Is it a good strategy to ‘average down’ when the price of a stock starts to fall?

The short answer is ‘NO’. Many small investors lose money by trying to ‘average down’ when the price of a stock, which they bought at higher levels, start to fall. How do I know? By the emails I receive from readers and the questions I hear on business TV channels.

Here is a recent email:’I bought Bartronics at an average price of 138. Now it is falling. What should I do?’ Reading between the lines, one can guess that the investor bought at a higher level than 138 and bought more as the price fell, to ‘average down’.

I wrote two posts on Bartronics – first in Jun ‘09 when the stock closed at 165 and the second in Mar ‘10 when the stock closed at 150. On both occasions, investors were advised to get out before it was too late, because the fundamentals of the company were poor. So, I referred the investor to my earlier posts.

The response was: ‘Thanks, I’ll sell Bartronics tomorrow at whatever price I can get, and reinvest in Punj Lloyd or Suzlon.’ I wrote back immediately that both those stocks should be avoided like the plague!

Why? Instead of providing 1000 words of explanation, I’ll take recourse to some pictures:

The Bartronics stock tried a brief recovery above the 200 day EMA on decent volumes in Jul ‘10 – setting up a perfect bull trap. The subsequent waterfall-like drop has taken the index well below the 200 day and 50 day EMAs on increasing volumes.

The Punj Lloyd stock went briefly above the 200 day EMA back in Jan ‘10, and has since been in a steady decline well below the 200 day EMA – making lower tops and bottoms. Volumes have been higher on down days. Signs of stocks going from stronger to weaker hands.

The Suzlon stock also went above the 200 day EMA in Jan ‘10, and has since fallen continuously – well below the 200 day EMA. Even if you are enamoured by wind energy, stay away from this bag of wind.

Note that while the Sensex has been making new highs for the past year in a bull market, all three stocks are in bear markets, with no end to their bottoms in sight. ‘Averaging down’ on such stocks can only lead to increasing your losses.

As a contrast, here are some other pictures:

After a long sideways consolidation, the Akzo Nobel (former ICI India) stock has had a huge upward break out.

Automotive Stampings is a small-cap auto ancilliary from the house of Tatas that was rising steadily before a sharp break out on strong volumes.

After making a loss and languishing due to the debt burden of the Jaguar-Land Rover acquisition, the Tata Motors stock has comfortably out-performed the Sensex over the past year.

I am not suggesting that you buy these stocks right away. It is better to be cautious when a stock is near a 52 week high. But here are a couple of thumb rules that can be easily followed by novice investors:

1. When a stock is moving up above a rising 200 day EMA, it is in a bull market. The strategy should be to buy the dips. That means ‘averaging up’. Use a trailing stop-loss to protect your profits.

2. When a stock is moving down below a falling 200 day EMA, it is in a bear market. You don’t make money in a bear market by buying, but by selling. The strategy should be to sell on every rise.

If you can buy the shares back at the next bottom and sell on the following rise, you can make a ton of money. But such a strategy – known as ‘short-selling’  - is not advised for inexperienced investors.

Related Post

Some do's and don'ts about Cost Averaging

Stock Chart Pattern - ICI India Ltd (An Update)

The stock chart pattern of ICI India was analysed 6 months back, when the BSE Sensex was near its nadir. A cash rich company with generous dividend payments and steady growth, it has enhanced share holder value by divesting unrelated businesses and using some of the cash to buy back its own shares.

Let us have a look at the 1 year bar chart pattern of ICI India and check out how the stock has fared in the past 6 months:-

In early Mar '09, the stock was at 416 and below its 200 day EMA. The bull rally had already started from the Oct '08 low - as confirmed by the progressively higher tops and bottoms. Note the gradual up move, well supported by the 50 day EMA.

The stock is neither a trader's favourite, nor one that FIIs lap up - hence the low volume of transactions. The low OBV reading indicated that right up to Jun '09, when the stock entered a bullish consolidation pattern called an 'ascending triangle' (i.e. flat top and a rising bottom).

The consolidation continued with a small up-tick in volume till the end of Aug '09. The slowly rising OBV indicates 'accumulation'. Volumes peaked at the  end of Aug '09, and the stock broke out above the resistance at the 550 level. There has been some selling after the break out, and now the resistance level has turned into a support level.

Both the RSI and MACD are showing negative divergence, making lower tops as the stock made a new high. The slow stochastic has dropped from the overbought zone and is now at the 50% level with the %K line below the %D. The stock may consolidate, or correct some more.

The rise of the ICI India stock from 416 to 557 means a return of 34% in 6 months. Add the Rs 16 dividend, and the return becomes a little more than 37.5%. That means an annualised return of 75%. Not bad for a boring, stalwart stock that manufactured paints 10 years ago and will continue to do so 10 years from now. It won't cause you sleepless nights and can be held 'forever'.

How to build wealth using a buy and hold strategy

The investment gurus have all advised investors to follow a buy and hold strategy to build long term wealth. Investors, fund managers, academics like Warren Buffett, John Bogle, Jeremy Siegel, Phil Fisher, Peter Lynch have provided us with their tried and tested methods.

Yet, whenever a bear attack makes the market trajectory go haywire (i.e. in any direction but up!) all kinds of 'new' theories start to appear and re-appear. Fundamentals and technicals are all hogwash. It is all about sentiment and momentum. It is a traders' market. Buy and hold is dead.

The last named theory has been bandied about quite a bit of late. Probably by those unfortunate folks who got all excited by an ever-rising bull market and got in pretty much near the very top. I have been there and done that, and lost a pile of money.

But that didn't make me go out and search for a new theory. It taught me that to make money in the stock market, you can't jump in feet first without any inkling about what the market is all about, and how some companies make real profits in a sector while many do not.

You've got to pay your dues. By losing money, and by spending the time and effort to learn how to analyse a company by studying the Annual Report in detail AND how to look at technical charts to analyse the supply-demand mismatch in the market.

You can pick the best company and buy it near the market top, and you may not make any money for years. You buy the same company near a market bottom and sell it when it gains 25% or 50%, and you can miss a multibagger.

However unexciting and boring it may sound, investment is serious business. It requires patience, perseverance and discipline - not only to build serious wealth, but to keep it from disappearing.

There lies the main problem with trading. You make money fast, and you lose it faster. The odds are better in a casino. After you pay the brokerage and your taxes, you may find that you would have been better off keeping the money in a savings bank.

Strong, well-managed companies have various ways of rewarding their shareholders. A bonus this year; a rights 3 years later; regular dividends; share buy-backs. After a few years you find that your 100 shares have become 350, plus the market value has tripled. There is one condition. You have to stay the course. Flitting in and out of stocks will only make your broker rich.

Take the example of ICI Ltd. A staid paints stock that was going abegging at Rs 85 in 2002. In the seven years since, it has paid a total dividend of Rs 85 per share. No bonus. No rights. A share buy-back last year, and the stock is at Rs 500! I'm still holding.

What do you think, dear reader? Do you feel the buy and hold strategy may be the way to long term wealth? If not, why not?

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About portfolio suggestions and a stock not to be picked

Investment Philosophy of an Experienced Investor

Stock chart pattern discussions - hits and misses

In my individual stock chart pattern discussions on Wednesdays, 10 stocks have been covered so far. It may be worthwhile to do a reality check to find out what I had observed and inferred and how the chart patterns actually shaped up.

1.  ICI India - ICI had pierced and closed above its 200 day EMA before dropping below, and was consolidating between the 50 day and 200 day EMAs around the Rs 416 level. I had suggested: Good stock to accumulate in small quantities for conservative, long term investors.

The stock has slowly but steadily moved up well above its 200 day EMA and added about 15%. Nothing great, but can be counted as a 'hit'.

2.  Suzlon Energy - The stock was looking oversold. There was a possibility of a bounce up, but it could also go lower. My advice: Investors should not go anywhere near this stock. Adventurous traders may want to make a punt with very tight stop losses.

After going marginally lower, the stock moved up rapidly with the global rally and jumped up by almost 150%! It is still well below its 200 day EMA in spite of the sharp rise. A 'miss'.

3.  State Bank - SBI was looking like a value buy as it was trading at its book value. I observed the strong support at 900, but did not expect an up move to go beyond 1100.

SBI moved up 40% with the global rally before facing resistance at a previous top of 1400. Another 'miss'.

4.  Unitech - The stock was being accumulated near its 52 week bottom and I expected a move upwards. But advised: Unless the strong resistance between 50-60 levels is overcome, there is no point in entering Unitech.

The stock did move up to the resistance zone of 50-60, but despite two attempts, was unable to cross it. A 'hit'.

5.  Hero Honda - This was one of the few stocks in a bull phase but at 1100 level was looking overbought and due for a correction. My suggestion: New investors may buy on dips. Existing investors should hang on tight and enjoy the ride.

After correcting to Rs 1000, the stock has steadily moved up to Rs 1200 and continues in its bull phase with all three averages moving up.

6.  Reliance Capital - I had expected the stock to face some resistance at 490-500 before moving up to 625 level, and had advised short and long term investors to get in at the next dip.

Reliance Capital sailed upwards to 580, reacted to 490 and then moved up to 625, where it faced resistance. I will count that as a 'hit', though the short term gain was only about 30%.

7.  Infosys - Despite a sell-off due to disappointing results that dropped the stock below its 200 day EMA, I had observed a 'rounding bottom' bullish pattern and advised: Wait for the selling pressure to subside before entering the stock on the dip. Be prepared for a longish wait for profits.

The stock smoothly moved up from Rs 1300 to Rs 1600, well above its 200 day EMA. Another 'hit'.

8.  DLF -  A 'rounding bottom' bullish pattern was observed but the failure to cross the resistance level of Rs 300 led me to suggest: If you haven't got rid of your DLF holding yet, you may get one more chance to do so. There is a possibility that this rally is taking a pause before trying to move higher again.

The stock moved down to Rs 220 before moving up to Rs 269 to provide one more chance for investors to get out. A 'hit'.

9.  Bharti Airtel - The upward rally looked too steep. The lower volumes remain a concern. The 20 day EMA did move up above the 200 day EMA as expected. My advice: An existing holder can keep riding the rally or book partial profits.

The stock has continued its upward move with a slight dip for 2 days. A 'hit'.

10. Balrampur Chini - The 50 day EMA did move above the 200 day EMA but instead of a correction, the stock is undergoing a triangular consolidation before the next up move. My suggestion: I would wait till the election results come out before entering.

It has been only five trading sessions since my discussion - too early to draw conclusions. A 'neutral'.

Without trying to be immodest, not a bad performance at all. Comments are welcome.

(Note: Please right-click on the charts and open them in a new tab or window for a better view.)

Stock Chart Pattern - Hero Honda Ltd

While discussing the chart pattern of ICI India Ltd on Mar 4, '09, I had mentioned how the stock was proving resilient after hitting a low in Oct '08 by slowly making higher tops and bottoms. But it still remained in a bear phase - below the 200 day EMA.

If you look at the 1 year closing chart pattern of Hero Honda Ltd, it will warm the cockles of your heart:-

(Please right-click on the image above and open it in a new tab or window for a better view.)

After going below the still-rising 200 day EMA in June '08, Hero Honda made a 52 week low at around 630 in July '08. The Sensex and almost all the known stocks were in a steep fall at this stage and most made their 52 week lows around Oct 27, '08.

But Hero Honda entered a new bull phase! After sharply moving above the 20 day EMA, the 50 day EMA and the 200 day EMA, it fell back below the 200 day EMA in late Oct '08 - along with the rest of the market. But it made a higher low on the stock chart.

It stayed in a sideways consolidation pattern for most of Nov '08 before embarking on an unbridled bull run, which is getting stronger as time passes. There were two short corrective phases in between. One in Jan '09 was supported by the 200 day EMA. The one in Mar '09 was supported by the shorter term 20 day EMA.

From the Jan '09 corrective phase onwards, Hero Honda has remained above all the three EMAs - the 20 day, 50 day and 200 day - with the shorter term averages above the longer term ones. This is the clearest sign of a bull phase.

The only note of caution is that the Mar '09 rally in the rest of the stock market has propelled Hero Honda far above the 200 day EMA and all three EMAs are pointing sharply upwards. This is usually the sign of an imminent correction.

The slow stochastics, and ROC are trying to move down from over bought regions. The MACD is still going strong. But have a look at the RSI. It has made a lower top while the stock is making higher ones. This is a 'divergence' in technical terms and indicates the possibility of a correction soon.

In Hero Honda's case, the technicals seem to reflect the fundamentals. Two-wheeler sales are strong and growing, in spite of the fact that the parent Honda Motors of Japan is becoming an active competitor.

Bottomline? Hero Honda is one of the few index stocks that is in a bull phase. New investors may buy on dips. Existing investors should hang on tight and enjoy the ride.

Stock Chart Pattern - Suzlon Energy Ltd

Today is the second of my stock chart pattern discussions. Last week I had shown the chart pattern of ICI India Ltd.  This week I have chosen the stock chart pattern of a stock I love to hate.

Before delving into the Suzlon chart, let me digress a bit and introduce a small part of a nonsense rhyme written by Sukumar Ray (father of well-known filmmaker, Satyajit Ray). Loosely translated from the original Bengali, it reads something like this:

Once there was a porcupine - in grammar it just could not shine

Turned into a 'duck-upine';  how? I can not determine!

Sukumar Ray, like his son Satyajit Ray, was an illustrator of repute and the above rhyme in the book 'Abol Tabol' (which means complete nonsense) had an illustration of a 'duck-upine' - the front part looked like a duck and the rear like a porcupine.

There have been several 'duck-upine's in the history of Indian industry - the most well-known recent example being Tulsi Tanti. From a relatively unknown background in cold storage, construction, textiles and several other businesses - none of which made him much money - he defied grammar to suddenly turn into a wind energy king, and the fourth richest Indian.

Please don't get me wrong. I have nothing against energetic entrepreneurs trying their luck in different fields. My gripe is against entrepreneurs who adopt dubious means - like reportedly laundering underworld money through an IPO, allegedly creating fictitious projects to avail tax breaks, supplying substandard materials, and technology bought from a loss-making bankrupt company, for export orders.

While no wrongdoing has been proven against Suzlon so far, there has been investigations by authorities and payment of penalty for substandard supplies. As the old saying goes: where there is smoke, there is fire.

Let us take a look at Suzlon's 1 year chart pattern:

 

(You can right-click on the image above and open it in a new tab or window for a better view.)

After holding on to Rs 250 level till the middle of Sept '08, the stock fell off a cliff to make new 52 week lows in Oct and Dec '08 and then entered a sideways consolidation pattern.

The volumes - overlaid on the price chart - increased significantly during Nov and Dec '08 before starting to taper off from Jan '09. The stock is at a new 52 week closing low of around Rs 34. (Please note that Suzlon is now a Rs 2 face value stock.)

The 20 day EMA is below the 50 day EMA, which in turn is below the 200 day EMA, and all three moving averages are heading down. That means no end in sight for the bear mauling. (If you are not aware of the significance of EMAs, please read the post:

"Why you need to follow the latest trends to become a better investor")

The gap between the 50 day EMA and 200 day EMA is large and increasing. The slow stochastics and RSI are below the '20' line. These indicate that the stock is oversold. MACD and ROC are hovering near the '0' line, indicating indecision.

The spurt in volumes in Nov and Dec '08 - usually caused by accumulation - pulled the stock up to the Rs 70 levels twice. Both occasions were used by smart investors to sell out. Small investors, sensing a 'bargain' and trying to average their earlier higher cost purchases, are now well and truly stuck.

Though the stock is looking oversold, and can make a small bounce up, the fact that it is making new lows on receding volumes indicates that it can go lower.

Bottomline? Investors should not go anywhere near this stock. Adventurous traders may want to make a punt with very tight stop losses.

Stock Chart Pattern - ICI India Ltd

Readers of this blog know that I have been discussing the chart pattern of the Sensex for quite some time. Since last month, Sensex chart pattern discussions have become a regular Saturday feature.

From this month, I plan to discuss the chart patterns of individual stocks on Wednesdays. For the 'inaugural' stock I've chosen ICI India Ltd (of "Dulux" paint brand fame) for a couple of reasons.

It is one of those steady, stalwart stocks - cash rich and with good dividend payments - that has been in my long term portfolio for many years. It has also proved quite resilient during this down turn. Just the kind of unexciting and below-the-FII-radar stock that is great for long term wealth building.

Let us have a look at the 6 months chart pattern of ICI:

(You can right-click on the image above and open it in a new tab or window for a better view.)

After making a 52 week low around 355, the stock has been steadily moving up, as is evident from the higher tops and higher bottoms. In Feb '09, it decisively moved above the medium term 50 day EMA from below and briefly penetrated the long term 200 day EMA as well, with a close above it on Feb 16.

Thereafter, it fell back below the 200 day EMA and has been trading between the 50 and 200 day EMAs. Both the moving averages have flattened out and the 50 day EMA is showing signs of moving up. (To learn more about EMAs, please read the post "Why you need to follow the latest trends to become a better investor".)

Of the other indicators, the ROC and RSI are just above the '0' and '50' lines, therefore mildly positive. The slow stochastics has fallen below the '50' line, but showing signs of moving up - slightly negative. The MACD is well above the '0' line - which is a positive.

Since the 52 week low, ICI has moved up by more than 17% and is currently consolidating around 416 level. The notable thing is that during the past three days of Sensex fall, it has held rock steady at this level.

The only major negative for the stock is the extremely thin volumes of trade. Lack of volumes make it difficult to move in and out of a stock, and a short spurt in volume can quickly swing the stock up or down by a comparatively large amount.

Bottomline? Not a great stock for traders or adrenaline junkies. Good stock to accumulate in small quantities for conservative, long term investors.