Some strategies about selling stocks

Why discuss stock selling strategies just when the Sensex is showing some signs of life after an 8 months long corrective move? Isn’t this a good time to buy and make some money?

The answer depends on what type of investor you are. If you want to play the momentum in the short-term, by all means buy and book profits after a gain of 3 or 5 points. May be even 8 or 10 points. Which isn’t bad at all – if you are trading thousands of shares. Such a strategy can be followed at any time.

But many small investors don’t have big money at their disposal. They can buy 200 or 500 shares at a time (I’m not talking about penny stocks here). A 5 or 10 point gain is neither here nor there – compared to the risks involved. May be this isn’t such a great time to buy after all – since the index is just about 10% below its all-time high.

Instead of having an ad-hoc hit-and-miss strategy, have a plan. For buying, holding and selling. The ‘Margin of Safety’ concept works well for buying. P/E bands work well too – for buying, holding and selling. I prefer to use an asset allocation plan for timing buy-sell-hold decisions.

Today, I want to discuss a few selling strategies. Before you buy any stock, decide on a selling plan – based on your risk tolerance, time horizon and individual preference. As a long-term investor, I prefer to have a three years time horizon for any stock to perform. You can just as well choose a one year or two years time frame. Anything less than a year, and you will be treading the fine line between an investor and a speculator.

Once you decide on a time frame, pick a realistic price point. 100% gain in 1 year may happen once or twice, but is not a realistic goal. But a 50% gain in two years, or a 100% gain in three years may be more achievable. When the price target is reached, it is best to sell out entirely. But if you feel that more upside is left, book partial profits, and hold on to the rest with a trailing stop-loss. If the price target is not reached, don’t hold on with the hope that it will be reached ‘some day’. Just sell.

If by partial profit booking you have withdrawn your original investment, don’t ever think that the balance holding is ‘free’. It isn’t. It has an opportunity cost. If the market dives and your balance holdings drop by 50%, you have lost real money. A trailing stop-loss will save you from such a calamity.

Supposing you have a two years time frame with a 50% appreciation target. After six months, the stock suddenly starts to flare up and gains 50%. What should you do? Wait for your two years time frame, or sell now? Sudden flare-ups in stock prices occur for different reasons - insider buying, some company-specific news that you may not have heard yet, a fundamental change in the sector, a merger or acquisition.

Why bother with reasons? If your target is reached, sell – even if it means paying short-term capital gains tax. After all, tax is paid from profits – so you are still ahead.

So far, I have discussed selling strategies when your stock is in profit. What if you buy a stock and it keeps falling down? Have a strict selling strategy – a 3% or a 8% or a 15% stop-loss, depending on the type of stock and the planned period of holding. Have the discipline to sell as soon as the stop-loss is hit on a closing basis.

Learn to be unemotional and unexcited about your buy-sell-hold decisions. Treat them like any monetary transaction – like buying a cup of coffee or getting a hair-cut.

Related Posts

What exactly is the Margin of Safety?

How to reallocate your assets

NSE Nifty 50 – a quick mid-week update

Some readers have written to me over the past couple of days, asking whether the worst is over for the Nifty and is it a time to buy. It is better to have a long-term view, and not be too bothered every time the index rises or drops by a couple of percentage points.

The ‘buy low – sell high’ theory is not just that. It works practically as well. How does one know when the index is low enough to buy and high enough to sell? Just look at historical P/E values of the Nifty, and check the range within which it trades most often. You will get the answer.

However, since the question has been raised by a few, there may be others who are thinking along the same lines. So, here is a quick update of the 1 year Nifty bar chart pattern:

 

Note the following points, and their implications:

1. Volumes have been strong during the past 5 days rally – bullish

2. The Nifty has crossed above the 200 day EMA after 2 months – bullish

3. The index touched a marginally higher top for this month – bullish

4. The ROC and the RSI reached lower tops while the Nifty reached a slightly higher top – bearish (negative divergences)

5. Last, but definitely not the least: the blue downtrend line has not been crossed yet – bearish

As long as the downtrend line is not breached, the 8 months long corrective phase remains in place. This up move gives an excellent opportunity to book partial profits.

Tipster SR

So I made a system a while back for MT4, based on support and resistance.  I backtested it and studied it to learn the strenghts and weakness.  I've been demo testing it for about 4 months with good results, its not the grail but it trades without causing platform errors and long term produces some gains. 

On MTI Live, it was running on Anotherbriandemo, you can see it in the comments of the published statement on the MTI site.  It's now running on my real account.  I've adjusted the published statement start date of the Anotherbrian MTI Live account to be the same time I started using it.  I also use two other trading strategies on this account.  ForexMorningTrade and dicretionary trading based on Sam Seiden. 

FMT - I use this as more of a scalper with small lot size - this is like a real account test - I didnt back test it.  I watch it the day it trades to see if I should close it or not. 

Sam Seiden - I usually use a 1 or 4 hour chart for this.  This strategy requires patience.  In order to help me with that, I found having a robot running kills most of the urge to trade, so I can wait as long as it takes.

So, time will tell.

See the right side bar for performance or visit these links
Demo MTI Account
Live MTI Account

For the longest time I've been breakeven or losing slowly.  For the past severla months I've been working on EA's and watching them, and trading myself.  I think I found what works for me, as overtrading is a problem.  Let's see what happens!!  Join the MTI competition for some fun.... it's outlined in the post below.

UPDATE (July3, 2011):  The MTI Live website doesn't seem to show things as they really are unless you include ALL history.  I haven't figure it out yet (how to correctly show stats from a certain day forward).
The Tipster SR EA is LIVE.  It's one of the 3 EA's running on my live account.

Notes from the USA (Jun 2011) – a guest post

One of the best ways to find out about the true state of financial health of a company is to scrutinise its cash flow statement. The Profit and Loss statement is based on the accrual system of accounting. The cash flow statement records the actual inflows and outflows of cash, which provides a better idea about the sustainability of a company’s business model.

What about an investor’s cash flow statement? Are you keeping track of exactly how much cash inflow is being generated by your cash outflows (i.e. investments)? Specially in a sideways or sliding stock market? In this month’s guest post, KKP shares some of his thoughts on the subject.

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Lets Get Down to Cash Flow Analysis

Q1 and Q2 2011 have shown that there might be a good size recovery, giving a feeling of hope to many people in the US, as well as corporations. The economy has slowly been recovering – no doubt. But the housing and construction market rebound has remained soft despite the big QE (quantitative easing) programs from the Fed and the low-low-mortgage rates (average 30-year fixed U.S. mortgage rate is around 4.82%). The reason is simple: Stubbornly high unemployment and underemployment, and also tight lending policies from the bankers/lenders. Bankers have swung the pendulum to the other end of the spectrum and have very stringent policies. In 2002-2008, lenders would lend money to people without any money down (by doing double mortgages), and today, even if someone is providing 25% down payment (upfront cash), they are scrutinized as if they are one of the worst borrowers.

Predictions show that home prices will fall around the 5% to 10% in 2011 compared to 2010, and they will remain flat in 2012. This median forecast was part of a poll by Reuters of 21 economists who provided price forecasts. In looking at really long term trends of US home prices, it clearly shows that home prices are close to the bottom and will hover around here for a bit, and with a ‘core-recovery’ we will see a bounce up in prices (albeit very slowly).

"It is hard to see the housing market doing better until the massive headwind of foreclosures is removed and that will likely take a couple of years," said Mark Vitner, senior economist at Well Fargo Securities in Charlotte, North Carolina. With home prices still falling, many potential buyers are sidelined and banks are more stringent with loan applications and credit scores, Wells Fargo's Vitner said. "It is not that I am pessimistic about the housing market, it is just that I am not optimistic and a gradual recovery probably will not happen until 2013 or 2014, with a full normalization not until 2015," he said.

I have noticed that there is a rise in the "distressed, foreclosed and short sale" homes due to the fact that the lower home prices have put mortgage balances (what you owe on the home) above the current price of the home. Therefore, the home either goes into a short sale (seller and lender put it on the market), or foreclosure (owner cannot or will not pay mortgage), or distress situation (seller does not pay mortgage, and lender cannot afford to keep the home on the books). The net result is that the price of the home has to be marked down significantly, for investors or home-upgraders or renters are willing to look at the properties.

I am currently sprucing up a home that I purchased as a ‘distressed home’, and will be renting it out before July 1^st, 2011. In addition, have offers out on Short Sales where the Seller and Lender are considering my offers for Downtown Condos (at 1/3^rd to 1/4^th the last sale price). Even with the above flat market situation predicted, I remind myself that I am buying real estate at the “equivalent of March 2009 Sensex prices”. Remember how undervalued we were in the stock market at that time, before we took off? Real estate will NOT take off in the same manner (of course), but my tarot-charts (figuratively speaking) is telling me that I am buying it close to the bottom and have no desire to price these out for sale since I will be renting them out in the near term (2 to 5 years).

In addition, I am buying these at really ‘distress’ prices, instead of chasing them, and have the ‘patience and privilege of dividends’ while I hold. Dividends are in the form of rent here so it is easy to convince myself to hold. So, equate it to holding a stock that may not move up immediately, but will pay you almost risk free 12% to 26% in return with minimum loss of capital (if so).

Bottom line is that a lot of books have been written about ‘cash flow’ production, and with this methodology, I have found how much of a parallel it holds to Selling Calls on individual stocks being held in a portfolio. Call Selling had been a very favourite methodology of mine when I was very active in the markets in the 1990’s, and most recently as a way of reducing my stock holdings. But, in both cases, it taught me how to ‘generate cash flow’ from the holdings, and ‘make a paycheck’ out of it.

Real estate has the power to make the same with almost the same amount of time involvement. Wow. Really? Yes, very true. In India, it is even better since you can literally buy a flat/condo and rent it out, making all responsibilities of maintaining the flat a responsibility of the tenant (minus big issues). I am able to replicate the same with a team of contractors to simplify my life and do virtual-maintenance (call someone to go and fix it at low cost).

For now, think cash flow, and figure out a way to generate a paycheck or cash flow from your investment holdings. If you hold RIL or HUL for a long time, the percentage yield to your purchase price could be significant enough to get a very net high yield, especially if the stock has provided splits/bonuses. With my net-buy-price of HUL under Re 1.00, the percentage yield on the annual dividend seems like a paycheck each time it comes. So, there are many ways to skin the cat, and as one gets more experienced, some of these techniques become part of the portfolio and life, and yet, it is each portion of the portfolio that needs to replicate the ‘cash flow’ generation methodology. Traders might be good at generating cash flow from ‘trading’, but very few can do it consistently, and hence doing it with many techniques/strategies will be good for your long term financial health.

Hope you can ‘draw’ some ideas from this to your thinking and add a twist to your investments that might change the overall short and long term return, such that it gives back some cash flow which can help with your own personal goals (buying gold or silver)…..Oh, that brings me to another favorite topic of mine (gold), but we will leave that for the future….

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KKP (Kiran Patel) is a long time investor in the US, investing in US, Indian and Chinese markets for the last 25 years. Investing is a passion, and most recently he has ventured into real estate in the US and also a bit in India. Running user groups, teaching kids at local high school, moderating a group in the US and running Investment Clubs are his current hobbies. He also works full time for a Fortune 100 corporation.

Stock Index Chart Patterns – S&P 500 and FTSE 100 – Jun 24, ‘11

S&P 500 Index Chart

The S&P 500 index chart spent another week of gyrations without making much headway. It rose a bit higher only to face resistance from the 1300 level, and closed marginally lower. Bulls may feel relieved that the index closed the entire week above the 200 day EMA.

Bears will point out that a higher high and a lower close means it was a bearish ‘reversal week’. The index has spent 18 straight trading sessions below the falling 50 day EMA. The down trend that began from the May 2 ‘11 top of 1371 remains firmly in place. The bearish pattern of lower tops and lower bottoms continues.

The technical indicators are weakening after showing some signs of life. The MACD is negative and about to cross below the signal line. The slow stochastic rose sharply to the 60% level, but the %K line has dropped below the %D line and the 50% level. The RSI is moving sideways, and is also below the 50% level. The bears are getting ready to take control.

There isn’t much good news on the economic front. The GDP growth has been downgraded to 2.7% from the earlier estimate of 2.9%. Unemployment claims increased by 9000 to 429000 – the 11th straight week above the 400000 mark. Sales of new and existing homes dipped in May ‘11. Oil prices have fallen – but that isn’t necessarily good news for the stock market.

FTSE 100 Index Chart

The FTSE 100 made a futile effort at an up move that was quickly stalled by the bears. The long-term moving average has now turned down and the ‘death cross’ of the rapidly sliding 50 day EMA below the 200 day EMA appears imminent. The index spent the second week in a row below the long-term moving average.

The technical indicators are bearish and not holding out much cheer for the bulls. The MACD is below its signal line, and both are falling in negative territory. The slow stochastic and RSI are both below their 50% levels. A test of the Mar ‘11 low of 5592 is on the cards.

Greece’s bailout is like using chewing gum to plug holes in a leaking boat – postponing the inevitable. The severe repercussions to European and UK banking systems have not been fully revealed yet.

Bottomline? The chart patterns of S&P 500 and FTSE 100 indices may face deeper corrections. If you are still invested, keep strict stop-losses at 1260 for the S&P 500 and 5650 for the FTSE 100. Things may get worse before they can get better.

BSE Sensex and NSE Nifty 50 Index Chart Patterns – Jun 24, ‘11

In last week’s analysis of the BSE Sensex and Nifty 50 index chart patterns, my concluding observations were:

‘The BSE Sensex and NSE Nifty 50 chart patterns are poised near important support levels. Things aren't looking good for the bulls. Both indices can lose another 2-3% from current levels easily.’

Both indices dropped by 3% to test their Feb ‘11 lows. Some times technical analysis works like magic. The charts almost ‘talk’ to you. Wish they did that more often – or may be they do so all the time, but my listening faculty is not always fine-tuned.

BSE Sensex Index Chart

The Sensex bounced up after dropping to an intra-day low of 17314 on Mon. June 20 ‘11. After consolidating sideways for the next three days, the index jumped up on Fri. Jun 24 ‘11 on a combination of strong FII buying and short covering. The falling 20 day EMA was breached, but the 50 day EMA provided resistance.

Is the worst over for the bulls? Not yet. Even if the 50 day EMA is breached next week, the 200 day EMA may prove to be a tougher hurdle. The strongest resistance is likely to be provided by the blue downtrend line that has been ruling the Sensex since the Nov ‘10 top.

The technical indicators have turned positive from being very bearish. But they haven’t quite turned bullish. The MACD has turned up, but remains below its signal line in negative territory. The ROC has crossed above its 10 day MA, and just about touching the ‘0’ line. The RSI has turned around quickly from its oversold zone, but is below the 50% level. Likewise for the slow stochastic. A deeper correction below the 17300 level has been averted – for the time being.

Nifty 50 Index Chart

A new lower support level for the Nifty has been drawn at the Feb ‘11 low of 5178, since the earlier support level of 5345 was breached again (though the Nifty whipsawed back within the 3% leeway). Chart patterns are not static. As new patterns develop, the supports and resistance levels need to be adjusted – even though an earlier support level wasn’t technically broken.

This may appear confusing to inexperienced observers, but is a common practice with more experienced analysts. By the way, the new support level was not redrawn on the basis of one previous support point in Feb ‘11. The level of 5178 had earlier acted as strong resistance during Oct ‘09 and during most of Dec ‘09.

Before bulls get too excited about rising volumes on the last two days of the week, it should be pointed out that the highest volumes occurred on Monday’s down day. The other point in favour of the bears is the large descending triangle pattern being formed by the blue down trend line and the 5178 level. The likely break is below the 5178 level.

With food inflation refusing to go down, another 25 bps interest rate hike is likely in July. The monsoon is expected to be slightly below normal. Though exports have grown, the slow turnaround of the economies in Europe and USA are causing concern. Q1 results next month may be below par.

Bottomline? The BSE Sensex and NSE Nifty 50 chart patterns have averted deeper corrections by bouncing up from long-term support levels. But it is a time to be cautious. Both indices are technically in bear markets – which means the sensible thing to do will be to sell on rises. If you want to be a contrarian, pick your stocks very carefully.

About astrology and technical analysis

Many consider astrology and technical analysis at par. Both have very little scientific basis and seem to go wrong in their predictions almost as often as they go right. Therefore, both should be consigned to the nearest dustbin as far as life and investments are concerned.

While there is a degree of truth in the premise, I have reservations about the conclusion. I have never been a great believer in astrology for two reasons. The idea of being able to know something even before it occurs by charting planetary movements seems too preposterous.

This disbelief was dented when I read the detailed description of the ‘Pashupat Astra’ in an unabridged version of the ‘Mahabharata’. Quite clearly, it was the description of an atom bomb. There could not have been an atom bomb in the days of yore when the ‘Mahabharata’ was written. The logical conclusion is that the ‘rishi’s could foresee the future with their yogic powers.

The second reason is harder to refute. Several years ago, I was having a chat with the Director of the Positional Astronomy Centre in Calcutta when a businessman walked in. After he left, the Director mentioned that the gentleman was a wealthy publisher of one of the most popular local almanacs.

Apparently, he visits the Director’s office once a year before the almanac’s publication and pays good money for the calculations of the exact times of various eclipses. “Their charts are all outdated. They write whatever they want about all the other dates and times. But if they goof up about eclipses, which are clearly visible in the sky, they will lose all credibility and their business!”

But I’m not a complete disbeliever either. An ex-boss was a good amateur astrologer. Once, an acquaintance was looking for prospective brides for his son who was studying abroad. He had brought along the respective horoscopes to find a suitable match.

My boss took a good look at the son’s horoscope and expressed surprise that the son had agreed to an arranged marriage, because he was having a torrid affair with a dark-skinned girl. The gentleman almost broke down in tears and admitted that he had recently come to know of the affair and was trying to get his son married off.

Later, I asked my boss how he could find out such intimate details from a horoscope. He said it was because of his long experience of studying and matching hundreds of horoscopes. He immediately noticed something very wrong – the affair with the dark-skinned girl was an educated guess.

Technical analysis works in a similar fashion – when it does work. Two analysts can look at the same stock chart and come to completely opposite conclusions – because one is a bull and the other is a bear. Their chart interpretations tend to get clouded by their biases.

The more experienced and unbiased an analyst, the greater are the chances that his observations might turn out to be the correct ones. In last Saturday’s post about the Sensex and Nifty chart patterns, I had written: “Both indices can lose another 2-3% from current levels easily.”

As it so happened, both the Sensex and the Nifty dropped 3% on Mon. Jun 20 ‘11. How did I know beforehand? I didn’t. It was an educated guess based on the expectation that the indices looked weak enough to test their Feb ‘11 lows.

How to choose stocks for trading

Regular readers of this blog need not feel let down by the subject of today’s post. I am a firm proponent of generating wealth through long-term investment by carefully choosing stocks, using both fundamental and technical analysis.

Though I occasionally indulge in longer-term trading in cyclical and FMCG stocks, intra-day or short-term trading remains a strict no-no. The odds for success are too low and the scales are heavily tipped towards the professional traders.

So, why write a post about how to choose stocks for trading? Last week, I had written a post explaining why good investment stocks may not be good trading stocks – and vice versa. The chart patterns of Titan and Reliance were used for comparison. The concluding statement in the post was: “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.”

I have already written a series of three posts on how to pick stocks for investment. If you haven’t read those posts, I would strongly recommend that you do so. But because of my antipathy towards trading, I had refrained from writing about choosing stocks for trading.

Why then the sudden change of heart? Let me explain. I have been working on this theory about suicides: If any one is hell-bent on committing it, it should be my duty to guide that person towards the least painful method.

If some one is planning to commit financial suicide (which I reckon a few readers may already have attempted), then it is also my duty to guide them towards the process that may be less painful.

Enough preamble. Now let us get down to brass tacks. Though any stock can be chosen for trading – regardless of its fundamentals – it helps to have a plan and some background knowledge.

High value stalwart stocks typically do not fall too much during down trends, neither do they rise much during up trends. That makes them good picks for stability in one’s long-term portfolio. Not so great for trading.

Penny stocks (i.e. those trading below Rs 10) tend to be irregularly and thinly traded most of the time. Only a few hundred shares being bought and sold can change the stock’s price by a significant amount. While that may appear attractive for trading, being able to buy or sell any decent quantity when you want to can pose a problem.

Mid-priced stocks – say those trading between Rs 30 – 80 – may be the best bets for trading success. Of course, such stocks should trade regularly and with decent volumes. Make a list of such stocks, and start studying their chart patterns. Short-list the ones that are most volatile (i.e. the ones that give big swings from high to low in short periods of time).

Even after going through the above exercise, you may have a short-list that is not so short. Checking the charts of more than 20 or 25 stocks on a regular basis can be a daunting task unless you are doing it full-time. Use the ‘Circle of Competence’ concept to drill down to about 20 stocks, and then spend a period of ‘paper trading’ to fine tune your short-list.

Drop the ones where your paper trades turn sour. Add a few more from the original short-list till you are comfortable with the final choice of the stocks you would like to trade.

Happy trading! (Don’t blame me if you get killed – you are the one attempting to commit financial suicide.)

Stock Chart Pattern - Container Corporation of India (an update)

My previous post about the stock chart pattern of Container Corporation is almost two years old. The stock was consolidating within a symmetrical triangle after a strong rally that touched a peak of 1149 in July ‘09.

I had expected a correction down to the 50 day EMA or 200 day EMA because the stock was trading well above the 50 day EMA, and the gap between the 50 day EMA and 200 day EMA had become large (which precedes a correction or reversal). The technical indicators were also looking weak.

A trend reversal was ruled out because a symmetrical triangle is usually a continuation pattern. The logical break out was upwards, and a test of the all-time high of 1222 (reached in June ‘07) was on the cards before the correction. Let us take a look at the two years closing chart pattern of Container Corporation and observe what transpired over the past two years:

Several interesting patterns have formed on the chart, and I will take them up one by one. The expected upward break out from the triangle pattern took the stock’s price to 1235 on Aug 24 ‘09, just above the all-time high of 1222, before a correction ensued – or rather a consolidation within a flag (which is also a continuation pattern).

Note that the first down leg of consolidation within the flag was supported by the 50 day EMA in Sep ‘09. The upward bounce found resistance at 1222 in Oct ‘09. The next down leg pierced the 50 day EMA but stopped well short of the 200 day EMA.

The upward break out from the flag was not accompanied by a volume surge. No wonder the stock price consolidated sideways between 1222 – 1235 during the better part of Dec ‘09 before a high volume surge propelled the stock to a new high of 1321 in Jan ‘10.

The subsequent correction dropped below 1222, but found support twice on the line projected from the upper boundary of the flag pattern. Another volume surge in Mar ‘10 pushed the stock to a new all-time intra-day high of 1500 on Apr 22 ‘10. It turned out to be a ‘reversal day’ (higher high, lower close) – warning of a reversal of the up trend.

The first leg of correction found support from the rising 200 day EMA in May ‘10 and then again from the 1222 level, before rising to 1429 in Jul ‘10 – forming a bearish double-top pattern and confirming the trend reversal.

The stock has been on a down trend since then, preceding the correction in the broader markets. Except for a brief rally from Feb ‘11 to Apr ‘11, the downward slide has been unabated. Note that the bottoms in Feb ‘11 and May ‘11 occurred on the projected line from the top boundary of the flag formation!

The stock price has made a bearish ‘rounding-top’ pattern, which is clearly visible in the 200 day EMA. All four technical indicators are bearish, so the 15 months correction hasn’t ended yet. There is long-term support at 1010, and below that, stronger support is at 900.

The zero-debt company is fundamentally strong – practically a monopoly business that generates a ton of cash from operations, and pays regular dividends (twice a year since 2005). For the past few quarters, growth has been tepid and profits have been flat. That doesn’t really justify the 32.7% correction from the Apr ‘10 intra-day high of 1500 to the May ‘11 intra-day low of 1010.

Bottomline? The stock chart pattern of Container Corporation has undergone a significant correction. While another 10% correction can not be ruled out from current level, small investors would do well to start accumulating slowly instead of chasing after ‘cheap’ stocks.

Was it a panic bottom or a capitulation?

Within a matter of a few minutes after opening of trade, the Sensex fell sharply by more than 500 points on Mon. Jun 20 ‘11. The Nifty dropped nearly 200 points. What happened?

Apparently, the selling was triggered off by the news that the Indian government was planning to review the double tax avoidance treaty with Mauritius. The treaty stipulates that taxes on capital gains incurred in India on sale of stocks by Mauritius entities will be payable only in Mauritius (which does not levy any capital gains tax).

It is unlikely that Mauritius will agree, since the tourism paradise has little industry of its own. They attract investors with the lure of their liberal tax regime. Many companies have set up shop in the island nation primarily to invest in the Indian stock markets.

40% of the so-called FII inflows into the Indian markets come from Mauritius. It is an open secret that much of this money is ‘round-tripping’. In other words, black money is sent to Mauritius through ‘hawala’ channels from India. That money comes back into India under the garb of FII inflow, and black money turns into tax-free white money.

It is laudable that the Indian government is trying to plug a loophole through which crores of capital gains tax are slipping through. But it is unlikely to happen any time soon – if at all. Then why the panic?

It was just a ‘negative’ news that seemed to get discounted in haste. Such sharp falls are typical in bear markets. The market has been in a down trend for seven months, without falling even 20% from its Nov ‘10 top (which is one of the definitions of a bear market). Bears tried to force the issue in their favour by using the treaty review news as an excuse to start selling.

Stop-losses got triggered as the indices dropped through known support levels, and added to the panic. Two thing happen in such situations. Weak holders tend to capitulate. Bottom-fishers start buying and lend some stability to the market.

So, was it a capitulation or a panic bottom? We won’t really know till Mr Market tells us in which direction it wants to go. A capitulation usually happens near the end of a bear phase, when investors get weary of waiting for things to improve, and start selling off at any price. It tends to be a slow, grinding down process followed by the start of a new bull phase.

A panic bottom, on the other hand, sets up a temporary bottom before the next down move, because panic bottoms seldom hold. This is another one of those ‘technical rules’ which don’t always work. The interesting point to note is that the Feb ‘11 lows of the Sensex and Nifty were tested but not broken. That keeps the door open for a double-bottom reversal. Possible, but seems unlikely at this stage.

What should small investors do? Maintain a strict stop-loss at the level of the Feb ‘11 lows. If those lows are taken out, another 10-15% correction from current levels will not be surprising.

Stock Index Chart Patterns – S&P 500 and FTSE 100 – Jun 17, ‘11

S&P 500 Index Chart 

Last week, I had speculated whether the S&P 500 chart will be able to bounce up from its 200 day EMA or not. The index dropped below the 200 day EMA on Wednesday and Thursday (Jun 15, 16 '11), but managed to close above the long-term moving average on both days. By Friday, the S&P 500 chart bounced up a bit to close absolutely flat on a weekly basis.

The good news is that the index halted its six weeks long downward slide. The bad news is that the halt may be temporary. As the Grateful Dead sang many years ago, there is 'trouble ahead, trouble behind, and you know that notion just crossed my mind'.

The technical indicators are bearish. The MACD has stopped falling, but remains negative and below its falling signal line. The slow stochastic's feeble effort to emerge from its oversold zone failed miserably. The RSI's up move stalled at the 40% level and it is heading down towards its oversold zone. Looks like the correction isn't over yet.

Economic indicators weren't great either. The index of small business optimism declined for the third month in a row. The Conference Board's Leading Economic Index rose by less than 1% after declining in April '11. The Weekly Leading Index growth indicator of the Economic Cycle Research Institute declined for the eighth straight week. The University of Michigan Consumer Sentiment Index was down to 71.8 from 74.3 in May '11.

FTSE 100 Index Chart 

The bears are beginning to take control of the FTSE 100 index chart. The Mar '11 low of 5592 was not tested, but the index closed the entire week below the 200 day EMA. In the process, the lower Bollinger Band was pierced. An up move may follow.

The technical indicators are bearish. The MACD is below its signal line and sliding deeper into negative territory. The slow stochastic is well inside its oversold zone. The RSI is falling towards its oversold zone. The FTSE 100 chart has formed a bearish rounding-top pattern - pointing to a deeper correction.

The UK economy remains in the doldrums, as GDP growth has remained flat in the past six months. Unemployment has decreased but consumer sentiment remains low. Retail sales declined by 1.4%. Greece's bailout is casting a pall of gloom over European indices, and the FTSE 100 is suffering from its ill effects.

Bottomline? The chart patterns of S&P 500 and FTSE 100 indices show that this is likely to be a summer of discontent. Sit back and let the corrections play out. Lower entry points are likely to be available in the not-too-distant future.