Tuesday, June 26, 2012

Nifty: Trends with Corrections

In this blog, I have often written about cycles of contraction and expansion. If there is one living truth in the markets, this is it.

Yet, money is made in trends. So, how does the trader look at trends?

Trends result in price moving in one direction. There can be any number of variations in the formation of a trend. Therefore, the pattern of how a trend develops is not easy to forecast (It is much easier to forecast that expansion will follow contraction and vice-versa).

In the Nifty, we are in some kind of an uptrend. A normal trend, should see corrections in between. If this is a normal trend, then the Nifty will undergo a correction after a 400 point rally which saw resistance at 5200. But, suppose this is a strong trend? Then, we may not see any meaningful correction at all. And, suppose, this is a weak trend? Then, we may see a deep correction.

My point is: corrections are not easy to predict. Which is why, we try to go with the flow, assume that conditions will be normal unless proved otherwise.

Sunday, June 24, 2012

Consolidation or Distribution

Rakesh Sethia asks "In the previous blog, we talked about the cycles - expansion and contraction. To extend the topic, how can we identify if the contraction is a consolidation or a distribution? what are the features and distinguishing points classifying them so"

My Notes: This is an interesting question. I find it so because the answer to this question should be actionable for traders.
There are no rules as such for distinguishing between consolidation and distribution. I have some thoughts on this subject which I will share with readers here. Please do not memorize them, do not convert them into rigid formulas. And, please do not come back and say "you said such and such should mean consolidation but it was distribution." My point is: these are just my thoughts, and, there cannot be any rigid set of rules since the markets themselves are dynamic.

1. Where are we in the market cycle? The cycle consists of four phases - Accumulation, Run up, Distribution and Markdown. If the run up phase has been going on for long, then maybe this is a distribution.

 2. Pending Targets: If there is a technical target that has not been reached, chances are that the contraction is a consolidation before another breakout takes us to the target.

3. Contraction in a narrow range: The process of contraction will normally start in a narrow range, then expand to increase the range. An expanded range can go either ways. But, if the initial range of the contraction more or less remains the same, while the number of bars in the contraction increase, then the chances are that this is a consolidation with prospects of a big, sudden breakout.

4. Patterns inside contraction: Sometimes, we observe the development of a predictive pattern inside a contraction. This can come about in the same time frame or lower time frame. Patterns can be an indication of which way the contraction may breakout.

5. Intra day rewards: While markets move inside a narrow range, often, the intra day trades are rewarding one group of traders - bulls or bears. This is the first sign of which way the contraction may breakout.

I am obliged to readers for contributing to this blog with their thoughtful comments. Please continue to do so.

Saturday, June 23, 2012

The worst mistake traders can make

Summary of a post in The Stock Sage

The worst mistake a trader can make is trading too large.

Trading too much size as a percentage of ones account leads to many of the other pitfalls because it affects the trader’s decision making and causes them to do things that they otherwise wouldn’t do such as:
  • Overtrading resulting from stops that are too tight because the position is too large
  • Not adhering to stops and/or adding to losers because “they can’t take such a big loss”
  • Using confirmation bias and/or indicator abuse to justify remaining in a trade that they would otherwise close out
  • Taking profits simply because the trader has a big P&L not because it’s objectively the right decision
  • Subjecting oneself to market noise (small price deviations) instead of being able to withstand normal market fluctuations because the position is too large
My Notes: I agree with this analysis. As an example, I am long in July Nifty call Options. I am comfortable with the quantity that I am holding. This has enabled me to ignore the intra day volatility that we have seen recently. If my volumes were larger, I would be looking for stops, exiting at the wrong points, then maybe even taking an opposite position just to cover up.

What do readers say?

Friday, June 22, 2012

Deflation is good news for India

Crude is down, prices of commodities are tumbling. All of this is good news for India.

Yet, we have seen that the U.S. Markets fell big time yesterday, putting question marks over the rally that we saw in our market.

My view is easy to understand: The Nifty has strong support in the 5000 zone. So far as this support holds, I assume we are in an uptrend. The first signs of distress will come if the Index goes below 5040. But, markets are volatile and will remain so.

We have to adapt to these volatile conditions. Trade only one side (long or short), keep volumes under control, take profits wherever possible.

I will remain a buyer on dips, the kind of which we are likely to see today.

Thursday, June 21, 2012

Cycles of contraction and expansion

If there is one living truth in the market, it is that markets go through cycles of contraction and expansion. The cycles are not perfect, in the sense that we cannot always say when contraction ends and expansion begins. But, however imperfect, these cycles exist.

This is useful knowledge. When we encounter contraction, we can be as certain as anyone can be, that expansion is coming soon. This is what happened with the Nifty. The Index was in a tight range throughout the day, finally moving up 55 points in just 90 minutes. The Index was also in a tight range for 10 days, which broke out on the upside today.

Traders should keep the contraction-expansion setup as part of their trading tools.

Gourav writes ".Even some one like you just before the break out in CNBC told "Now I am looking for the breakdown below 5050"."

My Notes: This is slightly incorrect. I had a 1.20 PM interview with Mitali. This is not my normal time slot, it was a special appearance. I said that the Nifty is in a very narrow range and now we are open to taking short positions if the Index breaks 5040 support. So far, the view was that we will take only long positions since the trend is up, but today mid-day, looking at the narrow range persisting, we thought that we will let the market tell us what to do. Therefore, any breakdown would tell us to take short positions.


Seriously, is the world coming to an end?

Seriously. Is it?

Will the Greeks - the birth place of civilization - complete the circle by putting an end to civilization as we know it. And how will they do this? By refusing to retire at 60 instead of 55. Or, by saying that 35% marginal income tax is not acceptable.

Maybe it will be Spain or Italy that will cause the end of the world. Spanish bond yields can go up to 7.78% causing this world to come to an end.

And then again, maybe the doomsday proponents will go wrong, as they have done in the past.

A very big difference between past crises and the current ongoing problem is - democracy. A government of the people has inbuilt checks and balances. Some times markets may not like what the Government does, but eventually the interests of the markets and the country will coincide. If the country prospers, markets will prosper.

My point is: A crisis will result in a bear market. We saw that in 2008 during the sub prime crisis. Are we going through such a crisis now? My answer would be: No.

If the environment is not bearish, then we revert back to the normal market cycles of accumulation, rally, distribution and decline. My sense is: we are in the accumulation phase.

Look at any number of charts which are building bases, bullish reversal patterns. There is a message by Mr Market - I am going up.

Wednesday, June 20, 2012

Is there a bull on the highway?

The classic definition of an uptrend is : higher highs and higher lows, holding of support levels, declines are shallower as compared to rallies.

So far, the up move from 4800 has broadly met these parameters. To me, these are signs of a change in trend from bearish to bullish.

With a lot of news around us, markets will not go up like a rocket. The up move may be filled with volatile movements. It is also possible that  markets may not go up. To take care of this eventuality, traders must have an exit strategy. For me, the up trend fails if the Nifty closes below 5000 - 4950. This is the broad area below which I accept that the up trend is no longer valid.

Analysis is one part of trading, it must be converted into actionable ideas. My plan is to focus mainly on long positions. Dips and breakouts.

Tuesday, June 19, 2012

5 Qualities of Top Traders

Summarized from a Post by Van K Tharp

1. A belief that you create your results in life.

Most people don't understand this concept. They repeat the same mistakes over and over again because they blame their mistakes on external factors.

2. The interest and desire to really understand yourself.

You cannot understand how you create your own results if you don't know yourself intimately.

3. Discipline to continually work to improve yourself.

Top traders often have a passion to work on themselves.

4. The ability to strategize well. 

Good traders tend to excel at high skill games (e.g., poker, backgammon, chess, blackjack) because they can create good strategies and stick with them.

5. The ability to get in the zone. 

Top traders can become one with the market and accurately sense what it is doing. They have the ability to live in the present moment without being influenced by the past or the future. It's a very intuitive state and often gives them a total sense of how successful their moves will be in the market even before they make them.

Now, take a look at yourself and consider honestly if you have what it takes to be a top trader.

Tuesday, June 12, 2012

I am back

After a four day absence, I am back on this blog.

I have been visible on CNBC, as well as trading, but I did not put up a new post on these four days. Then today,Rajesh Alawadhi wrote in his comments: " till date i have been the first reader of most of your posts.The most stressful trading days for me are not the ones when my positions are running in losses but the days when you dont post anything to get me back to rational thinking."

Thanks, Rajesh. I am really overwhelmed by all the affection I receive from fellow traders and readers.

The Magic

Let  us assume there is a magic formula to make money in trading. Let us also assume that I know of this magic formula. So, I share it with a few of my colleagues. They share it with a few others, who share this with some more traders. Soon enough, almost all traders are making money using this magic formula. 

Hey, wait a minute. If everyone is making money, then we must ask ourselves, where is the money coming from? Who is losing?

We can conclude that there is no magic formula. 

The Magic is inside you 

Trading remains one of the biggest challenges of life. We trade because we want to achieve something more than a nine to five job.
Trading is a profession at the highest level of human competence.

The reason we love trading is:

Not the Money

It is the human urge, desire or force to grow

Markets strike at the core of our competitive and adaptive instincts

(adapted from the book: Market Mind Games)

Thursday, June 7, 2012

Go with Market Flow

Rakesh Sethia writes:
"I follow your views ardently. over a period of time, I have come to terms with your trading style. However, I am unable to understand when should the positions be carried forward and when should those be squared off intraday. Can you please suggest some good book that covers this topic in detail?"

My Notes:

Rakesh, your words give the greatest compliment  that a trader can receive. As I perceive, you understand the reasons for my analysis, use the reasoning as one of the inputs to your own methods, then take trading decisions independently.
This is a wonderful compliment because this is exactly what I want to do - share my thoughts on TV and otherwise. 
In fact, I feel dismayed when people want to 'follow' me. Truthfully, I find it difficult to follow myself ! How can others do it? And, why should they?

The entire purpose of sharing my analysis is to tell you what I am working at. It may be right, it may be wrong, but this is what I currently believe in.  Just as a car driver may be good at driving - safe, careful. So also a trader may be good at analysis. But, we cannot 'follow' the car driver by copying all his actions. We have to develop our own driving style. So also, we cannot 'follow' a trader or analyst. We can listen to what he says, then develop our own ways of trading.

Carry Forward of Positions

Rakesh asks "I am unable to understand when should the positions be carried forward and when should those be squared off intraday."

My Notes: 
There is no mathematical formula or mechanical method to decide the issue of squaring off positions intra day. Here are some basic guidelines:

1. If the original purpose of the trade was intra day, then close it on the same day. Never allow an intra day trade to be carried overnight, no matter what the loss or profit may be.

2. If prices have seen a big range expansion in our favor, close at least a part of the trade. Short term traders should take profits when windfalls come their way.

3. If a new trend has just started, then it makes sense to carry some positions because of the expectations of gap open on the next day, plus further intraday gains also.

Then, the idea is: Is the trend likely to persist? Carry some positions.

Is the short term trend mature? If yes, then exit.

But, be careful of carrying losing positions. This is not usually a good idea.

Wednesday, June 6, 2012

Advice from Hedge Fund Market Wizards

Jack Schwager has written a new book "Hedge Fund Market Wizards". He sums up the advice given by these wizards in 15 points. Amazon.com has published five of these, and, I am giving below three of the published five.

3. The Road to Success Is Paved with Mistakes
Ray Dalio, the founder of Bridgewater, the world's largest hedge fund, strongly believes that learning from mistakes is essential to improvement and ultimate success. Each mistake, if recognized and acted upon, provides an opportunity for improving a trading approach. Most traders would benefit by writing down each mistake, the implied lesson, and the intended change in the trading process. Such a trading log can be periodically reviewed for reinforcement. Trading mistakes cannot be avoided, but repeating the same mistakes can be, and doing so is often the difference between success and failure.

4. The Importance of Doing Nothing
For some traders, the discipline and patience to do nothing when the environment is unfavorable or opportunities are lacking is a crucial element in their success. For example, despite making minimal use of short positions, Kevin Daly, the manager of the Five Corners fund, achieved cumulative gross returns in excess of 800% during a 12-year period when the broad equity markets were essentially flat. In part, he accomplished this feat by having the discipline to remain largely in cash during negative environments, which allowed him to sidestep large drawdowns during two major bear markets. The lesson is that if conditions are not right, or the return/risk is not sufficiently favorable, don't do anything. Beware of taking dubious trades out of impatience.

5. Volatility and Risk Are Not Synonymous
Low volatility does not imply low risk and high volatility does not imply high risk. Investments subject to sporadic large risks may exhibit low volatility if a risk event is not present in the existing track record. For example, the strategy of selling out-of-the-money options can exhibit low volatility if there are no large, abrupt price moves, but is at risk of asymptotically increasing losses in the event of a sudden, steep selloff. On the other hand, traders such as Jamie Mai, the portfolio manager for Cornwall Capital, will exhibit high volatility because of occasional very large gains-not a factor that most investors would associate with risk or even consider undesirable-but will have strictly curtailed risk because of the asymmetric structure of their trades. So some strategies, such as option selling, can have both low volatility and large, open-ended risk, and some strategies, such as Mai's, can have both high volatility and constrained risk.

As a related point, investors often make the mistake of equating manager performance in a given year with manager skill. Sometimes, more skilled managers will underperform because they refuse to participate in market bubbles. The best performers during such periods are often the most imprudent rather than the most skilled managers. Martin Taylor, the portfolio manager of the Nevsky Fund, underperformed in 1999 because he thought it was ridiculous to buy tech stocks at their inflated price levels. This same investment decision, however, was instrumental to his large outperformance in subsequent years when these stocks witnessed a prolonged, massive decline. In this sense, past performance can sometimes even be an inverse indicator.

Nifty and other issues

The Nifty continues to be in a trading range. Trading inside a range is difficult in the best of times. Large positions are best avoided.

I feel that this range is developing after a sustained down move. It could be accumulation. The other side is also valid - that the range is a consolidation in an ongoing bear market.

The markets will tell us which of the  possibilities will work out. Fortunately, the trading range itself is a sign that one of the two will work out, we just have to wait to find out which.

In Comments, Vasant Kumar referred to head and shoulder patterns in M&M and HUL. There is a pattern in the daily HUL chart which  suggests some more downside. I could not locate the pattern in M&M. One such pattern is developing on the weekly, but I would not pay much attention to it since large time frame patterns are often ineffective. But, Dr Reddy's is also showing a distribution with a bearish head and shoulder.

The message coming out is: Overpriced, defensive stocks may be in for a correction.

Sunday, June 3, 2012

Invest in Index funds when Markets are in Panic

In a previous post, I had advocated the use of Index Funds for Investing. My point was: it is not possible to identify the stocks that will outperform the Index. For Investors, it is wise to invest in Index Funds and trade in stocks.

Now, the same advise comes from Jeffrey Carter who advises investing in Index Funds. In a post titled "What Average Investors should do In Market Panics and Meltdowns", the advise is:

Don’t pick individual stocks. Making money in them is like doing heroin. It feels good for awhile, but then the habit gets ever more expensive. Eventually, you lose.

Instead, take your money and put it in a no load mutual fund that replicates the broad indexes, like the S&P 500, the Russell 2000 or something like that. Over the long haul, you won’t lose. You also won’t pay many fees. Investing is practically free. 

Once you put your money into a fund like that, ignore the news. Don’t look at the day to day gyrations of the market. Just consistently put money away. When the market dives like it has the past few days, you are buying cheaper. When it rallies like it did earlier this year, you are buying at a higher price. But the sum of your actions will be an even price over time and your money will grow at around an 8% clip. When you are old and gray, you will have a nice nest egg to spend on yourself at retirement.


Saturday, June 2, 2012

Peter Brandt changes his view on GOLD

That's why he is a great trader!

In his blog, Peter Brandt suggested that the next move in Gold could be a big down move giving a decline of $250. This was on May 30.

Two days later, on June 1, in his chart updates on Gold, found here, Peter says that Gold may be showing signs of a big breakout on the upside.

Mr Brandt changed his views on Gold, because the charts changed. This is a point that many novice traders do not understand.

And, chart action may change once again, which means that the trader will change his views.

Have a great weekend!

Friday, June 1, 2012

Preservaion of Capital

There is a famous saying:

"He that fights and runs away, may live to fight another day; but he that is in battle slain, will never rise to fight again. " by Tacitus

For Traders, Preservation of Capital is of utmost importance. If we miss a trade, or exit a trade early, or get stopped out, then nothing is lost. We will take the next trade, and many subsequent trades, with prospects of profits.

But, if we lose our capital then there is nothing we can do. We will have to stop trading altogether. We are out of the business.

Preservation of Capital is essential for traders.

Traders go with Market Flow

I received a comment which I did not add to the comments section, instead I am giving it here with my notes.

The comment was:

"You dont know even S of Share market Sudarshan. .....  one day u say to go long and another day short on nifty.. u just dont know anything."

My Notes:

There is a conceptual principle that I should explain. As traders, we follow the market. We do not control these markets. The purpose of trading is to try and identify the market trend and go with it. Quite often, the Market Trend will change. What should the trader do? The trader's task is to  go with the trend. If the trend changes, the trader MUST change his stance. If he remains obstinate and sticks to his original position, the Market will sweep him away.

Once the Nifty went below 4920, our long positions were to be closed. That is prudent money management. On Thursday, the Nifty opened gap down at 4900. We close our positions at 4900, without any waiting. No new positions were taken because the trend was confusing. In Markets Today with Udayan, a program broadcast at 5.30 and 8.30 PM, on Thursday, I gave two levels, 4880 below which a sell is possible and 4925 above which a buy. Today, Friday, the 4880 level was breached and we went short. This position was disclosed at the 12 PM show.

Our short positions were closed since we did not wish to carry overnight positions.As I write this, U.S. Markets are tumbling. Quite possibly, the Nifty may open lower on Monday. But, do I regret closing my short positions? Absolutely not. Because, we have two principles: we try to avoid carrying positions taken on the first day of the new settlement, since the trend is often unclear, and, second, we avoid overnight positions when Nifty is inside a trading range.