See... this is how you can make money?

Here's one very very basic example to show the power of technical analysis and the discipline and patience required to make sure shot profits. This example is aimed at individual and small investors who want to invest for long term and have very little time to do exhaustive equity research.

This is the weekly candlestick chart of ONGC over last two years. For beginners, all the green and red bars represents open, high, low and closing price of the stock and the red lines above and below such bars are called Parabolic SAR (it is a technical indicator to make a buy or sell transaction). As a thumb-rule, whenever the red line or arc is above the candles then buy and vice-versa. For example, at the beginning of the chart, red line is below the candles, thus buy the stock at around 170. This red line continues till 15th July, then it moved above the candles signalling a strong sell.

I think, this is a very simple rule to start with. For individual investors, who doesn't know anything about the Parabolic SAR and any other technical indicator, this would serve as a very effective 101. If you trade by following the rules mentioned above, then you will make the following transactions over two years.

This means, if you trade just by following one technical indicator, however with discipline and patience, you can get a return of ~35% per annum.

I'll explain first two trades to make things simpler for you.

Trade 1- buy the stock at 172 as the red line is below the candles. sell the stock at 281 on 24th July when the red line moved above the candles. And simply book profits. But don't stop here, make another trade on the same day i.e. trade 2

Trade 2 - sell the stock at 281 (carry this position in futures) and buy it again at 305 on 14th Aug. book a loss of 24 and make another trade i.e. trade 3. And so on.

I think you must be amazed to see the returns and I am sure your mind will be filled with n number of questions. Is it that simple? And I must say its not.

Have you observed, of all the eight trades that you made, only three were profitable while five of them end up hitting you with a loss. This is a very big concern. One must understand the fact that technical analysis is not an exact science and it can not always give you the correct signal. In fact, there can be more whipsaws than accurate signals, thus experienced traders use a mix of more than three signals to confirm a trade direction.

However, I have shown you the power of using just one indicator. One most important thing that you would notice here, its the discipline and patience that paid off. After the profit in first trade, next five trades resulted in losses that too for more than one year. This can easily frustrate anybody and force him to stop believing in technical analysis. But one must not forget, all the loss making trades resulted in 3-12% of losses while profit making trades resulted in whopping 16-63% profits. This shows that TA (technical analysis) helps you reducing your losses and increasing your profits.

I hope, this post would be insightful for the learners of TA and would increase their self confidence. I know you will have a lots of questions now. Do let me know and I'll try to answer them in subsequent posts. 

Solving the puzzle 103 - Technical Analysis

You must be wondering that after 101 and 102, why did I suddenly started talking about the picture and the chart and the way to read it. There is a reason behind it.

What you see is what you believe...!

Thats why I wanted to show you the power of stock charts, the uniqueness and versatility of pictures to explain whats actually going on. Finally, here's the post on technical analysis. And I recommend you, to do technical analysis before you buy any stock in any exchange. In previous posts, I have continuously discouraged individual investors like you, to do fundamental and information analysis because you just can't do it. You will never have the time and expertise to do such analyses. Thus the only thing that comes under the purview of investors like you is - Technical analysis.

You must be wondering that I am pushing you towards doing some kind of technical and mathematical analysis, however I bet you, its neither technical nor mathematical. You don't need any degree or diploma in rocket science, to understand this. This is very simple study of stock price movements and it require disciplined efforts and patience to make sense of such movements. Let me list down what all you can do with the help of technical analysis.

1. analyze thousands of stocks in 5 mins using a stock screener
2. identify patterns in the selected stock charts (may be 10-20)
3. apply and study various technical indicators and find out which one works best
4. you don't have to forecast revenues and earning for the next quarter or year
5. you don't have to keep waiting for a breaking news to make a transaction
6. you'll be confident of your analysis and can do back-testing as well
7. you can do it at your home without spending time and money to collect data
8. you'll be much more confident while talking to your financial advisor
9. they say, one can never time the market, see the chart and tell me what do you think
10. last but not the least, you'll be the in-charge of your future - you'll be charting your own future

I'll talk about what is technical analysis and how to go about doing it, in my next post. Till then.

Good Bye, have a nice weekend

A picture is worth a thousand words...

And thats true... you might read thousands of words, hundreds of webpages, tens of research reports and you might talk to more than one financial advisors. All of this usually goes in vain. You are still confused !!!

Why?

Simple, all of these reports and experts have their own views and conclusions. Most of the time, such views are almost opposite to each other. You would be in a dilemma - whom to trust and not to trust? And I bet you, you are not all alone. Everybody who get into doing all the research and consulting is bound be in the similar situation.

Thats why this picture is here.

This is NIFTY (one of the Indian stock exchange representing 50 scrips) chart for last three years. Chart shows the weekly movement of nifty over last 156 weeks. Its a candlestick chart (I'll tell you later what is that) in which each candle shows the open, high, low and close for a particular week. Below the candlestick chart, there is another bar chart showing weekly volumes.

What does this tell you?

Observe the red lines, below and above the candles. If you can see them, you are the expert. Because, these lines represents the market movement. Each of the small lines prompt you to make transaction i.e. either buy or sell. Its as simple as that.

If you observe it closely, you would know, when the red line comes below the candle you should buy and vice-versa. For example, in the week starting Apr-09 the red line is below the candle, prompted you to buy the index and you can calculate how much profit you would make till the red line moves above the candles.

Simple, huh?

Yeah, I think. But you should also tell me what do you think about it. Is it as simple as it seems?

BTW, if you have understood the same, I bet, you have become the guru of technical analysis.

Cheers

Do you like pictures...?

This is Nifty chart for last three years. What does that mean? Nifty? Chart? three years? Rather it looks like some exotic kinda snake... isn't it?

Technical Analysis of the Financial Markets: A Comprehensive Guide to Trading Methods and Applications (New York Institute of Finance)

Solving the Puzzle 102 - Information Analysis

Information analysis is the one of the approaches mentioned in the Equity research 101. It is all about analyzing all the news and rumors about the stock market and the scrip in question. Let me tell you, it takes a lot to collect and analyze all such information. Today, we are in the midst of an ocean of data, until and unless you are sure of what you want, you are most likely to get lost. Thus the analysis never happens.

One can do information analysis if his network is pretty strong. For example he knows a few top notch brokers and analysts on Dalal street or he knows people who actually has insider information or he knows someone who actually spread rumors. Thus, it seems impossible for individual investor to trade on the basis of information analysis.

Sometimes people rely on their local broker and business channels to get information and breaking news. Let me assure you none of them works in your favor. As the local broker usually doesn't have any insider information and most of the breaking news on business channels are actually one week old.

So, my advise to all of you is to refrain from information analysis. Guys, never ever trade on the basis of a breaking news or so called rumors.

Will discuss the technical analysis and its importance in subsequent posts.

Cheers

Solving the puzzle 101

Oops...!!! What's new? This Equity Research 101 is as old as gold. What's in it for me? Are you just here to give me some general gyan or what? I know all of these and this post doesn't solve any of my problems.

Yes, I was expecting the same. I wanted you to ask all the above mentioned questions and share the challenges. I know I have shared something that every book on investing says and every stock market expert talks about, however nobody was able to follow this. Not even the experts themselves.

So, what you should do? Lets try to solve this puzzle by untangling each of the threads one by one.

Fundamental Analysis:

It involves analyzing the financial statements, management, competitive advantage, competitors and markets of a business (stock). It is performed on historical and present data but with the goal of making financial forecasts. It is done usually by industry analysts and experts who have been tracking the industry  for many years. It includes the following major analyses -

1. Economic analysis
2. Industry analysis
3. Company analysis

On the basis of these three analyses the intrinsic value of the shares are determined. This is considered as the true value of the share. If the intrinsic value is higher than the market price it is recommended to buy the share. If it is equal to market price, hold the share and if it is less than the market price sell the shares.

This kind of analysis can be done only once in the quarter because its based on the earning reports. Most of the companies report their quarterly earnings and provides a guidance. Effectively fundamental analysis can be done only four times in a year. It requires meetings with senior management, visit to its facilities, meeting with industry chambers and forecasting skills. Even the experts focus on just one industry or one company. Not even top-dogs can focus on multiple industries and companies. Thus, this kind of analysis is very challenging for an individual investor to do and should be done by industry experts and equity analysts.

Now, what should you (as an individual investor) do? Don't try to dig deep in the profit-loss statements and balance sheets of a company. Never try to forecast earnings (EPS) for any stock. Never ever try to time your buy or sell transaction based on any of the fundamental analysis. This is something too sophisticated for you. Then what's the use of fundamental analysis in the life of an ordinary investor. I'll talk about it later in my following posts. Till then - relax and don't do any analysis.

Equity Research 101

Traditionally, there are three different ways to track and understand the movements of stock-market and believe me - Everything works....! However, making money requires consistent efforts in the right direction. It certainly means that detailed anlysis and study of selected stocks is required.

Following are the means to analyze the market:

1. Fundamental Analysis
2. Technical Analysis
3. Information Analysis

Every investor needs to match the trading style in line with his personal traits and abilities

1. Logical thinking - If you are good at arranging your thoughts logically and understands the basics of economy, balance-sheet, cash-flow, revenue trends and profitability, you are made for 'FUNDAMENTAL ANALYSIS'
2. Intuition - If you are technically sound, can read numbers, charts and graphs with interest in colors and shapes, "TECHNICAL ANALYSIS' is for you
3. Networking - If you are a party animal and love interacting with people and socializing, have reliable contacts and networks, "INFORMATION ANALYSIS' is your cup of tea

To invest and make profits consistently, you must have a robust investment plan. Following are the simple tips to make a workable investment plan.

1. Put everything on paper
2. What to buy (factors like PE ratio, growth projection, etc)
3. When to buy (under-valued, market correction, etc)
4. How much to buy (your risk appetite)
5. When to book profits (set time limit for entry/exit)
6. When to book losses (always set a stop-loss)

While trading, refrain from ego and greed as they are the way to add bias in your stock-portfolio. Follow a discipline to periodically analyze your portfolio, associate with like-minded people and keep learning from books as well as past mistakes.