Sensex, Nifty charts (Dec 20, 2019): at new lifetime highs

FIIs were net buyers of equity on all five trading days. Their total net buying was worth Rs 48.9 Billion. DIIs were net sellers of equity on all five trading days. Their total net selling was worth Rs 37.5 Billion - as per provisional figures.

According to a CARE Ratings report, production of consumer non-durables (i.e. FMCG products) moderated to 4% in FY 2018-19 from 10.5% growth in FY 2017-18 due to a sluggish economy and limited growth in employment. However, 14 items among the 36 taken into consideration showed increase in growth.

Fitch Ratings have cut India's GDP growth forecast to 4.6% for FY 2019-20 from the previous estimate of 5.6% due to significant growth deceleration in the past few quarters - thanks to credit squeeze and deterioration in business and consumer confidence.

BSE Sensex index chart pattern

The daily bar chart pattern of Sensex rose to touch new intra-day (41810) and closing (41682) highs during the week on the back of strong buying in equities by FIIs. The index is trading well above its three rising EMAs in a bull market.

Daily technical indicators are looking bullish and a bit overbought. MACD has crossed above its signal line in bullish zone. ROC has crossed above its 10 day MA and entered its overbought zone. RSI is hovering just below the edge of its overbought zone. Slow stochastic is well inside its overbought zone, and can trigger a correction or some consolidation.

Bull markets are supposed to climb 'a wall of worries' - and there are plenty of worries for Indian investors. Apart from a sliding economy and rising inflation with a possibility of stagflation, divisive forces have now been unleashed by the government's determined effort to implement CAA and NRC.

That may be a great tactic to win votes in upcoming state elections after a few recent setbacks and divert the nation's attention from gross mismanagement of the economy. But nationwide protests have added to the fear and uncertainty that have already damaged business and consumer confidence.

The lack of buying euphoria is an indication that Sensex may climb even higher. But without investor participation in the broader market (i.e. mid-cap and small-cap stocks), the rally in a few large-cap stocks will peter out sooner than later. Hold on to good large-cap stocks, but avoid buying them at current elevated valuations.

NSE Nifty index chart pattern

After struggling for three weeks, the weekly bar chart pattern of Nifty broke out and closed above its Jun 7 top of 12103, and touched new intra-week (12294) and closing (12272) highs. 

The index is trading well above its three rising weekly EMAs in a long-term bull market, and gained 185 points (1.5%) on a weekly closing basis. However, small investors should not get carried away by a rising index.

Note that Nifty has been trading within a large 'rising wedge' pattern for the past three months. Such a pattern has bearish implications - particularly when it forms at an index top. Falling volumes during the past three weeks is another concern for bulls.

Weekly technical indicators are looking bullish and overbought. MACD is rising above its signal line in bullish zone. ROC has crossed above its 10 week MA to re-enter its overbought zone. RSI has bounced up from the edge of its overbought zone. Slow stochastic is moving sideways inside its overbought zone. Bulls appear to be in complete control.

Nifty's TTM P/E has moved up to 28.57 - its highest level for the month and well above its long-term average in overbought zone. The breadth indicator NSE TRIN (not shown) has plunged inside its overbought zone, and can trigger some near-term index consolidation or correction.

Bottomline? Sensex and Nifty charts have touched lifetime highs on the back of strong FII buying. Rising CPI inflation, poor GDP and IIP numbers, a crisis of confidence among consumers and nationwide protests against the Citizen Amendment Act (CAA) do not justify a soaring stock market. Stay invested, but book partial profits wherever available, and avoid buying near lifetime high index levels.

Nifty chart: a midweek technical update (Aug 01, 2018)

FIIs were net buyers of equity on Tue. Jul 31, but net sellers on Mon. Jul 30 and today. Their total net buying was worth Rs 2.4 Billion. DIIs were net buyers of equity on Mon. and net sellers during the next two days. Their total net selling was worth Rs 8 Billion, as per provisional figures.

At the end of the three-day Monetary Policy Committee meeting, RBI hiked repo rate and reverse repo rate by 25 bps (0.25%) each today. The move was widely expected. Nifty closed just 10 points lower today after four straight days of rallying higher.

Revenue collection from GST rose to Rs 965 Billion in Jul '18 from Rs 956 Billion in Jun '18, thanks to increased compliance. However, it fell short of the Rs 1 Trillion per month target set by the government.

The daily bar chart pattern of Nifty touched a new high every day for five straight trading days. However, it closed lower today to form a small 'reversal day' bar (higher high, lower close).

All three EMAs are rising, and Nifty is trading above them, and above the (blue) up trend line, in a bull market. The index is in 'blue sky' territory with no known resistances.

Daily technical indicators are inside their respective overbought zones. MACD is rising above its signal line. ROC is above its 10 day MA, but has stopped rising. RSI and Slow stochastic are showing signs of correcting overbought conditions.

Nifty's TTM P/E has moved up to 28.14 - which is much higher than its long-term average and in overbought zone. The breadth indicator NSE TRIN (not shown) is oscillating just above its overbought zone. Expect some index consolidation or correction.

The index rally during the past 4 months has not been broad-based. A few large-cap stocks have propelled the index higher. Mid-cap and small-cap stocks have undergone profit booking, but their valuations still remain high.

If the index undergoes a correction - which is quite possible after a sharp rally - the mid-cap and small-cap stocks may correct even more. Any rally in mid-cap or small-cap stocks from here on can be used for partial profit booking.

Nifty chart: a midweek technical update (Jul 25, 2018)

FIIs were net buyers of equity during the first two trading days this week, but net sellers today. Their total net selling was worth Rs 8.3 Billion. DIIs were net buyers of equity on all three days. Their total net buying was worth Rs 7.4 Billion, as per provisional figures.

Nifty had 'lost' 1220 points from its lifetime high of 11172 (touched on Jan 29 '18) to its low of 9952 (touched on Mar 23 '18). By touching a high of 11157 today, 1205 of the 'lost' 1220 points have been regained - but the index has taken more than twice the amount of time to do so.

German agro-chemical major Bayer, International Finance Corporation, Netafim and Swiss Re Corporate Solutions launched the 'Better Life Farming' alliance to provide innovative solutions for smallholder farmers in developing economies to help them raise their incomes. The global alliance has now roped in local partners - Yara Fertilisers, DeHaat and Big Basket in India - to scale up its operations. 

The following remark was made in last week's technical update on the daily bar chart pattern of Nifty: "... expect the index to cross above the 'resistance zone' to a new lifetime high sooner than later."

The index crossed above the 'resistance zone' on Tue. Jul 24, and pulled back to the top of the 'resistance zone' today. It should make an attempt to touch a new high any time.

All three EMAs are rising, and the index is trading well above them - and the (purple) up trend line - in a bull market. 

Daily technical indicators are in bullish zones, and looking overbought. MACD is rising above its signal line. RSI is facing resistance from the edge of its overbought zone. Slow stochastic is showing negative divergence by failing to rise higher with the index, and may be forming a 'double top' reversal pattern inside its overbought zone. 

Nifty's TTM P/E has moved up to 27.66 - which is much higher than its long-term average and in overbought zone. The breadth indicator NSE TRIN (not shown) has bounced up from the edge of its overbought zone. Expect some index consolidation or correction.

A handful of large-cap stocks have propelled the index higher while mid-caps and small-caps have been battered out of shape. Many small investors who are facing deep cuts in their portfolio value should avoid the tendency to 'average down' - it may increase losses.

Benjamin Graham had suggested that an equity portfolio should have 75% or more in large-cap stalwart stocks and not more than 25% in mid-cap/small-cap stocks. At times like these, one appreciates the wisdom behind such an asset allocation plan. 

Nifty chart: a midweek technical update (Mar 21, 2018)

FIIs were net buyers of equity during all three trading days this week. Their net buying was worth Rs 7.3 Billion, as per provisional figures.

DIIs were net sellers of equity on Mon. Mar 19, but net buyers on Tue. & Wed. (Mar 20 & 21). Their total net buying was worth Rs 7.4 Billion.

The effect of several recent IPOs opening one after another is beginning to take its toll on liquidity. The HAL IPO scraped through because LIC picked up almost 70% of the stake on offer. 

The following was the concluding remark in last week's update on the daily bar chart pattern of Nifty: "The index may revisit and possibly breach last week's low of 10142."

Thanks partly to selling by DIIs on Mon. Mar 19, the index dropped to touch an intra-day low of 10075 and closed just below its 200 day EMA.

On Tue. Mar 20, Nifty formed a 'reversal day' bar by opening the day's trading below the channel but closing just above the 200 day EMA. The index rose further today on the back of combined FII and DII buying.

Nifty has been correcting within a downward-sloping channel ever since it formed a 33 points downward 'gap' on Feb 5 '18. Note that in spite of closing below its 200 day EMA, the index received good support from the lower edge of the channel.

Unlike a support (or resistance) level, which gets weakened by each subsequent test, a trend line gets strengthened by subsequent tests. That means, the down trend within the channel is not over yet.

Daily technical indicators are in bearish zones. All three showed positive divergences by not falling lower with the index. That may have triggered the technical bounce from the lower edge of the channel.

Nifty's TTM P/E has moved down to 24.76 - which is still much higher than its long-term average. The breadth indicator NSE TRIN (not shown) is falling sharply in neutral zone and can limit index upside.

Nifty may try to move up further, but is expected to face resistances from the falling 20 day and 50 day EMAs. A 'sell on rise' strategy within the channel should continue to work well for short-term traders.

Long-term investors need not be in a hurry to buy as better entry points may be available soon enough. However, gradual accumulation in good large-cap shares may not be a bad idea. (Have a look at ITC - now trading at a level seen a year back.) 

When is the Right Time to Sell a Stock?

The following comments appeared in a post titled "When should you 'hold' and When should you 'fold' a stock?":

"Buying a stock doesn't make any one any money. Holding it for a reasonable length of time, and then selling it at a profit completes the cycle." 

It may seem like a no-brainer, but in reality many small investors find it difficult to decide when is a good time to sell a stock.

If you are a long-term investor with a 'core' portfolio of good large-cap stocks, then there should be only three reasons (explained in the post referred above) for selling a stock.

However, if you also have a 'satellite' portfolio of mid-cap and small-cap stocks then Warren Buffett's strategy of 'holding forever' may not be a good idea.

Setting a price target and a stop-loss - and selling when the target or stop-loss is reached is often a better idea.

In a recent article in investopedia.com, Steve Economopoulos explains how you can fine-tune your selling strategies and provides a technical analysis example of setting a price target after buying, and selling when the target is reached.

Read the article here.

3 Secrets of Successful Companies

When small investors enter the stock market for the first time, they often make the mistake of buying individual stocks based on a friend's tip or a relative's recommendation. 

Such initial steps usually end up with a loss of the invested capital - either because the entry is at an inopportune time, or the stocks selected are of the cheaper/riskier variety, or both.

For the novice investor, the better way to start investing in the stock market is to select a couple of good equity and balanced funds and invest regularly - leaving stock selection to experienced fund managers.

At some point of time however - may be two or three years down the road - it may be a good idea to start selecting your own stocks. 

Why? Because fund managers tend to have a herd-like mentality - selecting from the same group of well-researched stocks for different funds. That leads to steady but average returns.

For above-average returns, one needs to select a few mid-cap and small-cap stocks for a 'satellite portfolio' - along with a 'core portfolio' of large-cap stocks.

Selecting under-researched mid-cap and small-cap stocks is not a trivial task. It requires knowledge and experience to choose from thousands of listed companies.

So, where should one start? Look for three essential characteristics that make a company successful. These are:

1) Barriers to entry
2) Management quality
3) Market leadership

What about other important metrics like Profit Margin, P/E, P/BV, RoE, Debt/Equity ratio, Interest Coverage ratio, Cash Flow, Growth rate and so forth? Those need to be looked at also for a more detailed study and analysis.

Learn more about the '3 Secrets of Successful Companies'. 

Related Post
How to Increase your stock market Returns - be an Investor and a Speculator at the same time

How to Increase your stock market Returns - be an Investor and a Speculator at the same time

There are two kinds of people in the stock market: those who invest and those who speculate. 

Those who invest transact rarely. Their motto is 'buy right and sit tight'. Those who speculate transact daily. They believe in 'get in - make a few bucks - get out'.

Unfortunately, neither make much money. Why?

Many investors are really speculators gone wrong. They 'get in - but can't get out' after getting stuck with a losing position. 

Most sell-out with a loss and swear never to buy a stock again. Some switch to mutual funds. 

A handful make the effort to really learn how to pick stocks that can give steady returns over the long term.

Speculators (read: traders) are a dime a dozen. They pick up the rudiments of technical analysis and think it is the 'Holy Grail' of getting rich.

They taste success with one or two trades but fritter away all their gains in the next few trades. Those who are really hooked get into deeper trouble by borrowing money for their daily trading fix.

A handful of traders really learn the tricks of the trade and are disciplined about booking losses when stop-loss levels are hit.

Like Voltaire's "Candide", you can enjoy the best of both worlds by becoming an investor and a speculator at the same time.

But isn't an investor and a speculator polar opposites? Like day and night? 

Au contraire. They are more like the Chinese Tao concept of Yin/Yang. One needs the other to make the stock market a complete whole.

Big investors bring in big money. A large number of speculators generate high volume of transactions that lead to price discovery.

Here is the secret to becoming an investor/speculator.

Allocate 75% of your portfolio to 8 to 10 financially sound, large-cap stocks that provide decent growth and pay regular dividends.

Allocate the balance 25% to another 8 to 10 mid-cap and small-cap stocks, which you can buy and sell to your heart's content.

The large-cap portfolio will give you boring but steady returns that will keep you solvent. The mid-cap/small-cap portfolio will provide excitement, and the occasional multibagger that can finance your dream trip to Bora Bora or Borobudur.

8 Signs of a Doomed Stock

One of the mistakes many small investors make is buying unknown small-cap stocks based on tips via SMS or advice from friends of friends who have ‘inside information’.

When they realise that a stock is a lemon and rapidly losing ground, they compound their original mistake by buying more in an effort to ‘average’ down the original cost.

Eventually the stock becomes unsaleable because there are no buyers left, or the stock gets delisted.

There are two ways to avoid such mistakes. The safer way is to buy only well-known large-cap stocks (though there are no guarantees that such stocks won’t go down after buying them).

The smarter way is to do a proper fundamental and technical analysis of the company before you buy its stock.

In a recent article in investopedia.com, 8 signs of a doomed stock have been listed. The list can be used as a guideline for the kind of stocks you should avoid buying.

You can read the article at this link.

What should small investors do when stock markets turn volatile?

A lay person’s understanding about volatility in the stock market is unusual and large fluctuations in a stock’s price or an index level. But there are more precise definitions of volatility. Here is what investopedia.com has to say: “Volatility is a measure of dispersion around the mean or average return of a security.”

‘Dispersion’ is the size of a range of expected values of a stock price or index level. It measures the uncertainty (i.e. risk) associated with a stock price or index level. The greater the dispersion, the greater is the volatility. ‘Beta’ measures the dispersion of a stock’s or fund’s return relative to a benchmark index. A higher ‘Beta’ means greater risk.

‘Standard deviation’ is a measure of the dispersion of a stock price or index level from its mean. It is, therefore, a measure of historical volatility. Small-cap stocks tend to have higher standard deviations (i.e. they are more volatile and more risky). Large-cap stocks have lower standard deviations – hence they are less volatile and less risky.

Volatility tends to decline during bull phases, and increases during bear phases. What causes volatility? Often, changes in taxes, interest rates and/or inflation can trigger it off. In the current scenario, the retrospective MAT on capital gains by FIIs was the trigger.

Nifty’s Volatility Index (VIX) measures the implied volatility (IV) of a basket of put options and call options on the Nifty. A higher reading on VIX means higher volatility, and is often associated with stock market bottoms. A lower reading on VIX means less volatility – but do not necessarily correspond with a market top.

If you have managed to read this far (without getting thoroughly confused), here are some do’s and dont’s in volatile markets:

• Don’t sell off in a panic
• Do stay invested in fundamentally strong stocks
• Don’t buy 10,000 shares of 3i Infotech just because it has halved in price from 8 to 4
• Do accumulate large-cap stocks that have corrected more than Nifty

And finally, do invest for the long-term – that means 5 years or 10 years, not 1 year. The longer your investment horizon, the less you will be affected by near-term volatility.

Technical updates – L&T and JK Lakshmi Cement

Stocks from the infrastructure sector were in doldrums due to the economic slowdown, and had fallen to two year lows during the second quarter of 2013-14. The ground-swell from Modi’s campaign brought them out of bear markets.

Once the Modi government came to power, many infrastructure stocks rose spectacularly, and provided multibagger gains. However, during the past one year, there has not been much progress in disentangling of stuck projects or initiation of new ones. High interest rate also played spoilsport.

Earnings of infrastructure companies haven’t kept pace with their stock prices. While stock prices haven’t crashed, large-cap and mid-cap stocks are down from their two year highs, and have entered sideways consolidations. The stocks of L&T and JK Lakshmi Cement are good examples.

L&T

After a 1:2 bonus issue in Jul ‘13 (marked by bell on chart), the stock of L&T dropped to a low of 695 on Sep 3 ‘13. From there, it rose to touch a high of 1752 on Jun 9 ‘14 – a huge 150% gain in 9 months.

The stock has since been in a sideways consolidation within a ‘rectangle’ pattern. The stock broke out above the ‘rectangle’ on good volume support and touched a two year high of 1843 on Mar 2 ‘15. But it failed to sustain above the ‘rectangle’. It subsequently formed a ‘head-and-shoulders’ reversal pattern with an upward-sloping neckline within the ‘rectangle’, and corrected below its 200 day EMA.

Daily technical indicators are looking bearish and oversold. A pullback towards the upward-sloping neckline is a possibility. A ‘rectangle’ pattern is usually a continuation pattern – which means the eventual break out should be upwards. But there has already been a failed break out and a reversal pattern formation. It may be better to wait for upcoming annual results to decide whether to buy, sell or hold.

JK Lakshmi Cement

The stock of JK Lakshmi Cement rose from a two years low of 55, touched on Aug 5 ‘13, to a two years high of 407, touched on Jan 19 ‘15 – a whopping 640% gain in less than 18 months. The stock has been consolidating sideways within a ‘rectangle’ pattern with a downward bias since touching its Jan ‘15 high.

The stock is currently receiving twin support from the lower edge of the ‘rectangle’ (at 340) and its 200 day EMA. Despite the correction, valuation looks quite stretched.

Daily technical indicators are in bearish zones, but showing some upward momentum. A technical bounce is a possibility. Sequential QoQ results have shown decline in top and bottom lines for the past three quarters. Check annual results before initiating any action.

Can investments in only 3 funds provide adequate portfolio diversification?

The short answer to the question is: Yes, provided you are willing to spend a little time in choosing the funds. How little is little time? That will depend on your internet connection speed and search skills.

Visit valueresearchonline.com. About half-way down on the home page are ‘Research Tools’. You can use the six tools provided to narrow down on funds you may want to invest in. It took me less than 15 minutes, even though my ADSL connection is pretty slow.

The ‘Fund Ranking’ tool allows you to check the performance of various categories of funds over different time periods. It was used to randomly select 3 funds. (Well, not so randomly because only funds ranked 5-star and 4-star were considered for selection.)

The table below shows the top 10 equity holdings of the 3 funds:

Quantum Long Term Equity	HDFC Mid-cap Opportunities	Reliance Tax Saver
HDFC	Aurobindo Pharma	TVS Motor
Bajaj Auto	Mindtree	ACC
Infosys	Supreme Industries	Alsthom T&D
Voltas	IPCA Laboratories	SBI
ONGC	Torrent Pharma	Titan
TCS	AIA Engineering	Wipro
Indian Hotels	SKF India	Honeywell Automation
Tata Chemicals	Bayer Crop Science	Schneider Electric
ACC	Axis Bank	Siemens
ING Vysya Bank	Bank of Baroda	Bharat Forge

The main reason for choosing these 3 funds was the lack of duplication in their top 10 holdings (except ACC). Effectively, any one investing in these 3 funds is investing in 29 different stocks covering sectors like financial institutions (both private and PSU), IT, chemicals, 2-wheeler, engineering, pharma, energy, consumer durables, hospitality and construction.

The absence of FMCG, 4-wheeler and metals (though AIA Engineering can be considered a ‘metal’ sector company) may be considered a drawback for adequate diversification. But these are 3 suggested funds to prove a point. Investors are free to choose other funds keeping in mind sector diversification and non-duplication of stocks.

Note that a large-cap fund, a mid-cap fund and a tax saving fund have been chosen for further diversification. Debt funds now have a tax implication that makes them less attractive than balanced funds. A gold fund can be added to the list, if required.

So there, you have it. Investing in individual stocks of the 3 funds to build a portfolio may cost an arm and a leg. But regular monthly investments of your savings in the 3 funds can help you build a well-diversified portfolio of top-performing stocks over time.

‘Fatal Attraction’, or why small investors prefer small-cap stocks

A few years back, I had written a post: Why small investors should avoid small cap stocks. The effect on small investors was the same as water on a duck’s back – it didn’t last long. With the stock market indices hitting new highs today, more and more small investors are getting ready to enter the market.

What stocks will they be after? L&T? ITC? Reliance? Glaxo? Tata Motors? M&M? TCS? Not a chance! Those stocks are too expensive. Too old-fashioned. They belong to the portfolios of grey-haired grandfathers, and are unlikely to give multibagger returns in 3 to 6 months. The name of the game is quick money.

And so, another generation of young investors are going to suffer from the ‘fatal attraction’ to small cap stocks in the hope of hitting a ‘six’ – just like it happens in every bull cycle. How do I know? Been there and done that. And lived to tell the tale, albeit with a big hole in my pocket.

If you buy a small-cap stock and it immediately spikes up and doubles your investment within a matter of days, you won’t know what you did wrong! Picking that stock at that time was pure luck – unless you happen to be knowledgeable about fundamental and technical analysis.

A bull market is like a high tide that lifts all boats. Stocks with ridiculously poor fundamentals often rise the highest in a short span of time due to their small trading volumes – sucking in investors and separating them from their hard-earned cash. Such stocks plummet just as fast, giving no chance to investors to exit.

Typically, small-cap companies belong to owners who wish to retain majority control and service a small niche product or service segment. The good news is that small niche segments are avoided by large players because of lower profit potential or lack of technology or expertise in the field.

That allows a niche segment leader to dominate the segment and make good profits without any threat from the big guys. That is why some small-cap companies often deservedly get high valuations and provide good returns to shareholders. But such ‘good’ companies are few and far between.

Many small-cap companies are out there to fleece the public. They make money from the IPO. Then they make money from the plant and equipment they install. Then they take bank loans for expansion and siphon off the funds to a chain of unrelated privately-held subsidiaries. Then they indulge in circular trading to jack up their stock price to trap unsuspecting buyers.

Then change their name, and repeat the whole fraudulent process. If they get caught, they bribe their way out and disappear to South America or Dubai. Their low equity capital facilitates price manipulation – which is not possible in a large-cap stock.

There is a market myth: small-cap stocks will become large-cap some day. Aren’t the large-cap stocks of today the small-caps of yesterday? Yes. That does not mean every small-cap you buy will eventually make the transition. Most will not. Some will remain small-cap for 50 years. Others will disappear from the face of the earth (with your money!).

Small investors have three choices about investing in small-cap stocks:

1) avoid small-caps completely and stick to large-caps or mutual funds (less adrenaline rush but good returns);

2) spend time and effort to learn how to pick stocks through detailed analysis (it is not rocket science – neither is it as simple as opening a demat account and listening to experts on business channels about what to buy);

3) subscribe to my Monthly Investment Newsletter that provides detailed fundamental and technical analysis of an under-the-radar small-cap stock every month. A limited number of paid subscriptions will be available till July 21, 2014.

Should you invest in large-cap or mid-cap stocks?

The stock market has been in a down trend for more than a year – losing 25% from its Nov ‘10 peak. Experts suggest that such falls provide excellent opportunities to accumulate strong large-cap stocks. Large-cap stocks are less risky and offer steady rather than spectacular returns.

Most small investors have a penchant for seeking out small and mid-cap stocks in the hope of making multi-bagger returns. But high returns are usually accompanied by high risks. What should small investors do? How to contain risk without missing out on returns?

In this month’s guest post, Nishit looks at the pros and cons, and comes up with an alternative approach.

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The argument will always continue whether to invest in large-cap or mid-cap stocks. One of my friends was asking me this morning whether it would be a good idea to invest in mid-cap IT stocks. It was the trigger for this post.

Mid-caps have several advantages. They are the real multi-baggers. Microsoft and Infosys were mid-caps once upon a time. Mid-caps can be a 10-bagger or even a 100-bagger. Mid-cap stocks carry a greater amount of risk as compared to large-cap stocks. In a bear market, a large-cap may lose 50% of its value whereas a mid-cap can lose as much as 90-95% of its value.

So, how does one address this conundrum? Every portfolio needs to be garnished by a sprinkling of mid-cap stocks, just like our food needs a sprinkling of salt to add to the taste. Just as too salty food is not good for health or taste, too many mid-caps is not good for the health of your portfolio, which leans towards risk.

How does one identify good mid-cap stocks? There are several criteria one must keep in mind.

1. They should have sound business models.
2. They should be generating real profits.
3. They should have good management. This is a very tricky question. How does one see a management to be good? A small investor cannot go and meet the management of a company he likes. One must look through the annual reports and notifications of the stock exchanges. The promoters should not have a shady reputation, or indulge in activities that harm shareholders – such as pledging of shares or dazzling announcements aimed at TV and newspapers.
4. The companies should be generating positive cash flows and providing steady dividends. Steady dividends can be ignored if the business is growing and the promoters are not investing the money in unrelated activities.

Now that we have looked at what criteria to use in selecting a good mid-cap company, the next question is when to invest. In bear markets, mid-caps are battered beyond recognition. Hence, one can follow this strategy. Keep accumulating large-cap stocks on every dip.

For mid-caps, buy only if the Nifty sustains above its 200 day Moving Average for a week or more. 200 day Moving Average is considered the dividing line between bear and bull markets.

Also, depending on one’s risk profile, the allocation has to be done between large-cap and mid-cap ideas. A conservative portfolio can have a 80:20 ratio between large and mid-caps. A more aggressive portfolio can have 60:40 ratio between large and mid-caps.

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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.)

Which stocks are dragging the Sensex down?

The Sensex closed well below its May ‘10 low today, and the talking heads in the business channels had grim looks on their faces and kept saying “It’s a very bad day”, and “It’s a terrible start to the Sep series”! They should have said: “What a great day for the bears”, or, “What an opportunity for those who sold at higher prices”. Guess they are pre-programmed to feel sad when the market falls.

I took a quick look at the weekly charts of the Sensex constituents (except Coal India, which is a recent listing and doesn’t have adequate trading data).

Only seven stocks are trading above their rising 50 week EMAs (equivalent to the 200 day EMA on daily charts) indicating bull markets. These seven have prevented the Sensex from falling much lower. Here are the ‘Magnificient Seven’ (you can check out a terrific Western of the same name featuring Yul Brynner, Steve McQueen, Charles Bronson, over the weekend; the movie is based on a Kurosawa classic: ‘Seven Samurai’).

Stocks trading above rising 50 week EMAs

1. Bajaj Auto
2. Bharti Airtel
3. Hero Motocorp
4. Hind. Unilever
5. ITC
6. Mahindra and Mahindra
7. Sun Pharma

The balance twenty-two stocks are trading below their 50 week EMAs indicating bear markets. These are the stocks that are dragging the Sensex down.

Stocks trading below 50 week EMAs

1. BHEL – at level of Apr ‘09
2. Cipla – at level of Oct ‘09
3. DLF – at level of Mar ‘09
4. HDFC – still above Feb ‘11 low
5. HDFC Bank – still above Feb ‘11 low
6. Hindalco – near Jun ‘10 low
7. ICICI Bank – at level of May ‘10
8. Infosys – at level of Oct ‘09
9. Jaiprakash – at level of Mar ‘09
10. Jindal St. and Power – at level of Jul ‘09
11. L and T – still above Feb ‘11 low
12. Maruti – at level of Jul ‘09
13. NTPC – at level of Dec ‘08
14. ONGC – still above Feb ‘11 low
15. Reliance – at level of Mar ‘09
16. SBI – at level of Feb ‘10
17. Sterlite – at level of May ‘09
18. TCS – at level of Sep ‘10
19. Tata Motors – at level of May ‘10
20. Tata Power – at level of May ‘09
21. Tata Steel – at level of Aug ‘09
22. Wipro – at level of Aug ‘09

What conclusions can be drawn from the above two lists? The seven that are still in bull markets will probably be the next target for the bears. The ones that have fallen the most, can give bigger percentage rises when the market turns eventually. Provided of course, that their fundamentals haven’t worsened. It does not mean that they can’t fall even further from current levels.

Small investors who do not own large-cap stocks can use the lists to short-list the fundamentally stronger ones and start accumulating slowly. But have a two-three years time-frame in mind. Please do not expect to get rich quick.

How many stocks should I buy?

From the emails I receive from readers and newsletter subscribers, this is a common question faced by many small investors. Due to limited resources, investors tend to swing from one end of the buying pendulum to the other. They either buy 30 shares of a fundamentally strong stock trading at Rs 500; or, they buy 500 shares of some unknown small-cap trading at Rs 30.

Both can be counterproductive for the growth of your portfolio. With the costlier stock, a sudden spurt to Rs 600 may tempt you to sell out quickly and miss a bigger profit opportunity. The alternative strategy of booking partial profits and holding the rest with a trailing stop-loss may not work too well with only 30 shares to play with.

For the less expensive stock, a 20% gain from 30 to 36 may not seem enough to do any profit booking. So you hold on with the hope of selling only if the stock reaches 50 – which it may never do. In fact, the cheaper stock is more likely to drop to 15.

What is the solution? Firstly, you need a decent amount of capital to build a portfolio of individual stocks. I recommend a minimum of Rs 5 lakhs – preferably Rs 10 lakhs. What if you have only 1 or 2 lakhs? You may be better off investing in mutual funds and fixed income instruments to build up your capital.

What if you do have Rs 5 lakhs? How do you decide how many stocks to buy? The thumb rule in buying individual stocks is: More is not merrier. Keeping regular track of any more than 10-12 stocks can become a full-time activity. You have to remain informed about the overall economy – local and global, individual sectors to which your stocks belong, quarterly performance of individual stocks as well as news flows about them; read Annual Reports; check if dividends are getting credited; apply for rights shares, and a myriad other things.

If you settle on 12 stocks for your portfolio, how will you allocate to large, medium and small-caps? A thumb rule for getting steady returns, protecting downside during bear attacks, plus having a growth ‘kicker’ is to allocate 80% of your capital into stalwart large-caps, and 20% to good mid-caps and small-caps.

How many stocks in each category? Say, 8 large-caps, 2 mid-caps and 2 small-caps. Allocating Rs 50000 for each large-cap, and Rs 25000 to each mid-cap and small-cap stock will complete your portfolio. This is a suggested portfolio. You can tweak it to suit your own style and risk tolerance.

Once you limit yourself in terms of the number of stocks and the allocation of capital to each stock, a funny thing will happen. You will be forced to be very selective about the stocks you pick. That will, in turn, make you more disciplined about choosing the very best stocks – and waiting to buy them only after a significant price correction.

The same Rs 500 stock mentioned earlier was probably trading at Rs 200 two years back, and may drop to 350 after the next correction. Instead of buying 30 shares now, buy only 10 (to help you to track it regularly). When (and if) it drops to 350, buy 130. You will end up with 140 shares and complete your Rs 50000 allocation to the stock.

Related Posts

Learn the Art of Partial Profit Booking

Why building a stock portfolio is like buying a car

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.

Learn the Art of Partial Profit Booking

Before we delve into a discussion about partial profit booking, readers may want to do some ground work. In an earlier article, I had given three reasons why you should sell a stock from your portfolio completely. Prior to that, I had written an article about asset reallocation.

Selling a stock totally from your portfolio may or may not generate profits - because the reasons for selling are to avoid a loss because of faulty stock selection or worsening company fundamentals; or, to generate cash for emergencies.

Your timing of selling may not coincide with a bull period, which means you may need to sell at a loss. It is important to note this point, because as human beings we are 'loss averse'. That means, taking a loss causes a bigger emotional upheaval than making a big profit. But prudence demands that some times you do have to sell at a loss - to avoid a bigger one.

Partial profit booking is a different skill altogether. Here, the reason and timing of selling is totally in the investor's control. When and how much quantity you sell depends on your skill and risk tolerance. The profits you make will depend on it.

Here are a couple of reader comments, that are good examples of why you need to learn the art of partial profit booking:-

1. 'I bought a stock at 37 and saw it go all the way up to 180, but did not sell. It came down, and I finally sold at 120.'

2. 'I bought a stock at 18. When it went up to 44 within 3 months, I sold it all. To my horror, the stock kept going up and hit 150. I have learned that to make big profits, one has to hold the stock for a long time.'

Both situations happened during a bull phase. Both investors made decent profits, but missed out on a much larger profit potential. Let us learn how partial profit booking can help.

Firstly, you need to buy a decent quantity of shares - at least 300 or 500 - of each company. Buying 50 shares or 100 shares won't work very well. Secondly, you need to decide whether a particular stock is going to be part of your core portfolio (80-90% of your total portfolio value) or your satellite or 'mad money' portfolio (10-20% of your total portfolio value).

The core portfolio should comprise fundamentally strong large-cap shares which should be held 'forever'. You should add to this portfolio near bear market bottoms, and book partial profits only near a market top. Otherwise, just sit back and enjoy the dividends and bonus issues, and subscribe to the rights issues. Good large-caps find various ways to reward their stakeholders.

The satellite or 'mad money' portfolio usually contains more risky and relatively unproven mid-caps and small-caps. These shares may shoot up like a rocket in the short-term, and collapse in a heap some time later. This portfolio requires closer monitoring, and partial profit booking is a must during bull phases.

Let us assume you had bought 500 shares at 18. You may have set a target - based on technical analysis or fundamental analysis (or both) - at 40 in 3 years. More than 100% returns in 3 years isn't bad at all. Expecting more than that would be bordering on greed.

To your pleasant surprise, you find the stock shooting up and crossing your target within 6 months. What should you do? Sell 200 @ 50, which recovers your original investment plus the 10% short-term capital gains tax (of 640). The balance 300 shares have become 'free', i.e. there is no holding cost for you.

So, enjoy the bull ride by keeping a 'trailing stop-loss' of say, 10%. That means, at 100 the stop-loss will be 90. If the stock moves to 150, the stop-loss should be 135. Sell the shares as soon as your stop-loss is hit.

If you are lucky enough to hold the entire 500 shares through the bull phase and sell it at the very top, then you will obviously make more money. In reality, picking exact tops and bottoms are next to impossible.

Partial profit booking reduces the risk considerably - first by pulling out your original investment; then, by letting profits ride on the balance quantity to the maximum extent possible. It also ensures that you will not make a loss.

(Note: Partial profit booking works in a bear market also. You 'short sell' when the market is falling, and at each drop you buy back a portion of the amount short sold. This strategy is not recommended for inexperienced investors.)

Why small investors should avoid small cap stocks

There are several reasons why small cap stocks should not be considered for investment by any investor - new or old, small or large. Before I start to argue my case, let me define what is a small cap stock.

The market capitalisation (or market 'cap') of a stock is the product of a stock's current market price and the total number of equity shares outstanding. In other words, a stock having total outstanding equity shares of 10 Million (1 Crore) and a price of Rs 100 has a market cap of Rs 1 Billion (100 Crore).

The question is: What market cap makes a company a small cap, or a mid cap or a large cap? The short answer is: It depends on whom you ask. There are no precise definitions. The industry norm for a small cap company seems to be a market cap of upto Rs 2500 Crore!

A mid cap company has market cap ranging from Rs 1000 Crore to Rs 13000 Crore. Large caps are those forming part of the Sensex 30 and Nifty 50 stocks. As you can see, the whole thing is pretty confusing.

Small investors get attracted to small caps because of two main reasons - 'affordability' and greed. Most small companies are also small cap companies that trade typically at few tens of Rupees. This price is attractive to small investors with small capital. (Many don't realise that a Rs 30 stock may have a Re 1 face value and may be trading at a P/E of 30.)

Many of today's large caps were small caps 10 or 12 years back. The general assumption is that all small caps have the potential to become large caps and give multibagger returns. But only a small minority out of the thousands traded in the stock market actually make the transition. Most will remain small caps, or disappear into the sunset.

Why are small cap stocks so risky that they are best avoided by small investors?

• lack of transparency of management
• lack of adequate research by fund houses and brokers
• lack of financial muscle
• low liquidity
• high volatility

Management is too busy trying to survive (or siphon off money) to look after investor relations and proper communication of plans. Fund houses shun such stocks, so analysts don't cover them or visit their factories to ask tough questions.

One or two bad quarters can wipe out a small company, who may not have access to big money. Low volume of trading leads to difficulty in getting in or out, and wild price swings if small quantities are traded.

Only those investors with adequate experience and knowledge of fundamental and technical analysis should attempt investing in small cap stocks. That too, with the awareness that the entire investment can go down the drain. Preferably, the investment in small cap stocks should be limited to 10% of total portfolio value, to mitigate the risks involved.

The vast majority of investors should look for more expensive but less risky large cap stocks, or stick to index funds or index ETFs. Always remember Warren Buffet's investment rule: Don't lose money.

Related Post

The futile quest for the mythical 'multibagger'

BSE Sensex Index Chart Pattern - May 15, '09

Last week's BSE Sensex index chart pattern led me to observe:

'The 20 day EMA moved up to touch the flattening 200 day EMA and should pierce through next week to provide the second confirmation of a trend change from bear to bull.'

A look at the 3 months bar chart pattern of the BSE Sensex index will show that the 20 day EMA has comfortably moved above the 200 day EMA, though the index oscillated at the 12000 level:-

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

The opening 'gap' created on Monday, May 4, '09 remained unfilled. The BSE Sensex moved down and took support at the gap to move back up again. But it didn't manage to go very far.

There were two closes below and three closes above the 12000 level. The bulls and bears seemed to be undecided about forcing the issue either way. Like the battling armies of the olden days, both sides decided to sleep over it till the declaration of results of the recently concluded general elections.

The results announced so far have been quite a surprise from many angles. The decimation of the left parties will be a major relief for market participants and this could lead the bulls to jump start a sharp up move next week.

The situation is also nicely set-up for the bears to initiate a 'sell-on-news' campaign. Should that happen and the gap in the Sensex get closed, the subsequent upward rally may be stronger.

The technical indicators are confirming the indecision in the markets. The slow stochastic has moved in and out of the overbought zone. The MACD played hide-and-seek with its signal line. Both the ROC and RSI are in the positive zones - the former has an upward bias and the latter is inching down.

The huge spike in volume on Wednesday, May 13, '09 was probably caused due to the stake sale to Foreign Institutional Investors (FIIs) by DLF.

The world markets have been boosted considerably by the flow of FII money, and indices have moved up by ignoring the continued weakness in the underlying economies. Since every one was expecting a major correction, Mr Market confounded all the experts and moved up.

Bottomline? The BSE Sensex index chart pattern shows that the upward thrust can continue some more - but this isn't the correct time to enter. Investors should stay calm and use a rapid up move on election results to book some profits. Should the bears take charge instead, wait a couple of days and then enter fundamentally strong large cap stocks or diversified large cap equity funds.

About portfolio suggestions and a stock not to be picked

Quite often I receive emails from young readers of this blog, requesting me to suggest a 'good portfolio' or 'some good stocks'.

I enjoy responding to such requests - it is one of the main reasons why I write this blog - but am often hamstrung by the fact that many readers do not reveal details like their age, professional background, risk tolerance, years of investing experience and existing portfolios. 

Without such minimum information, giving any suggestion is worse than shooting in the dark. You don't know who or what you will hit!

Another of my frustrations is caused by the proverbial 'generation gap'. Being a dyed-in-the-wool long-term investor, I believe in large-cap stocks with proven management, a portfolio allocation plan, capital preservation and the concept of accumulating wealth slowly.

Many young investors find such an investment philosophy boring and unexciting. Can't really blame them. I was once single, 27 and earning a reasonable salary also. (It was so long ago that my memory of those happy times are quite dim!) Like young lion cubs in a Discovery channel documentary, the thrill of the chase was more important than the actual prey.

The end result of chasing stocks like Indu Nissan Oxo Chemicals, Albert David, Hanil Era Textiles, and many other equally forgettable and forgotten companies was an empty wallet and a big hole in the pocket. It taught me some important lessons. Just like lion cubs learn that chasing a grown baboon up a tree isn't the smartest idea.

Not every young investor is as clueless as I was. Particularly impressive is young Rishi, who is not yet married but planning to do so in 2/3 years. (I didn't have the heart to dissuade him!)

He came up with a 20 year financial and investment plan for his future that included his marriage costs, his children's education and marriage expenses and his retirement plans! I doubt investors double Rishi's age have thought through and have a plan like his (that we honed over an exchange of several emails).

I will conclude today's post with a real-life example of a stock pick (or, rather, a stock not to be picked). Reader Donald sent me an email with the following information:-

"Came across Temptation Foods. Do you know of this company?
The results are impressive (perhaps due to slew of acquisitions, last acquisition was Everfresh in Jan 2008)

Summary of financials over last 3 years in Rs Crores:

Year	2008-09*	2007-08	2006-07
Revenue	872.0	348.1	40.8
EBITDA	73.4	32.3	6.6
PBT	55.0	27.4	5.8
PAT	52.7	23.8	5.8

* Based on quarterly results

Roughly 8.5% EBITDA margins is not so bad nor so great in this FMCG-like sector. But then the revenue growth is impressive and most importantly, zero debt (as per Mar 2008). But I see 10.28 Cr paid as Interest in FY2009 vs. 0.01 Cr in FY2008, so there is some debt now. BV =70; TTM EPS=21; CMP=33 (Apr 29).

There was some stricture by SEBI against the company in Feb 2009 for failing to disclose key developments.
http://www.thehindubusinessline.com/2009/02/17/stories/2009021751001200.htm

More than the non-disclosure, why would a zero-debt company pledge shares?? So what do you make of this meal??
Rgds"

Many investors would have simply asked me: 'What is your opinion of Temptation Foods?' To which my answer would have been: 'I have no idea about the company or what they do.' And that would have been the end of it.

But Donald is not only enthusiastic, he is also diligent. So he did some digging, came up with facts and news, and then asked for my opinion. This not only made my task simpler, but also motivated me to put in some effort from my side. Here is how I responded:-

"I have no idea about the business of Temptation Foods.

Eye-popping growth is usually to be looked at with suspicion. When it is accompanied by a rapid increase in negative operating cash flows (check out the numbers in money.rediff.com - EBITDA 32 Cr last year; op.cash flow -83 Cr) then you know it is a stock not to be touched with a 10 ft pole. Add SEBI strictures for stock market shenanigans with a competitor's stocks - and you have a perfect example of fraud management who will stoop to any depths to generate some money.

No wonder the stock dropped from 350 to 18! Always remember that there is only one Infosys and one L&T and one Microsoft. Look for the 'next' Infy/L&T/Microsoft at your own peril!

Best wishes"

The moral of the story? By all means send your requests for portfolio and stock suggestions. I welcome such interaction and love to hear from my readers. But please include some basic information about yourself (as mentioned above) and do some homework before asking your questions. You will become a better investor in the process, and help me to provide more meaningful feedback to you.