Avoiding mistakes in a volatile market

Mistakes are plentiful during volatile markets. Avoiding mistakes in a volatile market is essential to ensure to
ensure one keeps their hard-earned cash intact.

Buying before a base completes

During the recent volatility, many stocks breached, some pulled back to their respective 50-DMA or 200-DMA. To
some traders, long-term support was a buying opportunity. The key to making money in the market, though, is
waiting until a base completes before buying. In most cases, stocks that pull back to their 50-DMA or 200-DMA do
so amid signs of institutional selling. Wait for the stock to prove itself, and look for signs of institutional buying as
the stock builds the right side of the base. Then you have a legitimate base.

Buying every possible Breakout

Bullish stock charts tempt investors all the time during down markets. Some growth names will hang in there with
compelling charts. A Breakout may work for a while, but it will likely be short-lived. While stocks that hold up the
best during down markets can go on to be the next leaders, they still should not be bought in volatile markets.

Keep holding a stock or even averaging down

A stock trades at Rs 100 a share. Your cost basis is Rs 100. The stock heads lower, and you buy an equal amount of
shares at Rs 80, lowering your cost basis to Rs 90. Then you add further at Rs 75 after it breaches its 50-and [200-
DMA]. The problem is that you're averaging down in a former leader that's under tremendous institutional selling
pressure. You will be doing some serious damage to your portfolio. It rarely makes sense to buy a stock that has
the potential to spiral lower before finally hitting its bottom.

Buying low P/E stocks

The price-to-earnings ratio is a common valuation tool. But buying/selling decisions based on P/E is not a prudent
move. Expensive stocks can become cheap, but cheap stocks become cheaper in a down market. Trying to catch a
stock "on sale" is fraught with risk. In many cases, stocks with low P/E ratios are suffering from weak
fundamentals, where shrinking market share results in lower earnings growth. That's not something you want to
see in a stock. Remember, some of the best merchandise in the stock market often sells at a pricey valuation due
to strong fundamentals and bullish growth prospects.

Stop paying attention

It is easy to lose interest when stocks are selling off, but market downtrends let high-quality names take a breather
and eventually build new bases. During a market pullback, try hard to make a list of stocks that held up the best. A
few will show limited signs of distribution (heavy-volume selling) on the way down and accumulation (high-volume
buying) on the way up. Focus on the most resilient names with the least amount of technical damage. They will
generally be your best prospects.

In conclusion, avoiding these mistakes in a volatile market would give you an edge over other investors and also
help book healthy profits.

Related: 

When to Sell Stocks: Why New Highs on Low Volume Can Halt A Big Run

How to Track Weakness in the Market: Distribution Days

How to Spot Market Bottom & Next Set of Leading Stocks

Read our last week’s article: Share Market Basics: Overhead Supply Can Repulse a Stock’s Climb

Share Market Basics: Overhead Supply Can Repulse a Stock’s Climb

“Just remember buying at new highs is buying into emerging strength.” – William J. O’Neil

 

Overhead supply, also known as percent off high, represents price levels at which a stock’s recovery is impeded as it tries to rally back from a steep decline. The pressure comes in the form of investors who bought the stock earlier at lofty prices and are waiting for the stock to recover just enough so they can sell and break even.

 

In essence, these are the holders who are thinking, “If I can just get back to breakeven, I will sell.” This can add enough selling pressure to thwart a stock’s advance unless there is overwhelming demand.

 

Current market scenario: On April 19, we had changed the market direction to a Downtrend following our rules on market direction. Nifty had corrected over 6.5% from the peak it made in February. Accordingly, most of the stocks had also corrected from their peaks. Thus there is overhead supply concern in many of the stocks.

 

Using MarketSmith India charts, it is easy for individuals to find out the amount of overhead supply. It is represented as “OH” on charts. For educational purposes, we have taken a daily chart of HDFC Bank to indicate the “OH” on our charts.

For example, let us say a stock makes a run from 50 to 100 a share and then tumbles back to 75. Now, if a buying area emerges around 85 and you end up buying at that level, chances are, you are facing people who bought at the 90–100 level. As soon as the stock is back around their purchase price, they will unload shares. Conventional market wisdom says to buy low and sell high, but overhead supply is one reason to buy stocks at or near their 52-week high. At those levels, there’s little or no resistance to work through. That is why it is a good idea to buy stocks just as they are breaking out of sound bases into new high ground.

 

Overhead supply doesn’t weigh on a stock forever. According to research, its effects diminish after 18 to 24 months. In other words, after a while, fewer shareholders are still around waiting for a price recovery to eliminate their loss.

 

So, before you buy a stock, study its chart carefully and check for overhead resistance.

 

Related: 

How to Preserve your Hard-Earned Money

A Stock Stays Sideways After You Buy It: How Long Should You Wait?

CAN SLIM Investment Methodology

Read our last week’s article:What’s a Follow-through Day?

What’s a Follow-through Day?

It is difficult to identify the start of a major stock market uptrend if you are relying on headlines and news. By the time, reporters figure out what’s going on in the stock market, the best part is over.
At MarketSmith India, we have a defined set of rules to identify the upturn in the market. It will remove any personal judgment.

It relies on a follow-through day, a device identified by historical research. Follow-through day occurs if a benchmark index (Nifty in our case) delivers a strong gain (+1.5% or higher) in volume higher than the previous session. That big gain on rising volume is considered as a follow-through day, which confirms that a new uptrend is underway.

We changed the market status to a Rally Attempt as Tuesday (April 13) was a blue rally day (Day 1) and Nifty managed to stay above its Day 1 low for two consecutive sessions. Now, we wait for a follow-through day to occur to confirm the uptrend as most of the major rallies in the market start with a follow-through day.

follow-through day can’t pick the exact day when a market bottoms, but can get you close to the bottom. The most powerful follow-throughs usually occur between the fourth and the seventh day of an attempted rally. There will be cases in which confirmed rallies fail. A few large institutional investors, who have large funds, can run up the market on a particular day and create an impression of a follow-through. Hence, follow-through day should be used in conjunction with other indicators to provide firm evidence. One of the other indicators is simply to check if there are fundamentally good stocks breaking out of sound bases.

A follow-through signal doesn’t mean investors should go and buy with abandon. It just gives you a go-ahead to choose high-quality stocks with strong sales and EPS growth as they break out of their bases.

Related: 

Using CANSLIM Parameters to Increase Your Chances of Winning

Investing in Stock Market

How Do We Spot A Follow Through Day?

Read our last week’s article:Why the Buyer Demand Rating is a Key to Finding Great Stocks

Why the Buyer Demand Rating is a Key to Finding Great Stocks

“For the best prospects, do a price and volume check of each week within the stock’s base to help you conclude if the stock is showing sound accumulation or too many price and volume defects. Next, do a fundamental analysis checking for excellent earnings, sales, and return on equity.” – William J. O’Neil, MarketSmith Founder.

Winning stocks typically start rising in heavy volumes before they move onto new highs. The strong volume increases indicate that mutual funds and other big funds are actively taking positions.

It usually takes such investors weeks or even months to accumulate the many thousands or even millions of shares that they need to fill out their positions. MarketSmith India’s proprietary rating, Buyer Demand Rating, which analyzes a stock’s price and volume trends over the prior 13 weeks, is an indicator of this activity.

A rating of “A” or “B” indicates that funds are buying or “accumulating” the stock. A “C” rating is neutral, and a “D” or “E” indicates net selling or “distribution.”

Look at a stock’s daily and weekly charts to see if the stock is rising in heavy volume. On the breakout day, the volume should be more than 40% above average, which would indicate big fund buying. You can confirm this action against the Buyer Demand Rating too.

You can view the Buyer Demand Rating on top of the chart of each individual stock in the MarketSmith India App.

Before buying any stock, it is advised to examine the stock using the Buyer Demand Rating. This rating can be used along with other tools such as the Master Score, which combines major proprietary ratings into one, including Buyer Demand, Earnings per Share, and Price Strength ratings.

As always, make sure that the overall market is in a Confirmed Uptrend and the stock is at a buy point in a properly formed base before jumping in.

Also, do not wait for the A/D Rating to fall to D or E before selling. Analyze the stock’s daily and weekly chart action before deciding whether to hold or sell. Pullbacks in below-average volumes are usually not a concern, but heavy-volume drops could mean that the institutional investors are bailing out.

Related: 

How a Rules-Based Investing System Helps?

Secret to Success in the Stock Market!

CANSLIM Strategy

Read our last week’s article:How to Count Bases & Why You Should?

Technical Analysis: A 3-Weeks-Tight Pattern on Chart Indicates an Extra Buy Point

Oftentimes, if a stock progress well, you may want to increase the holding of that stock in your portfolio. In such cases, to take a follow-up entry can be a smart move. At William O’Neil, we analyze how the best growth stocks behave soon after a strong breakout. It was observed that if a true market leader with top-notch fundamentals holds firm near a certain price level for at least three straight weeks, it can give the alert investor a chance to add shares ahead of another solid price run. 

Continue reading “Technical Analysis: A 3-Weeks-Tight Pattern on Chart Indicates an Extra Buy Point”