A successful self trader – Rule # 38
Remember, the market always has a story to tell. It happens so often. We wonder as to why certain stocks are behaving so irrationally. Stock seems to be great but keeps plummeting. Sector outlook is rosy, but it is performing below par. In all likelihood, the market is trying to tell you a story. Keep your ears open and listen. Herd instincts may be wrong. Collective wisdom is rarely, if ever, wrong.
The indisputable wisdom of market signals
The legendary trader, Jesse Livermore, once said “the market is a hard taskmaster. But it is also a great teacher.” Typically markets represent the worst of herd instincts and the best of market wisdom. It has rarely happened that a market has made a big movement without giving sufficient warning and indication. It is just that we miss the woods for the trees.
Let us take the example of Educomp ltd. Once touted as the next big thing in education, it started quoting at crazy valuations in the heydays of 2007. Sadly, when the tide turned, the company saw its costs static, its margins dipping and its huge debt burden impossible to service. By 2013, the stock had lost over 95% of value, but can’t complain. Market gave enough hints.
On the positive side, let me talk of Bharti. The stock listed in 2002 and fell to almost 50% of its listing price. Around 2004, the numbers were picking up and Airtel was getting the free benefit of network expansion. By 2006, the stock had got close to the 1000 mark, a phenomenal outperformance in just 3 years. But for the more discerning investors, the hints were always there.
3 reasons why the market is able to forewarn you
Markets represent collective wisdom
The markets are not just about you and me! It consists of traders, arbitrageurs, long-term investors, insiders and hedgers. Their collective research and wisdom is unlikely to miss out anything of importance. You may miss out!
Some insider is always better informed
It could be a tip-off from an insider. Probably, a banker has mentioned about a client whose balance sheet is getting murkier. A lawyer chats up about a legal wrangle that can go horribly wrong. Just listen to the signals!
Markets are a zero sum game
The biggest advantage is that the market, per se, is neutral. Most trading and investment decisions tend to get distorted by bias. A market has nothing to gain or lose from a price movement and hence is closest to the truth.
“markets are never wrong. Opinions on markets are often wrong” – Jesse Livermore
5 ways the market gives important signals
- Sustained price movement is the simplest and most critical insight the market gives. This movement could be on the upside or on the downside. Sustained rise over several weeks and months never happen without a reason. Few understood why titan was rising, but it was always an obvious proxy for gold. It ended up being a 40-bagger in 4 years.
- Watch out for volume changes. These are an obvious give-away. Of course, there is that speculative volume, which is rarely sustainable. The sustainable volume comes from HNIS, big traders and institutions! Always watch out for the price movement along with the volume data. Sustained price rise with sustained volume increase, signals a big story! The reverse also holds true.
- Watch the insider and bulk trades data published by the exchanges on a daily basis. Of course, they only report beyond a threshold, but when institutions sell, en masse, you know something is wrong. Also see if filings hint at sustained selling by insiders and directors. L&T and Crompton saw big selling before the price correction. Again market signals were always there!
- Watch out for the futures and options indicators. A stock selling at a sustained discount without dividend indicates too much shorting. Not a good sign. Index futures quoting at a huge premium to the underlying also indicates market froth. Above all, when institutions buy deep otm puts it’s the proverbial lull before the storm!
- Most dangerous of all the indications that markets give us is the nonchalance of certain stocks. When a stock refuses to react to obvious bad news, it is a sign that the liquidity has been consistently cornered by a handful of players. Hence they are controlling the prices and defying gravity. When the trend shifts, such stocks can go for a free fall. Heed the warning!
Classic examples of not listening to the market
Between 2007 September and 2007 December, the indices showed unprecedented volatility with sharp spikes. The market was warning about pain ahead. January 2008 was the beginning of one of the most violent corrections in the market, where the index lost close to 60% from its peak. In late 2008, there was clear evidence of short selling in real estate stock futures. By mid-2009, they had lost close to 95% of their peak value. Same is the case with PSU banks in 2012. The market jitters were visible long before the fall started!
If you look at the history of stock failures, the markets have hinted anywhere between 3 months and 3 years in advance. Kingfisher airlines, Deccan chronicle, Satyam computers, Educomp, first leasing, ft are all failed companies where the markets had started giving price and volume signals well in advance. It was misplaced optimism that kept investors going.
Takeaways from the “market wisdom” debate
Long before the global crash of 1987, Paul Tudor Jones saw that the market was becoming a pressure cooker because of too much portfolio insurance (put buying). He estimated that a small fall will have a domino effect and went short. When the us markets tanked on black Monday (1987), he ended up a lot richer just by listening to market signals.
The great Jesse Livermore famously said, “Remember, don’t fight the tape”. Of course, he was referring to market prices in the previous era. But the moral of the story has lived for a 100 years. Respect the market for its collective wisdom, listen to the signals in the market, interpret them carefully and implement them to perfection. You may have just struck gold!