Sunday, December 26, 2010

Investing Skills

Most people believe that investing is a skill, with the more skilled investors earning above average returns. How is this skill created?

A post in http://www.investingcaffeine.com/ explains this:

Creating a Skillful Analytical Edge


Unlike the process of mowing lawns, in which more applied work time generally equates to more lawns cut (i.e., more profits), the investment world doesn’t quite work that way. You could work all day, stare at your screen for 23 hours, trade off of useless information, and still earn lousy returns. When it comes to investing, more work does not necessarily produce better results. Mauboussin’s prescription is to create an analytical edge. Here is how he describes it:

“At the core of an analytical edge is an ability to systematically distinguish between fundamentals and expectations.”
Steven Crist sums up this indispensable concept beautifully:

“There are no “good” or “bad” horses, just correctly or incorrectly priced ones.”

A disciplined, systematic approach will incorporate these ideas, however all good investors understand the good processes can lead to bad outcomes in the short-run. By continually learning from mistakes, and refining the process with a constant feedback loop, the investment process can only get better. On the other hand, schizophrenically reacting to an endless flood of ever-changing information, or fearfully chasing the leadership du jour will only lead to pain and sorrow.

Wednesday, December 22, 2010

Overestimating Risk

In the 2007 bull market, investors clearly underestimated the risk of financial instruments they were buying. Share prices of mid cap and small cap companies sky rocketed, as also real estate.Investors were not understanding the risk they were actually taking in.

Now, after a severe bear market, the opposite may well be true. Investors are fighting shy of taking any risk. It appears that the recent financial crisis may have changed saving and investment behavior. The discovery that the world is more uncertain than earlier thought of, may have resulted in a preference for more liquid savings and fewer risky investments.

A generation of investors grew up with two financial crisis periods - the 2000-2001 tech bust and then the 2008-9 bear market. This generation may have developed an aversion to risk, having seen how terrible the consequences of financial crisis can be.

Now, awareness of risk is good, because it ensures due diligence and allocation of capital to more desrving assets. But, fighting shy of taking risk is also a recipe for below average returns. All said and done, risk is what brings higher returns. Just be prudent.

Tuesday, December 21, 2010

Signs of Reversal

alphabet1 says:
How do you estimate advent of reversal ? What tools - Mclellan, fast rsi, candlesticks, etc. etc. Please carry forward this write up explaining how to catch the reversal set up in time, not too late.
I know this is a tall order, and I understand even you can go wrong, but still more important is the process you adopt, for us to imitate.

My Notes:
This is an wise question. I hope I can provide some ideas.
First, price bars. After a sustained uptrend, a DOJI, small bodies, long shadows, large black candle are signs of resistance. This could be a short term pause so price action must confirm by closing below the lows.
Second, leadership. The Index moves up but the leaders fail to make new highs. Banks were the leaders in the previous rally, while IT is the leader in the current, smaller, rally.
Third, trendline break. A minor trendline is broken which indicates at least a short term pause. These pauses will sometimes develop into a bigger decline.
Fourth, resistance. Failure to cross earlier resistance can often be the earliest sign of weakness.
Fifth, follow through on breakout. In a strong trend, a breakout has a strong follow thorugh. Prices remain above the breakout level. If the subsequent days after the breakout see small candles, pullback below the breakout point, then the new up move may not be sustained.
Sixth, breadth. New highs in the Index not confirmed by new highs in advance/declines is a red flag although the actual impact comes late.
Seven, trading ranges. Small, tight ranges begin to break down. The skill here lies in identifying the range. You have to use lines with maximum contact rather than simply connecting the highs or lows.

I hope you get the idea. Not all signs will come. So, the trader has to develop a sense of the market. The basic rule is: assume the trend continues unless proved otherwise.

Nifty at 6000

With an uptrend supporting it, the Nifty has managed to touch 6000. Rapid gains in previous rallies have overshadowed the slow gains reached in the current up move. Yet, the up move has seen the Nifty rally from a low of 5721 to a high of 6007.45 today in seven trading days, giving a gain of 285 points, which is five percent. That's good going.

The Market is in an uptrend. This analysis has been repeated by me, morning and afternoon on the ET Now channel. Therefore, if you are not yet watching it, you should.

There is a simple rule of trends - Trends are assumed to continue until proved otherwise. We therefore should go with the up move until reversal signs begin to come in. That has not happened so far. Instead, today's move to 6000 has seen the Nifty break out of a small trading range.

Sunday, December 19, 2010

Becoming a better trader

Here are several trading mistakes that can devastate a trader’s account.They are all violations of sound money management practices:

Not placing stop-loss orders. This allows a small loss to turn into a large loss and is a cardinal sin in trading.

Overtrading. Here traders are either trading outside of their trading plans, taking random trades, or having too many open positions at one time.

Moving stop-loss orders to avoid a loss. Never increase a predetermined stop-loss amount.

Exceeding the amount of capital risked on one trade or multiple open trades.

Not taking profits when available. This is letting a winning trade turn into a losing trade and should absolutely be avoided.
 
Basics of a trading plan
 

The most obvious place to start is with what you are trading. Here are several ideas to include as a start:

Define the markets you will trade.

Define specific setups you will trade.

Define entry point triggers into a trade.

Define market conditions that would void the trade.

Define the number of shares or contracts to be traded.

Define how much risk is in the trade by using money management rules.

Define stop-loss placement.

Define profit objective targets and how and when a stop-loss order is moved.

Use this list as a checklist until these questions become second nature. One excellent habit to develop is to write the information on a chart of the market that you will be trading.
 
(From Trade what you see by Larry Pesavento)

Saturday, December 18, 2010

More on Stops

A sensible discussion on the application of stops has started, and, I hope it continues.

Gaps

Piyush asks: "suppose you close the day at 5890, and so your stop does not get triggered, but the next day you come and see the market opening at 5800. now what?? shall i ait for the pullback to fill the gap or close my position immediately or wait for 15 or so minutes to see if the market is sliding or has any chances of reversal"

My Notes: Gaps are a problem for all traders. Sometimes, we have a gap open in our favor. Great. But, often, the market will open significantly against our position, thus triggering our stop. Then, the trader is faced with a decision: wait for the close or manage the trade now?

If I am long, for example, then the market opens below my stop loss, I first examine if the basis of my trade has changed. If it has, then I have to exit, the only question is how to exit. Usually, the 15 minute rule works well. I will exit if the 15 minute low is broken. If this low holds, then often, I get a better price on some intra day rally. But, I do not spend much time on managing the exit. I know, the trade needs to be closed.
In the context of the Nifty, 61.8% retracement of the previous upswing comes at 5832. Any open below this number tells me that the market may be changing direction, so the basis of the trade has probably changed.

But, we know that markets do not oblige us. What happens if the stop is at 5890, and, the Nifty opens at 5860? Now, the basis has not changed, but there is a lot of pain. There is no single answer to this situation. I usually bite the bullet and go with my 'evaluate at close' principle. If the trade is on EOD, then keep it on EOD.

I will answer the other questions over this holiday weekend. Cheers.

Friday, December 17, 2010

Setting Stops

If the stoploss is setup at 5880, then I will wait for the close (for me, it is at 15:20 PM) to decide if the stop is triggered or not. If he price at 15:20 is 5990, then it is not triggered, if it is 5960 - it is triggered. But, if the price is 5979 then I take a sense of the market - is the market likely to move down or up. and then decide. Rarely, I have a stop which is intraday. Then, of course, the trade is stopped out when the price is touched.

On Stops:

Many of our habits are designed to keep us safe. When sitting in a car, I always buckle my seat belt. When crossing the street, I look left and right, then cross. In the same way, when taking a trade, I always put a stop loss in. It comes naturally, without effort.

While successful trading will ultimately be determined by profits, you will not be profitable on every trade taken. Therefore, to make money, your edge must give you a higher probability in profitable trades as compared to the losses suffered in losing trades. For this reason, your losing trades must be restrict your losses. It is for this reason that a losing trade may actually be considered successful if the trade was executed properly.


Thursday, December 16, 2010

Trading Nifty with Support Levels

Ravi Prasad asks:

"sir, today nifty broke down 5880 and closed below 5900. Your level of 5880 is it on end of day basis? bit confused because if the level breaks down in intraday and recovers above it then how to trade. "


My Notes:

This is a sensible question. It should really be asked from all TV anchors who insist on asking for levels. We should ask them: what happens if these levels are repeatedly crossed intraday? You may not get an answer because anchors may not have any idea of real life trading!

But we are traders. We have to ask this question, then find an actionable answer. When I suggest nifty support and resistance areas, these are derived from my analysis of end of day charts. Unless specifically stated, the idea is to wait for the close. At 3:20 PM, if the closing price appears to be very near the zone then I take a 'sense of the market' to decide if the zone is holding or breaking.

Questions on this topic are welcome.

Tuesday, December 14, 2010

Nifty Moves

The Nifty continued its up move, closing higher or the third consecutive day.


There is support at 5700 and resistance at 6100 approx, giving a large 400 point trading range. Within this range, the Index has developed another smaller range, which is between 5960 and 5880. For short term traders, the position is as follows:

1. The short term trend remains up
2. A breakout above 5960 should confirm strength, giving the Nifty another 100 points of rally.
3. A close below 5880 will almost certainly be bearish, with the potential to touch 5500.
4. Strategy should be to buy on dips, till the Nifty is above 5880.

As the Nifty comes closer to 6100, trading positions should either be closed or protected with tight stops.

I am on ET-Now from 8:15 to 10 AM and 2:30 PM to 4 PM. I hope you get the time to watch.

Monday, December 13, 2010

Back to the future

After almost two and half months of rest, I started analysis for business TV again, this time on ET Now. I was available on their channel from 8 AM to 10 AM in the morning and then again from 2 PM to 4 PM in the afternoon.

I am glad to write that the shows were great fun. There was enough opportunity to speak our minds, to mention subjects which I thought were relevant even when not asked by the anchors. All in all, a satisfying experience.

I hope readers were watching ET Now, today. Please ensure that you get the channel in your cable / satellite service.

I also have a suggestion. ET Now offers a range of analysts, starting today, monday december 13. By watching only one channel, you will be following the analysts consistently. Therefore, channel surfing may not be a good idea. Just stick to one channel.

Cheers.

Thursday, December 9, 2010

Eleven Themes for 2011

Richard bernstein gives this:

1. The US Dollar Continues to Appreciate

2. The US Outperforms Emerging Markets

3. Stocks Outperform Bonds

4. Gold Produces a Negative Return

5. Longer-Term Interest Rates Rise by More Than 150 Basis Points 

6. Energy and Materials Sectors Outperform

7. US Consumer Stocks Outperform EM Consumer Stocks

8. Small-Caps Continue to Dominate Large-Caps Around the World

9. Muni Bonds Outperform EM Non-Dollar Debt

10. Japan Outperforms China

11. The Euro Survives.  Europe Recovers

Wednesday, December 8, 2010

The Monthly DOJI

Jagjit asks:
I want to ask that if the doji formation in the monthly sensex chart and closing of the next candle below the low of doji a confirmation of the downtrend to be started for some more months to come. What are the possible levels to watch out for?

My Notes:
This is thought provoking question.
I track the Nifty so I will discuss the DOJI made on the monthly chart. (Same as the Sensex). Here is the chart:

A DOJI is a sign of uncertaintly. When it comes at the top of a trend, the message is that the rally is coming in question. A correction may come in. The DOJI is confirmed when the next bar goes lower than the low of the DOJI. A DOJI made in October was confirmed on the downside when prices moved, then closed below its low. But, what happens if the trend suddenly changes? This did happen to the DOJI made in April 2010 (marked on the chart). A stoploss is therefore placed above the high of the DOJI bar.

In the current context, roughly, a close above 6300 will cancel out the bearish implications of the DOJI. Till then, we are in a correction of some kind.

Tuesday, December 7, 2010

Mid caps take a beating

I have returned to Delhi after a long holiday and three days of work in Mumbai. In Kolkata, I did not have access to the internet for many days. (Finally, I am acquring a data card.). In Mumbai, I was very busy. So, today, I opened my charting software and had a big surprise.

Paral has fallen from 600 to 295 with a down circuit today. Hanung Toys is at 225, down from 400. Any number of so called momentum stocks are in bad shape. They seem to be undergoing a bear market even while the Nifty is at 6000.

This is NOT a surprise. The rally in many mid caps and small caps was exceptional, probably unjustified. Anyway, every rally will be followed by a correction. Since the up move was parabolic, the down move will be equally sharp. That's the law of the markets. Most of these will become buying opportunities once they begin building a base. This takes time.

TV

I am pleased to write that I will be regularly available on ET Now - from Monday, December 13. Hopefully, almost every day. I hope you get the channel through your cable / digital operator. If not, you may like to get it quickly. Me, Ashwani Gujral, Rajat Bose, Deepak Mohini, C K Narayan, will be together in ET Now, giving a fairly experienced panel to viewers.