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Tuesday, June 14, 2011

Why good investment stocks may not be good trading stocks – and vice versa

The hundreds of stocks that are regularly traded in the BSE and NSE can be broadly separated into three groups – stocks that are good for investment; stocks that are good for trading; and, stocks that are plain junk and should not be touched.

Regular readers of this blog know that I’m neither a great fan of short-term or day trading, nor do I encourage small investors to do so. The only person that gets rich is the broker. No wonder various internet investment groups are full of brokers constantly giving short-term buy and sell calls.

However, it is a fact of life that small investors fall prey to the lure of making quick and easy money, and frequent investment groups and web sites that offer ‘free 100% sure-shot short-term calls’ as a short-cut to untold riches.

I was taken aback when I read read about a short-term sell call on Titan Industries. If the stock falls below a certain level, then it could fall by a whopping 2% more! However, if it rises above a certain level, then the uptrend will resume. A quick look at Titan’s 2 years closing chart pattern shows a more than 50% gain from its Feb ‘11 low, followed by a 3% correction that must have triggered the call.

Titan_2yr_Jun1411

Titan has gained 300% in 2 years, providing fabulous returns to long-term holders. Any sensible broker would have given a ‘buy the dip’ call instead of a short-term sell call for a paltry 2% profit.

Put it down to ignorance, or inexperience, or both. Many traders believe in the myth that all fundamentals are ‘in the price’ – so it is a waste of time to spend hours in stock analysis.

A trader, if he wants to make money consistently, has to spend hours studying technical charts to try and get into trades that will make huge profits - to cover up many small losses that are part of a trader’s life. Even a novice can take a look at Titan’s chart and conclude that a trade on the long side will be more profitable.

It is precisely because Titan is such a great stock for long-term buy-and-hold investment that it is not a good stock for short-term trading. It doesn’t provide enough wild swings to get in and out with big profits.

Is the vice versa true – that good trading stocks do not make good investment stocks? What is a good trading stock? For the answers to both questions, take a look at the 2 years closing chart pattern of Reliance.

RIL_2yr_Jun1411

Thanks to its massive market capitalisation, the Reliance stock finds a place in most large-cap and diversified equity funds as an investment-grade stock. But on 2 years, 1 year, 6 months and 3 months time frames, it has provided negative returns.

The rounding-top bearish pattern of the 200 day EMA, and the 50 day EMA trading below the 200 day EMA for the past five months are clear indications that the bears are getting the upper hand.

Experienced traders probably got seriously rich just by trading Reliance over the past couple of years. Look at the frequent and large price swings – just the kind of chart that should make traders rub their hands in glee.

The moral of the story? Whether you are a trader, or investor, or both – it improves your chances of making big money if you do your homework in selecting stocks.

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