Trading Steps

The blog Global Economic Anaysis highlights many of the news headlines on current topics. Some of them are:

Japan’s Factory Output Falls as Turmoil Hurts Exports
LandAmerica Goes Bankrupt
Lead Falls to Two-Year Low as Auto Demand Slumps; Copper Drops.
Housing is bad enough, but wait — it'll get worse
China downturn deepens, European rate cut sought
Malls, hotels next victims in new mortgage crisis.
Woolworths Near Collapse, Risking 30,000 U.K. Jobs
Shopping malls are running on empty
Satellite Halts Hedge Fund Withdrawals, Fires 30 After Losses
FDIC adds 54 more banks to its 'problem list'
Survey says Texas manufacturing outlook is bleak

I think you get the idea. News in this blog is about recession and depression.

Well, there is one more news item in Bloomberg. This headline says:
Stocks in U.S. Climb; S&P 500 Index Posts Biggest Weekly Gain Since 1974

So, what's going on ?
Possibility 1. The Markets have already discounted the bad news. The bear market is over.

Possibility 2. The markets are going through a bear market rally, probably disconnected with the 'real' world. This happens often. (Example: the boom in real estate stocks in India. Since 2006 September, I have been saying on CNBC - "the real estate stock price boom cannot be sustained. Share prices are going up on the wrong premise that companies will buy land for pennies, then sell it for millions. The business model is flawed because land is a very sensitive issue in India. But, brokers and fund managers went on singing the praises of these stocks. They were completely out of touch with the Indian environment.)

My own understanding is that we are in a bear market rally. More details in my previous post, here

Here are my views on the Market, short term & the long term trend.

Short Term
The Market moved in a narrow range on Friday, Nov 28. The narrow range suggests that the Market is undecided on its direction. It will soon come to a decision, and that may well be a decent move. Since the minor trend is up, a breakout above 2780 is likely to be a sign of some more steam in this up move.

Long Term
Bear markets end with a process of base building. This process is NOT visible on the charts. It may well happen, if the Nifty were to spend time in the current trading range , which is between 2500 - 3200.
Since there are no patterns yet that confirm the development of a trading range, we assume that the primary trend remains down. This means, there is the possibility of another down move that could take the Nifty below 2200.

How do you trade ?
The strategy is different for traders and investors.

For investors, the end of the bear market is not visible. Buy only if you cannot resist entering the market. Invest only a small part of your available funds. If you have momentum stocks, switch to blue chips. Remember that the favorites of the last bull market may not be favorites in the next bull market.

For traders, going with the intermediate trend is the best way to trade. As I write this, the intermediate trend is down, but the minor trend is up. Then, look for short term opportunities to buy. Also, on any signs of distribution, go for short selling, or, stay away.

While Indian Markets have been indifferent for the past three days (excluding the holiday today), world markets have been moving up. This is what The Big Picture says:

We have now had four days in a row of a higher market, something we have not seen since June this year. This is also the S&P 500 Index’s biggest four-day surge (+18.0%) since 1933.

..... Interestingly, according to Bloomberg, Société Générale global equity strategist James Montier said he’s never been so bullish after the financial crisis dragged down prices of stocks, corporate bonds and inflation-protected government debt.

.....Although there is as yet little evidence that we are leaving the corpse of the bear behind (especially with Q4 earnings disasters looming in January), it would appear that the nascent rally could have more steam left.

My Notes: Will we have a rally ? The answer should have been 'Yes', but Mumbai events have cast a long shadow over the Indian Market. There may be unpredctable consequences which we cannot foresee now. Therefore, my suggestion is to wait out any further decline in the market. Short selling is not a good idea. Traders should look for some kind of consolidation / V reversal and then consider buying.

Sector Rotation may give some ideas on when the Market is bottoming out. While there are no surefire rules, experts suggest that Technology will usually be the first sector to bottom out. Thus, tech stocks may start building a base even as the rest of the market is falling.
As the bottom approaches, we may see relative strength appear in banks & financials. While it still may lose value, it moves from a market laggard to a market leader to give us a sign that things are beginning to change.

Readers may have surmised the essence of this note: Financial and technology sectors should be the areas leading the market out of the bear grip. Relative strength + base building in these two sectors should start giving us warnings on the possible end of the bear market.

A bear market rally on the other hand, may see gains accross the board, with sharp, wild up moves. This could give us some idea that the up move is not the beginning of a bull market.

Not as easy as ABC

Identifying the start of the next bull market is not so simple. The best financial wizards of the world have failed miserably in doing so and protecting the money of millions of people. If they can fail so spectacularly, individual investors can be excused for getting some ideas wrong. The point is to try and be a market follower, not try to teach the market.

How do people become successful ? One study suggests that practice makes perfect. The tennis star plays tennis , practices tennis every day. He / She then becomes a champion. The same applies to doctors, lawyers, and, of course, traders. About 10,000 hours (ten thousand hours) of practice is the minimum required to acquire the chosen skills.

I have a comment which says:

"am no big shot trader, so may not be able to do detailed chart analysis etc. "

There is no relationship between big shot traders and chart analysis. Also, the definition of big shot traders is not clear. Were the people in Lehman Brothers big shot traders ? They probably were so, but you may not want to follow them , given the fact that they bankrupted their company.

To my understanding, technical analysis is the ONLY viable method for short term trading.

Therefore, if you wish to be a trader, you have to understand, practice and acquire skills in technical trading. Be prepared to give 10,000 hours for the practice, before you become skilled.

Some new posts are:

This bear market may last longer than Expected

Review of suggested safety portfolio

Practical technical Analysis - Inside Bars

The bear market started in January 2008 when the Nifty made its all time high. We have seen ten months of a down move, the bear is now 10 months old. Is this enough ?
With some regret, I have to say that the bear market is likely to last longer than we imagine. Here are many reasons for this contention.

First, History. The last two bear markets started in 1992 and 2000. The 1992 bear market bottomed out in 1993 while the 2000 bear market botomed out in 2001. After making the bear market lows, both markets spent a lot of time base building.

Second, Bases. The 1992 bear market saw almost all sectors participate in the 'harshad mehta' rally. The resulting bear market was prolonged bcause all sectors were hurt. The market took a long time to build bases before reaching out to new highs. The 2000 bear market was mainly a Tech crash. The so called 'old economy' stocks had not participated in the rally. They were quitely building strong bases even during the IT boom. After the market crash, the 'old economy' socks took up leadership quickly as they were already in the process of base building. The bear market lasted for three years with an unprecedented bull market starting in 2003.

Where are we now ? The 2003 - 2008 bull market was similar to the 1992 bull market where all sectors of the stock market participated. Now, there is no leadership left. All of the sectors must go through the base building process. This will take its own time.

What is the chart for the Nifty looking like ? It shows a straight line decline. Where is the base ? This market will take its own time to revive. Meanwhile, we do not know if the market has bottomed out. Thus, there is a lot of pain probably left. Take care.

With the NSE closing at 2700, also its high for the day, the US markets closing with 5%+ gains, there is the strong possibility that Monday could see a follow through rally. Any up move could see resistance at 2900. At this level, some profits should be taken.

How to Trade:
My suggestion is to go long if a buying signal comes in.
Traders can use the The Fifteen Minute Rule to enter. A second method is to wait patiently for the markets to go thorugh an intra day dip. Buy this dip, with a stop below the day's low.

The Market is extermely oversold. Now, this means nothing since an oversold market can get even more oversold. But, for traders, given the slight indications of an up move, short term buying may be easier for the next 1-2 days.

What do most accomplished traders have in common ? They enjoy the process of trading. The net result - profit or loss is important since trading survives only if it is profitable. But traders do not trade for money. They trade because they enjoy in the building up of trading rules, in its execution, in research. For a trader, if you have followed your rules properly, your trading has gone well. Profit or loss is in the hands of the market.

I give this background since I received a comment that said:
"Hope you recollect my earlier posts wherein I said "Before touching 3350,Nifty likely to go to within 3-5% of Oct lows" How accurate? But the sad part is during this period only I lost 15K due to erratic/excessive trading in put options with tight stop losses."

Nothing sad about it. This is good news. The writer is aware of his/her trading problems. It is only a matter of time before he/she can solve these issues. Do not worry about the results. The market takes care of that. Worry about the process of trading. Are you defining your rules. ? Are you doing research ? Are you following your rules with discipline ? Are you afraid of losses ? Are you overleveraging ?

The Nifty fell to 2500 before recovering a bit to close above 2500. Compared to most world markets, the Nifty did better, actually losing less. I am not sure if this is any consolation to investors who have seen almost 80% of their capital vanish.

The Test has come.
When the Nifty closed at 2525 on October 27, and subsequently rallied, there was a sense that the Index will fall again for a 'test'. That event has now come about with the Nifty falling again to 2503, today.

How will this test occur ?
First, The index should hold the 2500 lows. This will happen if the Nifty does not close below 2500.
Second, slowly, steadily, the Nifty needs to rally and eventually cross 3240, the pivot high made after the October 27 decline. This could happen fast, or it could take its own time. That's not a problem. In fact, the more time it takes, the better.

What do you do while the 'test' goes on ?
First, we need to understand that this is a bear market. Momentum clearly favors more downside.
Now, with this understanding, traders may buy when there is a buy signal on intra day charts. Keep a stop, plan to take profits if there is a move in your favor.
Going short is more difficult, although the trend favors short sellers. The difficulty lies in keeping wide stops. If you go short with tight stops, chances are you will be stopped out. Consider going short after a short term rally that lasts 2 to 3 days. Will such an event occur ? The answer is yes, sooner or later.

NIFTY WATCH
A breakdown in the Index may occur below 2500, probably leading to another free fall all the way to 2200. A rally will face resistance at 2600, then 2700, then 2900. At this point, the Nifty faces significant resistance at 2900, although these levels will change with time.

Does Technical Analysis Work ?
The answer is Yes. Recently, the Nifty was inside a trading range between 2900 and 3200. I had suggested that the Nifty will have a target of 2600 if the 2900 support breaks. the support did break, and today's Nifty low was 2503. The issue is: Can you trade on my analysis ? The answer is no. Trading is finally an activity that requires confidence. You have to develop your own rules. You can use inputs (example: my analysis) to clarify your rules, but the eventual decision should be yours.

The world markets are volatile, directionless, confusing to traders. Yesterday, the Dow was trading minus 150, then suddenly, a last hour rally saw it move up by 300 points. What is such market movement telling us ? Volatility inside a bear market is NOT bullish. The message may well be: there is more downside.

Why ? Because a bull market starts when the markets literally go to sleep. Volatility falls dramatically, the daily, weekly, monthly ranges contract. People forget that the stock market exists. An increase in volatility, as we are witnessing now, is giving quite the opposite message.

NIFTY WATCH
The Nifty closes near to the 2525 close made in October. Is this a test of the lows ? It may well be, although the momentum suggests that this is a bear market rather than a friendly 'test'. Any rally in the Nifty will face resistance at 2900. If and when the Nifty closes above 2900, the next resistance is at 3200. A new bull market should start if the Nifty were to close above 3200. This seems like a tall claim, as of now.

Inside such a strong down move, the wise trade is to go with the flow, which is down. Any up move will be corrective in nature, and, corrections cannot be easily traded.

A close below 2525 will take the Nifty into new closing lows for this bear market. That is a sign of more downside. It is possible to assume that the Nify may eventually touch 2000, or even go lower. There is no rush to buy. Wait patiently.

What should I do with my investments ? Many market participants have asked this question. Here is my view:

Investment in shares is part of your total investment planning. You may have a plan that goes like this:
50% of liquid funds to be invested in shares
(this should be reduced to 40% when the market is in a strong bull grip. It should increase to 60% when you perceive the market is in a bear grip)

Now, we assume that the current market scenario may well be called a strong bear grip. having a plan makes the decision process easy. If your current investments in shares are more than 60% of your liquid assets, then you have to bring it down to 60%. You need to sell on rallies. On the other hand, if your investment is less than 60%, then you can add whenever there is a panic decline.

This is about asset allocation. The percentages given here are only indicative. You should modify them to suit your own needs.

Now, many participants purchased shares for making a quick profit. they are stuck with these shares which have suddenly become a long term investment. Trading must always have stop losses. if you still own these shares then you did not follow the stop loss rules. If you are one of these traders, ask yourself: what do you do when you make a mistake ? You should seek the answer to this question. Each trader will get an answer that suits his/her mental attitudes.

The Nifty fell again (this seems to become a daily routine) to close below 2700. the Index has returned to test the lows made three weeks earlier.

A test is a determination of strength - in this case - bearish strength. If the bears are strong, the 2525 closing levels will break and the test will fail. If the bears are weak, the 2525 close will hold, the test of strength will succeed, telling us that that the 2525 close may well become an intermediate support.

We have to wait patiently for this process of testing to be complete. Markets do not move on demand. The Nifty closed at 2683, so a rally is possible before another decline. Also, today's lows may by themselves represent a test. the index does not have to go and touch the same levels exactly.

A close above 3148 will test us that the Nifty has undergone a successful test and may be ready for higher levels. As time goes by these levels will change but that has not happened yet.

How should the trader approach the market now ?
Go with the flow, which is down. Avoid selling after many down days. (For example we already have 5 down days). Wait for a rally to sell. if you are uncomfortable with selling, then stay away. Buying should be done mainly for day trades.

The primary trend of the stock market is down. This means we are in a bear market. The Intermediate trend is down, when we made lower highs and lower lows. Traders should follow the intermediate trend. The minor trend may change from up to down and down to up. Given the volatile conditions, the minor trend is not easily traded.

How do we then trade the intermediate trend ? The answer is: go short if the Nifty makes a high which is below the last high made at 3180. This will confirm a pattern of lower highs, lower lows. Another sell short opportunity comes in if the Nifty breaks down below 2700 support.

The intermediate trend will change to up when we have a pattern of higher highs, lower lows. This has not happened yet.

My earlier post, 'Udayan in Amritsar' can be read here

G20 meeting
The G-20 leaders have met in Washington. Will the meeting solve the economic crisis ?
Bloomberg reports:
The G-20 leaders, representing 90 percent of the world economy, blamed the crisis on investors who "sought higher yields without an adequate appreciation of the risks."
Response from globaleconomicanalysis :
Banks and brokerage packages sold poison apples. The G-20 is blaming those who bought poison apples not those who knowingly sold poison apples.

Surely these bailouts will help ? The answer seems to be, not really. The Price of everything says:
We are only just entering synchronised global recession. For the immediate future, bracing for further asset deflation and concentrating on capital preservation are the core priorities. But with every announcement of a further government bail-out to be paid for by future tax-payers, sceptics might rightly wonder whether a crisis brought about by easy credit is going to be resolved by more of the same.

CNBC had an Investor Camp in Amritsar on Saturday, Nov 15. The camp was sponsored by Angel Broking. I was in the Camp to give a presentation on : 'The Dream. How to become an investor or trader'. Udayan Mukherjee was moderating the progam. Participants were asking question in Hindi which seemed to be the preferred language. My presentation was in Hindi, while Ashwini Gujral spoke in Punjabi (that was fun). In response to a question, Udayan gave a well reasoned reply in Hindi. His proficieny in spoken Hindi was appreciated.

On Sunday morning, I found Udayan in traditional Indian attire - Kurta with Chooridar. He was going to the Golden temple to pay his respects. Good for him.

Udayan is probably one of a rare breed of analysts who have a clear, keen understanding of the markets. Listening to him could have saved you from ravages of the bear market that many investors are facing now. I am sure readers listen to him carefully. The point is: you also have to implement his advice if you agree with it.

Markets will be with us. There will be many opportunities for investing and profits. Be disciplined, listen to your mentors, then act accordingly.

[I had the opportunity of worshipping at the Golden temple, as well as the Durgiana temple, both places provide the worshipper with a sense of peace and harmony.]

While we enjoyed a well deserved holiday on Thursday, the US markets went through some ineteresting phases. With a big decline on wednesday and then an equally big rally (a bit more) on thursday. We start trading with the most markets covering up their losses.

For short term, momentum traders, this is indicative of an up move. Do not try to go short today, or even next week while this up move continues. Eventually, resistance will emerge around 3200.

For Investors / Position Traders, such choppy markets are confusing. This is a pity, but we have to accept what the markets tell us. The markets are telling us the primary trend is down, with a lot of volatility that is virually un-tradeable. If you are an investor, buy on panics with a 3 to 5 year time horizon. Invest small parts of your capital - since there can be many panics. For position traders, in theory it is possible to buy during panics, and sell on rallies. In reality, this is not easy to do in volatility. What defines the end of panic ? Not clear. Yet, with stop losses, small volumes such trades can be taken. Some of them will result in getting stopped out - so be it.

More weakness is likely in the market. This anticipation is not only due to earnings downgrades, or falling indirect tax collection.

While these factors do influence the maket, there is some fundamental change taking place the world over. Twenty years ago, the Berlin wall came down, heralding the demise of communism. This changed the world. The credit crisis is leading similar changes in the world economy. It appears that the excesses of crony capitalism will now be corrected through a reversal process - more for the people, less for the billionairs.

The stock market is already adjusting itself to the new era. But not all adjustment can be made in advance. Price earnings will be rerated, many sectors will see significant government ownership, focus will shift on fair deals for the people even at the cost of lower growth. In the long run, this will be beneficial to the markets since what benefits the country will benefit the market. But the adjustment process will be painful. More so because the investment bankers who control the money have ostritch like thinking. They have buried their heads inside a world of their own imagination - refusing to see reality.

My point is: there may be more downside. At some point, the markets will revive. But the gains seen in the 2003 - 2008 bull market were exceptional. We may not see similar gains in the coming years. That's fine, since traders should hope for steady gains rather than volatile earnings.

When the US markets gave away their early morning gains to close lower, we did assume that India will also fall. But today's decline was far more than what other markets were going through.
The Nifty closed at 2938.65, down a whopping 6.66% below yesterday's close (3148.25). The downside momentum is very strong. Any and every adverse news immediately pushes the Nify down.
I assume that the intermediate up trend is complete. We have a pattern of lower highs in the minor trend, with the first high at 3240 and the lower high made yesterday at 3161. This is bearish.

While the uptrend will resume if and when the Nifty closes above 3240, we assume that the primary trend - down will assert itself. Look for a test of 2700 support. If this fails to hold (chances are the support will break) then we are looking at 2000, or even 1600.

After a reversal day recorded on Monday, October 27, a greater than 3% gain was recorded today (November 10). Does this provide the much needed confirmation for the start of a bull phase ?

Today's gain came with lower than average volume. This does not provide the neccessary confirmation. The gains should have come in with higher than average volume. In fact, a similar pattern was developing in the USA, and gains did not have volume confirmation.

The intermediate trend remains up. This is the trend that traders should be following. We should never anticipate turning points against momentum. This means, when the markets are moving up, we do not decide where the up trend will stop. We let the market tell us when it wants to reverse.

A bullish pattern seems to be developing in the Nifty. This is an inverted head and shoulder which has bullish implications.A close above 3240 will confirm this pattern. A similar pattern was under development when the Nifty was in the 4200 - 4500 range, but confirmation did not come in and the pattern was eventually cancelled. If this pattern foes get confirmed, the targets may be 4000+. Now, once again, we let the market do the talking & the thinking.

My point is: while momentum favors the bulls, go with long positions. Avoid going short. When short term trend turns down, then exit long positions.

Have Fun!

Monday markets are trending - up. This is no surprise since the intermeidate trend has been up for two weeks. Last week saw a correction in this up trend when the Nifty fell from 3240 to 2900. This should be considered as a 'healthy' correction.

The primary trend is down. We are in a bear market. This suggests that the intermediate up trend should face resistance around 3300, and then around 3500. I would expect 3300 to be significant resistance.

If you are long today (and, you should be !) then the position or part of the position can easily be carried overnight. More in the evening.

Have Fun!

The market continues to exhibit excessive volatility. The Nifty recorded a low of 2860 at 1320 hours. A rally then started, which saw the Index move upto a high of 3005 at 1445 hours. This is a gain of 145 points in 1 hour and 25 minutes. The gain is five percent (5 %) in 85 minutes. This 5% is not for some penny stock, it is for the blue chip Nifty 50. That's not all. The Nifty then proceeded to fall, this time back to 2875, in 25 minutes (at 1510 hours). This is 5% up and 5% down, a 10% move in just two hours - for the Nifty which is considered the barometer of the nation's economic health.

The market is now behaving like a casino. This is worrying ! Such volatility is usually a sign of impending disaster. I hope I am wrong.

Actually, this is good news. After many days of almost free for all movements, classical chart resistance seems to work. This should also mean that chart support levels will also be respected.
For weeks altogether, the market has moved almost like a drunken elephant, without any clear direction. Finally, the market is adjusting to the new reality of lower prices, cooling down, and, accepting the 'normal' support and resistance levels.

There is strong resistance in the 3200 area. Today, the resistance held, with the Nifty closing below 3000, losing almost 250 points from its intra day high. This is a lot, almost 8%.

Too much Volatility

The market continues to exihibit far too much volatility preventing any kind of low risk trading.
Increased volatility is not a sign of base building which is essential for a bull market to start. My point is: the first signs of a new bull market will emerge when volatility falls. This has not happened yet.

The Nifty

The index, closing below 3000, is not a catastrophic event. The Market has moved 50% from its lows of 2252, in just 8 days. This could not be sustained. Today's decline should be taken as a correction. I assume that the intermediate trend remains intact, although volatile markets can do anything, anytime.
Support for the Nifty will come in a range between 2700 - 2800. If this support does not hold, then we have to step aside, let the market decide where it wants to go. If the support holds, then this should be a dip, which is a buying opportunity.

Why this column is still looking for buying ?

Because there are no signs that the up move is over. Today's decline is considered a correction. As usual, the markets decide, and, we can go wrong.

How much higher can this rally go ? This is an important question for those (a) who remain short in some form or the other (b) who missed buying last week, and, (c) traders looking to exit their long positions.

Now, momentum has its own logic. Traders do not question why a move is coming. Their task is to identify the move, then go along with it. Currently, momentum favors the bulls. Therefore, the appraoch should be: we will remain buyers on dips while bullish momentum continues. We cannot predict the turning points in a market.

Traders with existing long positions should pay attention to signs of weakening momentum, spccially when such signs occur near resistance levels. The Nifty is now near the 3200 - 3300 resistance zone. As the Index comes close to this zone, traders should tighten their stops. I have a blog post which explains how you can actually tighten your stops.You can read it Here .

The Fifteen Minute Rule (referred to in my previous post) is now described here .

The Nifty opened with a big gap, then stayed in a range, finally closing above 3000. The Index has gained over 800 points from the intra day low made at 2252 last monday. That is a gain of 35% in five trading days. If we take the close on Monday at 2550, the gain is 500 points, still at good 20%.
It seems fair to expect the market to slow down. The short term trend is up. We should remain buyers on dips. The first sign of trouble for the bulls will come if the Nifty were to close below 2900 - that will suggest a gap has been closed.

In any case, after a strong rally, all over the world, we should expect a period of quite with a sharp fall in volatility. This may be a good time to sell options (professional traders only).

I wrote a brief article for Money Today (from the India Today group) published in their Nov 13 issue.

Interest rate cuts as a means of improving stock market sentiment are not particularly successful. After the NASDAQ crash in 2000, Mr Greenspan begain his policy of rate cuts. While the cuts did improve sentiment for a few days, the bear market continued. In India, we have seen two cuts in October 2008 and big declines following the cuts.

Governments cannot change market sentiment by order. The market is a very democratic instrument. Markets change direction when a majority of the participants change their view. This change of view takes place on the changing market environment, not by government instructions.

Follow the Momentum

Short term Momentum is now in favor of the bulls. Traders should leave aside their preconceived ideas, and, follow the momentum. Thus, buy on dips, breakouts, with proper stops. Take profits on range expansion. On gap opens, follow the first 15 minute rule. These are the basics of technical analysis, and, they make money.

The base is the beginning of a bull market

In my previous post, I described Mr O'Neil's 'Reversal Day' theory and how it identfiies the start of a bull market. I also said, in my final notes: "I have not done any research on such inflection points. The base building process is my signal, that will take its own time. "

Now, my point is: It is possible that 2252 may have become the lowest point of the bear market. Maybe, another decline could stop at 2300 ? Or at 2700 ? Therefore, Mr O'Neil's Reversal Day theory may well work out, even as the market consolidates for months.