Nifty Breaks Important Support

Before I start this edition, I must apologize for not being able to post my views on this blog on Thursday night for Friday due to some personal problems. Rest assured, I’ll try to be as regular as I’ve been in the past. I’ll continue with my plan to post a newsletter for every market day and an extra on a weekend. The Nifty, on Friday, did open slightly in the green but soon started losing ground. It managed to hold on to the support between 5000 and 5050 for a couple of hours but soon after noon it started slipping quite heavily and from there it was a unidirectional decline for the Nifty.

The chart of the Nifty has suddenly changed in the last two days. If we ignore the last two candles in the chart, we can see that we were pushing against the resistance line and the blue candle had a long lower shadow which showed that the price did go down but buying came in at lower levels and that actually took the price past the day before’s close. Suddenly, that day was followed by two red candles which changed the chart completely. Now we have broken through the support line near 5000, as signified by the solid green line, which is highly negative. A lower high is now already in place and below 4913 we will have a lower low too, thus signifying the start of a new downtrend according to the Dow Theory. According to the trendline theory, we have now entered an intermediate term downtrend. The target for this downtrend may be somewhere between 4500 and 4550. However, support also comes in at previous lows of 4913, 4630 and 4470. There is a reasonable good support at current levels near 4950. It is important that the previous low of 4913 is not broken if we are want some stability in the markets.

A lot of the current fall in the markets has been attributed to inflation which has been on the rise due to the jump in prices of crude oil. Crude Oil has almost doubled in the last 10 months and the jump has been exponential in the last two months. What actually has been happening in crude oil? Is it likely to come down? Well, some people say it is likely to come down now and there are others who say a price of $150 per barrel is likely in the next few days. Who do we believe? The best thing, I would believe, is to look at its chart and decide for ourselves.

Given above is the daily chart of crude oil futures as traded on the Multi Commodity Exchange (MCX). The price is in Rupees but the chart, whether in Rupees or in Dollars will remain the same. As seen in the chart, the thick red line is the line chart (close) of crude oil and we can see that it has now found some resistance near 5650 near the blue line. We can see that the support trendline is too far down near 4800 (which will reach 4900-5000 by the time the price comes down). A fall to 5000, though, may not be possible but a fall to 5100-5150 is likely. 5150 also happens to be the 23.6% Fibonacci retracement level of the rise seen from the February lows. That would correspond to roughly $120 per barrel. Also embedded on the chart in the gray line is the chart of Gold futures on MCX (the scale for Gold has not been shown). As seen by the chart, the price of both Gold and Crude is moving in tandem and a fall in crude could also make the yellow metal cheaper.

Buying should be avoided for now since the short term trend is now down and it is likely that the intermediate trend may also turn to down, if it already hasn’t. Keep strict stops on all open long positions.

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The Probability of Profitability

Let us understand technical analysis in a different way today. We always knew that technical analysis is the study of charts and trying to predict the future. But does it work? Is it accurate? How often does it work? What is the probability of making a profit every time? What is the probability of being profitable after a year? Well, we have all the answers here. Come, let us understand probability in very simple terms.

We all have been studying since grade 6 that probability means the likelihood or chance of an event happening or not happening. We all know the example of the flipping of a coin and throwing a dice or drawing a card. For those who don’t know, here it is. When we flip a coin, only two possible things can happen. Either we get a heads or a tail. Since there is one chance of getting a heads out of 2 outcomes, the probability is ½ or 0.5. Similarly the probability of getting a six on the throw of a dice is 1/6 or 0.1667, the probability of drawing a card of hearts from a pack of cards is 13/52 or 0.25 and the probability of drawing an ace is 4/52 or 0.0769.

But, have we ever thought what is the probability of making a profit if we pick up a stock at random? Let us see what the possible outcomes are when we buy a stock. It can either go up or come down. Which means the probability of making a profit is ½ or 0.5 or 50%, which is a very high probability. Then why do we do so much of research and ask people to give us tips or spend hours looking at charts? Just for a simple reason that we want to increase our probability of making a profit to 0.7-0.8 or 70-80%. But, does it help us? Are we able to increase our profits? Actually speaking, no. Believe me, we are still better off picking up stocks at random and let the probability remain at 50%. I will give you a very simple formula. You pick up any stock at random, have a well-defined exit strategy and an equally well defined profit booking strategy. Let us say that our rules are that we will pick up a stock at random and book a profit if the price goes up by 10% and keep a stop loss 5% below our purchase price. Believe me, with such a strategy, you will never never make a loss.

Is the above system acceptable? It is not very difficult to follow. All we have to do is to book our profits and losses as defined by our rules. I am sure, we can all follow these simple set of rules to make profits. But, before you go ahead and implement it, let us talk about the drawbacks also. Over the years that I have been involved in the stock markets, I have not only studied technical analysis, I have studied human psychology too (as it works in the stock markets). I have learnt that the drawbacks lie in your mind. Firstly, you will never be able to come to terms with the fact that you have made money. You will always be thinking that it was this system that made money. The thrill of investing in the stock markets will be missing because the decisions are automatic and not your own. Secondly, you will be tempted to book profits at 9% (or lower) instead of 10% while when it comes to executing your stop losses, you will be reluctant to do so even at 8%. Thirdly, the returns are too low – only 2.5% on your total investment. You get more in a savings account. And last, the system will work well in bull markets and will be terrible in bear markets. God save you from the bear markets if you follow this system.

So, is fundamental option the best option? Well, it does help. But it has its own drawbacks. Fundamental analysis tells you whether to buy or not to buy a stock. But it has no clearly defined entry and exit strategies. So, you may never know when to book profits and when to cut your losses. The human psychology is such that it forces you to take your profits quickly before your profits turn into losses. And if you are in a loss, you will keep riding your losses because you are thinking that you had done proper research and that sooner or later the price should follow the fundamentals, so you keep holding on to your losing positions. No doubt, on some stocks you can get profits many times your investment but in some you could lose a lot too.

That leaves us with technical analysis. Technical analysis has well defined entry and exit levels and with proper discipline you can continue to ride your profits and cut your losses early and you can make a lot of money. But like any other method, this has its own set of drawbacks. The hit rate is not very good. If you choose 10 stocks, it is likely that only 3 or 4 calls out of those 10 will come out to be correct. But the advantage is that those 3 or 4 calls give you enough profits to cover not only all your losses from the remaining 6-7 calls but also gives you enough profits to give you a good return. Many technical analysts keep trying to develop methods which will give maximum profits. I am currently developing a system which will give me small profits but the hit rate would be between 85-90%. The details of the system are ready and I am currently testing it with my own money to fine tune it a little and it can then be given to a few selected subscribers who are disciplined enough to follow it and once they have also tested it for sometime and some more fine tuning is done, it can be shared with all others. This system, for convenience sake, shall be referred to as 'System A' from now on.

We should consider our trading to be a business. The objective of any business is to make money and that’s what will be the objective of our business. Like in any other business you will have some centers which will be your profit centers (which give you lots of profits) and some as your cost centers (which earn no profits but only cost you money). The objective is to maximize the profits from your profit centers and minimize the costs in your cost centres. Similarly, in this trading business there will be some stocks which will give you a lot of profits and some which will only give you losses. So, as long as you maximize the profits and minimize the losses, you will end up in a profit. And that is what technical analysis helps us achieve. Helps us to ride our profits and minimize our losses.

We have learnt today that there are many methods which help us to make profits. But all of them have their own advantages and disadvantages. Within Technical Analysis (which I consider to be the best, though this is a debatable topic) too, there are many methods but the Dow Theory is the oldest and the easiest method of technical analysis. According to Martin Pring, as mentioned on buddycom, if an investor had invested $44 in the Dow in 1897 and liquidated his position after 93 years in Jan 1990 (pure buy and hold strategy, as happens in fundamental analysis), he would have got $2,500 after 93 years i.e. 56.82 times his investment, while another investor who invested and liquidated at the same times and who sold on every sell signal and bought on every buy signal would have got $51,268, a whopping 1165.18 times of his initial investment. That is the power of technical analysis and that shows how our probability of profitability increases with technical analysis. And technical analysis requires only one skill. Discipline.

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Bulls At An Advantage

This article on moneycontrol gives the view of their Technical Analysis expert, Ashwani Gujral, who recommended Tata Steel with a target of 950 and Sterlite Industries with a target of 1070. These stocks were already recommended on this page with a target of 1050 and 1040 in the newsletters for 15th May 2008 and 30th April 2008 respectively.

The Nifty today opened with because of weak global cues but kept rising through the day to close the day slightly in the green. The Asian markets ended on a mixed note today with the Hang Seng closing green while Nikkei was in the red. European markets are now (at the time of writing the newsletter) more or less flat while the Dow is still losing 70 points after a loss of about 200 points yesterday.

Looking at the chart of the Nifty today, I find no difference in the chart since yesterday except that the support near today’s low at 5050 becomes a little stronger. So, I might as well copy and paste what I wrote here yesterday. In fact I’ll do better than that, I’ll just add a link to yesterday’s newsletter and you can click here to read what I wrote about the Nifty yesterday. We still have resistance near trendline 3 and trendline 2 and support near 5050 and then trendline 1. RSI has yet to cross 60 to give us bullish signs.

It is all becoming a little confusing now. We made a low of 1292.20 in the now infamous decline of May 2004 (when the BJP government fell) and a high on 8th Jan this year at 6357.10. The decline in mid Jan and then through February and March made is correct 38.2% of the move from May 2004 to Jan 2008. I think a 38.2% retracement in a secular bull market (what most market participants have been claiming to be in since the last 4-5 years and which is expected to last another 8-10 years) is quite enough. A decline deeper than this should not come about. We should probably just do some base building here (which, I personally think, is in progress now) and move on. But the signals from the western world and the investment gurus are not very positive. According to Eric Roseman, George Soros, the hedge fund manager of the Quantum Fund and one of the best investors, has gone on to say that investors are now participating in a bear market rally. Warren Buffett, nicknamed ‘The Sage of Omaha’, in this article, says that the end to the credit crunch is still not in sight and that the stocks could be heading still lower. I tend to agree with Haresh Soneji, CNBC TV 18’s Research Analyst, who says in this article, that investors the world over may be hoping that both Soros and Buffett are terribly wrong this time around but given their history, it seems unlikely. They may turn out to be right but one of the advantages of blogging is that I could disagree with them if I want to and I am disagreeing. I feel that we have already seen an intermediate term low and that we should not be going below that for a long time to come.

Hmm…., disagreeing with George Soros and Warren Buffett, what am I doing? In fact, it is a win win situation for me. If I go wrong, I’ll be expected to, because where do I stand as compared to Soros and Buffett, but the technical signals now do not show that the markets have anymore downside and I have Ashwani Gujral agreeing with me. And if I do turn out to be right, I can always turn around and say that I could foresee what George Soros and Warren Buffett could not. This is why I love blogging. I can never lose. I would appreciate your comments too on how you expect the markets to behave now because as I said, it is becoming a little confusing now and I would like to know what all of you are thinking.

Alstom Projects, with its Relative Strength Index (RSI) crossing 60 during its last peak and now finding support near 40 before turning back, seems to have given a good sign of turning around from the current levels. The stock may go up to its trendline near 720 from the current levels (which itself is a return of about 12-14%) and if it is able to cross the trendline then could continue to go up to a target of 950-1000. Buy now with a stop loss of 580 for a target of 720 and then between 950 and 1000.

Siemens seems to be getting support near 550 and 560 since a month now and with the downward sloping trendline coming so close, it is left with no option but to break out of the pattern. It now has to go above the trendline or may choose to come below the support. This is a perfect opportunity to buy it. If it goes up, it is in our favour and in case it comes down below the support, the stop loss is so close that we’ll hardly lose anything. Consider buying above 600 with a stop loss of 560 for a target of about 770.

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Resistance Found! Where Do We Go Now?

The Nifty opened on a weak note today because the Asian markets were down and even the American markets despite good gains last evening, lost strength in the later half of the day. This was not taken kindly by the Indian markets and after three blue candles, it decided to show a red one before deciding upon its next direction. But as per our analysis, the markets were in a strong uptrend and were likely to find resistance near 5300. So, what went wrong, why did the market come down today? What is the possible direction of the market now?

Attached above is the daily chart of Nifty. I know there are too many things drawn on the charts and the idea is not to confuse you. The idea is to do a little bit of analysis. And not too much of analysis too because we don’t want a situation of analysis paralysis. But just enough analysis to weigh the strengths against the weaknesses in this chart of Nifty. You can click on the chart to open it in a new window so that you can see a larger image. Let us take each point one by one. We were within a clear well-defined range between the two trendlines marked as 1 and 2. What did us in was this third dashed trendline marked as 3! Were we expecting it to happen? If yes, why wasn’t it discussed here? The answer is no, we were not expecting resistance here. We were expecting a little bit of profit booking soon but not exactly here. Why? Firstly, we were in a well defined range between the two trendlines and we weren’t expecting a third one to interfere in between. Secondly, have a look at the Relative Strength Index (RSI). The RSI has been respecting the trendline since 21st Jan 2008 and had gone well over 60 in the end of April and was clearly showing signs of bullishness. We were not expecting it to find resistance at 60, like it did this time around (as marked by the circle). One reason why the price found resistance here is because it reached the 38.2% retracement level from the 8th Jan 2008 high to 22nd Jan 2008 low. This level too was not expected to be too much of a resistance because this too has been breached a number of times since 22nd Jan 2008 without any real support/resistance. It was probably the combined effect of trendline 3, the 38.2% Fibonacci retracement level and the RSI at 60, all at the same levels, that did us in.

We now have two possibilities. The Nifty may ignore this small resistance soon and continue to go up to trendline 2, in which case the RSI may also cross the resistance at 60 and we could then expect the Nifty to cross 5300 soon too. Another possibility that may happen is that the Nifty continues to respect this trendline and starts coming down in which case it would find support near trendline 1 near 4950. In that case the RSI would also fall. And if it falls too much so as to cross the trendline, we can probably expect the Nifty too to break 4950. Another remote possibility is that this may be a small consolidation and could find support near 5000. Let us wait and see what the market decides to do.

No stocks discussed today.

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Target of 5300 Visible

The Nifty, on Friday opened in strength on Friday and remained range bound in a range of 40 points for a better part of the day and it was only in the afternoon session when the European markets opened that spurred a rally which took it past its highs of the day. A little bit of profit booking was seen near the end of the day which saw the Nifty losing about 15 points. On the whole, it was a green day with a gain of about 42 points.

As seen on this daily chart of Nifty, it has been rising since the last three days now and currently finds support at around 4950 and resistance near 5290. A move above 5290-5320 should be decisive for the markets. As seen from the charts, such a move will confirm a possible bullish head and shoulders pattern on the Nifty which could give us a target of around 6100. However, that is only a possibility and should not be acted upon till it happens. We cannot buy now on the assumption that a bullish head and shoulders pattern will be made. It is also quite possible that the market may go on to make another shoulder before actually crossing through 5300. One thing for sure is that we are in a short term and intermediate term uptrend (not to forget, that the long term uptrend was never broken) and that any dip in the markets should be used as a buying opportunity. Also shown in the chart is the 14 day directional movement ADX indicator which is currently around 18. A value below 20-25 suggests that the market may be going into or is currently in a sideways movement and it is not wise to take a position till the ADX crosses 25 or is at least 4 points above its previous lows. A move above 35-40 suggests that the trend may come to an end or slow down soon. A move above 5300 may probably also make the ADX go above 25.

The global signals are pretty positive today. The Asian markets were good on Monday and at the time of writing the Dow Jones is about a percent up i.e. 130 points in the green while the FTSE-100 closed 85 points up with a gain of about 1.3%.

I thought it might make some sense to look at the chart of Dow Jones also. As discussed in an earlier issue, the 9 month old trendline and the top of a 4 month old rectangle near 12740 was crucial and a cross above that would give us a target of 13700. This resistance was crossed on 21st Apr 2008 and has since gone through a pullback too and is now inching its way up. The downward sloping trendline at 13010 is providing resistance but at this moment, the Dow Jones is trading at 13132, much higher than this trendline. If it manages to close above this level (still about 3 hours of trading left in the day) today, it is on its way up to 13730 and then 14650. A close above 13010 will signify the end of the intermediate term downtrend in the Dow too.

Seen above is the daily chart of Aban Offshore and on it are seen three trendlines marked as 1, 2 and 3. Let us discuss each one in detail. The first trendline marked as 1 is the downward sloping trendline from the highs made on 29th Feb 2008 and Friday’s price movement confirmed that this trendline was broken. The second trendline, marked as 2, shows that the price has been finding resistance whenever it went to 4000 since 23rd Jan 2008, except for two exceptional days in February. The price did go above this trendline on Friday but closed well below it. The third trendline, the dashed one marked as 3, is an extended trendline starting from the lows made on 19th Mar 2007 (not shown on this chart). This trendline has been respected throughout except for the two areas marked by circles. A break of these three trendlines will be significant for Aban Offshore and the high volumes on Friday along with a large blue candle seems to suggest that this may soon be a reality. It may make sense to buy above 4000 with a stop loss of 3500 for a medium term target of around 5170.

Steel Authority (SAIL), if it manages to go past the trendline marked 1 on its daily charts would suggest an uptrend in the stock, which could take it to the next resistance near the trendline marked 2. The large blue candle with huge volumes on Friday seems to suggest that the price could go past this trendline on Tuesday. Consider buying above with a stop loss of 165 for a target of between 215 and 220. Revise the stop loss to 190 if the low is above 190 for two consecutive days.

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The Technical Analysis Game

Are you interested in technical analysis? You think you can see charts and forecast the future movement of prices? You think you want to test your technical analysis skills before risking actual money? Well, I’ve found just the thing for you on Inspectd.

Inspectd provides you with a free simulated technical analysis game in which it will provide you with a real chart from the past. You have the option to add one or two moving averages to the chart and you have the option of holding your trade for 1, 2, 3, 5, 10, 20 or 40 trading days and you can view a candlestick chart, a line chart or an open high low close chart. Based on the chart you have to take a trading call which can be a buy or a sell. If you want, you can also skip that chart and go to the next one. You also have the option of investing only 10% or 25% or 50% or 75% or 100% of the money available with you on each chart. The only thing that remains constant is the time frame of the chart, which remains 6 months. After you take a call, the game will calculate your profit or loss based on what actually happened in that chart in the days to come. You can either double your money in 15-20 trades or blow it all in the same number of trades. The best thing is that the game provides you with an opening balance of $100,000/- which you can replenish anytime you want and any number of times. So, you can lose a billion dollars in stocks and still not feel a pinch about burning your fingers.

But before you go on to the site to play the game, you must be forewarned of the risks involved too. The first is that you are only allowed 5 free trades after which you will be asked to register. But don’t worry, the registration is free. The risk that comes with registration is that your mailbox may be spammed with junk mails. But don’t worry about that too. They assure you of a no spamming policy. And finally, the riskiest of all things. The game is highly addictive. You could spend hours playing this game. Don’t let your boss or colleagues catch you playing it, the reason being that if everybody starts playing, who will work?

You think you are ready to play? Go to Inspectd.

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Back in an Uptrend, Target of 5180

As expected and as seen on this 30 minutes chart, the Nifty moved up today, thus accomplishing two major achievements on the short term charts. First, it signified the end of this fortnight long downtrend and second, it confirmed a double bottom pattern and gives us a target of 5180 on the Nifty. During the day the Nifty did face some selling pressure but then found support at the neckline and immediately changed its direction.

While a target if 5180 is there but in an uptrend the Nifty can go much higher and on the way up may encounter some areas of resistance near 5200, 5230, 5250 and then 5300. A move above 5300 should be relatively smooth till it reaches between 5440 and 5500. Support on the downside is now at the neckline of the double bottom pattern at 5060.

Hindalco Industries has been moving inside a large contracting triangle since the beginning of the year. The price now seems to have broken through the triangle and with huge volumes too, leaving little doubt about the genuineness of the breakout. It is easy to say that it is a good buy with a stop loss of close to 190. What is difficult to say (and to predict) is the target. Seeing it as a traditional triangle pattern, we get a target of about 270. 270 would be a 35% jump for the stock, which seems unlikely, if not impossible in such a rangebound market. Taking a very conservative and cautious view, we get a target of 230 and a more daring view would give us a target inbetween of 245-250. I would probably stick with a target of 245.

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