Market Making New Highs?

Emotions !  The root cause of all falls. What are the emotions of market players at new highs?  Fear and euphoria. Which is the right emotion ? Your guess is as good as mine. Markets never give you advance signals of what it is going to do next.  Remember all the negative divergences, bearish rising wedges, expanding triangles that I have been mentioning in my analysis?   All pointing to a fall.  Short sellers selling ATM calls !  Hedging Longs and the portfolio in the fear of a fall. So did the market fall?  No ! It just made new highs :) !  So does one continue with longs? Or should one go short with more confidence? Or should one add longs?

If we were to recollect  the basic theory followed in markets, the Dow Theory, then, new highs are telling us that the economy is healthy and that is the reason why the Indices,  which represent the top stocks is making new highs. The dow theory believes that all information - past, current and even future - is discounted into the markets and reflected in the prices of stocks and indexes. 

That  information includes everything from the emotions of investors to inflation and interest-rate data, along with pending earnings announcements to be made by companies after the close. Based on this tenet, the only information excluded is that which is unknown, such as a massive earthquake. But even then the risks of such an event are priced into the market.

It's important to note that this is not to suggest that market participants, or even the market itself, are all knowing, with the ability to predict future events. Rather, it means that over any period of time, all factors - those that have happened, are expected to happen and could happen - are priced into the market. As things change, such as market risks, the market adjusts along with the prices, reflecting that new information. 

The other important Dow theory tenet applicable to this situation would be ,  The Trend Remains In Effect Until Clear Reversal Occurs. This is a very important tenet to be remembered especially by those who have the habit to 'Jump the gun' in the greed to  short  at the top.

The reason for identifying a trend is to determine the overall direction of the market so that trades can be made with the trends and not against them.  A trend remains in effect until the weight of evidence suggests that it has been reversed.  Traders should wait for a clear picture of a trend reversal because the goal is not to confuse a true reversal in the primary trend with a secondary trend or brief correction. Remember that a secondary trend is a move in the opposite direction of the primary trend that will not continue. For example, imagine that the primary trend is up, but the indexes are currently selling off. If an investor were to take a short position, concluding that the sell-off is the start of a new primary downward trend, they could get burned when the primary trend resumes.

Unless you can safely conclude, based on the weight of evidence, that the trend has changed, you will be trading against the trend. As a general rule, this is not a wise idea, as many have been hurt by trading against the market.

Coming back to the question -- should you trade a stock/index  which is making new highs?   The fact is that there is nearly always a fundamental reason why  prices  are making new highs. It is a clear sign of a successful company / index that is performing well at the moment.

Look at historical charts and you will observe  that many of these breakouts last several days, weeks or even months. So you can profit from these breakouts whether you are a long-term investor or a short-term trader.The fact is that many fund managers, hedge funds and private investors are all keeping on eye on stocks that are making new highs. Therefore as soon as they spot a decent company whose shares are making new highs, many of them will start buying or trading their shares so they can ride this breakout. As a result of this you obviously get a lot of momentum behind this breakout and therefore the price just keeps on going higher. Of course not every breakout is successful because some breakouts run out of momentum very quickly, but a lot of breakouts will result in big price moves to the upside.

What if this is the last few points up with a reversal lurking inconspicuously ?   At such levels, it's a really tough and volatile market though. There are so many bullish and bearish arguments, trying to decipher which ones make the most sense is next to impossible. But  always keep one thing in mind: The market uses every bit of known information to come up with current prices. Don't believe for a minute that you have knowledge that the market hasn't considered. There's a reason it's priced where it is. So   always leave the door open on both sides - bullish and bearish.

There is no trading – classroom or otherwise – that can prepare you for trading the last third of a move, whether it is the end of a bull market or the end of a bear market. There is typically no logic to it; irrationality reigns supreme, and no class can teach what to do during that brief volatile time. The only way to learn how to trade during that last third of a move is to experience it.

Please tell me whether you liked this article so that I may be encouraged to write more.

Disclaimer  : Some parts of this article have been taken from the web.

Trading Wisdom

Do more of what is working for you, and less of what’s not. Each day, look at the various positions you are holding, and try to add to the trade that has the most profit while subtracting from that trade that is either unprofitable or is showing the smallest profit. This is the basis of the old adage, “let your profits run.”

Don’t trade until the technicals and the fundamentals both agree. This rule makes pure technicians cringe. I don’t care! I will not trade until I am sure that the simple technical rules I follow, and my fundamental analyses, are running in tandem. Then I can act with authority, and with certainty, and patiently sit tight.

When sharp losses in equity are experienced, take time off. Close all trades and stop trading for several days. The mind can play games with itself following sharp, quick losses. The urge “to get the money back” is extreme, and should not be given in to.

Be Patient


Be patient. If a trade is missed, wait for a correction to occur before putting the trade on.

Be patient. Once a trade is put on, allow it time to develop and give it time to create the profits you expected.

Be patient. The old adage that “you never go broke taking a profit” is maybe the most worthless piece of advice ever given. Taking small profits is the surest way to ultimate loss I can think of, for small profits are never allowed to develop into enormous profits. The real money in trading is made from the one, two or three large trades that develop each year. You must develop the ability to patiently stay with winning trades to allow them to develop into that sort of trade.

Be patient. Once a trade is put on, give it time to work; give it time to insulate itself from random noise; give it time for others to see the merit of what you saw earlier than they.

Courtesy : Anirudh Sethi's web page

Bar, candlesticks or line charts ?

This lesson is for those uninitiated to technical analysis.

Candles

The Bar , Candlesticks and Line charts are the most commonly used charts. The bar and Candle charts show the entire action that has happened during the period which it represents, as it shows the open, high, low and close of the day. The Line chart shows only the closing price but is very reliable as the closing price shows the consensus reached by the market players .

With good charting softwares available, it is very easy to change to a bar chart, candle chart or line chart at the click of your mouse. I use the Bar chart when I have to draw trendlines as it is easier to connect the highs and lows, than when drawn on a candle chart. Once the trendlines are drawn, I revert to the candle charts.

I prefer to view the charts in the candlestick form as they are more helpful in analysing.The Candles depict the entire action during time frame that the candle represents, at a single glance The distance between the open and close is called the real body of the candle. When the open is higher than the close then the real body is black. When the open is lower than the close, then the candle is white. Thus when the real body is black, we can instantly know that it has been a down day and a white candle depicts an upday.

Candle charts also have patterns of their own . I will discuss these patterns sometime later.

The overall market analysis

You must be getting impatient by now, wondering why I have yet not started the core topics of technical analysis which you hear so much about in the media. Well, for one, I think the topics which I am covering first are more core than the other core that we spoke about. I believe in building the basics solidly before putting up the rest . When you start trading, you will realise how much more well equipped you are than those who learnt only the tools of technical analysis. Now that you are satisfied that I am taking you on the right path, lets return to the present topic.


We are going to discuss some extremely important indicators which will be our crystal ball to foretell a change in sentiment of the market players. They are warning signals of a probable trend change. You may think, Oh no! not again! Of what use is it if you cant be sure? Well, as you have already been warned, the word “sure” does not exist in the stock market dictionary. But don’t be disappointed. These warning signals are very useful in preparing oneself to enter and exit.

It is a little difficult trading the contrarian way based on these indicators because humans always like stability and are in a constant quest for it. So shifting sentiments from bullish to bearish and bearish to bullish against the sentiments of the rest of the crowd is very difficult. More so because technical analysis teaches you to look for evidence before accepting that the trend has changed. For instance the DOW THEORY states that unless you have a "lower top and a lower bottom " the uptrend still exists AND unless you have a higher top and a higher bottom the downtrend still exists. But this is more theoretical than practical because, if you were to wait for the lower top and bottom to form the meaty part of the move is over.Also if you were to close your trades based on the theory then you may have already lost a substantial part of the profits.


"The crowd is right in the trends and wrong at the ends" the old Wall Street saying goes. This is because the crowd is not aware of the sentiment changes.

My next post will discuss the sentiment indicators.

Introspection- analyse your personality

You must be wondering what I'm talking about. If you went through my earlier lesson about psychology then you would know. It is very important to introspect and find out for yourself the type of personality you possess.There are two sides to personality, one of which is temperament and the other character. Temperament is your inborn nature, and character is developed by the environment you grow in coupled with your temperament.

In trading it is the temperament which will influence your moves. Successful trading is 80% psychological and 20% your startegy. So first analyse whether you are aggressive ,fearful ,laid back ,patient, egoistic. Your style of trading should completely depend on your peronality type. You should attempt short tem trading only if you are aggressive and bold. The turmiols in the short term are too much to take for the weak hearted. A laid back person would be best suited to make long term investments. If he were to attempt short term trading , he would surely lose money. The most dangerous of all is the egoistic trader. Accepting that the market is supreme and that your trade was wrong is the most important trait required for any person entering the markets. If not, you will soon be left with no capital.

The bottom line is that when a trader develops a trading strategy, it must cater to his personality and to the trading style he feels most comfortable with, rather than trying to mimic the approach of another trader with a different temperament. Now you know why I said never trade on tips.

Getting a grip on psychology

Psychology plays an important part in ones life. Psyching oneself to have a positive attitude to life can do wonders in achieving ones goals. So too in trading. Trading is not an exact science. It is a game of probability, and that is the reason why it is difficult to be right most of the times. Even the most seasoned players are sometimes affected by the ups and downs if the stock market. Euphoria can turn to despair in seconds.Thus getting a grip on psychology is the most important aspect of trading. You may be right technically or fundamentally about the trade you have put in, but if you have not got the right psychological approach your trade could go wrong. The fear of losing your money is high and unless you rein in this fear you cannot be a successful trader.

One way of removing this fear is to plan your trade from entry to exit before actually putting your money into it.

• Since we do not have easy access to data that will confirm essentials like integrity of the management, it is better to trade only the top 50 stocks which make up the nifty.
• First of all study the broad trend of the market. If it is in an uptrend then only pick stocks which are also in an uptrend. If the trend is up and the market is oversold, we would look for opportunities to go long. Or, if the trend is up but the market is overbought, we would become somewhat defensive, tightening stops in anticipation of a price correction.
• If the trend is down then it would be better to short sell. But short selling is a difficult game and it is much safer to watch the 'knife-catching' rather than take part. The sooner you recognize the advantages of this approach, the more capital you will conserve and be in an advantageous position to buy at the bottom.
• Analyse the stock technically ( will be detailing this very soon) to plan the entry.
• Introspect and arrive at your risk appetite level to be able to decide the amount of funds you will commit to the trade.
• Plan the exit. Remember this is a game of probability. A profit could tun into losses very easily or a small loss in a bad trade could multiply if you dont have a plan to exit. Exit can be by stop losses or squaring off as the target is reached. (Stop losses and target calculation will be dealt with separately , a little later).
• Never allow your trades to affect you personally. A loss can sometimes make you feel that you are worthless . If you do, you will find it difficult to put in a trade confidently.
• Never over trade. Trade only amounts with which you are financially comfortable else you may be left with no capital for a next trade.

REMEMBER

It is almost a certainty that when you lose in the stock market , you will experience negative thoughts such as Inferiority, Pessimism , Excessive Grief, Anger. Learn how to cope with these feelings by means of positive thinking. Positive thinking, in other words optimism, motivates you to never give up, which turns failures and set backs into comebacks and successes. Your thinking habits reflect on your trading. When a failed trade frustrates you, learn to accept the failure and learn from it.

Psychology and Prices

I found this lovely chart on a website . It shows how psychology of the market players drives prices.

I mentioned about greed and fear earlier. The point of maximum financial opportunity, shown above, is when the "uneducated" players are gripped with fear and sell in panic. When the mood is one of greed it is the point of maximum financial risk but that is when the "uneducated" players buy ! These are the two extremes the markets reach. These emotions are what we need to conquer. Never let your emotions get the better of your trades. Instead learn to exploit the markets by 'knowing' the psychology of the market. When the market is fearful, then we should buy and when the markets are euphoric we should sell .In other words we should be a contrarian. Once you have understood the psychological aspect, you will be able to make unemotional decisions to beat the market, with the help of technical analysis.

Easier said than done !! Just sharing with you that even now I sometimes tend to get greedy and fearful. It is indeed very difficult to sell a stock which is going up day after day. You tend to think that what if I sold now and the stock went higher? I would miss a large part of the profits. And then one fine day the stock takes such a vicious turn , you are caught unawares and sometimes the price of the stock goes even below the price level when you had first thought of selling it ! Remorse , if you sold it earlier and remorse when you didn't. whew! trading in stock markets will be very emotionally draining, unless you dicipline yourself to such an extent that emotions have no place in your trading.

Adding this chart I found in Equitymaster

Reading Dr. Jean Paul Rodrigue's Chart

Stealth Phase - "Smart money" gets in often quietly and cautiously. Prices gradually increase, but often go completely unnoticed by the general population. Larger positions are established as smart money investors start to understand the well-grounded fundamentals and realize that this asset is likely to experience significant future valuations.

Awareness Phase - Realizing the momentum many investors start bringing in additional money in and pushing prices higher. There can be a short lived sell off phase taking place as few investors cash in their first profits (there could also be several sell off phases each beginning at a higher level than the previous one). In the later stages of this phase the media starts to notice.

Mania Phase - Price rise catches everyone's attention and the public jumps in for this "investment opportunity of a lifetime". Floods of money come in creating even greater expectations and pushing prices to stratospheric levels. Fairly unnoticed from the general public caught in this new frenzy the smart money as well as many institutional investors are quietly pulling out and selling their assets to eager future bag holders. The market gradually becomes more exuberant as "paper fortunes" are made and greed sets in. At some point statements are made about entirely new fundamentals implying that a "permanent high plateau" has been reached to justify future price increases the bubble is about to collapse.

Blow-off Phase - A trigger arrives and everyone roughly at the same time realizes that the situation has changed. Confidence and expectations encounter a paradigm shift. Many try to unload their asses to a greater fool but there are few takers; everyone now expects further price declines. Prices plummet at a rate much faster than the one that inflated the bubble. Many over-leveraged bag holders go bankrupt, triggering additional waves of sales. The general public at this point considers this sector as "the worst possible investment one can ever make". This is the time when the smart money starts acquiring assets at bargain bottom prices.

Source: http://canadianfinanceblog.com