Ralph Acampora on Dow Theory (Video)

The godfather of technical analysis, Ralph Acampora, explains the value of Dow Theory. 

Acampora served as the New York Institute of Finance’s Director of Technical Analysis Studies and the Director of Technical Research at Knight Equity Markets. 

Read more at:
https://www.investopedia.com/video/play/ralph-acampora-dow-theory/

The Basics of Bollinger Bands

In the 1980s, John Bollinger, a long-time technician of the markets, developed the technique of using a moving average with two trading bands above and below it. 

Unlike a percentage calculation from a normal moving average, Bollinger Bands simply add and subtract a standard deviation calculation.

Standard deviation is a mathematical formula that measures volatility, showing how the stock price can vary from its true value. By measuring price volatility, Bollinger Bands adjust themselves to market conditions. 

This is what makes them so handy for traders: they can find almost all of the price data needed between the two bands. Read on to find out how this indicator works, and how you can apply it to your trading.

Read more at:
https://www.investopedia.com/articles/technical/102201.asp

Why use Technical Indicators?

Within technical analysis, indicators are used as a measure to gain further insight into to the supply and demand of securities. 

Indicators, such as volume, are used to confirm price movement and the probability that the given move will continue. 

Along with using indicators as secondary confirmation tools, they can also be used as a basis for trading as they can form buy-and-sell signals.

Read more at:
https://www.investopedia.com/university/indicator_oscillator/

Divergences Need Price Confirmation

Divergences visible on technical indicators often provide useful advance information of corrections or rallies. Usually, indications are more reliable when divergences occur inside overbought or oversold zones of indicators.

A negative divergence occurs when an index or stock touches a higher top while a technical indicator touches a lower top. That itself may not be an immediate sell signal.

A sell signal occurs when a technical indicator corrects from its overbought zone. A better sell signal occurs when the indicator drops below its neutral zone (viz. '0' line for MACD/ROC and 50% level for RSI/Stochastic). 

A positive divergence occurs when an index or stock touches a lower bottom while a technical indicator touches a higher bottom. That may not be an immediate buy signal.

A buy signal occurs when an indicator emerges from its oversold zone. A better buy signal occurs when the indicator moves above its neutral zone.

Divergence confirmation from several technical indicators are preferable. Investors should also await price/volume confirmation before taking any buy/sell decision.

Technical indicators of global stock indices showed positive divergences last week. Pullback rallies have followed.

Read more here.  

"There's Never Just One Cockroach in the Kitchen" - Warren Buffett

Buffett had made that comment in an interview following an accounting scandal in Wells Fargo. He may as well have made that comment about corruption in ICICI Bank and misreporting of NPAs by Axis Bank.

Yes Bank was the third 'cockroach'. (PSU banks are not being discussed here because collectively they are a massive 'anaconda' that is threatening to swallow India's financial system as a whole!)

The latest 'vermin' is IL&FS, whose MD has quit on his own. (The MD of ICICI Bank remains in suspended animation - for reasons best known to her. RBI has shown the door to the MDs of Axis Bank and Yes Bank, but is powerless to do likewise with the MDs of PSU banks.)

Moody's recently said that rising liquidity worries at IL&FS are credit negative for banks and debt market. The stock market reacted by indiscriminately pummeling the stocks of banks, NBFCs and housing finance companies.

It is interesting to note that despite a hurriedly-called concall with denials about any near-term liquidity problems, DHFL's stock failed to recover much from its lows on Friday (Sep 21). Which is the next 'cockroach'? 

There will be more than one. The business model of banks, NBFCs and HFCs requires borrowing short-term to lend long-term. If short-term liquidity dries up (or, gets costlier due to rising interest rates) the proverbial you-know-what will hit the fan - as it seems to be doing now. 

One market expert tried to reassure investors by stating that Friday's huge selloff was due to 'technical reasons'. One presumes he meant that fundamentally everything is hunky-dory in the financial system. Really?!

Talking about 'technical reasons', the market made a 'panic bottom' - with a sharp surge in transaction volumes - before bouncing up on short covering and some value buying. 

Typically, such a 'panic bottom' occurs during the second leg of a bear phase. 
However, the fact that it has occurred at an early stage of a corrective move is a clear warning to perma-bulls. 

Remember the stock market adage: Panic bottoms seldom hold. That means the market is headed lower than Friday's low. By how much? Likely support levels will be discussed in tomorrow's post on Sensex and Nifty.

Related Post
How to tackle a ‘panic bottom’

Market Timing Tips Every Investor Should Know

It's a long-held belief that market timing and investing are mutually exclusive, but the two strategies work well together in producing solid returns over a number of years. 

The effort requires a step back from the buy-and-hold mindset that characterizes modern investing and adding technical principles that assist entry timing, position management and, if needed, early profit taking.

This set of technical tips can guide your investments through a gauntlet of modern market dangers:

https://www.investopedia.com/articles/active-trading/043015/market-timing-tips-rules-every-investor-should-know.asp

Want to Make Money? Show Great Patience

"Earnings season is about to kick into high gear. Over the next few weeks thousands of companies will report their numbers. Some will beat expectations and some will disappoint. 

And some will present some great opportunities to make nice money, especially for those of you who are patient enough to pounce at the right time.

Here's a real life example."

Read more at:

http://stockcharts.com/articles/chartwatchers/2018/01/want-to-make-money-show-great-patience.html

How Market Psychology Drives Technical Indicators

"When technical tools are used judiciously, their value cannot be overstated. And every time you apply a tool of technical analysis, you are calculating a consensus of bullishness or bearishness among all market participants...

The principles of market psychology underlie each and every technical indicator, so a good understanding of crowd behavior is crucial to your understanding of the fundamentals of particular technical indicators. 

Assuming that most readers already possess some knowledge of interpreting the more common technical indicators, we will specifically describe how market psychology drives these individual tools."

Read more at:
https://www.investopedia.com/articles/trading/02/121602.asp

3 Charts Suggest Emerging Markets Downtrend Just Getting Started

"One of the most common sell signals used by active traders occurs when the 50-day moving average crosses below the 200-day moving average. 

This iconic breakdown is known by many as the death cross and is used to signal the beginning of a long-term downtrend. 

In the paragraphs below, we'll take a look at several charts suggesting that the emerging markets are in the early days of a major downtrend and that lower prices could be a consistent theme over the coming weeks or months."

Read more at:
https://www.investopedia.com/news/3-charts-suggest-emerging-markets-downtrend-just-getting-started/

Candlesticks and Oscillators for Successful Swing Trades

"Swing traders specialize in using technical analysis to take advantage of short-term price moves. Successfully trading these swings requires the ability to accurately determine both trend direction and trend strength. 

This can be done through the use of chart patterns, oscillators, fractals, volume analysis and a variety of other methods. This article will focus on using oscillators and candlestick patterns as a quick and easy way to characterize a trend and successfully identify swing trades."

Read more at:

https://www.investopedia.com/articles/trading/06/swingtrades.asp

Spotting A Market Bottom

Stock market bottoms can be challenging to spot. And many times, investors think that they have found this point, only for the major averages to head even lower. 

The big question many have is: just how do you know when a market bottom has taken place? 

This requires the tools and indicators that have identified major market bottoms in the past, and an understanding of what they are, how they work and that each indicator must correlate a similar reading.

Read more here.

About the Fibonacci sequence and the Golden Ratio

There is a special ratio that can be used to describe the proportions of everything from nature's smallest building blocks, such as atoms, to the most advanced patterns in the universe, such as unimaginably large celestial bodies. 

Nature relies on this innate proportion to maintain balance, but the financial markets also seem to conform to this 'golden ratio.' Here we take a look at some technical analysis tools that have been developed to take advantage of it.

Read more at:
https://www.investopedia.com/articles/technical/04/033104.asp

Retracement or Reversal: Know the Difference

Most of us have wondered whether a decline in the price of a stock we're holding is long term or a mere market hiccup. Some of us have sold our stock in such a situation, only to see it rise to new highs just days later. This is a frustrating and all too common scenario, but it can be avoided if you know how to identify and trade retracements properly.

Retracements are temporary price reversals that take place within a larger trend. The key here is that these price reversals are temporary, and do not indicate a change in the larger trend.

Read more at:
https://www.investopedia.com/articles/trading/06/retracements.asp 

Related Post
About Nifty Fibonacci retracement levels

Top 7 Technical Analysis Tools

Many analysts try to convey the impression that technical analysis is an esoteric practice not meant for investors at large. The more jargon one uses, the more it helps to obfuscate the uninitiated.

Contrary to its name, there is nothing 'technical' about technical analysis. So, what is it? 

A graphical representation of stock prices (or index level) over time leads to certain well-identified price patterns that reveal the underlying supply and demand for the stocks (or index).

But aren't graphs used in mathematics and physics and chemistry? In other words, graphs equals science equals technical, right? That is the mistake that many investors make (probably because they had a bad science teacher in school).

Observing and identifying price patterns as they are forming, and using a few tools/indicators that help to suggest likely changes in the patterns (i.e. the underlying supply and demand) is all that is involved in technical analysis.

May be that's a bit over-simplified. Understanding which combination of tools to use, and identifying which patterns are more reliable in helping to estimate future price changes require lots of practice and real-world experience.

In other words, technical analysis is quite simple but not easy. That should not deter an investor from learning the basics and applying the learning in actual trading and investing.

Fundamental analysis involves detailed study of Annual Reports, the economy, sectoral growth, competitive environment, management competence and integrity to identify which company stocks are investment-worthy.

Just because a stock is investment-worthy doesn't mean it has to be bought at the current price. This is where technical analysis can help. If the price pattern shows supply is exceeding demand, the stock's price may be getting ready for a fall.

If the supply and demand seems equally matched, the stock price may meander sideways for weeks or months. Only when demand exceeds supply can a stock's price start moving up.

A problem faced by many small investors - who have taken the brave step to venture into studying price patterns - is which technical tools/indicators to use when and how.

The KISS principle works well. The fewer indicators you can use to get reliable results the better. Three or four indicators taken together can be adequate.

In the following investopedia.com article, the top 7 technical tools - from the hundreds that have been developed over the years - have been listed. Try them out:
https://www.investopedia.com/slide-show/tools-of-the-trade/

How to Use Volume to Improve Your Trading

Most small investors I interact with are either looking for a multibagger stock that will generate quick profits, or trying to find that elusive technical indicator that can predict price movements with greater accuracy than anything known or available in the stock market.

A few experienced and knowledgeable analysts have even devised their own proprietary technical indicators, which enable them to charge higher fees from their clients.

At the end of the day, it is not the sophistication of your trading strategies or your incredible ability to take risks that will turn the tables in your favour. 

It is how well you have selected the companies you wish to trade in, and whether you can identify and capitalise on important turning points on a price chart.

One of the simplest and easiest to understand indicators that can be of immense help is the volume of trading in a stock or index. Yet, so many analysts who opine on price charts have very little understanding of how volume (or the lack of it) affects price movements.

In a recent article in investopedia.com, Cory Mitchell explains how understanding and analysing trading volumes can improve your trading. Read the article here.

(Wishing blog visitors, regular readers and newsletter subscribers a very happy and safe Diwali and a prosperous New Year.)

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.

How to be a successful Contrarian Investor

To be a successful contrarian investor, you need to follow Buffett's simple philosophy: Be greedy when others are fearful and be fearful when others are greedy.

In other words, a contrarian investor will look for opportunities to buy when there is blood on the streets and experts are advising that the economy will get a lot worse before it gets any better.

Likewise, a contrarian will look to book profits when the stock market is rising to new highs and everyone and his brother-in-law is offering tips on what to buy.

Simple, right? But almost impossible to follow when it is your own money on the line. The human brain seems to function irrationally when monetary transactions involve uncertain outcomes - like in the stock market.

Doing the exact opposite of what a consensus view is suggesting requires training and discipline. Knowledge of basic technical analysis tools can be of great help.

Here are some typical contrarian signals that even novice investors can learn to spot:

1. A stock's price is touching new highs, but volumes are falling
2. An index keeps rising but technical indicators are flat or falling
3. A stock's price touches a new low, but technical indicators touch higher bottoms
4. Widening distance between a stock's price and its 200 day EMA
5. An index is moving up but the number of declining stocks is more than the number of advancing stocks

The above list is not meant to be exhaustive - just indicative. 

Being able to spot certain chart patterns that indicate the opposite of what the price action is suggesting can also help a lot. E.g. a stock's price is falling but trading within a 'falling wedge' pattern indicates a likely breakout upwards.

Similarly, if a stock's price is rising but trading within a 'rising wedge', it is a signal for a correction.

Needless to say, buying or selling a stock just based on price patterns and contrarian indications is not enough. Adequate research about a company's financials and investment-worthiness should be carried out before taking any buy/sell decisions about its stock.

Also, refrain from buying or selling just because a stock has risen 20% or an index has fallen 20%. A rising stock can rise even higher, and a falling index can fall even lower.

How does one know beforehand how far a falling index will fall? What if it falls first, then rises again before falling even further?

One really can't tell beforehand. Again, some knowledge of technical analysis can be helpful. 

Those who have been regularly reading my posts know about long-term 'support-resistance' levels and Fibonacci retracement levels - and the roles these levels play time and again.

Most important of all, to be a really successful contrarian investor, you need to have oodles of patience. Waiting for the right price to buy or sell - without trying to catch the exact market bottom or top - will add several percentage points to your eventual returns.

Stock prices are fluctuating wildly - what should small investors do?

To answer that question, one needs to understand why stock prices fluctuate. You can read this article to learn more. 

In an ideal world, a stock's price moves only in one direction. If it is moving up, you make money by 'buying low and then selling high'. If it is moving down, you make money by 'selling high and then buying low'.

But life, and stock markets, are never that simple. In a longer-term up trend, there are periods of correction and consolidation that provide opportunities to buy for experienced investors.

A longer-term down trend has periods when there are counter-trend rallies and consolidations that provide selling opportunities.

If you prefer to look at stock price movements through a filter of fundamental analysis, you look at valuations and ratios. If you rely on technical analysis, you look at trend lines and chart patterns.

But there are times when markets seem to go completely haywire. Valuations go out the window in a frenzy of buying. Technical patterns and support levels lose all meaning amid a wave of selling.

Much like what has been going on for the past couple of days. Why? Primarily due to a couple of reasons that Taleb would call 'black swans' - events for which there were little advance warning and which are likely to cause upheavals in the economy and the stock market.

To make matters worse, these two 'black swan' events - Trump's victory in the US Presidential elections and demonetisation of Rs 500 and Rs 1000 bank notes in India - coincidentally occurred on the same day, viz. 9/11!

The best thing for a small investor to do is not to panic. 'This too shall pass'. 

If you have proper financial and asset allocation plans in place, you should simply follow those plans and invest accordingly.

If you don't have plans in place, the stock market will seem like a casino and you are unlikely to realise any of your your financial and investment goals.

If you are itching to fish in troubled waters, remember that you have to know exactly when to enter, how long to stay and when to exit. That is difficult for even experienced investors.

Is stock investing risky?

To be able to answer that question, one has to understand the meaning of risk. The problem is: there is no clear cut definition of risk, or the best way to measure risk.

Volatility is often considered a measure of risk - particularly by inexperienced investors. But seasoned traders thrive on volatility and make most of their money from it.

One often thinks of a bank fixed deposit as 'safe'. Why? Because there is very little chance of losing your principal amount. 

Compared to a bank fixed deposit, stocks seem more 'risky'. Why? Because during a bear phase the price of a stock can fall below the price at which it was bought.

Many small investors fall into the trap of such a simplified view of risk and choose the 'safe' option. What they fail to realise is that safety also comes at a price.

Returns from fixed deposits are taxable and subject to fluctuations in interest rates. A 3 years deposit earning 8% interest may seem like a good safe return, but the real rate of return is only 2% if inflation is 6%.

There are a couple of ways that risk can be reduced when investing in stocks. The first is by diversification: (i) across market capitalisation, i.e. investing in a mix of large-cap, mid-cap and small-cap stocks; and (ii) across sectors, i.e. buying stocks from auto, pharma, FMCG, financials, etc.

The second is by portfolio diversification through investment in different asset classes, like stocks, funds, fixed income, gold.

Another way to reduce the riskiness of stock investing is by learning the basics of technical analysis. 

While fundamental analysis is a must in understanding the financial robustness and competitive advantage of a company, technical analysis provides signals of when to buy, when to sell and when to sit tight.

Plus, the concept of a 'stop-loss' allows an investor to exit with a smaller loss when a stock's price is tumbling down.

If you are not adept at picking stocks, you can still invest in stocks and diversify your portfolio by buying units of different mutual funds.

By choosing the 'dividend option' in a fund, risk is reduced because the periodic dividend payments act as partial profit booking and freeing up some cash that can be utilised elsewhere.

So, the answer to the question is: No - provided you know what you are doing.

To learn more about risk, here is an interesting article from investopedia.com.

Are the movements of a stock market index predictable?

That may sound like a strange question coming from some one who regularly writes about the movements of Sensex, Nifty, S&P 500, FTSE 100. Nevertheless, it is a pertinent question.

Many small investors spend an inordinate amount of time and energy in trying to figure out in which direction a stock market index is going to move next. Some do it out of curiosity. Others, because they have taken a position in the F&O market. Some are trying to 'time the market' by fine tuning their entry or exit.

Those who have spent a long enough time in stock investing - whether using fundamental analysis, or technical analysis, or both - already know that predicting index (or stock price) movements is like tossing a coin. You only have a 50% chance of success at best.

(That may be good enough to make money. However, the 50% success rate comes from averaging multiple tosses/predictions. You may get 7 'heads' in a row and feel that you have mastered the art of coin tossing/predicting. But then you may get 12 'tails' in a row that will wipe out all your investments!)

What should a small investor do? Whether you are an inexperienced or an experienced investor, you need to accept the fact that index movements can not be predicted or controlled.

So, concentrate your time and energy on stuff that can be predicted and controlled. Like, how much you are likely to earn over the next 5-10-15 years. How much you need to save each year to achieve your financial goals. What kind of assets you should invest your savings in to get the required rate of return.

In other words, make an investment plan and then stick to that plan regardless of index movements. The plan may need to be tweaked to optimise returns - but such tweaking should not be done more than once or twice in a year.

It takes a lot of mental strength, faith and discipline to stick to a plan when an index goes through its periodic turmoil. Specially when a 15 months long bear phase decimates your stock portfolio.

But over the long term, a planned investment strategy will generate better returns than an unplanned strategy based on predicting index movements.

That was the long answer. The short answer is: Not really.