Calculating Risk and Reward

Are you a risk taker? When you're an individual trader in the stock market, one of the few safety devices you have is the risk/reward calculation.

Sadly, retail investors might end up losing a lot of money when they try to invest their own money. 

There are many reasons for this, but one of those comes from the inability of individual investors to manage risk.

Read more at:
https://www.investopedia.com/articles/stocks/11/calculating-risk-reward.asp

Understanding 'Buy the Dips' strategy

Buy the dips refers to purchasing an asset after it has declined in price. Buying the dips has different contexts, and different odds of working out, depending on the situation in which it is utilized. 

Some traders may say they are buying the dips if an asset is in a long-term strong uptrend. They hope the uptrend continues after the dip or drop. 

Others may use the phrase when no uptrend is present, but they believe an uptrend may occur in the future. Therefore, they are buying when the price drops in order to profit from a potential future price rise.

Read more at:
https://www.investopedia.com/terms/b/buy-the-dips.asp

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

Top 10 Rules For Successful Trading

Most people who are interested in learning how to become profitable traders need only spend a few minutes online before reading such phrases as "plan your trade; trade your plan" and "keep your losses to a minimum." 

For new traders, these tidbits of information can seem more like a distraction than any actionable advice. New traders often just want to know how to set up their charts so they can hurry up and make money.

To be successful in trading, however, one needs to understand the importance of and adhere to a set of rules that have guided all types of traders, with a variety of trading account sizes.

Read more at:
https://www.investopedia.com/articles/trading/10/top-ten-rules-for-trading.asp

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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/

The Number One Reason Why Most Traders Fail

The stock market has come out of a 3 months long correction and heading upwards again. Mid-cap and small-cap stocks are flying high. The temptation must be strong for first-timers to enter the market and become rich quickly.

Whenever anything looks tempting and really good there is a psychological urge to indulge. Doesn’t matter if it is a lunch buffet at a popular restaurant or an electronics sale from an online e-tailer or a fast-rising stock market.

The sensible thing to do would be to take a deep breath and step back. An irrepressible urge to do something is often followed by deep regret – specially when the only thing in your possession is an entry in your demat account that is sharply losing its value.

An oft-quoted statistic is that 90% of traders fail to make money in the stock market. The same statistic probably applies to most first-time investors as well.

The reason is simple. A recent article in investopedia.com not only explains the reason, but charts out the steps required for success in the stock market.

The different mindsets of traders and investors

The terms ‘trader’ and ‘investor’ are often used interchangeably because both participate in stock market transactions. In commodity markets, you will hardly ever hear the term ‘investor’. Why so? Because the mindsets of traders and investors are quite different.

A trader has a ‘short-term’ mentality. Time span for a typical trade can be a few minutes, or hours or at most a few days. An investor has a ‘long-term’ mentality. Time span for an investment can stretch from a few months to a few years.

Traders don’t worry whether the price of a stock (or commodity) is going up or down. If a profitable trade is possible – whether on the long side (up) or short side (down) – the trader will jump in. Investors usually enter long-only positions. They buy at a lower price, and expect to sell at a higher price.

A trader is quick and nimble. If a trade is turning into a loss, such losses are booked quickly by using a strict stop-loss mechanism. If a trade is in profit, the profit is also booked quickly. The process is repeated several times during a day or a week, depending on the traders time frame. An investor is more deliberate and slower in decision taking. Once a stock is bought, it is held for a long time to achieve the profit target. Short-term losses (or profits) are ignored.

Traders thrive when a stock (or commodity) has liquidity (i.e. large volumes) and shows volatility (i.e. big swings in price between the high and low points for the day or week). Liquidity allows trading in large quantities easily. Volatility allows huge profits within a short span of time. Investors prefer steady compounders that rise in price more gradually instead of swinging wildly, and provide returns through dividends and rights/bonus issues.

For traders, price action is the sole criterion. The best way to determine likely price movements in the short-term is to use technical analysis tools - like PSAR, CSI, pivot points. Investors are more concerned about the quality of the company they are planning to invest in. They go through a process called fundamental analysis to assess a company’s near and long-term growth, profit and cash generation capabilities; its management’s competence and integrity; and the valuation of its stock.

Now you know why there are no investors in the commodities market – because there can’t be much fundamental analysis for iron ore or turmeric or guar gum.

What successful traders and investors have in common is a plan and a system that has been developed over time and which has worked for a trader’s or investor’s individual style; and the discipline to stick with a good working system. Most losses are incurred by not having a plan, or deviating from a working system.

The better traders and investors use each others best practices: traders pick and choose the better companies to trade in; investors use some of the technical tools to better time their entry and exit.

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Is the recent stock market volatility unusual?

Before I answer that question, let me try and explain what volatility in the stock market really means. To the ordinary investor, volatility may mean sudden and unexpected changes in a stock’s price (or an index level).

But aren’t fluctuations in stock prices and index levels the norm rather than the exception? That’s an easier question to answer. Yes, stock prices and index levels do fluctuate all the time. But some times, the fluctuations are tolerable and ‘normal’. Those are periods of low volatility, which are conducive for trading and investments.

At other times, there are extraordinary and nerve-wracking fluctuations in stock prices and index levels that send traders and investors scurrying for cover. Such periods of high volatility increases risk and decreases returns.

For the mathematically inclined, volatility is a statistical measure of the uncertainty or risk associated with changes in a stock’s price (or an index level). It can be measured by using the standard deviation or variance (i.e. two standard deviations) of the returns from a stock or index.

A measure of the overall volatility of a stock’s return benchmarked against an index is called ‘Beta’. A Beta value of 1.0 means the stock’s return is the same as that of the index. In other words, if the index gains 100%, the stock will gain 100%. A Beta value of 1.5 means a stock will gain 50% more than the index during bull periods, but lose 50% more during bear periods; a value of 0.8 means the stock will gain 20% less than the index in a bull market, and lose 20% less in a bear market. The higher the Beta value, the more volatile the stock.

For the technically inclined, the Nifty VIX chart indicates the implied volatility (IV) of a basket of Nifty put and call options. A high VIX level (above 30) indicates high volatility; a low VIX value (below 20) indicates low volatility. Typically, when the VIX rises, the Nifty falls. The VIX can be used as a contra-indicator. Low values give an opportunity to sell, and high values provide opportunities to buy.

What causes high volatility? Unexpected changes - in interest rates (repo, reverse repo) or oil prices; a war or terrorist attack or earthquake; a change of government - can lead to wide fluctuations in stock prices and index levels.

What can small investors do? Understand this simple thumb-rule. Volatility declines when stock markets rise, and increases when stock markets fall. In a bear market – like now – high volatility is not unusual.

That is one reason why small investors may be better off staying away instead of trying to make a few bucks on counter-trend rallies; and avoid averaging-down during bear markets.

That was the long answer. The short answer to the question is: No.

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

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

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

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

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

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

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

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

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

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

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

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

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

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