the current scenario, I feel, an investment strategy should include Gold as a method of diversification.
Gold may be setting up for an up move. A reader, Pratik, wrote yesterday, pointing out that the chart for Gold shows a cup and handle pattern in development. He is correct. The cup includes a bullish head and shoulder which has broken out on the upside. Then, based on charts, this is probably a good time to start your investments in Gold. If prices go up, as the charts seem to suggest, you will have a short term capital gain - an event we all wish for. If prices stay stagnant or fall, well, you were going to invest in Gold anyway.
Some part of your investments should be in Fixed Deposits. Some part should be in stocks, while some of your funds should be in cash, ready to invest when the stock market becomes so dull that everyone has forgotten about it.

Thursday, July 24, 2008

Excessive Leverage: How they destroy

Lazard CEO says Wall St leverage fueled bubble
Lazard Ltd Chairman and Chief Executive Bruce Wasserstein said on Wednesday many of the financial market's current woes stem from years of too much risk-taking and not enough common sense among Wall Street executives. The famed deal maker told a Wall Street Journal-sponsored gathering of reporters and industry executives that, in recent years, broker-dealers had increased their leverage, or total assets relative to equity, to excessive levels.

In India, Stock Futures offer a 1:10 leverage, sometimes even more. Worse, many brokers trade in these instruments (proprietary trading).
Excessive leverage is financial suicide. This mesage has come clearly from all corners of the world in the year 2008 financial meltdown. Yet, stock futures with their killing leverage are offered to an unsuspecting middle class to 'gamble' with.
As a trader, understanding leverage is the most important part of your trading plan. If you have Rs 100, and you are trading in Rs 150 worth of securities, then your leverage is 1.5. With this kind of leverage, and just a little bit of common sense, you can make a profitable career in trading.
On the other hand, you have Rs 100/- . Now you can trade in financial weapons of mass destruction called stock futures which are offered to all middle class Indians with a leverage that can extend to 10 times your investment. So, you trade in Rs 1000/- worth of stock futures. This is financial suicide with a guarantee - meaning you will get exterminated, financially.
Stock Futures as 25% of all trading volume, are not used in any country except India. Why ? Are all other countries fools ? The answer is: Every other country protects its citizens from the evils of gambling. Since stock futures are just gambling and not much else, these are not allowed / encouraged, except in India.

A look at the charts for Crude

I am joining thousands of better informed traders who trade and analyze crude price movements. Crude oil futures have a congestion zone between $120 and $124. This zone devloped in May. Any decline should find support in this zone. If Crude futures close below 120, then the support is broken, with a target of 108.
On CNBC-TV18, I have been asked to give my views on crude. I have said that crude could easily dip to 120 without changing its uptrend. After all, even the strongest of bull markets will see corrections in between.
One principle of technical analysis is that the trend is assumed to continue unless proved otherwise. Crude started an up move in year 2002 when it was trading at $20. Since then, crude prices have consistently moved up, with a number of sharp corrections in between. The recent run up to 147 probably required some kind of corrective counter move. This is what we should be seeing now.
Why should the up trend continue? A big trend such as the one in crude should end after a prolonged period of distribution. The current down move started quite suddenly. The end of the crude bull market is likely to be accompanied by months of top formation. Of course, this does not have to work out, but this is what my best guess is.

Wednesday, July 23, 2008

Follow the Momentum

Five days of back to back gains in the Nifty tells us one significant fact: the markets truly discount the future. Only the collective wisdom of the market could foresee in advance the victory of the govt in the confidence vote, or the rally in international markets.
What this tells us is: Technical Analysis is the sensible method of trading the markets since TA follows the markets rather than predict it.
The minor trend has been up since last week. The intermediate trend is up since yesterday. We should be looking at 4600, which is a pattern target suggested when the Nifty broke out from 4200 resistance.
What Next ?
Traders must always go with momentum. The momentum is with the bulls, so we buy - buy on dips & buy on breakouts. This should be easy to implement. But, in reality it is difficult to do so. We are filled with the impulse to go short - thinking , it has gone up so much, how can it go any higher. Well, we all know that markets can move much further than we reasonably expect them to. It is not our task to dictate to the market. Our job is to follow the market.
This still does not answer the question: what's next ?
Well, as a trader, I am going with the momentum. In case you are confused, the momentum is UP.
As an analyst (traders make money, analysts do analysis.) my sense is that the current up move is a bear market rally. Bull markets do not start with V shaped reversals. Again, we do have sharp sudden rallies in a bear market, which is what we are seeing now. Then, at some point, the rally will face resistance, eventually see distribution, then a slow decline, then a much faster decline.
My analysis is used for my investments. My trading is purely on momentum & short term trend.
Thus, as an investor, I will wait for a correction. If the correction holds, stays above the earlier lows, then I will begin new investments.

Tuesday, July 22, 2008

Sell the News ?

The Indian Markets have seen gains of 12% in just four trading days, with the Nifty closing at 4260 today, up from its close at 3820 4 days ago. The anticipation of a victory in the confidence vote has sent the market moving up. The actual news of the victory may then turn out to be something of a damp squib for the market.
With 12% gains before the actual event, it is possible that the Nifty may see at least a short term top on Wednesday morning when the market should open higher after the victory news.
Except for the very short term when euphoria rules the market, nothing has changed. As the Government continues, elections will be held on schedule, around march or April of 2009. And, what will the government do till then ? With Parliament divided right accross the middle, What can it do ? Not much.
Markets hate uncertainty. A November election would be cheered for the simple reason that the uncertainty will end soon. Now, the fate of the govt remains in the balance almost every day, the outcome of elections is unkonwn for a longer period of time - hardly a scenario for a long term bull market.
Thus, investors should stay away from this market until a pullback confirms that the trend has actually changed to up. Traders should go with market momentum which is UP. They should be prepared to take profits at the first signs of resistance, which may happen tomorrow after an expected gap up.

Waiting for the Parliament Vote

The Nifty finished another day with big gains, making it three in a row. The Index is at 4159.50 within strking distance of the previous pivot high made at 4200.
If the Nifty closes above 4200, it will make a pattern of higher highs. This will break the bearish pattern of lower highs being made since April. Once a pattern of higher highs is confirmed, Intermediate traders (These are investors who may wish to take trading positions for a few days to a few weeks) can choose any one of the two options: They can start buying / investing now, or they can wait for a correction and then enter the market once it is evident that the correction will stop above the last low made at 3800. (This means a pattern of higher lows is confirmed).
There is no 'right' way. Early entry gives an advantage if the up trend continues. Waiting for a correction is safer since the trader / investor avoids the prospects of a false breakout. IThis is a decision that the trader has to make.
A numbr of individual stocks have made bullish patterns, mainly bullish head and shoulders in their charts. This does suggest that stocks are going through a bottoming out process.
We assume that we remain in a bear market. If the Nifty goes above 4200, the intermediate trend will change to up, but the primary trend will remain down.

This is the second blog entry for Monday evening. Scroll down to read the first - 'Banks lose Money, Markets are up, What's Next'.

Monday, July 21, 2008

Banks lose Money, Markets are up, what's next ?

CitiBank & Bank of America lost less money than estimates leading to a smart rally in the Asian markets - yes - you read this right, the results caused Asian markets to move up sharply, while the US markets remained almost unchanged.
How much more can Asia rally on the back of a 'thank god the American banks are not yet bankrupt' euphoria ?
I suspect the answers will be - not much. We will probably find this out in the next few days.
Bear markets see sharp and sudden rallies which fizzle out quickly. This is what seems to be happening in the US markets after a two day rally, the markets now appear subdued.
In India, the banks have embarked on a huge rally of their own, no doubt encouraged by the big up move in Financials in the USA. The Bank Nifty has broken out of a small trading range today. This is significant since the broader market Index - the NSE50 remains inside a trading range, although it is at the top of the range.
Every breakout has two possibilites: First, it is the real thing, the breakout suggesting that a change in trend has taken place, with higher levels ahead. Second, it may be a false breakout, the last thrust where smart money sells out while the unsuspecting 'public' enters.
What is the nature of the breakout by the Bank index ? is it real or is it a false breakout ? Now, the only way to answer this question is to wait for a few days by which time the market will tell us the answer. The right question to ask is: Do I want to trade this breakout ? My answer will be, NO. If this is the real thing, a true change of trend, then there will be many opportunities to enter this move. The first pullback will be an opportunity. There is no need to rush. Inflation is at the highest in 13 years, interest rates are moving up, the economy is slowing down - hardly an environment for banks.

Sunday, July 20, 2008

Fool's Rally or a New Bull Market ?

A two day rally in the Market saw the Nifty move up from 3800 to 4100, a handsome 7% gain in just two trading sessions.
It appears that at least a short term low has been made at 3800. The short term trend (wich traders should follow) is UP.
But, Investors should stay away from the market. Such rallies will come again and again in an ongoing bear market. The Bear is very much alive and kicking.
Why do I say this ?
Let us examine past history to determine how a bear market should end. While we can review many examples from world markets, we will confine oursleves to bear markets seen in India.
The 1992 bull market saw its final lows about 15 months later in 1993. The 2000 bull market saw its final lows, almost three years later in 2003.
With the top of the bull market made in 2008 January, the earliest, we should expect a bear market bottom will be 15 months later, around April 2009. Strange, but this also coincides with the Q4 results for 2008-2009 and maybe, a general election.
If the bear market is an extended one, we could go all the way for three more years, finally bottoming out somewhere in 2011.
Now, these may well be the outer limits (minimum and maximum) with the market finally bottoming out anywhere it wishes. If we assume that the bear market has finished at 3800 now, then we are looking at just a six month bear market. Given past evidence not just in India, but the world over, it does appear that a six month bear market is probably not likely to happen.

How should you trade the current two day rally ?
A 7 per cent upthrust is certainly a short term uptrend. Day traders and Swing traders should already be long. (My previous blog entries had suggested this - scroll down to read them.) Dips can be used to initiate fresh long positions. A Nifty below 4000 will be a sign that the rally is fizzling out. These levels will change over time.
As an Investor, just stay away.
Investors must follow the primary trend of the market. This trend is down. The Market must (a) Make higher highs by closing above 4200 for at least three days, then (b) remain above 3800 when there is a pullback -( a dip).
After these two conditions are satisfied, there will be a sign that at least an intermediate up trend has started. That will be the time to invest. Read this blog daily to get updated on the markets!
Trading on News Days:
July 21 & July 22 are news based days, when the confidence motion will be debated, then finally voted on. Day Traders and Swing traders should avoid trading to such days since rumors and news can cause sharp spikes of voaltility which can cause lot of financial damage.
I hope to add more blog entries by Sunday evening, so keep coming back.

Thursday, July 17, 2008

Ray of Hope for Bulls

The Nifty found strong support at 3800. Upbeat international markets provided the right environment for a strong rally on Thursday when the Index closed at 3947, up 131 points (3.42%).
It appears that the 3800 - 3850 range is acting as a bouncing pad for the Index, a level from which it gets buying interest. So far the Nifty remains above 3800, dips can be used for buying. Long positions are justified with a stop below 3800. Yet, we must remember that Indian markets face event risk with Inflation, Confidence Vote & Monsoon blues. Thus, traders should keep volumes low and trade with stop losses.
Looking ahead at the Nifty
The Nifty is at 15 month lows. Since most European markets are at 2 year lows, we are faring much better. So far, this has been a bear market with very little pain (as compared to, say, the year 2000 - 2001 IT debacle).
But, we cannot say with certainty that we have seen the end of the bear cycle. Some analysts feel that the current down move is a correction in an ongoing bull market. On this basis, they suggest that the correction may be getting closer to its end. Now, this is a matter of subjective analysis since there is no clear cut rule defining a bear market as opposed to a correction. The Index has lost over 40% of its value from ts all time highs. I would classify this as a bear market. If this is really a bear move, then there may be more downside ahead, as well as a lot of time to be spent building a base. There is no way to forecast what will actually happen. Therefore, it is wise to follow our charts.
Buy signals have NOT yet emerged on the charts. This is fair, since till yesterday, the Nifty was making new lows.
The first signs of a new bull market will come if and when the Nify moves above 4200 and closes above it. Let us wait and watch.

Wednesday, July 16, 2008

Market Ends Dull Day with a Whimper

True to its trend (down), the Nifty closed lower, below the 3850 level that was considered to be support. Yet, trading was dull, with the Nifty moving in both directions in choppy movements.
As the Index touches 3800, down almost 600 points from a minor high at 4400, market participants may be tiring of the sustained down move with choppiness in between. The result could then be at least a short term bounce. This bounce could get momentum IF the ruling Congress party wins the vote of confidence scheduled on July 22. On the other hand, if the ruling party is defeated we may well see panic like situation resulting in the free fall that should happen once 3800 is broken again. I have decsribed just one possible scenario. There are too many possibilities, including sudden declines in international markets, a sudden spurt in crude prices, increased inflation numbers due to be released on Friday, and so on.....
So, how does the trader position herself ? Today's market action - declines with a narrow range suggested that the bears may be willing to take some rest. With strong chances of a relief rally, the trader may like to close short positions, take a small long position. The short positions should be re-established if the Nifty were to close below 3800. Traders may consider using options to create their positions.
Ideally, traders should have well defined rules to take trading positions. I have outlined a scenario if you do not have such rules.

Tuesday, July 15, 2008

Nifty falls again, large risks of a free fall

The Nifty continued its trending move, falling again to new lows, breaking the 4000 level decisively, then touching and closing at 3850. It is possible that 3850 may provide short term support for the Index. Below 3850, the Nifty has minor support at 3600, then a free fall. The nearest support after 3600 is at 2600. Now, this is not to suggest that the Index will fall to 2600. I do not know. But, the absence of support suggests that we do not have any measure of a point at which the Nifty may stop falling. Worrying
An upward sloping flag in the Nifty has broken down today. A flag is usually made half way in a decline. Earlier, we had calculated that the target for the flag comes at 3170. Again, a target is just that - a mathematical measure. It may or may not come about. We must remember that it does often work out, so the probability is in favor of meeting the target.

Financial Instruments of Mass Destruction ?

Derivatives - Warren Buffet called them "Financial Instruments of Mass Destruction" . These instruments are responsible for a lot of losses - Long term Capital Management, Amaranth, Barings, Society Generale...... It is a long list.
Derivatives in different shapes are responsible for the current finncial crisis in the USA which is now engulfing the entire world.
In India, the indiscriminate use of Derivatives has caused havoc and destruction. Here is how. First, The introduction of stock futures has turned the stock exchange into a gambler's den. Lakhs of middle class families have been destroyed by losses caused by trading in stock futures - an instrument with no productive purpose. While Index Futures & Equity Options provide hedging and risk management benefits, stock futures are simply an instrument for gambling. This is the reason why no other country in the world offers such extensive trading in stock futures.
We have created gambling dens in every nook and corner of the country. At this rate, an entire generation of the middle class will be addicted to gambling (in stock futures) ,destroying themselves. When this happens, we can say farewell to the India Story. Why are we doing this ? When the badla stystem was abolished, the regulators said that this was done to prevent unwamted speculation. We were told that the system will provide for Equity Options which will enable hedging and risk management. Fair enough. Instead, the country has been gifted with the 'Mother of all Gambling Instruments' - the stock future.
Now what purpose does the stock future serve ? Nothing. If you want to buy a share, you can buy it by paying the full amount or by buying it on margin. Thus, the stock future serves no puirpose when buying. If you want to sell a share, you can sell it outright, or borrow stocks to sell. For both buying and selling, you should be able to use Options. (Thanks to stock futures, the options market has languished, with no depth.)
When both buying and selling activities can be conducted without stock futures, what purpose do the futures serve ? Nothing. They are a pure and simple instrument for gambling.
Second, Proprietary trading in derivatives by some brokerages has caused an increase in risk in the financial system with an unfair influence on the market. The more respectable brokerages do not do such trading.
These are difficult times. In order to prevent a financial catastrophe, SEBI should withdraw the instrument of stock futures & ban Proprietary trading in derivatives by brokerages.

Monday, July 14, 2008

Nifty in a Box

The Nifty again moved in a narrow range today, suggesting indecision. It seems the bulls and bears are equally matched. However, periods of indecision do not last long. The Index is now locked inside a trading range, which has resistance at 4200 and support at 3850. These are the boundaries of the range. A move out of the range should give a trending move.
The Nifty is currently at 4060. It may have to travel a lot before it manages to breakout from resistance or breakdown from support. Fortunately, another significant support has developed around 4000. Then, a breakdown from 4000 is a sell signal.
The Index is in a trading range. A sell signal had come on Friday when the Nifty broke down from 4100. A second sell signal will come if the Index breaks down below 4000. Buying is suggested if and when the Nifty moves above 4200.
Traders can set up positions in the Nifty using Nifty Futures or Options. What are these positions ? Go short below 4000. Now, there is one more trade possible. Since we have 4000 as a clear support base, traders can go long above 4000 with a stop and reverse trade if the Nifty does fall below 4000. Traders can use their discretion in deciding when the 4000 breakdown will be considered valid - If the Nifty closes below 4000 or if the Nifty goes below 4000 during intra day trading. The difference is not significant, it is important to decide on a rule, then follow it properly.

Sunday, July 13, 2008

Stagflation: Inflation with no Growth

Friday's numbers on Inflation (almost 12% - highest since 1995) and Industrial production growth (3.8% - lowest in six years) have caused a great deal of worry for the Indian Economy: Are we heading towards an era of Stagflation ? There was a period in the 1970's when infllation mvoed up to 20% + while the growth rate was at 2%. That was the period of rising crude prices with rising commidity prices. (Sounds familiar ? ). The public was squeezed between ever rising prices and a stagnant economy. It was a terrible time to be in.
Now, what will be, will be. As traders, we are not in the corridors of power. We have to protect our business of trading & our families from the ravaging effects of stagflation, should it raise its head.
One option seems to be: Gold. A thoughtful article is available here which discusses Stagflation as well as the reason why Gold may be a hedge against inflation without growth.
Traders in India should consider adding Gold to their trading list as well as their portfolios.
Gold can be traded on NCDEX and MCX as well as bought through a number of exchange Traded Funds - ETF available on the NSE. The ETF is just like a share purchase, it goes into your demat account.
New bull markets are born out of extreme pessimism. While this is true, we cannot say when the period of pessimism will be over. Just as bubbles can last much longer than we imagine, these periods of pessimism can also last much longer. The key is to keepw atching our charts for signs of exhaustion. As of now, such signs have not come in. It does appear that there is much more pain left. Hopefuly, I am wrong.

Saturday, July 12, 2008

Proprietary Trading in Derivatives: A Time Bomb ?

Lehman Brothers & Bears Stearns, two of the largest brokerages in the USA have fallen in deep trouble. While Bears has been sold, Lehman is on the verge of such a sell off. Both companies have large losses. What do these stories have in common ? Proprietary trading.

As the brokerage business moved up to become 'Investment Bank' some brokerages increased their profits by resorting to the highly risky business of derivatives trading on their own accounts.
Why should an institution (brokerage) which accepts public money do trading in derivatives on their own account ? By doing so, they put at risk the entire financial system of which they form a part. Of course, they also risk the money of their clients.
If the owners of a brokerage wish to trade, they should set up a seperate corporate entity, at arms length with the brokerage. This trading vehicle can be capitalized properly and then trade in the market by opening an account with a broker (any broker).
Fortunately, most Indian brokerage houses do not do any kind of derivatives trading for themselves. Just to be on the safe side, clients should ask their broker: Do you trade derivatives on your own account ? If the answer is : Yes, then quickly close your account with the broker, withdraw your money and go to another broker who does not do any proprietary trading in derivatives.
Why is this issue discussed today ?
The improper use of derivatives has caused large losses all around the world. Barings bank, Long Term Capital Management, Society Generale, are just a few of the big names. Currently, the entire financial world is reeling under the weight of losses in derivatives. In such circumstances, it is wise to be prudent and prevent such events from occuring in india.

Manipulating the Markets

On Friday, the US markets were seeing a sell off on news that Fannie Mae and Freddie Mac (both housing finance giants) were on the verge of bankruptcy. The Dow was down 225 points, below 11000. Suddenly, a rally started which took the Dow into positive territory. The rally did not last as the Dow fell again to close 125 points lower. But, what happened ?
The Blog, Bigpicture says: Go figure: In the midst of a deep selloff, a bullish rumor seems to have been planted that would allow for the rescue of Fannie Mae (FNM) and Freddie Mac FRE).
The rumor was wrong as the Fed denied any such move, but the market had been manipulated.

Friday, July 11, 2008

The Nifty has a big move - It is Down!

On Thursday, I had suggested that the Nifty has a technical pattern that suggests a big move is coming. Today, Friday, that big move has come. The Nifty opened almost unchanged then fell steadily to go below 4115 to activate a sell order (see my previous post: The Nifty is ready for a big move). The Index made an intra day low of 4014 before a quick rally brought it to 4062 where it closed.
A Day trader who sold at 4115 would have made money. A position trader will be carrying his short position over the weekend. Chances are that the Position Trader will be able to catch a significant down trend since it does appear that the Nifty has started on its down move after a brief corrective rally.
The daily chart for the Nifty shows an upsloping flag. Such flags are made half way in a down trend. A rising flag comes in a down trend. The flag gets confirmed if the Nifty closes below 4000. The current leg of the down trend started at 4680, then touched a low of 3850, making a total move of 830 points. From the breakdown point at 4000, this gives a downside target of 3170. Now, a target is just an estimate, it may or may not come about.

I hope to add more posts over the weekend, so keep visiting.

Thursday, July 10, 2008

The Nifty is ready for a Big Move

The Nifty has made a significant chart pattern today which suggests that the Market is poised for a big move - up or down. The pattern does not predict the direction of the move, but a big trend is likely to com , that is almost certain.
The pattern is: A narrow range day combined with a DOJI. The narrow range day suggests indecision in the market, neither the bulls nor the bears could move the market much, keeping the market in a narrow range. The DOJI suggests - you got it - indecision, where the open and the close for the day were nearly the same suggesting that neither bulls nor bears could move the market in their direction.
Now, this state of equilibrium is not going to last for long. Either the Bulls will have it, or the Bears. Short term traders should go with the winners in this skirmish. An easy way to follow the leaders is to buy above the highs of today - above 4185, or sell below the lows - 4115, whichever event happens.
Early warning on how the market may behave will be available tomorrow morning when Infosys announces its Q1 results. The stock price has gone up from 1250 in April to 1800 currently, in anticipation of better results. If Infosys guidance is not optimistic enough the market may not like it.

This is my second post for the day. Just below the post that you are reading is the first post : The Nature of bear market rallies.

Nature of a Bear Market Rally

Bear Market rallies are sharp & vicious. This happens for two reasons. First is the bears who are caught unawares at a suddenly developing rally. They rush to close their short positions which fuels the ally even more. Second is the undying optimism of the masses. Every time there is an up tick, the retail trader thinks this may be the start of another super bull market. He then rushes to buy, hoping to catch the very lows.

Eric Roseman, blogger, (http://rosemanblog.sovereignsociety.com/2008/07/bear-market-ral.html) says: Bear market rallies tend to be awfully convincing. Previous bear market rallies from 2000 to 2002 resulted in big single-digit gains for global stocks. But gains were savagely cut as investors eventually headed for the exits at the same time as the economy deteriorated until prices finally bottomed in October 2002. But by then, the MSCI World Index had plunged more than 50% from its March 2000 all-time high and the S&P 500 Index more than 40%.

More cheer comes in from News Corp. Chief Rupert Murdoch who Says He's `Very Bearish' on Economy as food and energy prices rise for consumers. . Bloomberg.com quotes him : ``Every country in the world has serious food inflation and then of course you've got the same thing with energy,'' he said. ``It's really squeezed.''

Bloomberg again. If you want to know how capitalism committed suicide read this: http://www.bloomberg.com/apps/news?pid=20601039&sid=a11PeBn6TV8A&refer=home

What is Fannie Mae and Freddie Mac ? These are two companies in the USA which are the biggest providers of financing for U.S. home loans. Something like the State Bank, National Housing Board, HDFC & LIC taken together, only much bigger. Both these comapnies are now bankrupt since they have more laibilities than assets. It does appear that the American Economy has more downside left as new problems crop up.

Wednesday, July 9, 2008

A Relief Rally, finally

After six days of volatility, the Nifty gave an impressive performance today, gaining almost 150 points to close at 4160. The Index had made a pivot low at 3850 last week. Since then it has held on to this low. Six days of volatile action also created a trading range between 3850 and 4100. The Index today successfuly broke out from this range, closing above the 4100 resistance. Based on the width of the trading range (4100 - 3850) we get a target of 4350 for the Index.
This is a bear market. Even bear markets should see corrective rallies. The current up move is one such rally - call it a relief rally.
It is possible that the current rally may continue and could in fact be the first leg of a new bull market. After all, in this world, anything is possible. But, we have to wait for a pattern of higher highs to say that the bear market is over. Such a pattern will emerge if and when the Nifty moves above 4350 and also closes above it.
Investors should wait for the first signs of a bull market - higher highs. As explained above, this will occur if and when the Nifty moves above 4350.
As I write this, Bloomberg says:
Profit at S&P 500 companies declined 11 percent on average in the second quarter, according to the average estimate of analysts surveyed by Bloomberg. Income is projected to slump 60 percent on average at financial companies.
It does apear that similar news items will eventually appear in the BRIC nations, specially India & China. In India, bear markets last for two to three years. We are just six months in such a market. I assume there is much more pain ahead.
The chart for Crude Oil suggests that a pullback to $121 is possible. Why 121 ? A 38.2% retracement of the current up move brings crude prices to $121. Such a pullback will be normal. The bull market in crude will NOT end if it corrects $25.

The Samajwadi Party says it is supporting the Congress Government without expecting anything in return. Mr Amar Singh, the Samajwadi party spokesman said this.

"SOMETHING FOR NOTHING"
Words by Neil Peart
You don't get something for nothing
You don't get freedom for free
You won't get wise
With the sleep still in your eyes
No matter what your dreams might be

Tuesday, July 8, 2008

Out of the frying pan into the fire

If you get out of one problem, but find yourself in a worse situation, you are out of the frying pan, into the fire. (http://www.usingenglish.com/)
This applies to two different issues facing Indian Investors - the political crisis at home and rising Crude prices.
The Politics of Support & withdrawal of support.
The Four Left front parites with 60 MP's in Parliament finally withdrew from the government coalition today. Their loss was compensated when the ruling Congress party negotiated with the Samajwadi Party led by Mr Mulayam Singh and Mr Amar Singh, with 39 MP's.
It is reasonable to expect that the support will come with strings attached. There is likely to be more of horse trading, instability and measures that seem to help the public but actually help just a few select individuals. At some point the Samajwadi Party is likely to make life so miserable for the Congress party that they (Congress) will begin to think of Mr Prakash Karat & Company as benevolent angels. Then, for the nation, it is a case of "out of the frying pan into the fire."
Crude Falls after many weeks
Surely, this piece of information should be good news for crude importing countries like India. Unfortunately, not. Bloomberg leads with the heading : "Oil Falls as Economic Slowdown Concern Sparks Commodity Selling "
This is our worst nightmare come true. Crude prices falling not because of increased supplies, but because demand falls. Gold, soy and corn and aluminum declined today. Not just commodities, equities fell in Asia & Europe amidst concern that the world economy is may slow further. Now we have a scenario where India gets hurt when crude prices go up (inflation), and it gets hurt when crude prices comes down (recession).
The curse is upon me cried the Lady of Shallot
This line is from the poem "The lady of Shallot" by Tennyson.
Well, for TV viewers, the curse has come upon them in the form of the start of the Quarterly earnings season. All business channels will feaure serious looking analysts doing what they do best - analyze. Every number will be dissected till the TV viewer grabs the remote and switches to news where he sees another group of serious looking analysts - analyzing the political situation.
Here are three starting Q1 results:
Infosys: July 11
TCS: July 16
Wipro: July 18
What will the Q1 results tell us ? That the economy is grinding to a halt ? It is not. That corporate earnings are improving ? Maybe. I feel that Q1 will tell us next to nothing. It is Q2 and Q3 results which will tell us if the corporate sector is feeling the pinch of slowing demand and rising prices. This also means, Q1 is not expected to give any negative surprises. If such surprises do come, the Market may not like it.

Monday, July 7, 2008

Not a Friendly Neighbourhood Bear

The Nifty opened higher, almost a gap of a 100 points, then slid during the final hour of trading, to close virtually unchanged at 4030 (Friday's close at 4016).
The Nifty now seems to be in a well defined trading range between 3850 and 4100. The Index has spent five trading days inside this range, giving this trading range some credibility.
When we see a trading range develop, trading becomes easy. A breakout above the resistance (4100) is a buy while a breakdown belwo the support (3850) is a sell. Short term traders should follow this while trading the Nifty.
Here are some snippets of information to cheer you.
A report by Morgan Stanley titled: "How long will the bear market last" says:
Sentiment is very weak and is best reflected in how poorly India has fared relative to emerging markets. This is about the worst performance in more than a decade on a year-on-year basis. However, domestic households seem convinced that equities have to be bought and not sold. We think for the market to bottom-out, these investors need to panic.
That's not all. Here is some more:
The currency is depreciating, growth is slowing, crude oil prices are rising and inflation is at new highs. This is a bad macro recipe for equities. ........ Ultimately, for the markets to bottom, crude oil prices need to decline, global risk appetite has to revive and help the Indian currency and thus stop long bond yields from rising.
[My Notes: So who is going to order crude prices to come down, force global money to India & reduce inflation ?. Will it happen by executive order ? ]
But, there is good news also. The report says:
For genuinely long-term investors, cash flows (i.e., dividends) are now available in several parts of the market at a reasonable price.
UK feels pressures of recession
A bloomberg report says:U.K. manufacturing unexpectedly contracted in May to the weakest in eight months, choked by record commodity prices and slowing economic growth. .......``The outlook for the economy is clearly deteriorating and the risks of a recession are rising,'' said Nick Kounis, an economist at Fortis Bank NV in Amsterdam
Britain's economy is at risk of falling into a recession as house prices slump and surging oil prices squeeze purchasing power. Marks & Spencer Group Plc lost a quarter of its value on June 2 after saying trading conditions won't improve for two years.

DEMOCRACY
The Political Drama in Delhi is simply astounding.
It is said that the people of a country get the government they deserve. What did we Indians do in our past lives to deserve this ?
All of the above no doubt makes cheerful reading, just before bed time. Here is a ZEN story to make you feel better.
Maybe
There is a Taoist story of an old farmer who had worked his crops for many years. One day his horse ran away. Upon hearing the news, his neighbors came to visit. "Such bad luck," they said sympathetically. "May be," the farmer replied.
The next morning the horse returned, bringing with it three other wild horses. "How wonderful," the neighbors exclaimed. "May be," replied the old man.
The following day, his son tried to ride one of the untamed horses, was thrown, and broke his leg. The neighbors again came to offer their sympathy on his misfortune. "May be," answered the farmer. The day after, military officials came to the village to draft young men into the army. Seeing that the son's leg was broken, they passed him by. The neighbors congratulated the farmer on how well things had turned out. "May be," said the farmer.

Saturday, July 5, 2008

A DOJI after a sustained Down Trend

Doji candlesticks have the same open and close price or at least their open and close prices are very near each other. Doji suggest indecision or a struggle for positioning between buyers and sellers. Prices move above and below the open price during the session, but close at or very near the open price.
Neither buyers nor sellers were able to gain control and the result was essentially a draw.
In the NSE, a number of stocks in the Futures & Options Secment made DOJI patterns on the weekly chart, for the week ending on July 4. Some of the names are: ABB, APIL, AURO PHARMA, BAJAJ HIND, .......
What's going on ? The Nifty has been in a bear market falling from 6350 to 3850, going down week after week. Now, in the week that just ended, a number of stocks have made DOJI patterns suggesting indecision. Indecision on what ? Since the current trend has been down, the DOJI patterns coming at the lowest point of the down move (so far) tell us that the market has suddenly become indecisive on further down moves.
This, then is an initial sign of a possible reversal of trend. The signs are not enough. if prices fall below of the DOJI candles, the indecision is removed as the trend becomes down again. But, after a long period, some stocks are saying: We have a DOJI, maybe we will change the trend to up.

Salute on the American Independence Day

Exceprts from the Declaration of Independence of the Thirteen United States of America:
[The basic principles of democratic society]
We hold these truths to be self-evident, that all men are created equal, that they are endowed by their Creator with certain unalienable rights, that among these are life, liberty and the pursuit of happiness.
[Governments are created to serve the people]
That to secure these rights, governments are instituted among men, deriving their just powers from the consent of the governed.
[A despotic government must go]
That whenever any form of government becomes destructive to these ends, it is the right of the people to alter or to abolish it, and to institute new government, laying its foundation on such principles and organizing its powers in such form, as to them shall seem most likely to effect their safety and happiness.

Thursday, July 3, 2008

Friday is Inflation Day

For the past few weeks, the stock market has been watching Friday's inflation numbers closely. Suddenly, inflation seems to have become to Indian markets, what the Fed is to the US markets.
For tomorrow, CNBC reports that the consensus number is 11.44%. . These numbers are reported at 11:45 AM. For day traders, it is wise to have zero positions when the numbers are flashed over CNBC.
For the US, Bloomberg starts off with this news item:
U.S. Economy: Employers Cut Payrolls for Sixth Straight Month
This remains another sign of the US under coming under recession.
The Nifty made a pivot low on Wednesday, at 3850. If this low breaks, we again have a continuation of the lower low pattern, suggesting more weakness ahead. As the Index closed at 3920, it is within striking distance of these lows. If by chance the Nifty does manage to move up, keeping these lows intact, then a change in trend will be assumed if the Index closes above 4350. Between 3850 and 4350, trading opportunities are limited since the market may remain volatile and uncertain.
Technical traders should look at the weekly chart for the Nifty. The Bull market saw the Nifty move up in a straight line advance from 2500 to 3600 in 2006. Week after week, the Index went up, with no correction or dip inbetween. Such straight line advances create a vacuum. When the market begins to move down, it encounters no significant support since such support was not created on the way up. This is the worry if the Nifty were to break below the 3600 - 3700 zone. We could be looking at a free fall.
If 3850 holds, we may be looking at a period of choppy market movment as Q1 results start coming in from July 7 onwards.
Gains made in the market in coming days will not signal the start of a bull market. The bear market is barely six months old. It is probably not over. Then, bull markets start after a prolonged period of base building, probably months or even years. Therefore, rallies should be used for short term trading or even selling at higher levels.

Wednesday, July 2, 2008

Smart Rally in Stock Market

The Nifty made a new low today at 3848. 25, but what is significant is that it rallied from these levels with gains of nearly 200 points during the day itself. Today's market move should qualify as a bullish reversal day. Now that a low is in place, we will soon find out if the bulls have enough strength to provide support at this low.
The short term trend is UP today after this bullish reversal. The Index needs to close below 3848 for this trend to change to down. We now have a pivot low against which we can compare the movements of the Nifty. So far as 3848 holds, the short term trend should be up.
The Intermediate trend remains down. One day cannot change this trend to UP.The last minor high was made at 4325. A close above this pivot will change the intermediate trend to up.
Is this the start of a new bull market ?
Well, considering the pessimism that prevailed even today in the morning, a four hour rally cannot change the overall trend of the market. Fortunately, the Market can answer this question by moving up and closing above 4325. We wll then assume that the down trend is over.
Is this a bear rally ?
That's what we assume so far the Nifty remains below the last pivot high at 4325. Once this is taken out, we classify this rally as the first leg of an up move.
If I wait for 4325, then will I miss all the up move ?
Why should you think so ? If this is the start of a new bull market, then surely the Nifty will go much higher than 4325. If this is a bear rally, then by waiting it is possible to avoid an unneccessary whipsaw.

Tuesday, July 1, 2008

Blame it on Crude Prices

This is a bear market in full form. The Nifty closed below 4000, today, at 3896.75 to be exact, a 15 month low. The Index was down 3.56%.
Technical Analysis teaches us that new highs should be bought, while new lows should be sold. As the Nifty keeps on making new lows, selling opportunities arise. Now, the last of these sales will be a losing trade. This will happen when the Nifty begins its up move after making a short term low. A loss in a short position will be the first sign that the short term trend is changing to up.
On CNBC today morning, Udayan Mukherjee gave an excellent presentation of the excuses given by analysts when the markets do not behave according to their wishes. Instead of accepting that the market is supreme, the analyst provides some reason why the market did not do what the analysts said it will do. During the bull market the reason why stock prices were going up was "Liquidity". For the Technical Trader like me the reason was: Bull markets will see higher prices as the trend is UP. But, for the fundamental analyst, this would mean that the market knew more. So,the reason became "Liquidity". Now, as the market plunges down, day after day, the reason is: Crude Prices. The analyst tells us: everything would have been fine but for higher crude prices. Blame everything on crude. India is facing political uncertainty - because of higher crude. World markets are falling - due to higher crude prices. The sub prime crisis - thanks to higher crude. Real estate stocks in India have come to 25% of their highs - blame it on crude prices. The fact is that crude prices are just a small part of the bear market. Markets are falling because there are more sellers than buyers.