Stock Chart Pattern - Sanghvi Movers (An Update)

In the previous update of the stock chart pattern of Sanghvi Movers back in Jan '11, the stock had broken down below a bearish descending triangle pattern. Descending (and ascending) triangles have measuring implications. The downward target was calculated as 116. Stock prices don't really understand or follow arithmetic. Actual targets are never exactly met. Prices typically overshoot upward targets and fall short of downward targets.

So, what happened? The two years bar chart pattern of Sanghvi Movers is an example of how a fundamentally strong stock with a good business model can suffer when sentiments turn negative towards the sector in which the company operates:

The stock fell to a high volume 'panic bottom' of 114 in Feb '11, meeting the downward target of 116 almost exactly. It bounced up sharply - only to face resistance from the falling 50 day EMA and then dropped past its 'panic bottom' of 114 to a low of 104 in Mar '11. 'Panic bottoms' seldom hold and this is another example of it. But that doesn't prevent intrepid investors from trying to bottom-fish - and get stuck at higher levels.

Note that both the RSI and the slow stochastic were deep inside their oversold zones when the stock price dropped to 104. A correction to the earlier down move usually follows. The ROC touched a higher bottom and hinted at a possible correction or consolidation. Over the next 8 months, the stock price consolidated within a bearish 'rising wedge' pattern - oscillating around its entangled 20 day and 50 day EMAs. Throughout the consolidation period within the 'rising wedge' pattern, the 200 day EMA continued to fall - leaving no doubt that the bears were in control.

After breaking downwards below the 'rising wedge' on Nov 14 '11, the stock price attempted a pullback to the wedge. Such pullbacks after a downward break happen often, and provide a selling opportunity. The stock continued to fall on high volumes and dropped to a low of 84.50 on Jan 2 '12. It has since been trading within a small symmetrical triangle, and may seek even lower levels.

The technical indicators are bearish, but showing faint signs of improvement. The MACD is above its signal line, but in negative territory. The ROC is below its 10 day MA, and trying to climb out of the negative zone. The RSI dropped below its 50% level, but trying to rise. The slow stochastic fell inside its oversold zone, and is trying to come out.

The infrastructure sector has turned from being a darling of investors to a villain. Stocks of almost all companies with any links to the sector are getting hammered - regardless of their underlying fundamentals. The stock of Sanghvi Movers has been no exception. Debt/equity ratio is more than 1, but for a capital intensive company, that shouldn't be a major issue. Cash flows remain positive. Margins are definitely under pressure - but that is a common feature with stocks from almost all sectors. But the market knows best. No point in betting against it.

Bottomline? The stock chart pattern of Sanghvi Movers is facing technical headwinds though fundamentals appear to be reasonable. As and when the infrastructure sector starts picking up, the company will again start making a lot of money. But that seems a couple of quarters away. Watch Q3 and Q4 results before considering an entry.

5 strategies to follow in a bear market

Most small investors enter the stock market when a bull market is nearing its peak. They don’t have clear goals and strategies, and get caught on the wrong foot by the bear market that inevitably follows. The trauma of losing money in a hurry can be soul-destroying.

Without the necessary skills and experience of surviving in a bear market, investors resort to all kinds of ill-advised strategies in an effort to quickly recover the losses. That only makes a bad situation worse.

The current bear phases in the Sensex and Nifty indices are 14 months old, and so far there has been very little indication of a reversal in the down trends. Experts are saying that the bear phase can last till the first half of Financial Year 2012-13. If they are right, the bear market may sustain till Sep 2012 – another 9 months!

Whether you are one of the unfortunates who are ‘stuck’ at higher levels, or a more seasoned investor who is sitting on cash to deploy at lower levels, here are 5 strategies that you may want to follow in the current bear market:-

1. Remember that bear market rallies are sharp and swift. Don’t jump in by thinking that you will miss a buying opportunity at a low entry price. Such rallies are some times ‘created’ by bears so that they can sell at a higher price.

2. Just because a stock has fallen to a 52 week low doesn’t mean it can’t fall any lower. As long as the trend is down, it can fall lower. If it is worth buying, being patient can help you to enter at a much lower price.

3. A sharp vertical drop in price – often accompanied by strong volumes - usually attracts a lot of buyers who believe that they are being smart by entering at a low price. It is the sign of a ‘panic bottom’, which seldom holds. Prices bounce up on the buying, but then fall lower than the ‘panic bottom’.

4. At the risk of sounding like a broken record (or, a damaged CD) – do not, repeat do not, average down in price. No one knows how much further a stock’s price will fall, or worse still, if it will ever recover (e.g. Cranes Software). It is far better to average up once the price forms a bottom and starts its up move.

5. Major down trends are not reversed in a day or a week. Bottom reversal patterns take a few weeks to a few months to form. Ability to ‘read’ chart patterns can help investors to accumulate a stock while a reversal pattern is ongoing (refer Chapter 7: Reversal Patterns of my free eBook: Technical Analysis – an Introduction).

If you can’t ‘read’ a reversal pattern, don’t worry. Eventually, prices will turn up and a new bull market will begin. You may enter at a higher price, but the chances of a loss can be minimised by using a trailing stop-loss.

Related Posts

Five things you should avoid in a bear market

Five more things to avoid in a Bear Market

To make money in the stock market, avoid these three buying mistakes

Stock markets have trading days or holidays. Using stock market jargon, trading days can be either ‘bullish’ or ‘bearish’. But if you follow the so-called experts on business channels or the pink papers, stock markets have ‘good’ days or ‘bad’ days. On ‘good’ days, the Sensex gains. On ‘bad’ days, the Nifty falls.

What happens when both the Nifty and the Sensex drop by 4% – like they did today? It is a ‘terrible’ day! For whom? Obviously for the brokers and the business channels, because their business thrives on ‘good’ days. When the market moves up, more viewers tune in, and more investors place ‘buy’ orders. For investors, who were lucky or prudent to sell at higher levels, ‘panic’ days offer a great opportunity to cover back the stocks sold earlier.

So, are ‘panic’ days great opportunities to buy? The short answer is: No. In an earlier post, ‘How to tackle a ‘panic bottom’, I had explained that panic bottoms seldom hold. Technically, today’s heavy FII selling didn’t create a bottom in the Sensex or the Nifty. But it is a sign that the lower level of the last six weeks’ trading range may get tested, and possibly broken.

If you ever watch a tennis match between a top 10 player and a player ranked much lower, you will notice that there may not be much difference in their respective skill levels. The big difference lies in their ‘unforced errors’ stats. The better player makes fewer ‘unforced errors’.

In stock market investments, there are three such ‘unforced errors’ that you must learn to eliminate to enjoy greater success. These are common buying mistakes that many investors make:-

1. Buying near a top
2. Buying during a down trend
3. Buying before a bottom is formed

The buying mistakes in 1 and 3 are caused mainly due to inexperience with technical analysis. In the majority of bull and bear markets, a top or a bottom just do not happen out of the blue. There is a process, usually accompanied by a clearly identifiable reversal pattern, through which a top or a bottom gets formed. Such reversal patterns may take a few weeks, or a few months to form.

In both the Sensex and the Nifty, the Nov ‘10 peaks were part of ‘diamond’ reversal patterns, which transformed into large ‘descending triangle’ reversal patterns. So, we actually had two reversal patterns to indicate a change of trend from bull to bear.

The 2008 bear market ended with a 5 months long rectangular reversal pattern. It is expected that the current bear market will also form an identifiable pattern before the next bull phase can start. No such pattern is visible yet.

It is easier to identify reversal patterns after the pattern is fully formed. But there are prior signals given by various technical indicators that help to ascertain whether a reversal pattern is in progress. It is better to err on the side of caution when stock markets are rising or falling fast.

Buying during a down trend is acceptable only if you are covering up an earlier sale at a higher price. Not otherwise. Unlike tops and bottoms, which are tougher to identify, a simple trend line or the 200 day EMA can show whether a stock or an index is in a down trend. The biggest mistake you can make is to think that ‘it can’t fall any lower’. Learn to be patient and stay away during down trends. Buy only after an up trend is re-established.

Stock Index Chart Patterns – Hang Seng, Singapore Straits Times, Malaysia KLCI – Aug 19 ‘11

Two weeks back, downward gaps occurred in the Hang Seng, Straits Times and KLCI chart patterns. Since the gaps were below support levels and accompanied by strong volumes, they were ‘breakaway’ gaps – signalling deeper corrections. I had suggested that investors should not try to be brave, and should sit out the corrections. Fortunately, the suggestion turned out to be judicious and timely.

Hang Seng Index Chart

The Hang Seng index chart dropped sharply on rising volumes to an intra-day low of 18868 on Aug 9 ‘11. Such sharp falls are usually followed by upward bounces, which are used by the bears to sell. The index couldn’t even reach its rapidly falling 20 day EMA, before heading downwards. Note that volumes reduced during the few days of rally, indicating that the rally would be short-lived. Today’s gap-down day on higher volumes has put paid to any lingering hopes of recovery by the bulls.

The technical indicators are bearish. The ROC crossing above its 10 day MA is a slight positive. The low of 18868 was a ‘panic bottom’, which means it is unlikely to hold. If you are still holding on, brace yourself for another 1000 point fall.

Singapore Straits Times Index Chart

The Singapore Straits Times index chart has two gaps – as if one wasn’t bad enough! The sharp fall on high volumes was followed by a ‘dead cat bounce’, which failed to prevent the ‘death cross’ of the 50 day EMA below the 200 day EMA. Today’s gap-down day on a volume spike means that the bears are taking complete control.

All four technical indicators are bearish, to the point of being oversold. That doesn’t mean that they can’t remain oversold for a while. The index has entered a strong support zone between 2700 and 2740. If it drops below 2700, the next support level is at 2430.

Malaysia KLCI Index Chart

The Malaysia KLCI index has exhibited a classic break down and pullback pattern. The drop below the support of the 200 day EMA was accompanied by a sharp rise in volumes, which means that the support would turn into a strong resistance. And so it did, when the index bounced up from its ‘panic bottom’ of 1423 (touched on Aug 9 ‘11).

The upward bounce led to the ROC crossing above its 10 day MA and the slow stochastic climbing above its 50% level. But the MACD failed to cross above its signal line and the RSI has slipped back into its oversold zone. The 50 day EMA is still 23 points or so above the 200 day EMA, but the ‘death cross’ appears inevitable. Time to head for the exit door.

Bottomline? The chart patterns of Asian indices bounced up from ‘panic bottoms’, but the worst isn’t over. Sentiments have taken a huge hit, and the FIIs are leaving in droves. Await lower levels to re-enter.

How to tackle a ‘panic bottom’

Panic bottoms, which are sharp price drops accompanied by large volumes, frequently occur in stock price and index chart patterns. It is important, therefore, that investors understand and learn how to tackle a panic bottom in a portfolio stock.

This is a follow up to last Friday’s post about the Crompton Greaves price crash after the Q1 results fiasco, which raised quite a few comments and queries from blog readers and investment group members.

The nature of some of the queries and comments mentioned below motivated me to write this post:

‘I bought at a higher price. What should I do now?’

‘I bought on the day the stock crashed, and will buy more if it falls further.’

‘A big fund bought large quantities on the day of the fall. Shouldn’t we buy as well?’

Like promises, technical analysis rules are made to be broken. That doesn’t mean we shouldn’t be aware of the rules before playing the game. So, here are the two basic rules about panic bottoms:

1. Panic bottoms usually occur in the middle (or second) stage of a bear market

2. Panic bottoms seldom hold.

How do we know if a stock is in a bear market? In a post titled: ‘Is this a Bear Market, or a Bull Market correction?’, I had provided four different definitions of a bear market. Let us look at the chart pattern of Crompton Greaves to find out if it was in a bear market when the ‘panic bottom’ occured:

In Jan ‘11, two of the definitions were satisfied: the stock corrected 20% from the Dec ‘10 peak of 349, and fell below the 200 day EMA. In Feb ‘11, the dreaded ‘death cross’ (marked by light blue oval) of the 50 day EMA below the 200 day EMA confirmed the bear market. (The fourth definition – a >50% correction of the previous bull rally – wasn’t checked, since three of the four definitions were met.)

The rally that led to the Apr ‘11 top above the 200 day EMA was a good opportunity to exit the stock. In the next (second) stage of the down move, the ‘panic bottom’ occurred – accompanied by heavy volumes.

An upward bounce from the ‘panic bottom’ – caused by bottom fishing and short covering – was a selling opportunity. Today’s low and close were both lower than the ‘panic bottom’ low of 171. Both rules of the ‘panic bottom’ have been followed.

The lessons?

1) Once a bear market is confirmed, hanging on to a stock – regardless of its fundamentals (or lack of them) – doesn’t make any sense. Use the first bear market rally to exit, and avoid the gut-wrenching experience of a ‘panic bottom’.

2) Don’t try to bottom-fish on a ‘panic bottom’ – because lower prices will be available later. It is safer and prudent to wait for a clear signal of change of trend before entering.

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 market quiz for new investors – a discussion

Before getting into a detailed explanation of last week’s stock market quiz, I would like to specially thank all the readers who attempted answers. Answering questions in an open forum requires a certain amount of courage. There is always a fear that you may get the answers ‘wrong’.

That is why the answer options were provided in a way that apart from a few obvious ‘wrong’ answers, readers could choose from several ‘right’ answers. This is an important point for new investors to appreciate. If you are going to be successful stock investors, you need to have your own strategies and tactics. If a system or style works for you, it is a good system. Otherwise, you need to tweak or change it to make it work.

Let me provide the answers that I would have chosen – as a conservative, risk-averse, long-term investor:

1 (d); 2 (b); 3 (d); 4 (d); 5 (e), and I will explain why. That doesn’t mean that my answers are ‘correct’ – it merely reveals my investing style, which can be summed up as ‘Safety First’. By the way, there was a typographical error in 1 (d), which reader VJ had pointed out.

Why 1 (d)? Karan summed it up nicely in his answer, and this was really the only ‘correct’ answer in Q1. The other options are too risky. The answer option I didn’t provide was: “Nothing – because I do not buy or sell on tips”. Every one would have chosen that option!

Small investors should stay away from small-cap stocks in general – because of low liquidity that makes buying and selling difficult, and due to lack of financial staying power through tough times. But if you do buy a small-cap, maintain a stop-loss of no more than 8%. A 20% price drop may be a sign of worse to follow – so get out.

Why 2 (b)? Most of you chose option (a), which is not ‘wrong’. As a general rule, don’t average down because you don’t know how far the stock may fall. This is a rule for small and mid-cap stocks. For large-caps – if you have done your homework before buying, a 10% drop in price is a good opportunity to add. (Follow the thumb-rule of never buying near a 52 week high.)

Why 3 (d)? No one chose this option, except Venkat. Most chose (c), which isn’t ‘wrong’. The situation described is called a ‘panic bottom’ – which usually happens during the first or second stage of a bear market. Such bottoms are invariably broken, and the stock tends to fall much lower. So you may be better off by closing the trade, and buying lower again after the stock bottoms out.

In such stocks, it is good to keep a stop-loss between 8-15% – to avoid a 50% drop.

Why 4 (d)? Almost every one chose this option. The point I was trying to make is that investors get hung-up with round numbers. If you buy at 10 you want to sell at 15 or 20. If you buy at 50, you want to sell at 75 or 100. Markets rarely work to suit your convenience. In a low-priced stock – which investors should avoid in the first place - it is better to start taking profits home whenever they are available. Most investors get killed when they go out to make a killing!

Why 5 (e)? Only Saurabh and Joe chose this option. There are two points here. In a step-wise up move, prices tend to find support near previous tops. Those are good places to add. Since we don’t know if 55 was a previous top or not, we would not know if the correction will stop at 55 or fall further.

Also, it is a good idea to take profits at a 52 week high – more so because the original investment has doubled. Remember that you make money only when you sell. So you need to have a selling plan when you buy a stock.

Venkat gets the hat-tip for the ‘best’ answer. His responses suggest that he isn’t a ‘new investor’ any more!

Thanks once again to all who participated in the quiz. For those who didn’t participate – hope you will be able to pick up a few pointers from this discussion to improve your buying and selling.

Stock Chart Pattern - Sesa Goa (An Update)

Several interesting technical patterns were observed in the stock chart of Sesa Goa in the previous update back in July ‘10. The stock had been consolidating within a symmetrical triangle after falling from its Apr ‘10 top 0f 493.

Triangles are notorious for being unreliable – a stock’s price may break out upwards or downwards; it can fizzle out through the triangle’s apex, losing any technical significance. But they tend to be continuation patterns.

Since the stock had entered the triangle from above, I had guessed that the likely break out would be downwards. The 15 months bar chart pattern of Sesa Goa shows some more interesting technical phenomena:

‘Normal’ break out points from a triangle occur at about two-thirds or three-quarters of the distance from the base of the triangle to the apex. Some times – but not always – a break down close to the apex will tend to pullback to the horizontal line drawn through the apex, and provide a good opportunity to sell.

Not only did Sesa Goa’s stock price pull back to the horizontal line through the apex in Jul-Aug ‘10, it did so a second time in Oct ‘10 – providing another selling opportunity. In between, two other interesting things happened technically.

The blue circle (in Aug ‘10) indicates the ‘death cross’ of the 50 day EMA below the 200 day EMA – confirming a bear market. Prior to that, the stock had made a ‘panic bottom’ at 312 on very high volumes – falling more than 35% from the peak of 493.

Panic bottoms occur quite often during bear markets. Investors would do well to recognise them as a warning bell for worse to follow. Panic bottoms are almost invariably tested and broken.

Note that after the ‘death cross’ in Aug ‘10, the stock made three unsuccessful attempts to move above the 200 day EMA – forming a bearish pattern of lower tops and lower bottoms. Is it all doom and gloom then? Has the tax on iron ore exports and ban on exports from Karnataka taken the wind out of the sail of this blue-chip company? The good Q4 results certainly don’t indicate that. Once the Petronas and Cairn acquisitions go through, the stock may reach its glory days again.

Observant readers may notice that the MACD, ROC and RSI made higher tops in Apr ‘11 while the stock made a lower top. The positive divergences seem to be helping the stock price to stage a revival.

The MACD is negative and below the signal line. The ROC is also negative, but has climbed above its 10 day MA. Both the RSI and slow stochastic have emerged from their oversold zones, but are well below their 50% levels.

Bottomline? The stock chart pattern of Sesa Goa is showing the effects of fundamental and technical headwinds. This is a good portfolio stock for patient, long-term investors. The best time to buy such stocks is when no one wants them. Buy on a convincing break above the 200 day EMA, with a stop-loss at 255.