Friday, June 23, 2017

Behavioural biases that affect investment success

An interesting topic came up for discussion during a recent family lunch. Electric vehicles - and how they were going to bring a paradigm shift not only for passenger and goods transportation but also for the oil industry.

The logic went like this: Global warming is being caused by auto emissions. Oil resources are getting depleted. Alternative bio-fuel experiments haven't worked. Electric vehicles are the obvious viable and environment-friendly solution.

Prices of electric cars are high because of lack of volumes. Batteries need to be recharged after travelling fairly short distances. But battery technology is improving. Vehicle prices will fall as demand increases.

A few years back, wind turbine maker Suzlon came out with its IPO. Wind power was touted as the future of energy. Investors piled into the stock and lost their shirts. Why? 

Oil prices came down from well above the $100 mark to $40. Wind power was no longer the talk of the town. It didn't help that Suzlon's technology was faulty.

Aren't these classic cases of judgement influenced by what happened or was heard in the recent past?

Investing success requires a planned and dispassionate approach. Emotions like greed, fear, euphoria, despondency lead to poor decisions. Buying or shorting a huge quantity of stock on 'gut-feel' can lead to disastrous consequences.  

The study of behavioural finance enables us to be aware of some of the common emotional and cognitive biases that affect decision making, like:

1. Anchoring
2. Confirmation
3. Loss aversion
4. Disposition effect
5. Hindsight
6. Familiarity
7. Self attribution
8. Trend chasing

Learn more about these behavioural biases from the following article:
8 Common Biases that impact Investment Decisions

Wednesday, June 21, 2017

Nifty chart: a midweek technical update (Jun 21 ‘17)

FIIs continued to sell equity shares. Their net selling during the first three days of the week was worth Rs 7.2 Billion.

DIIs were net buyers of equity worth Rs 9.6 Billion, as per provisional figures. Nifty consolidated sideways within a trading range.

SEBI has announced tightened regulations on P-notes and offshore derivatives while easing registration rules for foreign investors. Hedge funds will now be able to participate in commodity derivatives


The daily bar chart pattern of Nifty has been consolidating sideways within a 'rectangle' (shaded in grey) for nearly 4 weeks.

A 'rectangle' is usually a continuation pattern. Since the index entered the 'rectangle' from below during an up trend, the eventual breakout should be upwards.

However, sometimes a 'rectangle' can act as a 'reversal' pattern. So, a downward breakout is also a possibility.

In either case, the upward or downward target following the eventual breakout should equal the height of the 'rectangle' (about 160 points). That gives an upward target of 9870 and a downward target of 9390.

Technical targets are rarely exact. Let us work with an upward target of 9900 and a downward target of 9400 - provided the 'rectangle' pattern plays out as expected.

Nifty has received good support from its rising 20 day EMA while consolidating within the 'rectangle' and is trading above its three EMAs in a bull market.

Daily technical indicators are in bullish zones, but giving conflicting signals. MACD and RSI are showing downward momentum. Slow stochastic is showing upward momentum. MACD and Slow stochastic are showing negative divergences by touching lower bottoms.

Nifty's TTM P/E is at 24.31 - much above its long-term average. Chances of earnings catching up with index valuation appears slim in the near term. Rollout of GST from July 1 will bring its own set of challenges and teething problems.

The breadth indicator NSE TRIN (not shown) is falling inside its overbought zone, limiting index upside. FII selling will also keep Nifty's rally in check.

It is better to look at individual stocks than worrying about index movements. Several stocks have touched new highs in June while the index has gone nowhere.

Tuesday, June 20, 2017

Gold and Silver charts: bears pour cold water on month-long bull party

Gold chart pattern


The following comments appeared in the previous post on the daily bar chart pattern of Gold: "A convincing move above 1296 is required for the bullish pattern of 'higher tops, higher bottoms' to continue. Bears will try to prevent such a move."

Gold's price rallied to a slightly higher top of 1299 on Jun 6, but MACD and RSI touched slightly lower tops. The negative divergences was just the trigger the bears needed to pounce.

A sharp correction dropped gold's price below its 20 day and 50 day EMAs. (At the time of writing this post, gold's price is testing support from its 200 day EMA.)

Daily technical indicators are looking bearish. MACD is falling below its signal line in bullish zone. RSI has slipped below its 50% level. Slow stochastic has dropped like a stone into its oversold zone. 

A technical bounce from the 200 day EMA is a possibility. Bears may use the opportunity to sell again.

On longer term weekly chart (not shown), gold’s price formed a 'reversal' bar (higher high, lower close) and corrected below its 200 week EMA in long-term bear territory. Weekly technical indicators are in bullish zones, but showing downward momentum.

Silver chart pattern


The following comments appeared in the previous post on the daily bar chart pattern of Silver: "Silver's rally may continue a bit longer, but expect bears to pounce at any time."

Silver's price touched an intra-day high of 17.75 on Jun 6 and closed at 17.71. Bears attacked the very next day. A sharp correction dropped silver's price below its three EMAs into bear territory.

(At the time of writing this post, silver's price has bounced up a bit after finding some support at 16.45.)

Daily technical indicators are in bearish zones, and showing downward momentum. Slow stochastic is well inside its oversold zone, and can trigger a technical bounce.

A test of the May 9 low may be on the cards.

On longer term weekly chart (not shown), silver’s price closed below its three weekly EMAs in a long-term bear marketWeekly technical indicators are in bearish zones, and showing downward momentum.

Monday, June 19, 2017

S&P 500 and FTSE 100 charts (Jun 16 '17): tug-of-war between bulls and bears continues

S&P 500 index chart pattern


The daily bar chart pattern of S&P 500 consolidated sideways within a 25 points range during the week. 

The index touched a slightly lower top of 2444 on Wed. Jun 7. The rising 20 day EMA prevented a fall below the Jun 9 low of 2416.

The large volume spurt on Fri. Jun 16 ensured a flat close for the week. Neither bulls nor bears managed to wrest any advantage.

Daily technical indicators are in bullish zones, but not showing any upward momentum. RSI is moving sideways. MACD and Slow stochastic are displaying a bit of downward momentum.

The index continues to trade above its three rising EMAs in a bull market. Some more consolidation is possible before the index decides to move higher.

(On the daily closing chart - not shown - the index has been consolidating since the beginning of June within a narrow 'rectangle' pattern between 2429 and 2440. A breakout from the 'rectangle' can occur in either direction.)

On longer term weekly chart (not shown), the index closed well above its three rising weekly EMAs in a long-term bull market. Weekly technical indicators are looking overbought, but not showing any upward momentum.

FTSE 100 index chart pattern


The daily bar chart pattern of FTSE 100 had touched a new high of 7599 on Jun 2 before breaking out below a bearish 'rising wedge' pattern (refer last week's post).

The index has formed a bearish pattern of 'lower tops, lower bottoms' since then. FTSE dropped sharply below its 50 day EMA to a low of 7378 on Thu. Jun 15, followed by a pullback to its 20 day EMA but closed about 0.8% lower for the week.

(At the time of writing this post, the index has bounced up above its three EMAs - regaining most of its previous week's loss. However, the bearish pattern of 'lower tops, lower bottoms' is intact.)

Daily technical indicators are giving mixed signals. MACD is below its falling signal line in bullish zone. RSI has moved above its 50% level after falling below it.  Slow stochastic has bounced up from the edge of its oversold zone but remains below its 50% level.

Expect the tug-of-war between bulls and bears to continue a little longer before one side can wrest the advantage.

On longer term weekly chart (not shown), the index closed above its three weekly EMAs in a long-term bull market. Weekly technical indicators are in bullish zones, but not showing any upward momentum.

Sunday, June 18, 2017

Sensex, Nifty charts (Jun 16, 2017): bears stop charging bulls

FIIs were net sellers of equity worth a huge Rs 20.5 Billion for the week. DIIs more than matched them with their net buying of equity worth Rs 20.6 Billion, as per provisional figures.

Both Sensex and Nifty closed lower for the week - Sensex by about 0.7% and Nifty by 0.8%.

The NDA government has initiated two long awaited banking sector reforms. 12 corporate entities with huge outstanding debts from PSU banks are being wound up. Several smaller PSU banks are going to get merged with larger PSU banks.

BSE Sensex index chart pattern

The following comments appeared in last week's post on the daily bar chart pattern of Sensex: "It is important that the index receives support from 'fan line 3' if the correction continues. In case 'fan line 3' is breached, a deeper correction towards 30000 may ensue."

On Fri.Jun 16, the index closed just below 'fan line 3'. Technically, it is not a convincing breach because of the 3% 'whipsaw' rule. Also, the index is receiving good support from its 20 day EMA, and can bounce up from here.

Note what happened back on Mar 8, when 'fan line 1' was initially breached. The index recovered and moved back above 'fan line 1', but subsequently breached 'fan line 1' more convincingly on Mar 21.

Any breach of a trend line - even if unconvincing at first - should be treated with caution. It is a warning about things to come. In other words, don't jump in to buy the dip just yet.

Daily technical indicators are looking bearish and hinting at some more correction. MACD is sliding down below its signal line in bullish zone. ROC, RSI and Slow stochastic have dropped inside their respective bearish zones, and showing downward momentum.

Sensex continues to trade above its three EMAs in a bull market. Stay invested. Let the correction play out.

NSE Nifty index chart pattern

The weekly bar chart pattern of Nifty broke its 7 week stretch of touching higher tops. Last week's 'doji' candlestick pattern may have marked an intermediate top.

The index is trading well above its two rising weekly EMAs in a bull market. Some more correction will improve the technical 'health' of the chart.

Weekly technical indicators are inside their respective overbought zones, but showing downward momentum.

Nifty's TTM P/E is at 24 - lower than last week but much higher than its long-term average. The breadth indicator NSE TRIN (not shown) has bounced up a bit after dropping sharply into its overbought zone.

The correction may continue a bit longer - specially with FIIs in sell mode.

Bottomline? Sensex and Nifty charts have started to correct after touching new highs in the previous week. The corrections will enable the indices to gather strength to climb to new highs. Stay invested. Wait for the correction to play out before buying.

Friday, June 16, 2017

Does large debt on the Balance Sheet make a company's stock a risky investment?

It is that time of the year when Annual Reports of companies will be hitting mailboxes. Instead of just checking the dividend amount and tossing the report in the recycle bin, it may be worthwhile to go through the report.

At the very least, the balance sheet, P&L, cash flow statement and the notes to accounts should be studied. These will reveal the financial health of a company.

One of the things that get many companies into trouble is trying to grow too fast, too soon. Many tech companies had fallen prey to the syndrome of 'grabbing eyeballs' instead of having a solid business plan that would lead to cash generation.

They had taken on a huge amount of debt to gain market share quickly by expanding globally or by acquiring competitors. Their subsequent bankruptcies were caused by the inability to service their debts.

Even the well-established houses of Tatas and Birlas made gross errors of judgement by financing their acquisitions of overseas competitor companies through large debt.

But what if taking on large debt to buy out a competitor actually results in increasing market share and enabling a move up the value chain? Tata Motors did that successfully by acquiring Jaguar-Land Rover from Ford.

So, how does a small investor decide if large debt on the Balance Sheet of a company makes investment in its stock risky or not? 

One way is to look at the Interest Coverage ratio. Another is to look at the Return on Capital Employed (RoCE) ratio. The higher the ratios the better. Both these ratios should be compared with other companies in the same sector.

Read more

Thursday, June 15, 2017

10 Books Every Investor Should Read

When it comes to learning about investment, the internet is one of the fastest, most up-to-date ways to make your way through the jungle of information out there. 

But if you're looking for a historical perspective on investing or a more detailed analysis of a certain topic, there are several classic books on investing that make for great reading. 

Here we give you a brief overview of our favorite investing books of all time and set you on the path to investing enlightenment. (To find more recommended books, see Investing Books It Pays To Read.)

Read more here.