About trend lines and channels

Here are some extracts from my free eBook on Technical Analysis taken from Chapter 2: Trend Lines and Channels:-

“Stock or commodity prices tend to move in a trend. A bullish (or up) trend occurs when demand for a stock or commodity exceeds supply. In other words, there are more buyers than sellers. A bearish (or down) trend occurs when supply of a stock or commodity exceeds demand. That means there are more sellers than buyers.

Some times, demand from buyers and supply from sellers are almost equally matched. The trend becomes sideways – neither going up nor falling down. At such times, technical analysis doesn’t work too well. At some point, a mismatch between buyers and sellers causes a break out from the area of sideways consolidation.

There are three types of trends. A major trend lasts for a few months or years. This is the trend of greatest interest for buyers and sellers. An intermediate trend moves in a direction opposite to the major trend, and lasts for a few weeks or months. Eventually, the major trend resumes. A minor trend occurs for a few days during major and intermediate trends, and is of very little consequence.

Prices don’t move in one direction in a straight line. An up move of a few days is followed by two or three days of a down move, producing a zigzag pattern on the chart. Trend lines enable investors to identify the major and intermediate trends. These lines are drawn by connecting the progressively higher bottoms touched by prices in an up trend, or the progressively lower tops touched by prices in a down trend.

Some times, prices move within trend channels – a pair of parallel lines can be drawn connecting the tops and bottoms touched by prices during an up or down trend. A trend channel is similar to a sideways consolidation, but with an upward (or downward) bias. Eventually prices break out of the channel.

Drawing trend lines (and channels) is a skill that improves with practice. Despite its name, there is nothing ‘technical’ in technical analysis – other than dealing with graphs and geometrical shapes taught in school to every student. The important thing is to remain flexible about adjusting to changing conditions if chart patterns don’t form exactly as per expectations.”

Why remain satisfied with these extracts? Get the real thing. The eBook is absolutely free. Just send me an email at mobugobu@yahoo.com with your full name and a request for the eBook to receive your copy.

What if the stock market remains in a down trend for another year?

The Sensex and Nifty indices had touched their peaks one year back. Since then, both indices have been in down trends – neither falling a lot, nor rising much during counter-trend rallies. A gradual drift downwards that has all but sapped the bullish energy of small investors.

Several rounds of interest rate hikes by the RBI have failed to restrain rising inflation, but has started affecting economic growth. The high interest rates have led to postponing or cancelling of capital expenditure by companies, which in turn has affected the order books of capital goods makers, and engineering and construction companies.

The RBI had indicated the possibility of pausing the rate hikes if inflation begins to moderate. If the situation doesn’t improve within the next month or so, the RBI may be forced to hike the interest rate again.

Even if there is a pause in the rate hike, the already high rates are unlikely to be reduced immediately. Market sentiments do not turn bullish when interest rates are high and the GDP growth is slipping. It is quite possible that the Sensex and the Nifty may continue to trend downwards for another year.

However unlikely or pessimistic the above may sound, the path to success in stock market investing is to assess the surrounding environment at all times, and have strategies and plans in place. So, what can small investors do to prepare for another year of down trend in the stock indices?

The most important – and I can’t emphasise this more – is to have a financial plan, and based on it, an asset allocation plan. The queries I receive from small investors are mostly of these two types: “This stock is going up in a bear market – should I buy now or wait” or, “That stock has fallen a lot – should I wait longer or buy now”.

Hardly anyone asks me: “How do I make a financial plan” or, “How do I work out an asset allocation plan”. Without a plan, random buying and selling of stocks will lead to an unwieldy portfolio and very little returns.

Once plans are in place, a portfolio to suit the plans and the risk tolerance level of an individual can be built. A stock market in a down trend is the best time to build portfolios, because many good stocks are available at bargain prices.

What if you are one of those enlightened investors who already has plans and a well thought-out portfolio in place? Allow your portfolio to grow and prosper. How do you do that in a down trend? Mostly by not being overly aggressive. Within an overall down trend, individual stocks may perform better or worse. Use opportunities to book part profits or add to fundamentally strong stocks that have been beaten down.

Needless to say, whether to buy, sell or hold should be determined not by market fluctuations or gut feel, but by your asset allocation plan. When you book part profits, try to control the impulse of buying some thing right away. The high interest regime has its benefits in the form of higher bank fixed deposit rates and good returns from debt funds. Invest in them – as per your asset allocation plan.

Use the stock dividends that you receive at this time of the year to reinvest in your portfolio companies. Dividend reinvestment is like adding fertiliser to your plants. It helps them to grow better and faster.

Continue with your regular savings and systematic investment plans. There is a tendency of many small investors to stop investing when the markets are down. If you haven’t developed the skills to time the market (very few investors do), stick to your regular investments. Again, follow your asset allocation plan in a disciplined manner.

That is all there is to it. No magic formula will produce phenomenal returns in a down trending market. Just a boring, disciplined approach to planning, saving and investing for building wealth over the long term.

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.

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 – May 27, ‘11

S&P 500 Index Chart

The S&P 500 index chart spent another week in the downward trend that started from the May 2 ‘11 top of 1371. On Mon. May 23 ‘11, the index dropped sharply below the 50 day EMA and the lower edge of the Bollinger Band. After spending the next three days below the 50 day EMA, the index finally managed to close above the 50 day EMA on Fri. May 27 ‘11 - almost flat on a weekly basis.

The good news is that the index made a higher bottom in May ‘11, keeping the longer term up trend from the Mar ‘09 low intact. The bad news is that Friday’s volumes were the lowest of the week, which is contrary to bullish hopes.

The technical indicators are bearish. The MACD is negative, and below the signal line. The slow stochastic bounced up from its oversold zone, but remains below the 50% level. The RSI is treading water below the 50% level. A drop below the Apr ‘11 low of 1295 will signal a deeper correction. A convincing break above the down trend line connecting the intra-day tops of May 2, 10 and 19 will be a ‘buy’ signal.

The economy continues to struggle. New orders for manufactured durable goods declined by 3.6% in Apr ‘11. Unemployment claims rose by 10000 to 424000. GDP growth remained flat. Import and exports are strong, which is a positive sign. The Univ. of Michigan Consumer Sentiment index was unexpectedly higher in May ‘11 (at 74.3 vs. 69.8 in Apr ‘11), but almost 14% below the average of 86 (calculated since 1978).

FTSE 100 Index Chart

The down trend in the FTSE 100 chart tested support from its 200 day EMA, only to bounce up and close the week bang on the 50 day EMA – losing about 10 points on a weekly basis.

The technical indicators are bearish, but showing some signs of revival. The MACD is negative and below its signal line. The slow stochastic has bounced up from its oversold zone, but is below the 50% level. The RSI has risen to its 50% level. A convincing move above the 5950 level may provide an impetus for the bulls.

The UK economy is in deep trouble. The British Chamber of Commerce (BCC) expects inflation to rise to 4.5%, forcing the Bank of England to raise interest rates. The BCC lowered their growth rates for 2011 and 2012 as per this article, but ruled out a return to recession.

Bottomline? The chart patterns of the S&P 500 and FTSE 100 indices are in clear down trends. Investors should be circumspect about buying the dip because there is a possibility of deeper corrections. The longer-term trends are still up, as both indices are trading above their 200 day EMAs.

BSE Sensex and NSE Nifty 50 Index Chart Patterns – Apr 22, ‘11

Another trading week, shortened by a holiday, has gone by. Both the Sensex and Nifty indices continued their consolidation within the trading ranges marked in last week’s chart patterns. The bulls and bears have been unable to resolve their differences. Or have they?

I have been analysing the daily bar chart patterns of both indices. This week, I decided to take a longer term view. Weekly closing charts of the entire bull market since the closing lows touched in Mar ‘09 are analysed below. They throw up some interesting findings.

BSE Sensex Index Chart

The down trend line drawn through the closing tops of Nov 5 ‘10 (21005) and Dec 31 ‘10 (20509) was touched by Thursday’s (Apr 21 ‘11) closing level of 19602. The down trend appears to be intact, but may not be for long. The technical signs are bullish, and I will take them up one by one.

The long-term support/resistance level of 17600 – which corresponds to the closing top of Jan ‘10 - was briefly, but not convincingly, breached in Mar and Apr ‘10. A convincing break out (i.e. past the 3% ‘whipsaw’ leeway) occurred in Jul ‘10, after which 17600 acted as a support level during the recent correction.

The 20 week and 50 week EMAs came close to touching each other during the recent correction. Both have started rising and moving away from one another, and the index is trading above them. The long-term bull market is very much alive, though the Sensex spent 8 straight weeks below the 50 week EMA (which is considered equivalent to the 200 day EMA on daily charts) and threatened to fall into a bear market.

The MACD has crossed above its signal line into positive territory. The ROC is positive, and rising above its 10 week MA. The RSI has moved above the 50% level for the first time in 2011. The slow stochastic is about to enter its overbought zone after almost 6 months. More importantly, three of the four indicators are showing positive divergences by reaching higher tops (marked by blue arrows).

The bulls are all set to regain control of the Sensex.

Nifty 50 Index Chart

The Nifty 50 chart is looking even more bullish. This week’s closing level breached the down trend line (barely visible on the top right corner of the chart, and marked with a down-arrow) – though the breach is not convincing yet. Volumes were not significantly higher. Some more consolidation may be required before a convincing break out occurs. The technical indicators are supporting the bulls.

Despite all the global and local bad news, the Nifty hasn’t breached the long-term support/resistance level of 5300. On a closing basis, the index corrected just about 1000 points (16%), and remains in a long-term bull market. What we have witnessed over the past 6 months appears to be just a bull market correction.

Q4 results declared so far have been good. Infosys and Reliance results were good, but below market expectations. TCS, HCL Tech, Yes Bank results were very good and above expectations. Food inflation is still a concern, and the market appears to have discounted a 25 basis points interest rate hike by the RBI next month.

Bottomline? The BSE Sensex and Nifty 50 index chart patterns are showing signs of emerging from 6 months of correction. Valuations look fair, which means aggressive buying should be avoided. This may be a good time to churn your portfolios based on Q4 results – get rid of the weak performers and switch to better stocks. Long-term investors can stay invested using the long-term support/resistance levels marked on the charts as stop-loss levels.

BSE Sensex and NSE Nifty 50 Index Chart Patterns – Apr 15, ‘11

In a trading week shortened by two holidays, both the BSE Sensex and Nifty 50 index chart patterns consolidated within a range, facing resistance from the downward sloping trend lines and getting support from their rising 20 day EMAs.

I had presented bullish and bearish cases last week. Both sides seem to be holding their grounds. The bears may seem to have the upper hand, as both indices closed lower on a weekly basis. But technically, the 20 day, 50 day and 200 day EMAs are rising, and both indices are trading above their three moving averages. That is the sign of a bull market.

BSE Sensex Index Chart

The up trend from the low of Feb ‘11 took the BSE Sensex index to a lower top, keeping the 5 months long down trend intact. However, all four technical indicators are showing positive divergences. The MACD, ROC and RSI reached higher tops than the ones in Jan ‘11. The slow stochastic made a flat top.

However, the near term indications are bearish. The MACD is well inside positive territory, but has turned around and is about to touch the signal line. The ROC has dropped close to the ‘0’ line – well below its falling 10 day MA. The RSI spent a few days in its overbought zone, but is about to drop down. The slow stochastic has slipped below its over bought zone. Some more consolidation within 19000-19800 can be expected. The 50 day and 200 day EMAs are likely to provide support if 19000 is broken.

Nifty 50 Index Chart

The Nifty 50 index chart gyrated to the tune of the FIIs, on alternate days of net selling and net buying. There seems to be no end to the spate of bad news – globally and locally. Japan’s nuclear power plant disaster is going from bad to worse. Production and availability of spare parts in the automobile sector is likely to be affected badly.

European economies are tottering – particularly the weaker ones like Portugal and Ireland. However, inflation in UK seems to be moderating. USA’s jobless growth continues, but inflation is becoming a major concern. Domestic news isn’t much better. Oil price is still above $100 per barrel, worsening the trade deficit. Inflation refuses to come down, which could lead to another interest rate hike soon. The Capital goods and infrastructure sectors are facing tough times. On top of it all, Infosys declared Q4 results that were below consensus estimates, and the stock took a beating that affected both indices.

One would have expected the Nifty to crash under the weight of such negative news. But the index has proved remarkably resilient so far. The consolidation between 5700-5950 may continue. Below 5700, there are likely supports from the 50 day and 200 day EMAs.

Bottomline? The BSE Sensex and NSE Nifty 50 chart patterns are trading within a range. Long-term investors should stay invested with appropriate stop-losses, and await a clear break out from the range to decide the next course of action. Short-term players can trade the range.