How to Read the Market Direction?

It is often said, “Only when the tide goes out, do you discover who’s been swimming naked.”

When markets come under pressure, a strict sell-rule is what can protect you from emotional and financial stress. Often, when the market is in a correction, three out of four stocks follow the market direction. Investors often believe they are right in their research and approach and cling on to a stock, even if the markets turn the tide. Selling is the key factor that determines a successful investor from others. If a sell-rule is in place, it provides a clear framework for avoiding biases and emotions to creep into your investing. With the Indian market in a correction, do not hesitate to sell away stocks that breach your sell rules. You simply cannot afford to have a love affair with a stock as it could become an extremely expensive affair.

Post a correction in the markets, a Rally Attempt begins after the markets cool off, and the index trades above the recent bottom for at least three consecutive sessions. A Follow-Through Day is a solid up session, generally a 1.5% or higher gain, with volume being higher than the previous day. A follow-through session officially opens the buying season for leading stocks. Leaders often second the Rally’s confirmation by breaking out of bases near the Follow-Through Day. A Distribution Day is a weak day in the market, when the index closes on higher volume by 0.2% or more. The number of distribution days in the market can be used to gauge the strength in the market

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How To Spot Stock Market Tops

How To Spot Stock Market Tops

​​​​We all know the importance of market status in determining an investor’s stance in the CANSLIM style. It not only helps you realize gains by being aggressive when the risk is minimal but also protects you from unwarranted risks of markets.

When the market is in a Confirmed Uptrend, it is the best time to make the most of your gains. This is when most breakouts are successful, and hence an investor carefully following the patterns of his/her stocks makes big gains. But how can you pre-empt a probable weakness in the market so that one can lock-in gains and play defensive with less or no exposure? A distribution day can provide a systematic and credible approach to do that.

What is a Distribution Day?

A distribution day is when a market representative index (for example, Nifty50) loses more than 0.2% in a day, with volume higher than that of the previous session. When a distribution day occurs, it hints that big institutional investors are exiting or reducing their positions in the market. Institutional activity is what moves any market, especially in India where retail participation is small. Though a distribution day hints at institutions liquidating their positions, it loses its impact after 25 trading sessions. 

How Does it Help in Sensing Market Weakness?

An investor should keep count of all valid distribution days during a Confirmed Uptrend. Successive distribution days imply a weakening market. But what threshold of distribution day count is enough to say the market is under pressure? A distribution day count of 2–3 is benign and usually normal in a Confirmed Uptrend. But when the count increases to 5–6, one should prepare to get his/her positions trimmed.

William O’Neil wrote in “How To Make Money In Stocks,” “After four or five days of definite distribution over any span of four or five weeks, the general market will almost always turn down.” When this happens, carefully assess each stock in your portfolio and reduce your exposure accordingly. And in some cases, it’s wise to get out completely. Market rallies do not go on forever. At some point, they will end. This usually happens when the market gets smacked with a heavy load of distribution days.

Understanding Distribution Day

The below example is for understanding. Do not relate it with current market. Currently we are in a Confirmed Uptrend. Distribution Day count is three

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Break the Stereotype; Buy High, Sell Higher

Break the Stereotype; Buy High, Sell Higher

“What seems too high in price and risky to the majority usually goes higher, and what seems low and cheap usually goes lower.” – William J. O’Neil

The ‘N’ in the CANSLIM strategy stands for either a ‘New Product,’ ‘New Management,’ ‘New High,’ or any other new factor, which could positively change the operating environment for the stock and ultimately drives its price into newer realms.

Contrary to conventional wisdom, buying low and selling high is not an easy way to make money in the stock market. In fact, it can be quite risky because in many cases, you’re buying damaged goods.

We would like to specially draw your attention to buying into new highs. Buying a stock when it is scaling new highs might seem strange and scary to many investors. About 98% of individual investors would never buy a stock that makes new highs. Buying a quality stock at a new high is buying into the emerging strength with a belief that it could prove to be the beginning of the next big move.

But, don’t buy every stock that makes a new high, make sure that the stock breaks out of a sound base pattern before it sails above the pivot, on a higher than the average volume. In addition, investing when the stock price is way too extended, say 5–7% or higher from its pivot is not ideal.

Traditionally, investors often believe that they are value investing, when they prefer to shop stocks near their 52-week lows. The idea of buying from a discount sale in a supermarket rarely applies while buying stocks. Stocks on the new-high list tend to go higher in price, while those on the new-low list tend to go lower. Good quality products are always expensive, so are the good quality stocks.

Don’t be afraid to buy a stock when it is showing supreme relative strength and sitting near highs. There is no shortage of precedents that show big market winners staging multiple breakouts during multiyear runs. Don’t be quick to say it is too late, especially if a compelling growth story is still intact.

For example, look at the chart of Central Depository Services (India). It advanced 70% in the last three months. Its ideal breakout and buy point was at an all-time high in February, and after breakout, it progressed higher making higher highs. By avoiding growth stock at all-time high with a proper base pattern and strong fundamental and technical profile, you are avoiding a multibagger stock.

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Nifty Breached its 50-DMA; What to Expect from the Market

Recently, the markets have been highly volatile. We have to be cautious as Nifty has breached its 50-DMA and distribution count has increased to three. The next level of support is at its 100-DMA (14,575), which is just 100 points below the Friday’s closing of 14,677. Historically, 100-DMA has been a good support for Nifty. If that level, is breached then further downside is expected.

What if the market continues to decline?

If the Nifty declines more than 0.2% on volume higher than the previous session, we would consider it as a distribution day. Accumulation of distribution days is tracked, if the count increases to four/five, we would downgrade the market status to an Uptrend Under Pressure.

The above picture explains our methodology in changing market direction. In a Confirmed Uptrend, our conviction toward the market is high and capital allocation would be maximum. In an Uptrend Under Pressure, we would start trimming our positions and book out most of our profits. Fresh initiations would be minimal, only highly rated stocks exhibiting strong price-volume action would be added to our model portfolio.

In a Downtrend, our conviction is the lowest. We would exit our model portfolio and stay in cash. Fresh positions will not be initiated in this status.

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Currently, the market is in a Confirmed Uptrend. We have upgraded the market status to a Confirmed Uptrend on April 28 as the Nifty advanced over 1.4% on volume higher than the previous session. Now is the best time to make the most of your gains. This is when most breakouts are successful, and hence an investor carefully following the patterns of his/her stocks makes big gains. Now, most of the investors have a question, when will the rally end, and how to identify the market top. Once your total capital is invested in the market; you need to pre-empt a probable weakness in the market so that one can lock in gains and play defensive, with less or no exposure. A distribution day can provide a systematic and credible approach to do that.

We all know the importance of market status in determining an investor’s stance in the CANSLIM style. It not only helps you realize gains by being aggressive when the risk is minimal but also protects you from unwarranted risks of markets.

What is a Distribution Day?

A distribution day is when a market representative index (for example, Nifty 50) loses more than 0.2% in a day, with volume higher than that of the previous session. When a distribution day occurs, it hints that big institutional investors are exiting or reducing their positions in the market. Institutional activity is what moves any market, especially in India, where retail participation is small.

How does it help in sensing market weakness?

When the market is in a Confirmed Uptrend, the intensity of market weakness is determined by the distribution day count. An investor keeps count of all valid distribution days during a Confirmed Uptrend. Successive distribution days imply a weakening market. But what threshold of distribution day count is enough to say the market is under pressure? A distribution day count of 2–3 is benign and usually normal in a Confirmed Uptrend. But when the count increases to 5–6, one should prepare to get his/her positions trimmed.

Distribution Day Expiry

Though a distribution day hints at institutions liquidating their positions, it loses its impact after 25 trading sessions. A distribution day is also removed from the count after the index rallies 5% above that day’s close.

Nifty 50 is in a Confirmed Uptrend from April 28; it experienced its first distribution day on April 30 (D1) and the second on May 4 (D2). These are indicated in the chart below. Today (May 7), Nifty reclaimed its 50-DMA, which is a good sign. Further upside can be expected from here if the leaders exhibit strong price-volume action.

 

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