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Thursday, March 4, 2010

Is every drop in the Sensex a buying opportunity?

There is no easy answer to that question. A drop in the Sensex can happen due to several reasons. Some external event like a terror attack or war can cause a sudden fall. Stock markets recover from such shocks pretty quickly - so it provides a buying opportunity.

It could also be an external event of a more 'fundamental' nature. The recent economic downturn had its origins in the financial excesses of the western world. But its ripple effects - large scale withdrawal by FIIs - caused a major bear market in the Sensex that lasted more than a year.

Many investors who were facing a bear market for the first time made the error of jumping in during April/May 2008 - only to find that the Sensex fell steeply thereafter making a big dent in their savings.

Newsworthy internal events can also induce a sharp fall. Remember the Satyam scam hitting the front pages in Jan 2009? The Sensex had a sharp downward reaction in the middle of a bear market that lasted two months. Most news driven index falls last only 2 or 3 days, and can be bought into.

Internal events of a more fundamental nature - a deteriorating economy or a major stock market scam (a la Harshad Mehta or Ketan Parekh) can cause the Sensex to change its trend from bull to bear in a flash. Bear markets are not the time to buy - except when it is close to, or emerging from, a major bottom.

Being able to identify such reversal points constitute the "Holy Grail" of stock market investment success. Which means it is easier said than done. But it isn't impossible.

One of the thumb rules for the Sensex that I have observed is the widening distance between the 50 day and 200 day EMAs. A reversal or correction occurs when the gap stretches to about 2000 points. Please remember that this is not a rule, but an observation.

The 'correct' answer to the question is another question: Why does it matter? Small investors don't buy the Sensex. They may invest in an index fund or an index ETF. In which case, they should be following a SIP method and be oblivious to Sensex gyrations.

Even if a small investor decides to buy individual stocks, it is unlikely that a particular stock's bull or bear phase will coincide with that of the Sensex.

HUL had a long bull market from 2006 to 2009 - right through the Sensex bear market. It hit its peak in July '09, 6 months before the recent Sensex top, and has been correcting for 8 months.

The bear phase in Tata Motors preceded the Sensex by a good 20 months. The bear market bottoms in the stock and the Sensex were formed together. The subsequent bull rally by the Tata Motors stock hugely outperformed the Sensex.

Keep close track of the individual stocks in your portfolio. Otherwise, the noise and hype created by the media about Sensex movements may confuse you into making a poor investment decision.

5 comments:

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Jasi said...

Sir greeting ... a good post!
Enlightening.
Two such good recent opportunities spring to my mind ...
a) Rumor ridden correction in Unitech: I remember it falling from 60's to 30's in a dramatci post lunch fall. The very next day it managed an around 50% gain
b) Fall in sensex during last Oct I guess due to the Dubai crisis. It was a close to 7-8% single session fall. Sensex kept rising ever after for a few sessions

Subhankar said...

@Thomas: Thanks for your comments.

As a long-term investor I only venture into long-term trading in cyclicals. For a small investor, odds of making money in shorter term trading are less than 50% (if not lower).

@Jasi: Appreciate your comments and interesting as well as appropriate observations.

satarora said...

Sir, do you'r observation of wide gap between 50 dema and 200 dema has similar significance in stock specific studies.
thanks in advance.

Satvinder.

Subhankar said...

I'm glad you asked that question, Satvinder.

The answer is: Yes. Obviously, the gap between the 50 day EMA and 200 day EMA is different for different stocks at turning points.