When you are a trader, the basic rule is to be on the side of the trend. There is no point in trying to short a housing finance stock at a time when there are individuals and institutions waiting to buy these stocks at every dip. The closer your trading strategy is aligned to the market trend the more you are likely to be successful in your trades. As a trader, your focus is on protecting your capital and hence bucking the trend add little value…
SPOTTING THE UNDERLYING TREND…
The trend can at times be intuitional and therefore quite hard to explain. But we are referring to trends that can be backed up by market data. Let us take some instances. When a stock is constantly being de-rated by analysts and traders, there is no point in trying to find opportunity. IT and pharma are classic examples where you would have been consistently wrong if you had tried to buck the market trend and buy these stocks. As a trader, you always try to find the best trading level. It is the trend that helps you to decide whether you should be buying on dips or selling on rises. Trading against the trend can be dangerous largely because you trade with strict stop losses. You may be theoretically and intuitively right, but if the trend is against your trade, it really does not matter.
HOW TO PLAY THE MARKET TREND?
Once the trend is identified, the next challenge is how to play the trend. There some basic rules here. Firstly, when the underlying trend in the market or the sector is positive, never try to short the story. You may be occasionally right but then the risk-return trade-off in your strategy will not be favourable. Secondly, before arriving at a sector-specific trend or stock-specific trend, you need to back it up with data points. What are the analysts saying about the sector or the stock? What is the ratio of upgrades to downgrades? Are the rating agencies downgrading or upgrading the sector? Are we seeing bouts of institutional buying or selling, especially from long-only funds? What is the volumes story in the market? Above all, what are the accumulation / covering signals that you can capture from the derivatives data? It is only with all these data points that you arrive at the underlying trend. Then you need to work out whether to buy, sell, buy on dips, sell on rises, stay neutral etc.
“There are 2 kinds of investors in the market. Those who don’t know and those who do not know that they don’t know” – Ben Graham
6 WAYS TO DECIPHER AN UNDERLYING TREND AND TRADE ACCORDINGLY…
- First is a market level trend. A quick look at the Nifty or Sensex chart along with higher tops, higher bottoms, MACDs and other technical indicators will give you a quick idea of where the Nifty could be headed. Once the trend is deciphered, you need to remember one basic thing. Indices are not stocks and hence a buy-on-dip or a sell-on-rises strategy will work best based on the underlying trend that you identify. Remember, once you identify trend, don’t every try to contradict the trend rule.
- Then there is a very important thematic trend. Themes are a set of companies that tend to benefit or lose out due to some key development in the market. For example, when the RBI cuts rates then all rate sensitives like housing finance companies, NBFCs, banks, real estate companies and automobile companies tend to benefit due to cheaper credit. On the other hand when rural incomes are likely to pick up then all sectors like FMCG, two-wheelers, white goods that can benefit from rural demand tend to do very well. When you are trading a trend, you need to be very clear that you have interpreted and deciphered the trend properly before trying to play it.
- Sectoral trends or industry trends are a lot simpler. You can refer to the performance of the sectoral indices on the BSE and NSE and that will give you enough ammunition to decide which sectors that you must play and in what direction. Normally, there are trends within the sectors like private banks within banks; four wheelers within automobiles, steel makers within metals etc.
- Stock specific trends are easy to spot and normally the impact can be gauged by higher volumes, new highs or new lows, institutional buying, analyst views etc. Such views can be helpful in identifying the trend for the short term as well as for the long term which means this intelligence can be used for trading and for investing.
- Global trends are normally quite apparent and are limited to stocks that have strong global dependencies. The impact of stringent FDI regulations on pharma companies and the impact of Trump’s visa policies on the Indian IT industry are cases in point. There can be unrelated impacts too. When Volkswagen got embroiled in its diesel controversy in the US, it had its impact on diesel car makers in India as well as auto ancillary companies supplying components to auto companies globally.
- Finally, from a trader’s point of view there is all-important intraday trend. Interestingly, this is one area where you can attempt a contrarian approach with a specific logic. When a stock corrects too sharply or rises too sharply, you can spot a contrarian trend of these long positions unwinding or short positions covering, which will give an opportunity to play contrary. But such trades should eschew the overnight trend risk!
STAY AS CLOSE TO THE TREND AS POSSIBLE…
As a trader the trend in the market is your biggest friend. Over a period of time, you will make more money as a trader by staying as close to the trend as possible rather than trying to second-guess the market or trying to play the contra game. Even at a time when the markets are directionless and virtually going nowhere, there are enough opportunities for you to identify underlying trends and trade them profitably. The closer you are to the trend, the closer you to staying profitable!