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Innings under Consolidation

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After the sharp fall witnessed in the first month of the new year, the Indian benchmark indices for the last few weeks have been consolidating in a range.

The moves in such consolidation have been very sharp and swift.

The idea of a rangebound market is a difficult one to comprehend in terms of a trader’s point of view, because in such cases he is likely to lose more money than in a trending market. Ideally for any ‘trader’ in such markets, with each losing trade the trading capital has to decrease, but as the human feeling of inevitability grows, the size of the bet goes higher.

It is however noteworthy that there are always three types of trends in the market, uptrend, downtrend and consolidation. Yes, consolidation is also a trend in the market.

Let us take a closer look at consolidation pattern: After a sharp trend in the market,(either uptrend or downtrend), the markets likely fall into consolidation. Now why does this happen.

Generally as the market witnesses a sharp rise/fall in prices, there are a lot of new investors and traders who enter into the market and with each win their bet goes higher and higher. After a critical level has been attained by the market, either in terms of a new resistance being broken, or a new support being breached, the sentiment just intensifies and we see a flurry of activity in select stocks and indices. At every breach of a support or a resistance, the activity intensifies, because there a number of stop loss orders for shorts or longs, respectively, which gets triggered, and investors are looking to exit and book their losses. However, there are a section of investors who have a slight different perspective in such times. They believe that either the market is highly overvalued or highly priced in a rising trend or they are of a belief that the stocks have been hammered to pulp, and that this is a strong level to start nibbling in from a longer term perspective. Either case will lead to a strong bout of volatility in the market, with the markets trying to find a suitable top or a bottom.

The type of consolidation also differs in different market conditions. For those who trade on breakouts or breakdowns, their portfolio becomes subjected to a lot of whipsaw, as markets either have a contracting range of a expanding range during consolidation.

Also in such range bound markets, the technical indicators generally provide a mixed picture of the markets, hence I believe that the best way to sail through such times is to trade light, and nimble. Adhere to the stop losses and trade only liquid stocks. In falling markets liquidity generally diminishes thereby making it difficult for the investor to exit his full quantity of stock at lowest impact cost.

Written by Kunal Bothra

March 14, 2011 at 1:12 pm

Posted in Market Watch

Tagged with , , ,

Investor Sentiment in Bull/Bear markets

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As I write this article, Indian equity markets are trading at new 52-week highs and very close to their all time high levels. After seeing such strong momentum the one question which still lingers in the minds of many investors is whether we can trust the strength of the market or blindfold ourselves to the actual truth.

More precisely, ARE we in a BULL market or is it just a strong Rally from the deep lows?

post imageI believe that the key to understanding the markets and also to trade successfully is to understand the psychology of an investor at every stage of markets. Why do resistance and supports occur on charts and why does price correct from these levels. It’s because there is a significant amount of investor sentiment seen at such levels. The more the time taken for a chart formation and the more the number of shares traded in a range, the more powerful is the breakout/breakdown, because of the high number of sentiment’s involved.

The two most widely used terminologies for depicting the investor sentiment are ‘optimism’ and ‘pessimism’.

Let us discuss the case of a bull market. In bull markets there is an aura of euphoria and exuberance amongst people. The general outlook of an economy is that of prosperity, probable decoupling of the economy from other world markets, to put it crisply, there is ‘optimism’ everywhere. For example, according to the socioeconomic theory, a very interesting theory is that, in bull markets we see that animation movies perform very well. This is mainly due to a cheerful sentiment among the people.

There is an urge to outperform our counterparts in bull markets. We don’t want to miss out on any new ideas and want to implement every new strategy to make big returns. This gives rise to a sense of speculation in the minds of a so called ‘investor’.

Speculation is an activity seen more when there is subjectivity and good amount of difficulty in determining the true value of a stock. Speculation in stocks pushes the prices to unfathomable levels.

During a bubble however the propensity to speculate is high, many big sized players in the market argue for higher valuations for a young, currently unprofitable but good potential for growth. By contrast, the value of a firm with long earning history and tangible assets is much less subjective, and thus the stock is likely to be less sensitive to sentiment. That is probably the reason why we see a string of previously unknown companies making headlines, we see a good number of IPO’s in the markets getting launched and many of them even with a satisfactory business model making it big. I believe that is where the crux of the bubble scenario is, that the midcap and the small cap stocks will always give higher returns as compared to any other large cap stocks. Such mid to small sized company stocks give good returns, because of high amount of sentiment involved in them.

Now let us discuss the case of a bear market, there is fear and panic around. The general belief is that the worst is not yet over, and there is still more to come. Investors are made to believe that the fundamentals of a company cannot improve any further. In the socioeconomic theory, by a similar logic to that of bull markets, more horror movies would get successful, because of the fear existing in the minds of the people.

Corrections are generally sharp because there is FEAR which is the predominant sentiment involved. As I quote from one of the famous dialogue writers “Madness is like gravity. All it needs is a little push. Nobody panics when things go according to a plan, even if the plan is horrifying.”

I am sure very few people are aware of the HEM-line indicator. The theory states that the stock market rises and falls with women’s hemlines. This is another example of the prevalent psychology of the investing public.

I think the bull and bear phases of any markets are formed based on the sentiment of the investor.

The key to making money in stocks is not to get scared out of them.

–          Peter Lynch


Written by Kunal Bothra

October 18, 2010 at 5:10 am