We are now in the 12th and final month of a year that has been a roller coaster ride throughout. Global indices are now clocking all-time highs after correcting by almost 50% in the beginning of the year. There were those who made money, those who lost money and those who learnt a lot from the markets this year regardless of the monetary gain/loss. And that needs to be our prime focus. As long as the learning is in place, you’ve gained in this market.
Everything is Relative Strength is everything
When I was studying for my CMT Level III exam, I came across this chapter by Julius de Kempenaer. I read the title over and over again. I was amazed by that statement and the validity that it holds universally. What we see, believe and feel is all relative. For the most part, we don’t deal with absolute perceptions or ideas. Everything is in relative terms based on the variables we’ve been exposed to in the past. Just as we choose a particular asset class based on its relative strength among other asset classes, we make choices in life based on the relative strength of those decisions over others. Similarly, there are numerous concepts that could be picked up from the market and incorporated in our lives because at the core of these concepts are basic human emotions and reactions.
Market participants (like myself) who witnessed extreme moves in global indices across the globe this year for the first time, have been exposed to important lessons early in their career. While this year has been difficult for many reasons, it has taught us innumerable lessons in a short span of time. For me, this year has reiterated the importance of basic concepts and understanding which often get clouded by over analysis and over thinking. As an analyst sometimes one’s judgement gets clouded by expectation rather than by reaction. We are not here to dictate or predict patterns and scenarios. We are here to react to the price to the best of our risk management abilities and move with the trend.
To all the aspirants appearing for their exams this December, make sure your basic foundations are strong, because in turbulent times like the March 2020 crash, the very same basics can bail you out.
Until next time, Think Technical!
Rashmi Shastry, CMT
Editor, Technical Insights
Equity Indices Overstretched; Sectors To Look At For Adding A Protective Layer To Portfoliosby Milan Vaishnav, CMT, MSTA
Backed by strong FII inflows, the Indian equity markets continued their unabated surge in November. As the month comes to an end, the market has gained much more than it had lost during the...
Nifty on Point & Figure and Swing Patternsby Prashant Shah, CMT, CFTe, MFTA, MSTA
Point & Figure is considered to be one of the oldest charting methods. It considers only price hence it is known as one-dimensional charting method. It is an interesting method of representing...
PSE sector: Are the Underdogs ready to Outperform?by Kush Ghodasara, CMT, CFP
After the financial crisis of 2008, trust in equities took a setback. Gradually things improved on the ground in 2010 and equity investments picked up in India in the year 2012. Since then investors...
What sort of trader are you?by Aditya Shroff, CMT
To become a successful trader, you must ask yourself one question. What kind of trader are you? Confused? Let me explain. There are some traders who like to anticipate where the market is going. They...
A year for the ages.by Joel Pannikot
Enough virtual ink as been spilt on what a year 2020 has been. John Oliver went so far as to literally blow up the year, in his final episode for the decade. In this last issue of the year, it is...
Backed by strong FII inflows, the Indian equity markets continued their unabated surge in November. As the month comes to an end, the market has gained much more than it had lost during the meltdown that was triggered by the Coronavirus pandemic.
The equities have stayed buoyant globally to the extent that it has made other asset classes become relatively weaker mid-way through their rotation as they suddenly lost their relative strength against the equities. Bonds became cheaper as the yields spiked, and Dollar Index remained perpetually weak for the entire month indicating no signal of pull back. The emerging markets in general and India in particular benefited the most in terms of FII inflows and this made sure that NIFTY and the broader Market Index NIFTY 500 ended at all-time highs.
The frontline index NIFTY and the broader market index NIFTY500, both remain overstretched and so do all the high beta stocks and sectors that played out on these lines. That being said, with the markets showing no signs of weakness, it makes a prudent case for the investors to shift to a traditionally defensive play as these sectors are showing all the signs of resumption of a fresh move. This ensures that existing profit of the investors does not reduce drastically in case of a corrective move going ahead; and while if at all this happens, the defensive components in the portfolio would lend resilience during corrections, if any.
November showed strong gains in these traditionally defensive plays that include FMCG, Consumption and Pharma Indexes. In the current view, we also include PSU Bank Index, which may not be classified as a defensive play, but is in the process of bottoming out after a prolonged period of underperformance against the broader markets.
The above table throws interesting insights. Although the weekly gains in the FMCG, Consumption, Pharma and PSU Bank Indexes is moderate to good, the monthly gains have been robust. If we look at the YTD returns, barring Pharma which has returned 47.25% on the YTD basis, the other three sectors have seen a bulk of their YTD gains coming in the month of November. The PSU Bank Index, despite gaining 23.60% in November, still shows a net negative return of 38.27% on YTD basis. We expect all these sectors to do much better relatively as compared to the broader market over the coming weeks.
The line charts of the four sectors corroborate this inference. While the FMCG index is on the verge of breaking out, the Consumption Index has already shown a breakout. The Pharma Index stays in a strong uptrend following a channel breakout, the PSU Bank Index has shown a strong positive divergence on the RSI and appears to be in the process of a strong bottom formation.
When compared to the broader NIFTY 500 Index, the RS line also supports this reading. The RS lines of FMCG and Consumption Indexes have tested their major supports, the RS line of Pharma Index has already confirmed the reversal and has ended its downtrend trend. The RS line of PSU Bank against the broader NIFTY 500 Index appears to have ended its multi-month downtrend. It has also broken above its 50-Week MA as a sign of confirmation of this attempted reversal.
Markets in general may continue to stay strong despite consolidation at current levels. With the equity indices overstretched but not showing any signs of giving up, it would make sense to add a layer of protection and stability to the portfolios. Increasing allocation to these sectors may make perfect sense if at all we see some range bound but sharp corrective bouts from current or higher levels.
Point & Figure is considered to be one of the oldest charting methods. It considers only price hence it is known as one-dimensional charting method. It is an interesting method of representing price. It is the only method where we plot price in columns, and they move vertically when the price moves.
In this method, because price is not plotted based on time, we need to define the criteria to plot the price. This is known as box-value or the size of every box.
When the price goes up, it is plotted in the column of X. When the price falls, it is plotted in the column of O. Price remains in the column of ‘X’ or ‘O’ unless the reversal criteria is met. Hence, a column of ‘X’ or ‘O’ can represent the price action of several sessions. Usually, criteria of three box is used for plotting the reversal.
Below is a 3% box-value chart of Nifty.
Value of each box is 3% in the above chart. It helps us in looking at a bigger picture. By choosing a higher box-value of 3%, we can take a look at the price information of more than 13 years on a ‘daily’ timeframe in the above chart. The 45-degree objective trend lines are one of the important properties of P&F charts. Trendlines are plotted in the above chart from the major high of 2008 and the major low recorded in 2009.
The bullish trend line drawn from bottom after consolidation during Feb 2009 was recently tested by the price and is still intact. Observe the duration of the consolidation highlighted in the circle. It can capture the price action of a few months to few years. The recent price consolidation was less than 2-months timewise, but significant in terms of price volatility.
The vertical counts shown in the chart are plotted from the immediate column of ‘X’ formed after the bottom. In the past few instances, the price got into a consolidation phase after achieving the targets. After the consolidation phase, the price has proceeded higher and has activated more higher counts. Current trend is bullish and strong, vertical counts plotted from the recent bottom has been achieved.
Let us reduce the box-value that captures the short-term and medium-term price action.
Bullish green trend lines shown in the above chart are 45-degree trend lines plotted from important bottoms. Red lines are bearish trend lines plotted in the uptrend and the breakout above such lines are continuation-trading opportunities.
The short-term bullish count that got activated recently has almost been achieved. The count of 14,000+ is open but I would prefer to wait for more confirmation for validation of the second vertical count. The XO zone indicator, displayed in the lower pane in the above chart, is also is suggesting that the trend is bullish.
Notice the recent column consolidation in the short-term chart. This is an interesting discussion.
If we divide the price pattern based on the recent swing moves, below are the possibilities:
From the above schematic, it is apparent that the last four price swings in any chart can help us identify the four broad price patterns captured above.
This kind of pattern identification and classification can be easily defined and achieved in P&F charts. Recall how each column of X or O represents a swing move. Let us understand how the above patterns will manifest in the P&F chart. Have a look the chart below.
The swing patterns can be easily made objective in P&F chart. Now that we have successfully identified the swing pattern into 5 broad categories, we can assign scores to them as well.
It can help us in performing multi-timeframe analysis on any stock. Higher box-value chart will capture the price action or the swing pattern on the higher time frame while the smaller box-value will capture the short-term structure.
Below are the current patterns on Nifty on multiple box-values.
Pattern of consolidation on short-term (0.10%) and medium-term (0.25%) charts and bullish breakout on higher timeframe (1% and 3%) chart. This study across multiple box size is called as P&F Matrix.
Let us explore more possibilities with this swing identification of last four swings. We can count number of boxes in the above patterns. The total number of the boxes in a column tells us about the length of the pattern. If the length of a column is big, it indicates strong momentum in price. If it is too narrow it is more of a consolidation. So, by calculating the number of boxes in the pattern, we can come to know about the range or volatility of the pattern.
As mentioned earlier, the column of ‘X’ in P&F chart captures rising price or bullish prints and ‘O’ captures falling price or bearish prints. If number of bullish prints are more than bearish prints the trend is bullish and strong. If bearish prints are more the trend, then is bearish.
So, we now have three aspects based on the swing pattern: Nature of the pattern, Volatility and Trend.
Trend / Volatility = Trend Ratio of the pattern
With this knowledge, there are many possibilities of defining the market phase. For instance, a high range score and a high trend ratio indicates strong momentum. During such a phase, trading the stocks with high range and momentum proves beneficial. Low range and high trend ratio show us pattern of consolidation where undertone indicates possible breakout direction. Determining market phase can help us in deciding the appropriate trading strategy.
In the Nifty 50, 3% box size chart, there are 18 ‘O’s and 20 ‘X’s (Refer image) in the last four columns. So, the total range score is 38 boxes while the net strength out of these 38-boxes is 2 (20-box of X minus 18 box of O). The Trend ratio is about 5%. In the short-term charts too, there is a pattern of consolidation with a trend ratio of less than 10%.
The above concept is applicable on stocks as well to filter the universe. Chart analysis can help in filtering the candidates. Analysis tells us about the probability, while the objective patterns can help in managing the trade.
Below is a chart of Nifty v/s major asset classes. Nifty is currently outperforming all other markets.
The picture was same even during recent bearish trend in Nifty. For a strong reversal, this picture needs to change.
P&F charts are unique but lesser explored. Using its properties, we can read the hidden price patterns. It can complement any form of analysis or method of trading.
After the financial crisis of 2008, trust in equities took a setback. Gradually things improved on the ground in 2010 and equity investments picked up in India in the year 2012. Since then investors of Equity markets have been in a dream run. As seen from the table below, Nifty clocked new highs each year compared to the previous year on 7 occasions out of 8 years in the past (excluding 2020).
There have been many crucial events in this period such as NDA sweeping out UPA in 2014, Demonetization in 2016, GST regime in 2017, few banking scams and bankruptcy and last but not the least covid-19. Despite the challenges equities have been outperforming as an investment class
If we observe stock performance during these 8 years of rally, we will notice a handful of stocks that have given the best returns leading Nifty’s outperformance such as, Reliance, Bajaj twins, HDFC Twins, Auto stocks, IT stocks and some mid-cap stocks. But now a question arises: can a new investor earn 3x or 4x from current levels from stocks? Maybe, but the risk to reward ratio is not favorable.
Then where should one invest at current levels?
The answer is ” Invest in the under-dogs: PSE”
Nifty PSE (Public Sector Enterprise) index is a thematic index which several investors and analysts have ignored for the last 8 years because it has under-performed consistently.
The NIFTY PSE Index monthly chart as seen above is trading at 2599 as on 27 the November close. It has been underperforming the nifty benchmark by a huge margin since 2011. But now it’s time to be overweight on these stocks. As per November closing, it is expected to form a morning star pattern at the bottom which is a strong bullish reversal pattern. PSE has been facing a strong resistance at 2660 which is a small hurdle for a confirmation. We are anticipating an early break out since RSI has given a strong crossover over its moving average. As we can see, RSI faced resistance twice at the moving average level in early 2020 which corresponds with the resistance at the trend line on the price chart too. But a positive divergence could be noticed this month where RSI has successfully crossed over moving average at the third attempt while price has yet to cross over the resistance line. The 25 Month Moving average (Yellow line) which has been acting as a strong pivot level around which the index has been moving since 2013, has a resistance hurdle at 2950 which coincides with the trend line, making it a strong confirmation breakout.
As for the weekly time frame, we can notice that the index has been trending in an upward sloping channel, with an RSI confirmation and moving average support on price reiterating the investment call on the monthly charts.
Keeping in mind that the government of India has plans to disinvest in many PSEs we can expect a positive move in the near future. I would recommend looking into all PSE stocks which are part of the index as mentioned below.
Start investing in these stocks at current levels, as they could outperform going forward. But always remember that risk management is an important aspect of investing. We maintain a stop loss of 2150 in the index for a target of 3100.
To become a successful trader, you must ask yourself one question. What kind of trader are you? Confused? Let me explain.
There are some traders who like to anticipate where the market is going. They use studies like Hurst time cycles, Elliott waves (also may be used as patterns), Fibonacci levels, Harmonics, Bollinger bands, Gann levels etc. to enter or exit their trades early and at the best possible rate. Let us call them Anticipatory traders.
Then there are others who like to respond to patterns which have formed on the charts itself. They use studies like trendlines, price patterns, moving averages, RSI, MACD, Ichimoku etc. to enter established trends, either on breakouts or minor retracements. Let us call them Reactionary traders.
No trader or trading system is better or worse than the other. We are merely attempting to understand them by noting the characteristics of each type of trade and trader –
- Anticipatory: Likes to anticipate reversals, and enter as soon as possible
Reactionary: Likes to enter setups, only after a trend is established
2. A: Trades have small stops, lower strike rate
R: Trades have larger initial stops, better strike rate
3. A: Larger number of trades are possible in a short period of time
R: Lesser number of trades, patience is required to wait for the right setup
4. A: Almost always a trader
R: May be a trader or investor
5. A: Many lost opportunities in a trending market
R: Risk of loss through incorrect identification of trend
6. A: Analytical & monetary satisfaction, good bragging rights
R: Monetary satisfaction only, fewer bragging rights
7. A: Exciting, faster reflexes are needed, difficult to master
R: Boring, slower, easier to learn
There are some experts who are able to do both types of trades simultaneously. They are able to segregate charts into trending and non-trending, and use different indicators for each situation. This is quite difficult for the inexperienced trader.
It is much easier to stick to one type of trading system. As there are a large number of stocks available for trading, it is far simpler to look for a different stock rather than adopt multiple trading strategies.
I have found, with practical experience, that it is easier to master and implement the Reactionary system of trading rather than the Anticipatory.
In case I am unable to identify a good setup in a stock, I simply move to the next one till I am able to find a good setup in another stock. In the absence of that, I can easily move to a lower time frame to find a good setup using my familiar indicators.
Have I abandoned the use of ‘anticipatory’ tools? The answer is, No. this is because they serve a purpose in calculating approximate targets and this is important while evaluating the risk-reward ratio of any setup. In addition to that, they point to zones of supports and resistances on the chart where profitable setups may occur. However, due to a more basic use of these indicators, I do not need to master them completely.
Again, please keep in mind that there are many extraordinarily successful Anticipatory & Dual-system traders, who are masters of their craft. It is just not meant for me.
The million-rupee question is what should you do as a trader? I feel the answer is – analyse the characteristics of each trading system, and match it to your commitment to learning, your personality, emotional setup and trading goals. Then choose for yourself. Or, just try them all, and then follow whichever is most profitable.
Enough virtual ink as been spilt on what a year 2020 has been. John Oliver went so far as to literally blow up the year, in his final episode for the decade.
In this last issue of the year, it is prudent to take stock.
This has been a year of unquestionable tragedy for millions of families around the world, members of which either lost their lives, or their livelihoods. My wife Heads HR as a prominent hospitality company and spent most of the year overseeing the company’s downsizing.
At the same time, for many others, the year has been at worst an inconvenience, and at best a blessing. Market participants, and other professionals, got to experience a life without commute and spent more time with their loved ones. A couple I know had a child in April and got to spend all these months watching their baby grow. Another conceived in the beginning of the lockdown and spent their entire pregnancy in the comfort of their home.
This year of strange dichotomy also introduced us to the concept of a K-shaped recovery.
Like Rashmi mentioned in her editorial, the markets went from a 50% crash to all time highs. The market seems to have “decoupled” from the real economy. The production and consumption of real goods and services is at a significant low. What we know to be fundamentals don’t seem to make sense at all.
And yet, we continue to trade, surfing the behaviours of the markets in our own ways. Aditya beautifully described the traits of anticipatory and reactionary technical analysts. (see his chat with Ralph Acampora, CMT).
Similarly perhaps, we ought to reflect on how we have approached this year, and our lives and careers. Not so much in judgement, but as a third person observer, seeking to learn about ourselves. As we develop our skill as market technicians, we must also pay attention to our role as fellow humans, and develop empathy for those less fortunate in this year.
This year has not ended, and neither has the pandemic. We need to continue in our vigilance of both the safety of our families and ourselves, as well as the markets as they continue to behave in ways that confound us. We also have an opportunity to reach out of our cocoons to reach out to those in need around us and lend a figurative hand, from at least 6 literal feet away.
As we close this year, Technical Insights is 4 issues old. I invite you also to help us reflect on the value this magazine has brought to you, and what more we could do. Reach out to us (firstname.lastname@example.org) and share your thoughts, and suggestions. Rashmi has done a fabulous job as the first editor of the first national level newsletter of the CMT Association, but to quote a phrase that has lost its pristine innocence this year, “the best is yet to come”.
New Educational Content This Month
October 19, 2022
New Horizons on the Relative Strength Index
Presenter(s): Sofien Kaabar, CFA
October 12, 2022
Are The Streets Still Smart? Evaluating Swing Trading Strategies in Modern Markets
Presenter(s): Davide Pandini, PhD, CMT, MFTA, CSTA
September 14, 2022
Candlestick Analysis, Enhancing Portfolio Management Returns
Presenter(s): Stephen W. Bigalow