Advice and Strategy for
those who believe in only Defensive Investment
When
it comes to Investment, once a bear phase is established it is advisable to
keep our capital in home until we get fresh signals of positive reversal.
In
bear market people are tempted to buy stocks that are available cheap relative
to their historic highs, so they accumulate such stocks.
Most
people follow the strategy of trying to buy cheap and sell high. They very well remember to buy cheap, but
when it comes to selling they forget the principal altogether.
When
it comes to serious investment, our investment and exit decision must not be
dependent on how cheap or expensive a stock may be. Relative to a specific time
horizon, a stock may look relatively cheap or expensive. There are various
fundamental calculations based on which it is said whether a stock is cheap or
expensive. But when it comes to rational investment system, our investment
decisions must purely depend on the matter of timely investment. We must be
able to spot the start of a bull phase, and enter the market or a stock.
When
we can spot a stock on beginning of its real long term up move, why must we
block our money for say 2 or 5 years in advance?
People
do this because they have a fixation of getting cheap deals, and so in process
of doing this they run after stocks, which are making historic lows. Some
stocks could become multibaggers in future and they can benefit by doing this,
but in most cases their capital gets blocked for a long time, without a
guarantee of excellent returns in future.
Most
of the time what happens that you buy a stock in bears market and you keep
invested in it for long time with a hope that when the bull market will start
it will benefit you. Now as far as index is concerned, you can predict to some
extend when bull market can begin based on past cycle references. But stock
specific bull runs cannot be predicted so easily in all cases. No one clearly
knows when a secular bull market will start. And if the stocks that they hold
declines further they make mistake of averaging. You could also need money for
a serious matter, and so when that happens you have to prematurely exit from
the market, with whatever price you may be getting, which could result in
compulsory or unwarranted loss.
Then What to do?
As
mentioned earlier what I prefer is to monitor the stocks that you want to
include in your portfolio. Instead of trying to catch them at a price that may
look cheap, wait for them to breakout positively and give long-term bull
signals. By doing this we ensure that our capital is in our hands most of the
time and it is invested only when the real bull phase is in place. We have to
learn doing this, which we can with the help of technical analysis.
If
you want to get somewhere, they would you prefer to sit in a bus, which is not
going to leave the station for many hours to come? Same principle must be
applied to stock market.
We
have to do regular study for this, and it is a price that one must pay. We must
be always eager to do what is in our interest. If someone will tell you that a fortune
is hidden in your compound of your home, what will you do? You will immediately
start digging to retrieve that fortune. Same way what we have learnt so far in
this book is the knowledge which will enable us to get the hidden fortunes
present in the stock market.
Generally
those who do not know technical analysis are seen accumulating stocks in small
quantities over a period of time. They believe that it is difficult to pick a
top and bottom, so they try to accumulate stocks in small quantities to average
out their prices.
Now
it is true that it is difficult to pick exact all time high tops and bottoms.
One must never insist that the price at which they sell must be the top most
prices and the price at which they buy must be the lowest price.
Even
highly trained people are not able to do this.
If
we try to bottom fish, the declining prices could keep on declining for long
time, and we can get trapped in a stock with an average buying price lot
higher.
Instead
what we must do is to wait for the bottom to establish, and when the stock
starts its up move, which is sustained, it is then when we must start buying
that stock.
Let us take an
Example for this
There
are many investors who accumulate stocks in bear markets and hold them for a
longer period. They have both extra money and holding capacity, which is not an
option available to everyone. The extra money that they may not need for
another 10 years is invested by them in blue chip stocks and mid caps, which
could give them good return in longer run.
This
type of strategy, is followed by those who can invest for longer periods,
without need of the invested money in short term and short term loss due to
decline in stock prices does not make them uneasy in anyways.
Holding
for a longer period with a clear plan is one thing, and having to hold for a
long period, because we can’t do anything is totally different thing.
Our strategy must be such that we decide what to do
and when to do.
Example:
Mr.Abc
decides to buy a share. He starts buying the stock at declines. The top in bull
phase was established at 276. Now the price is near 150 so he thinks it is near
bottom, so he starts buying the stock. He buys 100 shares at 150. Now the price
declines further to 125 and he buys again 100 shares. He did not have expectation
of having to average the stock when he bought first, but he does that
compulsively. Now price declines further to 90, and he unwillingly adds 100
shares more. The prices keep declining further and eventually he realizes that
he is stuck with the stock for long time now, with no hope of recovery in near
term.
In
the same case, had he waited for the bottom to be established, and say the
stock made a bottom of 50, and started its uptrend from there, he could have
bought the share at 75, if not 50, and entered the stock at a juncture where
the downside would be limited and scope of uptrend greater, which could give
him great percentage return in very short time.
This
matter is very important because most people do not have enough money at hand,
which they can invest, in the market considering as a fix deposit. Mostly such
capital is invested which they may need in short term to medium term. Even if
they have such amount at hand, I would not advise them to invest their hard
earned money in the market for long term without considering various factors
involved in it, which we have already discussed.
Never
get trapped in the illusion that a stock that is good today will necessarily
remain good forever.
In
recent past we have seen that scams can be witnessed in such good companies
too. That does not mean that we have to see every company with suspicion. But
we have to be alert all the time, so in case of such instances, we can exit
immediately.
On Overall Basis which
Strategy we should follow?
For investing in stock market, many
strategies can be used. As we have seen
above different trading strategies are based on different factors. Before
building and following any strategy, we need to test the efficiency of that
strategy.
Every individual can follow a strategy suitable to them. It is not necessary that one trading strategy would be suitable for all. But every successful strategy must have few characteristics as mentioned below.
Characteristics of an optimum strategy
The strategy should let the profit
run, and must cut losses at right time.
This is the most important factor, for any strategy, to become a successful strategy. As failing to cut losses at right time could prove to be a big mistake, same way, premature exit from potential multibaggers could also be considered a big mistake. People try to justify their action by thinking that it’s ok if they got less profit, but they fail to understand that the profit that they fail to take home is also a loss. You enter the stock market to make profit, so you should be able to take most of the profit home, if not all. Any strategy we follow must ensure that this happens.
Keeping stop loss at a level, which ensures that capital, is safe and most of the profit is taken home
It depends on individuals, and different people follow different strategy. Keeping 10 to 15% stop losses, can be too tight, as most of the stocks can gyrate up and down more than this during a weekly cycle, so one could exit the stock, and later on see the same stock recovering higher.
What happens in our strategy is that we keep
stop losses based on averages, and those supports are well below 25% or more.
This amount of stop loss can also sometimes considered tight, as during a
correction in a rally, one could see a correction of 50%. The reason why we
have kept this stop loss level is that even in case of such corrections, I see
no point in losing more than 50%, with no guarantee that the stock would see an
up move later. When the Bull Run is about to end, if we let the stock decline
50% then we lose a big amount of profit margin, which I believe we can’t let it
happen. Though the overall portfolio impact may not be more than 15 %, but
during a reversal, most of the stocks could witness such movement, which on
overall basis could have greater impact on our portfolio.
If we keep the stop loss level based on
averages, it saves most of our money, as a 25 to 30% stop loss trigger results
into less than 6% capital erosion of the portfolio of 5 stocks as we divide 20%
money in each stock. Diversification helps in this way.
The system must make us take rational decision under all market conditions.
Most of the time when markets get volatile, and witness huge gyrations, most of the investors witness a decision paralysis during that time, as they do not have any plan for exit. Our strategy unable us to take rational decision, as decision points are defined in advance, and are followed mechanically once they are hit. So the emotions like, fear, panic, excitement, and euphoria does not take over our decision taking capacity and we take rational decisions most of the time.
A
stock must be out of the portfolio once it starts under performing.
A time comes when more juice is not left in
Bull Run of a particular stock, and it starts under performing the market and
our portfolio. At some stage it hits the lower decision point, which confirms
that that stock is no longer a winner, and so we make an exit. This system
ensures that laggards and losers are out of our portfolio at right time and
only winners remain in our portfolio.
Most capital is invested in the winners.
Most of our capital must be directed in stocks that are consistent winners. Most people focus on losers to increase their capital, thinking that averaging will help, and they fail to take advantage of the winners. When you go for horse races, would you bet on a loser? Still when it comes to stock market people do that.
Our investment strategy can be considered
optimum only when it has the mechanism to ensure that capital flow is directed
towards the winners, and capital is withdrawn from losers in time, saving most
of the capital to reinvest in the winners.
One can never tell what will happen in a
company or market in general terms, so our strategy must ensure that we are
able to take action as and when it is required without worrying regarding why
it happened.
Note:
Many times we hear that one must sell if the
EPS of the stock declines, and one must buy the stock of good product
companies. It does help, but a strategy based on only such factors is
incomplete. There are so many things that happen in a life of a stock, which is
difficult to comprehend, and most of the time the effect of a development is
already reflected in the stock price. So if we try to sell or buy on such news,
we can get caught on wrong foot. So
our strategy must not be based on such parameters.
Important Points worth
checking in all Kind of Markets
Though our focus in this book is on Technical Analysis, there are some fundamental aspects that I believe should not be ignored. As these aspects helps us to make rational and quality investments.
Diversify
between industry groups
Because stocks within an industry tend to
move more or less in lockstep, make an attempt to diversify your portfolio
between at least three industry groups. This will help to reduce some of the
risk in your portfolio and having your money spread over several industries
will help even out more of the ups and downs in your account value than if you
had everything in one industry. Whether you are investing in stocks, fine art,
certificates of deposit, bonds, or whatever, the first rule of investing is:
Diversify.
Always Check out the Chart before
making an Initial Investment
Before you buy a stock, take a look at its
price chart for the past year or two. This will give you a snapshot of the
stock's personality from a volatility standpoint. It is prefrable avoiding
stocks, which have high week-to-week volatility and instead prefer ones, which
have a tendency for a cleaner trend. If a stock has a very volatile price
pattern, then it generally means the company has no clear advantage in the
marketplace for its product, services, etc., versus the competition. Since
there are many companies out there, which do have a clear, sustainable
advantage in their particular market, I generally opt to purchase these
instead. As an extreme example, following is a chart of a stock, which has
shown a very volatile price pattern in the past year:
As
an example of a stock, which shows an excellent trend pattern and low
volatility, study this chart of Dabur. As you can see, the stock is making a
new all-time high combined and is moving more steadily upward than many other
stocks. I would tend to favor a stock with this type of price chart.
The
lower-priced a stock is the more tendencies it has to be volatile in its trend
pattern. This is a good reason to avoid low-priced penny stocks.
As
far as taking advantage from the chart trends is concerned, it should not
matter what price a stock is. But the reason why we insist that you must buy
quality rather than going for cheap deals is because in such company charts,
the movements are erratic and volumes can dry up without any warnings or
reason, and stock can go into a seller circuit without any warnings, and one can
get stuck in such stock. Now what can you do if you are holding a stock and you
are not left with a window to exit?
There are several ways to obtain a chart of a company's recent price history. By far the best and cheapest way these days is by Internet. There are some charting software’s available which one can use.
Fundamental Analysis: How Important is it?
Fundamental analysis does help us to check the health of the market or a particular stock. It also helps us in distinguishing between a rubbish stocks, against a blue-chip.
But
when using technical analysis, it can be said that we are always more
interested in “What” and less interested in “Why”. That is why you may have
noticed that there is nothing in this chapter regarding how to perform fundamental
analysis of industries, companies within that industry, financial analysis of
earnings statements and balance sheets, etc.
Those who want to, can first check the financial health of a particular company, and then focus purely on whether the stock is trending upwards or not. Apart from the initial quality check, there is no further need to get deep into why the stock is trending up and what the target could be.
The simple reason for this is that if the market is saying that a certain company's earnings are expected to grow (evidenced by an accelerating upward stock trend), or a stock is simply moving up coinciding with the bull run established in the stock market, why should we find reason to dispute what the market is saying?
Even if a stock with good volumes is moving up without any evident reason, we can still take advantage of the uptrend in such stock. As long as we have a loss-cutting mechanism in place, we do not need to use fundamental analysis to validate what the market already has told us about the trend or future earnings of the company.
The opinion of the aggregate marketplace has far more credibility in my eyes than does the opinion of any fundamental analyst, no matter how good. And this aggregate opinion is always reflected in the charts of stocks and Indexes. So I will always go with the opinion of the market, as opposed to anyone else's opinion, including my own. To me, anyone who tells me that a stock, which is moving up, shouldn't be moving up, has by definition missed something in his analysis.
What
we need to understand is that when a bear market is shaping up, not all
companies fortunes change overnight. Still during the bear market, even so
called blue-chip shares tend to crash. People tend to stick to them, first with
disbelief that they should not decline like this, and then with compulsion, as
there is no use selling those stocks at such drastically reduced prices. Now
despite of what we think, or what people in market say, such shares do decline,
which is a fact.
Most people are in same situation described in above paragraph. If one wants to save themselves from this trap, they have to take help of charts. During such situations one must focus only on what charts are saying, and not on what they themselves believe, or anyone else is saying.
To
make my point on the futility of fundamental analysis for the average investor,
think of how you would determine if the grass in your lawn was growing quickly.
Wouldn't you just measure the grass today, wait a few days, then measure it again
and subtract? If you did this and discovered that the grass was growing
quickly, would you then go out and conduct a survey of the temperature,
rainfall and hours of sunlight per day to validate that the conditions for
growing grass are indeed good? Of course not! You would rightly conclude
that the conditions for grass growth are good based solely on the fact that the
grass is growing. Even if you did cook up some formula to predict grass growth
based on environmental conditions, would you trust your formula more than your
direct measurement of the grass's actual growth? If your formula said that
grass shouldn't be growing and yet it was growing, would you stop mowing your
lawn? Again, to do so would be preposterous. You would have to conclude that
something is wrong with your formula.
Unfortunately, many people do not apply common sense of this sort in the stock market.
Even though we can directly measure through a stock's price trend what the company's growth prospects must be, there is always someone there to try to make us lose sight of that simple fact by pointing to his "analysis." You can be sure that for every fantastically bullish trend, there is some analyst somewhere saying why it shouldn't be happening all along the way. The best you can do is to not listen to such opinions, and, again, go back to the Charts as your one source of advice.
Still those who want
to check out some fundamental criteria’s should consider checking the criteria that
are mentioned below.
Earnings Growth.
One-way to further narrow your list of potential stocks is to focus on those that are reporting high rates of earnings growth. Do not think that because a company is presently generating rapid earnings growth that it cannot continue to do so well into the future. It often takes years or even decades for competition to nullify such a company's competitive edge in the products or services it provides, and it is this competitive edge that allows the rapid growth in sales and earnings. So, pay close attention to the earnings trend of your potential stock selections. Where can you get this information? It can be gotten from any number of publications including Fortune India, Capital Market etc, by far, though; the easiest place to find summary information on earnings growth is websites like www.bseindia.com & www.nseindia.comn
Market Capitalization.
Market capitalization is another thing you will want to pay attention to. Market capitalization is simply the total market value of all the company's outstanding shares, or total shares multiplied by the price per share of the company's stock. I generally like to avoid the very biggest capitalization stocks.
Why
take market capitalization into account when picking stocks? The larger the
base of earnings a company is working from, the less likely they are to be able
to grow earnings at a sustainable clip of 30% or more - and the less likely we
are to be rewarded with a windfall profit. So, try to stick with the
smaller-company stocks appearing on the new-highs list.
OTHER FACTORS TO REMEMBER
Share Price: Focus on Quality
Finally, try to limit your purchases to stocks sporting a share price at or above Rs.10/share. It is not a thumb rule that stocks below this price level are not quality stocks. But most penny stocks without any value and fundamentals tend to trade around of below this price levels. And low-price stocks tend to have very choppy trading patterns and are much more subject to false trend reversals. Though one must not have any fixation on a particular price or price range, it is observed historically that stocks priced in the Rs.30 to Rs.50 price range can be considered, as they are often well established enough to have a high success rate, but if they are smaller capitalization issues they also are small enough to have nice growth potential. But when it comes to quality, be prepared to buy a stock even if it is available and 1000 plus price, as quality always comes at a premium price.
Whether you are investing in stocks, art, coins, or real estate, it is my opinion that it is always best to buy the highest quality you can possibly afford. Any review of the return on rare coins or masterpieces of fine art will quickly reveal that those who bought the rarest and highest-priced items have enjoyed the best returns on investment. The same principle is true in stock investing. Do not be afraid to pay a high price relative to earnings, book value, or sales. In fact, I would ignore such items. I recommend that you buy the stocks which are moving up persistently in price, and don't concern yourself that these stocks tend to cost a little bit more than some more boring issues. History shows that the premium paid for high-quality items of any kind is generally worth the extra money.
When
you want to go from one destination to another, if you want to move fast, you
have to buy a ticket for an aero plane. Compared to other options, aero plane
tickets definitely look expensive. But to save money if we pick a bullock cart,
then during the course of the Bull Run, how far can we reach? Just think about
that.
Short-term timing
Many
investors let short-term timing considerations overwhelm their choice of which
stocks to buy. I believe this is an error, and also greatly complicates their
stock-picking criteria. People become so confused by what is happening with
short-term oscillators, moving averages, chart formations, and other
mumbo-jumbo that these things begin to dominate all other considerations. In
this book, we are not ruling out short term timing, but I want you to focus on
the big picture: Long-term results.
The simple reason for my philosophy is, I would rather buy a stock that looks overextended and may have a relatively small short-term pullback in price but on its way to a 1,000% gain than one that is not at all extended but on its way to only a 50% gain. In fact, on weekends I often look at the largest percentage price gainers for the week and I strongly consider those stocks for purchase. I am not afraid to buy a stock just because it is moving decisively upward. I believe that with right rational strategy in place, you can accumulate your positions gradually enough that you will not need to worry about whether a stock is overextended, under extended or other short-term timing concepts. Therefore, you can keep your stock-picking techniques as simple as what is presented in this chapter.
When picking stocks for investment, apply these criteria:
Restrict
your stock-picking to stocks that have turned around and are showing positive
trend based on technical triggers received in charts.
Those who are aggressive Investors must weed out defensive stocks and those involved in buyout situations.
Don't be afraid to pay up for quality.
No comments:
Post a Comment