Technical Analysis : Trend Following for Investment as well as Trading

Technical Analysis : Trend Following for Investment as well as Trading 

Technical Analysis : 

Technical analysis assumes that all information studied by fundamental analysis is already reflected in the PRICE of given stock. It is a method employed to evaluate stocks by analyzing statistical trends gathered from trading activity, such as price and volume.

• In technical analysis historical data of stock is used to understand pattern of price movement and to evaluate stocks strength or weakness on the basis of the same.

• Technical Analysis has 3 major assumptions :

1. Price moves in Trend
2. Patterns tend to repeat 
3. Everything is factored in the PRICE

• Technical analysis is of great assistance for timing the entry and exit in investment or trading decisions.

Trend Following : What is that ?

There are forces of nature which function with their own characteristics. Eg. Gravity. It is an invisible force which ensures that everything stays down on earth. Anything thrown up in the air simply falls down due to gravitational force. Similarly in investing and trading price trend is an important force. Surprisingly price trend is the cause as well as the effect impacting prices.

Movement becomes effortless or with least resistance when one goes in the direction and in sync with various forces at play. Stock prices move in trends. Trends can be majorly of 2 types : Uptrend and Downtrend. Sometimes when market is not trending it can be said to be flat.

It makes sense to follow something that works. That is why Trend Following !

           HH=Higher High                                                        LH=Lower High
           HL=Higher Low                                                         LL=Lower Low   

Trends can form on all time-frames namely Hourly , Daily , Weekly, Monthly. From an investor perspective it is important to analyse and study trends on higher time-frames like weekly and monthly charts. From a traders perspective as the horizon is smaller it will make sense to study hourly or daily time-frame charts. Price trends on higher time-frames have more impact on the stock prices in the long-run.

Uptrend :

In uptrend stock price tends to make a series of Higher High(HH) and Higher Lows(HL).

All the Lows are higher than the previous Lows indicating that there is constant demand at declines which eventually leads to higher prices in future.

As the natural momentum is upward the stock price which is in uptrend moves effortlessly on the higher side.  Investors must invest only in those companies which are in uptrend on higher time-frames of weekly and monthly charts.

Downtrend :

In downtrend stock price tends to make a series of Lower High(LH) and Lower Lows(LL).

All the Highs are lower than the previous Highs indicating that there is constant supply at upsurge which eventually leads to lower prices in future.

As the natural momentum is downward the stock price which is in downtrend moves effortlessly on the lower side.Investors must always avoid investing in those companies which are in downtrend on higher time-frames of weekly and monthly charts.

Trend is your friend until it bends !

Charts for stocks are available free for study on -> (Trading View)

Diversification : Don't Put all your Eggs in One Basket !

Diversification : Don't Put all your Eggs in One Basket !

"Don't put all eggs in one basket" is very well-known quote in the investing community. Objective of the statement is to distribute the risk so that failure of any single investment does not have material impact on overall return of the investor. Technical term for distributing risk is called "Diversification".

Diversification can be done across asset-class like equity, debt, commodity, real estate etc. If you invest in assets that do not move in the same direction at same time and same pace then one can get benefits of diversification. Eg. In 2008 when the stock markets crashed big time, equity portfolios delivered high percentage of negative returns but at the same time debt(bonds) delivered positive returns which mitigated negative return to a certain extent for an investor who held equity and debt both in his portfolio at the same time. In this post we will deal majorly with diversification in respect to equity.

Diversification from Equity Perspective :

Why is there a need for Diversification ? Investment in shares is done after performing the necessary analysis. Analysis may be either technical analysis or fundamental analysis. How much ever detailed analysis is done it is never possible to determine and understand each and every variable out there in the universe impacting share prices. There is always a possibility of analysis turning out to be wrong due to change in known variables, or unknown variables may have adverse impact on the share prices and thus create risk of loss for investor. To reduce the impact of such risk, diversification is done.

Investment in shares provide opportunity for higher growth in long term. However the return from investment in shares is very volatile in nature due to drastic fluctuations in the share prices.

Important Points in respect of Diversification : 

• What type of shares to chose in portfolio of stocks for diversification will depend upon the risk appetite of the investor (Aggressive/Moderate/Conservative). However, stocks from same sector can be avoided in single portfolio from diversification perspective

• As per our understanding not more than 10% of equity portfolio must be invested in a single stock. Maximum of 15 stocks may be held in any equity portfolio. Holding very few stocks will increase the risk whereas holding stocks in excess of 15 is likely to dilute the returns along with the risk

• Warren buffet once said that "Wide(Over) diversification is only required when investors do not understand what they are doing". Wide (Over)- Diversification is time consuming, inefficient and also leads to increase in transaction costs of investor, reducing the returns

• Total Risk in Investment = Systematic Risk + Unsystematic Risk

• Systematic risk is the risk which can impact adversely the entire stock market or financial system as a whole. Eg. Political Instability, Natural Disasters, Change in Tax laws, Economic crashes, Recession Etc. It is difficult to manage or mitigate systematic risk due to it's inherent nature

• Unsystematic Risk is the risk which can impact adversely shares of a specific company or a specific sector. Eg. Change in regulations impacting one industry, Financial Fraud in a company, strike by employees of an airline company etc. Unsystematic risk can be mitigated to an extent with the help of diversification

• Diversification is very important tool available to all the investors which helps them survive in the financial markets and maintain a balanced growth in the long term

Important Parameters for Stock Selection in Investing - FINAL Summary

Important Parameters for Stock Selection in Investing - FINAL Summary :

Preparing a tasty dish requires a perfect combination of ingredients for a good outcome. Similarly for identifying a multi-bagger stock or a stock with good upside potential requires a perfect combination of ingredients which will substantially increase probability of stock turning out to be a good one. Below stated are few major ingredients which will help any investor in identifying and understanding whether the stock has good investment potential or not. Detailed analysis has been done for each point and it is prepared in a very user-friendly language so that even a common man can understand the same. If an investor understands and follows below stated points in his due diligence then chances of failure in investment will be reduced. Further diversification and risk management will also help investor reduce risk to the portfolio even if somehow a bad stock has been selected in the process of evaluation. In future we are going to publish more articles on diversification and risk management. Summary of Important parameters in stock selection process are as below. CLICK HERE has been provided for detailed view of each point

1. Sector/Business -> CLICK HERE

2. Promoters -> CLICK HERE

3. Returns -> CLICK HERE

4. Valuation -> CLICK HERE

5. Expansion of Activity -> CLICK HERE

6. Operating Profit Margins -> CLICK HERE

7. Debt/Borrowing -> CLICK HERE

Returns and it's importance on Investing in Shares

Returns and it's importance on Investing in Shares 

Introduction

Average nominal GDP growth rate of India was around 12% for the past 5 years. 

(Nominal GDP includes both prices and growth, while real GDP is pure growth. Real GDP  is what nominal GDP would have been if there were no price changes from base year. As a result, nominal GDP is higher than real GDP)

A return on capital in excess of nominal GDP can be considered as a good return from investor perspective. Return on Capital Employed (ROCE) helps an investor understand what is the level of profitability with respect to total capital employed in the business. Return on equity (ROE) and return on assets (ROA) are also important ratios to asses the efficiency of the business with respect to owners fund and assets deployed respectively. The higher these ratios the better. Again these ratios are measure of efficiency of business. We want to invest in companies/shares which are most efficient and thereby will yield investor maximum returns

Investing activity is normally undertaken with objective of capital appreciation. Returns which the underlying business generates has a substantial and direct impact on the share prices of the company. Higher the return a business generates with consistency the better share price appreciation will be reflected. Investing in equity (shares) comes with it's inherent risks. When capital is invested in shares a return which is in excess of risk-free rate has to be generated otherwise there is no rationale of taking the risk.

Formula for calculating Return on Capital Employed (ROCE) : 

Return on Capital Employed (%) = Earnings before Interest & Taxes / Capital Employed

Capital Employed = Total Assets - Current Liabilities

Formula for calculating Return on Asset (ROA) : 

Return on Assets (%) = Profit After Tax / Average Total Assets

Average Total Assets = (Assets at beginning of year + Assets at End of Year) / 2

Important points in respect of Returns : 

• ROCE and ROA are two important return ratios for evaluating investment in shares of a company. Companies with lower ROCE and ROA must be altogether avoided. ROCE must be always greater than weighted average cost of capital employed.

• Return on Capital Employed (ROCE) is a better assessment ratio for returns compared to Return on Equity (ROE) because it is possible to inflate Return on Equity (ROE) by taking high levels of debt which may not be sustainable for business

• By using ROCE, investor can compare whether company is employing it's capital efficiently in comparison to peers in the sector as well as on standalone basis

• News and media normally talks about profit and turnover figures. However for an astute investor it is important to verify how much capital has been employed to generate the amount of profits. Eg. Business A and Business B both in same sector have generated profits of 40 crore for the year. But Business A has employed 250 crore of capital and Business B has employed 175 crore of Capital. With this data we can easily determine that investor will be willing to invest in Business B because it is more effective

• Return on asset (ROA) is higher for companies with asset-light business model rather than capital intensive businesses. Eg. Sectors like Steel, telecom, defense etc. have low ROA while consumption companies are likely to have higher ROA