How small investors can widen their Circle of Competence

Warren Buffett is a strong believer of the Circle of Competence concept. If a company or business doesn’t fall within his Circle of Competence, he won’t touch it. He famously avoided buying into any high-tech company in the 1990s – when every one and his brother-in-law were investing in dot.com companies. He didn’t understand how high-tech companies were making money, and whether they had sustainable businesses. He missed the boom – and the inevitable bust that followed.

Warren Buffett is one of a kind. You and I will never be able to match his skill and wisdom in investing. That doesn’t mean we shouldn’t follow some of his money-making principles. What if our Circle of Competence is too limited? Is there a way to widen the Circle?

Let me give you the bad news first. You can’t widen your Circle of Competence in a hurry. It is a process that will take a lot of time and effort. The good news is that the process is not difficult or complicated. It takes patience, perseverance, and a plan.

First make a short-list of all the knowledgeable people you know. The list isn’t likely to be a long one if you are looking for people with real knowledge. Not some one who knows how many hundreds Tendulkar scored before the age of 25, or the exact locations of the seven wonders of the world. But some one who knows about the economy, business and industry.

Next, figure out how you can meet such people without imposing too much on their time and patience. May be he is a friend’s father or your wife’s uncle. If you inform them in advance that you want to meet them, and the reasons for the meeting, knowledgeable people will be more than happy to share some of their experiences.

Don’t know anyone knowledgeable enough? Join discussion forums and investment groups. There are many in cyberspace. Each group or forum will have a few knowledgeable members. Try and pick their brains.

Going to a family wedding or a party? Don’t just waste your time eating and drinking and being merry. Introduce yourself to people you don’t know, and find out about what they do. If you show genuine interest in their activities, they will give you a lot of information that you won’t find in TV channels or pink papers.

Carry on this process for some time, and you will be amazed at how much wider your Circle of Competence can become. Then, have the discipline to stick to your Circle of Competence when choosing stocks to buy. That will prevent you from getting badly stuck in the shares of a company that you really know nothing about. Like Suzlon, or Punj Lloyd, or Bartronics.

Related Post

What is your Circle of Competence?

Stock Index Chart Patterns – S&P 500 and FTSE 100 – May 27, ‘11

S&P 500 Index Chart

The S&P 500 index chart spent another week in the downward trend that started from the May 2 ‘11 top of 1371. On Mon. May 23 ‘11, the index dropped sharply below the 50 day EMA and the lower edge of the Bollinger Band. After spending the next three days below the 50 day EMA, the index finally managed to close above the 50 day EMA on Fri. May 27 ‘11 - almost flat on a weekly basis.

The good news is that the index made a higher bottom in May ‘11, keeping the longer term up trend from the Mar ‘09 low intact. The bad news is that Friday’s volumes were the lowest of the week, which is contrary to bullish hopes.

The technical indicators are bearish. The MACD is negative, and below the signal line. The slow stochastic bounced up from its oversold zone, but remains below the 50% level. The RSI is treading water below the 50% level. A drop below the Apr ‘11 low of 1295 will signal a deeper correction. A convincing break above the down trend line connecting the intra-day tops of May 2, 10 and 19 will be a ‘buy’ signal.

The economy continues to struggle. New orders for manufactured durable goods declined by 3.6% in Apr ‘11. Unemployment claims rose by 10000 to 424000. GDP growth remained flat. Import and exports are strong, which is a positive sign. The Univ. of Michigan Consumer Sentiment index was unexpectedly higher in May ‘11 (at 74.3 vs. 69.8 in Apr ‘11), but almost 14% below the average of 86 (calculated since 1978).

FTSE 100 Index Chart

The down trend in the FTSE 100 chart tested support from its 200 day EMA, only to bounce up and close the week bang on the 50 day EMA – losing about 10 points on a weekly basis.

The technical indicators are bearish, but showing some signs of revival. The MACD is negative and below its signal line. The slow stochastic has bounced up from its oversold zone, but is below the 50% level. The RSI has risen to its 50% level. A convincing move above the 5950 level may provide an impetus for the bulls.

The UK economy is in deep trouble. The British Chamber of Commerce (BCC) expects inflation to rise to 4.5%, forcing the Bank of England to raise interest rates. The BCC lowered their growth rates for 2011 and 2012 as per this article, but ruled out a return to recession.

Bottomline? The chart patterns of the S&P 500 and FTSE 100 indices are in clear down trends. Investors should be circumspect about buying the dip because there is a possibility of deeper corrections. The longer-term trends are still up, as both indices are trading above their 200 day EMAs.

BSE Sensex and NSE Nifty 50 Index Chart Patterns – May 27, ‘11

Last week, the BSE Sensex and NSE Nifty 50 index chart patterns had thrown up bearish and bullish possibilities. The scales remain tipped in favour of the bears, in spite of the FII buying on the last two days of the week that ensured that both indices closed about 1.5% higher on a weekly basis.

Why? For three easy-to-observe technical reasons:

1. The down trend lines (in blue) from the Nov ‘10 tops are intact

2. Both the Sensex and Nifty are trading below their 200 day EMAs

3. Both indices have spent 4 straight weeks below their falling 20 day EMAs; the 20 day EMAs are below the 50 day EMAs; the 50 day EMAs have slipped below the 200 day EMAs – the dreaded ‘death cross’.

Are the indices getting ready for a bigger fall?

BSE Sensex Index Chart

All the signs are pointing towards a deeper correction. What should investors do? The answer will depend on what kind of a fish they are! The Anagatavidhatas should sell and preserve capital; the Pratyutpanyamatitwas may set a stop-loss 3% below the Feb ‘11 low of 17300; the Jadvabishyas will await their destiny.

The technical indicators are showing signs of life, but are still bearish. The MACD is deep in negative territory, but has moved up to touch the signal line. The ROC is above its rising 10 day MA, but both are still negative. Both the RSI and slow stochastic have emerged from their oversold zones, but are below their 50% levels.

Observant readers may notice the positive divergences. The Sensex reached a lower bottom of 17786 on Wed. May 25 ‘11. The ROC, RSI and slow stochastic made higher bottoms. Was the net buying by the FIIs on the last two days of the week a mere coincidence?

Nifty 50 Index Chart

There is every chance that the Feb ‘11 low of 5200 (or 5178, if you want to be precise) will be tested, if not broken. I’m not a gambling man, but if I was, I would put some money on 5200 level holding. Why?

Three reasons. First, despite all the negative news and lack of buying support from investors, the Nifty has not crashed. Second, the time-wise correction of the 20 months long bull rally (from Mar ‘09 to Nov ‘10) is almost over. Third, the MACD, the RSI and the 10 day MA of the ROC are forming bullish saucer-like rounding-bottom patterns. My guess is that the FII buying was triggered by these technical reasons.

Food inflation went up again. The proposal to allow FDI in multi-product retail – should it become a law – will not only help tame inflation, but provide huge job opportunities for semi-educated youth. The impending hikes in the prices of diesel and cooking gas, and the likely moderation in the GDP growth rate have already been discounted by the market.

Bottomline? The BSE Sensex and Nifty 50 index chart patterns have entered bear markets, and may face steeper corrections. There are signs of reversal of the down trends in the near term. Unless the down trend lines in both indices are convincingly breached, one should not go on a buying spree. This may be a good time to nibble into fundamentally strong stocks that have corrected a lot.

Stock Index Chart Patterns - BSE Sectoral Indices, May 27, '11

In last month’s analysis of the BSE Sectoral indices, I had looked at the weekly bar chart patterns from Mar ‘09 onwards. This month, I have attached the one year bar chart patterns once again to get a clearer view of the near term situation.

BSE Auto Index

BSE Auto index is technically still in a bull market – despite the dip below the 200 day EMA during Feb and Mar ‘11. The index received good support from the 8115 level and bounced up to prevent the ‘death cross’ of the 50 day EMA below the 200 day EMA. However, the technical indicators are looking bearish and the index is struggling to stay above its long-term moving average. The down trend from the Nov ‘10 top is intact. Hold.

BSE Bankex

BSE Bankex has once again slipped below the 200 day EMA and the ‘death cross’ looks imminent. The index has turned up before reaching its support level of 11330, but the technical indicators are not holding out much bullish hopes. The 7 months long down trend is yet to be reversed. Hold.

BSE Capital Goods Index

The down trend in the BSE Capital Goods index has turned into a bear market, confirmed by the ‘death cross’ in Jan ‘11. The recent rally faced strong resistance from the falling 200 day EMA. The technical indicators are mildly bullish. Buy only on a clear break above the 200 day EMA.

BSE Consumer Durables Index

BSE Consumer Durables index has been one of the better performers and is in a bull market. It recovered quickly from the drop below the 200 day EMA in Feb ‘11, but the up move faced resistance from the 6600 level. The index is making a saucer-shaped bullish pattern. Add on a break above 6600.

BSE FMCG Index

BSE FMCG index has been the star performer during the past year, and has outperformed the Sensex in the past 7 months. It formed a bearish triple-top pattern and dropped below the 200 day EMA in Feb ‘11. A magnificient recovery took the index to a new high this month. Negative divergences in all four technical indicators has stalled the rally. Any dips can be used to add. 

BSE Healthcare Index

BSE Healthcare index has recovered from a 2 months stay below the 200 day EMA, but the rally has lost momentum. Technically, the index is in a bull market but is well below its Jan ‘11 top. Hold.

BSE IT Index

BSE IT index performed sensationally till its peak in Jan ‘11. The subsequent correction bounced up strongly from the rising 200 day EMA, but failed to test its Jan ‘11 top. This time, the index has dropped below the 200 day EMA, and the ‘death cross’ will confirm a bear market. Technical indicators are bearish. Hold.

BSE Metal Index

BSE Metal index is in a bear market, despite a valiant effort in Apr ‘11 to reverse the trend. The technical indicators are hinting at a recovery, but the index has dropped well below the 200 day EMA. Buy only on a convincing move above the Apr ‘11 top. Avoid till then.

BSE Oil & Gas Index

BSE Oil & Gas index is a clear example of how populist government policies and meddling can push a good sector into a bear market. The so-so performance of the largest private sector player, Reliance, has also not helped the cause of the index. The index has recovered some what from oversold conditions, but has a long way to go. Avoid.

BSE Power Index

BSE Power index has been in a down trend since Oct ‘10 and sliding deeper into bear territory. The technical indicators are bearish. Avoid.

BSE Realty Index

BSE Realty index is also deep inside a bear market, with little hope of any recovery soon. Avoid.

Five sectoral indices are in bear markets. Even good performers like the BSE Bankex and BSE IT index are struggling to escape from strong bear grips. That doesn’t mean all the stocks in these sectors should be avoided. I have been posting about stocks comprising different sectoral indices – and a handful of them are bucking the trend. Those are the stocks to watch.

Notes from the USA (May 2011) – a guest post

We have become accustomed to living life in a perennially fast-forward mode - thanks to instant coffee, instant noodles and instant access to information through satellite TV, mobile phone, internet. (Amazon.com recently reported that their eBook sales exceeded the combined sales of hard cover and paperback editions.)

In this month’s guest post, KKP suggests that we should occasionally hit the ‘pause’ button to take stock of our own lives. He shares some ideas from the blog of Anastasiya Goers.

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Bring Sanity to Life by Slowing Down Your Pace

As part of the computing generation, we were working towards getting/giving all the answers within days in the 90’s……..This raced to getting/giving answers within a day……And, now we are working as if there is no tomorrow, and we have to have answers within the hour or minute.

Email, Forums, Blogs, eOpinions, Facebook, Twitter, Picture-books and then the myriad of portals that we log onto everyday, and do the clicks throughout the day or night.

As a result, today’s technology, the pressures of work, the fast-paced economy, and fear of the future are just a few of the things that are causing havoc to our mental, emotional, family and spiritual life.

The cost of a hurry-up lifestyle in our 24/7 society is loss of self-awareness, self-evaluation and linking-to-future. We move with the herds and get distracted by one of twenty things around us; home phones, mobile rings, email-notification, pop-ups, SMS texts, voice-mail-prompts, discussion about V2.x and then there’s shopping for the next version of ‘everything’ to keep up. We over-consume and never proper-digest anything, since we fail to see underneath the surface of everything that touches our lives.

Is it time to get off the roller coaster of this fast-paced-life? It’s up to each of us to become aware of where we are now, recognize our potential to change and create a life that brings more joy, real joy. Here are some tips to create more balance by implementing empowering choices highlighted by Anastasiya Goers (Balance In Me blog):

1. Take responsibility

No one is coming to rescue you. No one is coming to save you. Most of us, know exactly what we need to do to make our lives better. Make a commitment. Write down your plan for change.

2. Take a step in the right direction today

Today is the perfect day to begin. Apologize, attend an AA meeting, go for a 15 minute walk, or add vegetables to your diet. Begin small, you’ll gather momentum and eventually have a different perspective, a new mindset, and a better life.

3. Prioritize at work and home

There is no need to consistently work overtime when you focus on doing the most important tasks first. Learn to delegate. Teach your children to help with everyday chores. Learn how to work with coworkers and family members in an effective way.

4. Take a digital break

Begin your day with all technology turned off. Use the first hour for quiet time, prayer, meditation or stillness. Talk to family members face-to-face. Show interest in each other’s lives. Eat dinner together and end your day with more quiet time, minus digital distractions.

5. Create boundaries

When you have a ‘big’ yes, it’s easy to say no to the demands of others. Practice telling others, “No, that’s not going to work for me.” After you say it pause. Make a “not to do” list. This will leave space and time for your dreams.

6. Practice minimalism

Don’t buy into the next best thing. Create a budget. Eliminate stuff from your life. Stop recreational shopping. This will keep you from becoming a workaholic. It will also allow you to be debt free with less stress.

7. Have fun

When you do the work, you make space in your life for joy and happiness. The opposite of happy isn’t sad, it’s depression. Make each day an adventure. Never underestimate the power of creating good times for yourself.

8. Volunteer

Giving of yourself creates meaning in your life. My daughter spent two years in the program, Teach for America. My most meaningful giving experience was volunteering in Mississippi after hurricane Katrina. Life is richer when we give in both big and small ways.

9. Drop judgment

When you compare yourself to others, you discount who you are and what you do. You lose your joy. You don’t know what anything is for and you can’t see the big picture. Nobody can. Learn to live in the moment, change what you can and surrender the rest.

10. Create a bucket list and take action

List everything you want to do before you die. Then begin fulfilling your list. We are here to enjoy life. Begin now.

11. Live in the present

It’s easy to live in the pain of the past or the fear of the future. When this happens, stop, breathe, and ground yourself in the moment. Anxiety is nonexistent in this moment.

12. Live love

Learn to always come from a loving heart. Each morning have an intention of love. Think loving thoughts, speak loving words and take loving action. Mother Teresa said, “When we die the only thing we take with us is the love we gave away.”

Summary:

It’s easy to believe the sky is falling when you are neglecting your personal needs. Learn to put yourselves first. Nobody else will do it for us! Change happens really slowly as one ages, but that is when we need to make the changes and impact life for many decades to come. It takes time to recreate a new life, whether it is to change our weight, eat more healthy, introduce new elements in our life, and make that a lifelong habit. My personal life is transforming in a huge way from almost all angles, and I am making time for everything from health, eating habits, wealth management, sharing/caring, handling kids, improving friendships, being gentle, respecting things more, enjoying sunsets and moon-shines, and learning to go with the flow. Life was a big competition for me (being a Type A personality) and now I feel satisfied enough to enjoy the achievements and manage them to the best of my abilities. So far it has been a 2 year 4 month journey, and much more to come…

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KKP (Kiran Patel) is a long time investor in the US, investing in US, Indian and Chinese markets for the last 25 years. Investing is a passion, and most recently he has ventured into real estate in the US and also a bit in India. Running user groups, teaching kids at local high school, moderating a group in the US and running Investment Clubs are his current hobbies. He also works full time for a Fortune 100 corporation.

Stock Chart Pattern - Bharti Airtel (An Update)

The previous update of the stock chart pattern of Bharti Airtel was written way back in Jan ‘10. Prior to that, I had written a post in Oct ‘09 advising investors to switch out of telecom sector stocks. Despite growth in subscribers, low ARPUs, competition from overseas players with money power, and the likely high cost of the impending 3G auction were the reasons for my bearish view at that time.

Bharti’s stock had been an outstanding performer, giving multibagger returns to savvy investors who had entered early. Customer service was the best among the various service providers. The management was aggressive and clued on. But all sectors eventually mature. The fast growth of the early years tend to slow down to more stable and sustainable levels. Bharti was no exception.

The charts began to reflect the ground realities. The stock reached a high of 495 (adjusted for the subsequent 2:1 split) on May 19 ‘09 – thanks to the post-election market euphoria – but failed to test its Oct ‘07 top of 575. After a sharp correction, followed by a sideways consolidation, the stock attempted another rally – only to reach a lower top of 467 on Oct 1 ‘09. Combined with the fundamental headwinds, the weakness in the chart pattern confirmed that worse was to follow.

The bar chart pattern of Bharti Airtel from Jan ‘10 onwards shows that the worst may be over for shareholders, but there are technical hurdles that need to be crossed:

The stock continued to fall below its 200 day EMA after my previous post on Jan ‘10, till it fell below its Mar ‘09 bear market low of 272 and made three bottoms at 254 in quick succession (two in May ‘10 and one in Jun ‘10). An upward spike above the 50 day EMA on decent volumes was followed by a bullish rounding bottom pattern. A high volume spike took the stock above its 200 day EMA.

The subsequent rally reached a high of 376 on Sep 28 ‘10. Note that the ROC and RSI made lower tops (marked by blue arrows) while Bharti’s stock moved higher. The inevitable correction turned into a 6 months long sideways consolidation till Mar ‘11. The sharp rally in Apr ‘11 did not have volume support. The ROC and RSI were making lower tops (blue arrows). The negative divergences once again stalled the rally.

The high volume spike on May 6 ‘11 touched an intra-day high of 400.10 before closing lower than the previous day – a distribution day. The rise from the low of 254 to the high of 400.10 retraced 60.6% of the fall from 495 (May ‘09) to 254 - close to the Fibonacci retracement level of 61.8%. The stock needs to clear 400 convincingly (i.e. by at least 3%), and then cross the previous tops of 467 and 495 before the bulls can regain control.

The technical indicators are not conducive to bullishness. The MACD is positive, but falling below its signal line. The ROC is just above its 10 day MA, and barely positive. The slow stochastic is below its 50% level. Only the RSI is showing some bullishness by rising above its 50% level.

Shareholders who heeded my advice and sold the stock on Oct 7 ‘09 (it touched a high of 367.70 and closed at 358.35) would have made more money even if they kept the cash in a savings account. At today’s closing price of 369, the stock has gained less than 3%.

Bottomline? The stock chart pattern of Bharti Airtel is back in bull territory, but not yet out of the woods. Without a doubt, this is the best stock among the telecom service providers. But its glory days are behind it. As an investor, you always have choices. If you are going to invest in a slow growth, stalwart stock – would ITC or Dabur be better bets?

(My friend, Nishit, didn’t agree with my bearish view about Bharti and wrote a well-argued opposing view: http://investmentsfordummieslikeme.blogspot.com/2010/07/bullish-case-for-bharti-airtel-guest.html. What are your views about Bharti, dear reader? Are you bullish or bearish? Why?)

What to do when stock prices fall?

Most small investors – particularly the recent entrants to the stock market – are ‘bulls’. That means, they buy a stock at a certain price and expect the price to quickly move higher so that they can sell and make a tidy profit without going through Step 1 (see below).

The idea is not entirely wrong. Being a bull is usually more ‘fun’. When you buy a stock and it starts to rise rapidly, you tend to feel elated and proud that you have made a smart choice. But it is no fun at all when the stock you have bought recently suddenly turns around for no rhyme or reason, and starts falling like a stone.

Your elation vanishes into thin air. Your pride takes a beating. You can’t confide to friends or family because they will either laugh at you or scold you for being a greedy gambler. You start losing sleep and look for ways to recover from the situation.

One of the worst things to do is to buy more as the stock price keeps falling. Your ‘average’ price goes down, but your losses keep on increasing. You eventually lose hope, and either sell when the stock price is near its bottom, or become a reluctant long-term investor.

So, what was wrong in being a bull? Forgetting that there is always another animal called a ‘bear’ in the stock market. While bulls are strong and can sweep aside all resistances when they are excited and charging, they are basically peaceful vegetarians.

Bears, on the other hand, are vicious and cunning meat-eating predators. In the stock market, a handful of professional bears make mincemeat out of the hordes of peaceful small investor bulls. What helps the bears is that they only need to pay a margin amount for shorting a stock which they may not even own. Then they square off the deal at a lower price and pocket the profit.

How do you avoid being decimated by bears? Follow three simple steps:

1. Do your homework before buying a stock. Is it fundamentally strong? Does the company have growth opportunities? Does the business model generate adequate cash from operations? What is the reputation and track record of the promoters?

Learn about some basic ratios like P/E, P/BV, Debt/Equity, Market Cap/Sales, Return on Assets. (Most of these concepts have been covered in different blog posts.)

2. Buy any stock with an adequate Margin of Safety

3. In spite of doing your home work and buying with a Margin of Safety, a stock’s price may start to fall after you buy it. Avoid a big loss by taking a small one. Learn how to set a stop-loss.

That was the long answer. The short answer is: Sell, and sit on the cash. Go to Step 1 above. Don’t go to Step 2 before becoming thoroughly conversant with Step 1.

Related Posts

How to lose more money and become a better investor

What exactly is the Margin of Safety?

What is the Return on Assets (RoA) ratio?

Stock Index Chart Patterns – S&P 500 and FTSE 100 – May 20, ‘11

S&P 500 Index Chart

The S&P 500 index chart consolidated for another week, as was expected from the weakening technical indicators. After touching a new intra-day high of 1371 on May 2 ‘11, which pierced the top edge of the Bollinger Band, the index has been trading within a downward sloping channel for three weeks.

The sharp drop below the 50 day EMA on Tue. May 17 ‘11 touched the lower edge of the Bollinger Band, but recovered quickly – just as it had done after dropping to an intra-day low of 1295 on Apr 18 ‘11. However, the rally fizzled out by Thu. May 19 ‘11 as the index approached the top of the downward-sloping channel. The S&P 500 index managed to close the week almost flat and above the 50 day EMA.

The technical indicators are not holding out much bullish hopes. The MACD is still positive, but falling below its signal line. The slow stochastic bounced up from its oversold zone, but is below the 50% level. The RSI is also below the 50% level. A test of the Apr ‘11 low of 1295 is likely.

Initial jobless claims were lower by 29000, but still remains above the 400000 mark. Housing permits and starts declined. So did existing home sales. People neither have the confidence, nor the buying power, to avail of the fire sale in the housing market. Sliding sales at Walmart stores is another sign of waning consumer confidence.

FTSE 100 Index Chart

The FTSE 100 index chart has been trading within a downward sloping channel for three weeks, after reaching an intra-day high of 6104 on May 3 ‘11. A sharp intra-day spurt to 6018, riding on the highest volumes of the week on Fri. May 20 ‘11, failed to break the down trend. The index closed 20 odd points higher on a weekly basis – almost exactly at the level of its 50 day EMA.

The technical indicators are suggesting that the corrective move isn’t over yet. The MACD is negative and below its signal line. The slow stochastic bounced up from its oversold zone but remains below the 50% level. The RSI is also below its 50% level.

The UK Business Secretary, Vince Cable, candidly admitted in a recent interview that the UK economy is in worse shape than what the politicians are making it out to be.

Bottomline? The chart patterns of the S&P 500 and FTSE 100 indices have been trading within downward-sloping channels for the past three weeks. Both indices are above their rising 200 day EMAs. That means the bull markets are intact. But there are dark clouds on the horizon. Time to use the ‘umbrella’ of partial profit booking.

Contrarian plays in the Capital Goods sector

The BSE Capital Goods index has been a major underperformer over the past year because of poor performances of investor favourites like Crompton Greaves, Praj Industries, Punj Lloyd, Thermax, Suzlon. Even stocks of stalwart companies like L&T and BHEL have disappointed.

In every sector, there are always a handful of stocks that buck the trend and provide money making opportunities. 15 out of the 19 stocks that comprise the BSE Capital Goods index are in bear markets. The 4 remaining stocks can be good contrarian plays. Given below are their one year bar chart patterns.

ABB

After trading below its 200 day EMA in Aug ‘10, the ABB stock made a bullish rounding bottom pattern and rose sharply to reach a 52 week high of 975 on Sep 29 ‘10. A ‘reversal day’ pattern (higher high, lower close) marked the end of the up move. A strong 39% correction ended with another ‘reversal day’ (lower low, higher close) on Feb 10 ‘11. A ‘V’ shaped recovery culminated with a top at 907 on May 11 ‘11 – correcting 82% of the fall and restoring the bull market in the stock.

The technical indicators are suggesting that the current consolidation may last a little longer. Any dip to the 50 day or 200 day EMAs may be a good entry point.

Havell’s India

The Havell’s India stock chart pattern may look similar to ABB’s, but there are a couple of notable differences. The stock hit a pre 1:1 bonus adjusted high of 446.50 on Oct 5 ‘10 after a 19 months long bull rally. The subsequent correction was exacerbated by the additional liquidity from the bonus issue. The stock dropped below its 200 day EMA for the first time in 20 months, and reached a low of 290 on Feb 11 ‘11 – a 35% correction from its peak. The sharp recovery prevented the ‘death cross’. The Apr 27 ‘11 top of 422.50 retraced almost 85% of the correction.

The stock is consolidating within a symmetrical triangle, and the technical indicators are looking weak. Can be accumulated slowly.

Lakshmi Machine Works

The strong bull rally of the LMW stock ended with a double-top reversal pattern. After touching an intra-day peak of 2920 on Nov 8 ‘11, the stock corrected almost 32% to a low of 2000 on Feb 25 ‘11. A bullish rounding bottom pattern seemed to restore the bull market in the stock. But a sharp correction has dropped the stock below its 200 day EMA again.

The technical indicators are looking oversold, which means the down move may be ending soon. Accumulate slowly.

Siemens

The brief drop below its 200 day EMA in Jan ‘11 did not have much effect on the bull rally in Siemens. The stock is consolidating sideways, and may continue to do so for some more time. Can be added on dips.

BSE Sensex and NSE Nifty 50 Index Chart Patterns – May 20, ‘11

In last week’s analysis of the chart patterns of BSE Sensex and NSE Nifty 50 indices, I had observed bearish ‘flag’ patterns from which downside breakouts were expected. Possible lower targets were also mentioned for both indices.

The downward breakouts occurred on Tue. May 17 ‘11, but by the end of the week, both indices pulled back to the lower edge of the ‘flag’ patterns. Both Sensex and Nifty closed lower by a bit more than 1% on a weekly basis.

Are the pullbacks good opportunities to sell, or is there a possibility that the downward breakouts were ‘false’ providing decent entry points? The doubt arises because we are dealing with indices comprising several stocks, and, except for ‘black swan’ events, all the stocks comprising a market index are unlikely to move in unison. Even stocks from a sectoral index don’t necessarily move in lock-step.

BSE Sensex Index Chart

To reinforce the point mentioned above, I had a quick look at the charts of 30 stocks that comprise the Sensex, and the findings were interesting. 11 of the 30 had formed bearish flag patterns, of which 5 haven’t broken downwards yet, and 2 are showing signs of turning the flag into an upward sloping channel.

8 stocks are consolidating within triangle patterns. 6 are trading within downward sloping channels. 5 are trading within upward sloping channels. 20 stocks are trading below their 200 day EMAs and 10 are trading above their long-term moving averages.

Since each stock has a different weightage in the index, the net result is the ‘flag’ pattern on the Sensex. The downward target of 16800 may not be met. More realistic targets may be the long-term support level of 17600, and the Feb ‘11 low of 17300.

The technical indicators are bearish, which means the down move should resume next week. The MACD is negative and below the signal line. The ROC is also negative, though above its 10 day MA. The RSI has emerged from its oversold zone, but is below the 50% level. The slow stochastic is still in its oversold zone.

Nifty 50 Index Chart

Bulls may feel encouraged by the uptick in volumes on the last day of the week, when the Nifty pulled back to the flag pattern. In fact, Friday’s volume was the highest during the week. Moderation in the inflation rate – thanks more to the base effect, and encouraging Q4 results from heavyweights like L&T and ITC may further boost bullish hopes. A well-known fund manager expects the market to start moving up after a month.

The bears are in no mood to relent yet. The down trend line from the Nov ‘10 top is holding firm. The technical indicators are all looking bearish. Impending price hikes in diesel and LPG will worsen inflation – and lead to another couple of rounds of interest rate hikes by the RBI. To cap it all, the FIIs have been net sellers through the past week. It was DII buying that caused last Friday’s price spurt.

With oil and commodity prices showing signs of easing, and the Indian economy on a growth path, equity valuations may start to look more attractive over the next couple of quarters. We are close to the peak of the interest rate cycle, and markets tend to rally before interest rates hit their peak.

There is another reason for bulls to feel encouraged. It has been observed that time-wise, bear phases continue for a period which is a third or a fourth of the previous bull phase. The previous bull phase – from Mar ‘09 to Nov ‘10 – consumed 20 months. A fourth means 5 months (which has elapsed already) and a third means 6 months and 20 days. If this ‘thumb rule’ holds, then we are pretty close to the end of this particular bear phase.

Bottomline? The BSE Sensex and Nifty 50 index chart patterns continue to struggle in strong bear grips. The ‘death cross’ of the 50 day EMAs below the 200 day EMAs is imminent. Further down moves are possible, and investors should closely watch the Sensex support zone between 17300 – 17600 and the Nifty 50 support zone between 5200 – 5300. This is a good time to stay on the sidelines and research individual stocks.

Stock market quiz for new investors – a discussion

Before getting into a detailed explanation of last week’s stock market quiz, I would like to specially thank all the readers who attempted answers. Answering questions in an open forum requires a certain amount of courage. There is always a fear that you may get the answers ‘wrong’.

That is why the answer options were provided in a way that apart from a few obvious ‘wrong’ answers, readers could choose from several ‘right’ answers. This is an important point for new investors to appreciate. If you are going to be successful stock investors, you need to have your own strategies and tactics. If a system or style works for you, it is a good system. Otherwise, you need to tweak or change it to make it work.

Let me provide the answers that I would have chosen – as a conservative, risk-averse, long-term investor:

1 (d); 2 (b); 3 (d); 4 (d); 5 (e), and I will explain why. That doesn’t mean that my answers are ‘correct’ – it merely reveals my investing style, which can be summed up as ‘Safety First’. By the way, there was a typographical error in 1 (d), which reader VJ had pointed out.

Why 1 (d)? Karan summed it up nicely in his answer, and this was really the only ‘correct’ answer in Q1. The other options are too risky. The answer option I didn’t provide was: “Nothing – because I do not buy or sell on tips”. Every one would have chosen that option!

Small investors should stay away from small-cap stocks in general – because of low liquidity that makes buying and selling difficult, and due to lack of financial staying power through tough times. But if you do buy a small-cap, maintain a stop-loss of no more than 8%. A 20% price drop may be a sign of worse to follow – so get out.

Why 2 (b)? Most of you chose option (a), which is not ‘wrong’. As a general rule, don’t average down because you don’t know how far the stock may fall. This is a rule for small and mid-cap stocks. For large-caps – if you have done your homework before buying, a 10% drop in price is a good opportunity to add. (Follow the thumb-rule of never buying near a 52 week high.)

Why 3 (d)? No one chose this option, except Venkat. Most chose (c), which isn’t ‘wrong’. The situation described is called a ‘panic bottom’ – which usually happens during the first or second stage of a bear market. Such bottoms are invariably broken, and the stock tends to fall much lower. So you may be better off by closing the trade, and buying lower again after the stock bottoms out.

In such stocks, it is good to keep a stop-loss between 8-15% – to avoid a 50% drop.

Why 4 (d)? Almost every one chose this option. The point I was trying to make is that investors get hung-up with round numbers. If you buy at 10 you want to sell at 15 or 20. If you buy at 50, you want to sell at 75 or 100. Markets rarely work to suit your convenience. In a low-priced stock – which investors should avoid in the first place - it is better to start taking profits home whenever they are available. Most investors get killed when they go out to make a killing!

Why 5 (e)? Only Saurabh and Joe chose this option. There are two points here. In a step-wise up move, prices tend to find support near previous tops. Those are good places to add. Since we don’t know if 55 was a previous top or not, we would not know if the correction will stop at 55 or fall further.

Also, it is a good idea to take profits at a 52 week high – more so because the original investment has doubled. Remember that you make money only when you sell. So you need to have a selling plan when you buy a stock.

Venkat gets the hat-tip for the ‘best’ answer. His responses suggest that he isn’t a ‘new investor’ any more!

Thanks once again to all who participated in the quiz. For those who didn’t participate – hope you will be able to pick up a few pointers from this discussion to improve your buying and selling.

How to use Options as a hedge – a guest post

In Chapter 3 of my FREE eBook, I explained why small investors should avoid Futures and Options trading. The odds for success are too low, and the chances of making a loss are too great for my liking.

I belong to the old school of buy-and-hold investors who prefer to get rich slowly. For younger (and smarter) investors, who are not as risk averse as me, Options can be a useful hedging tool. Nishit explains how in this month’s guest post.

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Options are much misunderstood and much maligned. They are best used for hedging, and not as a gambling mechanism.

To read the basics of Options one can refer to this older post of mine:

http://money-manthan.blogspot.com/2010/12/introduction-to-options-part-1.html

How do we use Options?

Let us suppose we have a portfolio of stocks and feel that the market is going to take a beating. One approach is to sell our stocks and sit on the cash – which is the safer route. Another approach is to write calls and pocket the premium. E.g., when the Nifty was at 5900, we could have sold the 5900 call option at Rs 142 and pocketed the premium. One would have been at a loss only if the Nifty went above 6050, a gain of about 3%.

To buy options you need to pay a premium, and the seller gets the amount the buyer has paid. He is paid this amount in order to compensate the seller for the risk he is taking - the risk of markets rising.

If the markets rise, your portfolio would also have risen proportionately, provided it had blue chip stocks in it. One could do this month after month and earn extra money while at the same time keeping the portfolio intact. This requires a bit of effort in the sense that one needs to know a bit of technical analysis to understand the support and resistance levels.

What-if Analysis

One could come back and ask: why not buy Puts to hedge? The problem here is that Options are like mangoes, a perishable commodity. If the markets don’t fall, you lose your premium. In case of writing calls, you are getting a net inflow and you would only make less money and lose money if the markets rise more than 3%. If the markets rise more than 3%, then you have got your technicals wrong.

Is the converse true? When we feel the markets are going to rise, can we write Puts?

Writing Puts is one of the most dangerous things to do. Why? Most of the falls are sudden and unexpected. The triggers are something out of the blue. Consider the 9/11 events or some assassination or natural disaster.

Writing Puts and Calls leaves one open to unlimited liabilities. In case of writing calls, one has his or her portfolio as a hedge, but in the case of writing puts there is no hedge really. It should be left to big institutions to do.

Writing Puts can be indulged in, when one has bought another put as a cover. E.g., I know the market is at a support level and will bounce form that level. I write a 5700 put at Rs 150 and buy a 5500 put at Rs 60. My net inflow is Rs 90. The maximum loss I can suffer is if market closes on expiry at 5500, which would render the 5500 put worthless and for the 5700 put I would need to pay Rs 200. I have already got an inflow of Rs 90. So, my net loss would be Rs 110.

Options are great hedging tools but need to be handled very carefully.

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(Nishit Vadhavkar is a Quality Manager working at an IT MNC. Deciphering economics, equity markets and piercing the jargon to make it understandable to all is his passion. "We work hard for our money, our money should work even harder for us" is his motto.

Nishit blogs at Money Manthan.) 

Stock Chart Pattern - Sesa Goa (An Update)

Several interesting technical patterns were observed in the stock chart of Sesa Goa in the previous update back in July ‘10. The stock had been consolidating within a symmetrical triangle after falling from its Apr ‘10 top 0f 493.

Triangles are notorious for being unreliable – a stock’s price may break out upwards or downwards; it can fizzle out through the triangle’s apex, losing any technical significance. But they tend to be continuation patterns.

Since the stock had entered the triangle from above, I had guessed that the likely break out would be downwards. The 15 months bar chart pattern of Sesa Goa shows some more interesting technical phenomena:

‘Normal’ break out points from a triangle occur at about two-thirds or three-quarters of the distance from the base of the triangle to the apex. Some times – but not always – a break down close to the apex will tend to pullback to the horizontal line drawn through the apex, and provide a good opportunity to sell.

Not only did Sesa Goa’s stock price pull back to the horizontal line through the apex in Jul-Aug ‘10, it did so a second time in Oct ‘10 – providing another selling opportunity. In between, two other interesting things happened technically.

The blue circle (in Aug ‘10) indicates the ‘death cross’ of the 50 day EMA below the 200 day EMA – confirming a bear market. Prior to that, the stock had made a ‘panic bottom’ at 312 on very high volumes – falling more than 35% from the peak of 493.

Panic bottoms occur quite often during bear markets. Investors would do well to recognise them as a warning bell for worse to follow. Panic bottoms are almost invariably tested and broken.

Note that after the ‘death cross’ in Aug ‘10, the stock made three unsuccessful attempts to move above the 200 day EMA – forming a bearish pattern of lower tops and lower bottoms. Is it all doom and gloom then? Has the tax on iron ore exports and ban on exports from Karnataka taken the wind out of the sail of this blue-chip company? The good Q4 results certainly don’t indicate that. Once the Petronas and Cairn acquisitions go through, the stock may reach its glory days again.

Observant readers may notice that the MACD, ROC and RSI made higher tops in Apr ‘11 while the stock made a lower top. The positive divergences seem to be helping the stock price to stage a revival.

The MACD is negative and below the signal line. The ROC is also negative, but has climbed above its 10 day MA. Both the RSI and slow stochastic have emerged from their oversold zones, but are well below their 50% levels.

Bottomline? The stock chart pattern of Sesa Goa is showing the effects of fundamental and technical headwinds. This is a good portfolio stock for patient, long-term investors. The best time to buy such stocks is when no one wants them. Buy on a convincing break above the 200 day EMA, with a stop-loss at 255.

Stock Index Chart Patterns – S&P 500 and FTSE 100 – May 13, ‘11

S&P 500 Index Chart

It was a week of consolidation for the S&P 500 index chart. It traded within a range of 28 points – between 1332 and 1360 – before closing flat for the week, just below the 1340 level. But the index managed to stay above the rising 50 day EMA.

The technical indicators have weakened some more. The MACD is positive, but falling below the signal line. The slow stochastic has dived below the 50% level and is headed towards the oversold zone. The RSI has dropped to the 50% level. More consolidation is on the cards.

The economic news is slowly getting better. Retail sales grew 7.6% during the past 12 months – thanks mainly to rising food and fuel costs. Producer Price Index (PPI) for finished goods rose 0.8% in April, after rising 0.7% in March and 1.6% in Feb ‘11. Initial unemployment claims declined 44000 from the earlier week, but continued claims rose by 5000. Exports are increasing and commodity prices are falling. No wonder University of Michigan’s Consumer Sentiment Index for May was higher at 72.4 against April’s 69.8.

FTSE 100 Index Chart

Last week, the weakening technical indicators of the FTSE 100 index chart had suggested a period of consolidation. The index oscillated about the 50 day EMA before closing 50 points lower on a weekly basis.

The technical indicators are turning bearish. The MACD is below the signal line, and on the verge of entering negative territory. The slow stochastic is headed downwards below its 50% level. The RSI is resting at its 50% level. Should the FTSE 100 index drop below the May 6 ‘11 low of 5872, a bearish pattern of lower tops and lower bottoms will be formed.

Manufacturing growth is flagging. GDP growth is almost nil. The austerity measures by the government seem to be stalling hopes of a quick economic recovery. 

Bottomline? The chart patterns of the S&P 500 and FTSE 100 indices are consolidating after the previous week’s correction. Stay invested but remain watchful about a deeper correction. Risk averse investors can take some profits home.

Stock Index Chart Patterns – Hang Seng, Singapore Straits Times, Malaysia KLCI – May 15 ‘11

In last month’s analysis of the Asian indices, the concluding remarks were:

‘The down trend in the chart pattern of the Hang Seng index appears to have been reversed. The Singapore Straits Times and Malaysia KLCI haven’t quite reversed their down trends yet, but should be able to do so soon enough.’

Looks like ‘soon’ will take a bit longer! All three indices are still in down trends, which is bad news. But the good news is that all three indices are trading above their rising 200 day EMAs, which means technically they are in bull markets.

Hang Seng Index Chart

Last month’s down trend (dotted blue) line had been penetrated from below, but the Hang Seng couldn’t quite get past its Jan ‘11 top. The technical indicators were looking overbought, and I had expected the pullback to the down trend (dotted) line. Instead of bouncing up and resuming the rally, the index dropped down to its 200 day EMA.

The technical indicators are looking bearish, with just a hint of revival. The MACD is below its signal line, and both are in negative territory. The ROC is negative and below its 10 day MA, but trying to move up. The RSI has bounced up from the edge of its oversold zone, but is below the 50% level. The slow stochastic is struggling to emerge from its oversold zone.

The down trend in the Hang Seng index has been re-drawn as a downward-sloping channel, within which it may trade for a while longer.

Singapore Straits Times Index Chart

The Singapore Straits Times index dropped far enough below its 200 day EMA in Mar ‘11 to raise the spectre of a bear market. But the ‘death cross’ of the 50 day EMA below the 200 day EMA – which would have confirmed a bear market - never happened. The subsequent rally rose above all three EMAs, only to face strong resistance from the down trend line.

The technical indicators are less bearish than those of the Hang Seng index, but are giving mixed signals. The MACD is positive, but below its signal line. The ROC is negative but touching its 10 day MA. The RSI has dipped below the 50% level. The slow stochastic has moved above its 50% level.

Of late, the volumes on up days have been greater – a sign of accumulation. However, bulls should remain circumspect till the down trend line is convincingly broken.

Malaysia KLCI Index Chart

The technical indicators were looking overbought in the Malaysia KLCI index chart last month, and a correction to the 50 day EMA was expected. The index dropped a little below the medium-term moving average, only to move up again without coming anywhere close to the 200 day EMA.

The technical indicators are bullish, and there is a possibility of another test – and even a break – of the down trend line. The MACD is just above its signal line, and has entered positive territory. The ROC is barely positive, but above its 10 day MA. The RSI is above the 50% level and rising towards its overbought zone. The slow stochastic has entered its overbought zone.

Bottomline? The chart patterns of the Asian indices are still in their down trends, but are technically in bull markets. This is a good time to reallocate your portfolios by getting out of non-performers and switching to better stocks.

BSE Sensex and NSE Nifty 50 Index Chart Patterns – May 13, ‘11

Honours were even as the bulls and bears fought it out during the week’s trading. The chart patterns of the BSE Sensex and Nifty 50 indices closed flat on a weekly basis – the Sensex closing marginally higher and the Nifty closing marginally lower.

The better-than-expected IIP numbers were ignored by the market on Thursday (May 12 ‘11). Favourable state election results on Friday triggered buying, but failed to overcome resistance from the 200 day EMAs. Both indices have formed bearish inverted ‘flag’ patterns, which have measuring implications.

BSE Sensex Index Chart

The 20 day EMA has crossed below the 50 day EMA, and is likely to drop below the 200 day EMA next week. The ‘death cross’ of the 50 day EMA below the 200 day EMA will confirm a re-entry into the bear market – unless the FIIs dramatically step-up their buying.

Now, about the ‘inverted flag’. Such consolidations usually appear in the middle of a move, and tend to be continuation patterns. In other words, the likely break out will be downwards. How far down? The fall can equal the height of the inverted flag pole.

In this case, about 1500 points (from the intra-day top of 19700 on Apr 21 ‘11, to the intra-day bottom of 18200 on May 5 ‘11). Assuming the break from the flag occurs at 18300, the Sensex can drop to about 16800. Will it?

The technical indicators are suggesting as much. The MACD is below its signal line, and both are falling in negative territory. The ROC has managed to cross above its 10 day MA, but remains negative. The RSI briefly emerged from the oversold zone, but dropped back. The slow stochastic tried to come out of its oversold zone, without much success.

Nifty 50 Index Chart

Volumes have been comparatively low during the week - not unusual during flag formations. Down day volumes were higher than up day volumes, which is bearish. Note that the up trend line from the Feb ‘11 low is going right through the flag – a sign that bulls are desperately trying to defend the up trend?

The height of the inverted flag pole in the Nifty 50 chart – from the Apr 21 ‘11 intra-day top to the May 5 ‘11 intra-day bottom is about 470 points. That gives a down side target of about 5000. The consolidation within the flag can continue for a few more days.

What makes technical analysis challenging is that a spurt in FII buying (or selling) can upset all expectations. In the previous week, FIIs were net sellers. This week, they were small net buyers during the first 3 days, but turned net sellers on Thursday and Friday.

If commodity prices – particularly gold, silver, oil - continue to fall, FIIs may re-deploy in emerging markets. Their buying can turn any bearish pattern into a bullish one. Food inflation is moderating, which is a positive sign.

It is too much to expect that the plodding UPA government will suddenly announce a slew of economic reforms – now that election results are over and done with. But this is a good time to do it, and can provide a big boost to the sagging market sentiments.

Bottomline? The BSE Sensex and Nifty 50 index chart patterns are trading below their 200 day EMAs, and have formed bearish inverted ‘flag’ patterns. Remain cautious and watch the 17600 Sensex level and 5300 Nifty level closely. Any breach of those levels may provide selective buying opportunities.

A simple stock market quiz for new investors

Many new investors get attracted to the stock market because they hear stories from friends about the large sums of money that can be made easily. So they jump into the market without doing adequate homework – usually when the market has already risen significantly. No wonder they stare at huge losses when the market suddenly turns around and starts heading south.

If you have entered the market already – or thinking about doing so – take a simple, multiple-choice stock market quiz and find out how much learning is required before you can think of making any money from buying and selling stocks. Use the ‘comments’ link below the post to provide your answers (e.g. 1(a); 2 (b); 3(c); and so on. Please choose only one answer from the five choices provided for each question.)

A simple stock market quiz

Q1. You buy 200 shares of a unknown small-cap stock for Rs 50, based on a tip from a colleague. A few days later the stock falls to 40. What would you do?

(a) Wait for it to fall more so you can buy more; (b) Start buying more; (c) Sell 100 shares and hang on to the balance 100; (d) Sell all 500 and cut your losses; (e) Wait for the stock’s price to climb back to 50 so you can sell without making a loss

Q2. You buy 50 shares of a well-known large-cap stock for Rs 200. A few days later the stock falls to 180. What would you do?

(a) Wait for it to fall more so you can buy more; (b) Start buying more; (c) Sell 25 shares and hang on to the balance 25; (d) Sell all 50; (e) None of the above, because as a small investor buying expensive large-cap stocks doesn’t make sense

Q3. You buy 100 shares of a well-known mid-cap stock for Rs 100. Soon afterwards, the stock starts to fall – slowly at first, followed by a sharp vertical drop - on good volumes - to 50, before it bounces up to 60. You are caught unawares. What would you do?

(a) Start buying more to ‘average out’ your cost price; (b) Wait for it to fall below 50 before starting to buy; (c) Wait for the stock to find a bottom and buy after the stock starts to move up; (d) Sell all 100 and cut your loss; (e) Wait for the stock’s price to climb back to 100 so you can sell without making a loss

Q4. You have identified a cheap stock that has been trading in a range between Rs 8 – 12 for the past 6 months. You buy 1000 shares at Rs 10 hoping to make some quick money. Within a month, the stock breaks out of the range and starts rising. What would you do?

(a) Sell all 1000 shares when the price reaches Rs 15; (b) Wait to sell all 1000 only when the stock price hits 20; (c) Wait to sell 500 shares at 20 so that your original investment is recovered, and the balance 500 becomes ‘free’; (d) Sell 200 shares every time the stock’s price rises by Rs 3; (e) Plan to sell all 1000 as soon as the stock reaches Rs 18

Q5. You have bought 200 shares of a good mid-cap stock at Rs 50. It rises slowly to 60 before dropping to 55; it then rises to 70 before dropping to 60; the next move takes it to 85 before dropping to 70; then on a sharp volume spurt, the stock reaches a 52 week high of 100. What would you do (you may need paper and pencil to answer this question)?

(a) Buy more at the minor bottoms of 55, 60, 70; (b) Buy more only at 60 and 70; (c) Sell all 200 shares at 100; (d) a combination of (a) and (c); (e) a combination of (b) and (c).

Time to put on your thinking caps and give this simple quiz a shot. Please don’t bother too much about ‘right’ or ‘wrong’ answers. The options you choose will give you some insight into how market-savvy you are.

Please feel free to provide the logic behind your choices – but it is not mandatory to do so. Needless to say, the best answer(s) will be duly acknowledged in next Thursday’s (May 19) post.

Stock Chart Pattern - Bilcare Ltd (An Update)

In the previous update on Jun 30 ‘10, I had concluded with the following comment: ‘The stock chart pattern of Bilcare Ltd had made a brief foray out of the bear market, and is now back again to where it belonged for the past two and a half years. Small investors should avoid this stock.’

My advice was based on the massive 85% bear market fall (from 1830 in Jan ‘08 to 279 in Mar ‘09). Small-cap and mid-cap stocks – including fundamentally strong ones - rarely recover from such huge corrections. Even if they do, it may take years.

Shortly after writing the post, the stock price slid down further to touch a low of 403.30 on Jul 13 ‘10. This was close to its previous low of 400 touched in Dec ‘09. A ‘V’ shaped rally ensued – which strengthened on increasing volume support and periodic corrections down to its rising 20 day EMA. The previous top of 600 was cleared without much trouble, and the stock price went on to touch a peak of 787.40 on Nov 12 ‘10 – an impressive 95% gain in 4 months!

From reader comments on the previous update, it will become apparent that the reason for the renewed enthusiasm for the stock was the acquisition of a German company at a very attractive valuation. There were also rumours that Rakesh Jhunjhunwala had re-entered the stock, after bailing out earlier.

Did I make a mistake in advising small investors to stay away from the stock? A 95% gain in 4 months is not to be scoffed at. But as a long-term investor, I’m more concerned about protecting capital and sustainability of gains. A look at the 18 months bar chart pattern of Bilcare Ltd. will clarify what I mean:

Note that at the beginning (on Sep 16 ‘10) of the last phase of the bull rally – volumes peaked, and so did the technical indicators. Thereafter, as the stock made higher tops, the volume bars and all four technical indicators reached lower tops (marked by blue arrows).

The negative divergences provided ample warning that the good times were coming to an end. The 18 month peak of 787.40 - touched on Nov 12 ‘10 – confirmed the end of the rally by turning out to be a ‘reversal day’ (higher high, lower close). From the Mar ‘09 low of 279 to the Nov ‘10 high of 787.40 may seem a commendable 182% gain, but it managed to retrace less than 33% of the bear market fall from 1830 to 279. Technically, the stock remains in a long-term bear market that started in Jan ‘08, and the entire move from the Mar ‘09 low to the Nov ‘10 top was a bear market rally.

A swift correction from the Nov ‘10 top pierced the 600 level and dropped well below the 200 day EMA to an intra-day low of 529 on Dec 9 ‘10. That was the last warning for the bulls in the stock to get out. As often happens after such sharp corrections, there was a strong pullback rally that took the stock price above all three EMAs to touch an intra-day high of 703 on Jan 4 ‘11. The pullback provided a good opportunity to sell.

The intermediate top on Jan 4 ‘11 was confirmed by another ‘reversal day’ pattern. This time, the force of gravity proved too strong. After a brief bounce from the 200 day EMA, the stock price desperately clung on to the long-term moving average for a few days before falling back into its long-term bear market.

The MACD and ROC are both in negative territory, but have made higher bottoms and are showing signs of recovery. The RSI and slow stochastic are trying to emerge from their oversold zones. Any rally in the stock’s price is likely to be short-lived. The intra-day low of 389.55 – touched on Mar 28 ‘11 – may be tested and broken. In which case, Bilcare’s stock may fall to 350.

Bottomline? The stock chart pattern of Bilcare Ltd is back in its long-term bear market. Die-hard thrill seekers can look for opportunities to bottom-fish for quick gains. Prudent investors should continue to avoid this stock.

5 reasons why small investors should avoid stocks and buy mutual funds

Reason No. 1: Insufficient funds

Many small investors are unable to spare more than Rs 5000 or 10000 per month for investing. Such amounts are insufficient for investing in excellent stocks. Investors can at best buy only 25 shares of ITC, or 10 shares of HDFC.

Alternatively, they can buy 50 units of DSPBR Top 100 fund. The fund’s equity holdings include ITC, HDFC, TCS, Larsen & Toubro, Coal India, ONGC, ICICI Bank, Hindalco, Grasim, Bank of India, Bharti Airtel, Glaxo Pharma, Lupin, and many more stalwart stocks. 

Reason No. 2: Insufficent knowledge

Small investors have very little knowledge of how the stock market works, and what are the rules and criteria for success. They jump into the market feet first – attracted by stories of untold riches with very little effort. No wonder they end up losing big time.

Some never recover from the initial trauma, and quit the stock market for ever. Others plod along manfully, feeling happy if they can recover their losses after a few years. A handful eventually learn the ropes and end up with a decent retirement kitty.

It is much better to invest in a mutual fund, and leverage the knowledge of the fund manager.

Reason No. 3: Insufficient time

For most small investors, buying and selling stocks is a part-time activity that provides some extra money and thrills. But to become truly wealthy from one’s stock investments, one has to be engaged in it full time.

Why? Because one has to learn and monitor a variety of information – the economy, its particular cycle stage, inflation, interest rates, oil and other commodity prices, activities of FIIs and DIIs, quarterly results of individual companies, analysing annual reports, tracking promoter activities, their shareholding, and so on. Most investors have insufficient time to spare for such learning and monitoring.

The fund manager and his team get paid to do such monitoring on a daily basis. Benefit from their services.

Reason No. 4: Insufficent experience

It takes years of experience in the stock market to learn the intricacies of fundamental and technical analysis that would enable a small investor to distinguish between a good stock and an excellent stock. A good stock may give you decent returns over a couple of years and then fall from glory (think Pantaloon or Suzlon). An excellent stock – like ITC or HDFC – will provide superior returns year after year, and can be bequeathed to future generations.

Take a re-look at some of the stocks in the portfolio of DSPBR Top 100 fund (mentioned in Reason No. 1 above). That is an excellent portfolio selected by an experienced fund manager.

Reason No. 5: Insufficient risk tolerance

Almost inevitably, a stock falls in value when a small investor buys it, and rises in value when a small investor sells it. The result is usually panic, and a desperate desire to either recoup the loss or re-enter for more profits at the earliest. Without knowledge of her own risk tolerance, a small investor invariably sells too soon or buys too late.

Better leave the buying and selling of portfolio stocks to the fund manager, so you can sleep more easily at night.

Please note that a fund manager is human and can make errors in judgement. That is why it is important that you do a little research before selecting the fund you buy. Keep investing your monthly savings regularly in buying a fund through bull and bear markets. After a few years of regular investing, your investments are likely to grow considerably – and so will your experience. Then you can contemplate building a stock portfolio of your own.

Related Post:

Why building a stock portfolio is like buying a car

Stock Index Chart Patterns – S&P 500 and FTSE 100 – May 06, ‘11

S&P 500 Index Chart

In last week’s analysis of the S&P 500 index chart pattern, the technical indicators were looking overbought and the RSI had displayed negative divergence. So the correction wasn’t a big surprise.

The index touched a new intra-day high of 1371 on May 2 ‘11 that pierced the upper Bollinger Band, but closed lower – forming a bearish ‘reversal day’ pattern (higher high, lower close). Over the next three days, the index corrected down towards the 50 day EMA, but pulled back to the 1340 level by Fri. May 6 ‘11.

The bullish pattern of higher tops and higher bottoms that started from the low of 1249 (Mar 16 ‘11) is intact. But the technical indicators have weakened some what. The MACD is positive, but has slipped below the signal line. The slow stochastic has dropped from the overbought zone to the 60% level. The RSI failed to reach its overbought zone and has fallen to its 60% level.

The economic growth is listless. The American Trucking Association’s truck tonnage index rose 1.7% in Mar ‘11 – a 6.3% YoY growth as per this article. Initial unemployment claims increased from previous week’s 431000 to 474000, the largest weekly increase in 2 years. The private sector has started hiring, while there is a reduction in public sector jobs. The fall in oil price should come as a boon to consumers.

FTSE 100 Index Chart

It was a strangely volatile week of trading for the FTSE 100 index. The intra-day high of 6104 on May 3 ‘11 tested the Feb ‘11 top of 6106. But it couldn’t quite reach the upper Bollinger Band. A sharp drop below the 50 day EMA on increasing volumes over the next 2 days sent a clear warning to the bulls.

The index fell to 5872 on Fri. May 6 ‘11, piercing the lower Bollinger Band but stopping short of the Apr ‘11 low of 5870. Short-covering led to a smart bounce above the 50 day EMA, and formed a bullish ‘reversal day’ pattern (lower low, higher close).

Is the worse over for the bulls? The technical indicators are not holding out great hopes. The MACD is positive, but has dropped below its signal line. The slow stochastic has descended rapidly from the overbought zone to the 40% level. The RSI also dropped below the 50% level, but has bounced up a bit. Some consolidation can be expected.

The UK economy continues to struggle. Manufacturing growth is faltering on lower orders from the construction sector and subdued consumer spending. However, export orders rose in Apr ‘11.

Bottomline? The chart patterns of the S&P 500 and FTSE 100 indices suffered another bear attack last week. The S&P 500 emerged reasonable unscathed, but the FTSE 100 is still struggling. Both indices are trading above their rising 200 day EMAs and remain in bull markets. Stay invested, but maintain stop-losses.

BSE Sensex and NSE Nifty 50 Index Chart Patterns – May 06, ‘11

The higher-than-expected interest rate hike by RBI triggered a fresh wave of selling, and all support levels mentioned in last week’s analysis of the BSE Sensex and NSE Nifty 50 index chart patterns fell by the wayside.

The FIIs were net sellers throughout the week. The DIIs were net buyers. Last Friday’s (May 6 ‘11) pullback was mainly due to DII net buying overwhelming FII net selling.

BSE Sensex Index Chart

The bulls may be enjoying their weekend, content that the sharp fall in oil prices should halt the relentless FII selling. The pullback of the Sensex above the upward-sloping trend line is a positive. The higher bottom of 18161 touched on May 5 ‘11 keeps the bullish pattern of higher tops and higher bottoms since the low of 17296 (Feb 11 ‘11) intact. That is another positive.

But a glance at the technical indicators is enough to banish any bullish hopes. The MACD is negative and below its signal line. The ROC is negative and below its 10 day MA. The RSI is trying to emerge from its oversold zone. The slow stochastic is inside its oversold zone. All four indicators reached lower bottoms while the Sensex made a higher bottom. The negative divergences may extend the correction.

Almost forgot to mention (in case you haven’t seen it already) that the Sensex is trading below its 200 day EMA. The ‘death cross’ of the 50 day EMA below the 200 day EMA will confirm a re-entry into a bear market.

Nifty 50 Index Chart

Friday’s pullback in the Nifty 50 chart didn’t quite make it above the upward-sloping trend line, and there is every possibility of the index resuming its down trend next week. In spite of the drop in oil price, twin concerns of inflation and high interest rates are taking a toll on investor sentiments.

Last week, I had mentioned that higher volumes on down days during Apr ‘11 (note the higher red volume bars) was a sign of distribution. The sliding OBV indicator clearly exemplifies distribution.

There are no signs of a turn around in the down trend yet. But the index is indicating oversold conditions, which could lead to a recovery. If oil’s price continues to tumble, India’s fiscal deficit situation will improve. If results of the state elections go in favour of the ruling party at the centre, it could provide a trigger to buy.

Lots of ifs and buts. Shows that the near future is uncertain. Patience and discipline are virtues during such times.

Bottomline? The BSE Sensex and Nifty 50 index chart patterns are on the verge of dropping into bear markets. Long-term investors should keep a close watch on support levels of 17600 for Sensex and 5300 for Nifty. Use Q4 results to short-list stocks for your ‘buy’ list.