THINGS TO REMEMBER.
Last day of an epic year!!
A year, during which I shifted jobs, moved out of IT, moved cities, got married, formed new relationships, turned 30, and started this blog from scratch!
Phew!! If that is not happening, I don’t know what else would be 🙂
Hopefully, 2019, will be bigger, better and stronger!
A lot of moving pieces, which I hope will settle down soon and a lot of new pieces, which I hope will pose fresher challenges!
Down to Business!
In the last blog, I touched upon what are trends and the different types of trends.
Here is a continuation post, where I am going to list out three critical features of trends, which is essential while trying to gauge a trend.
#1 – Parts of Trends in a Stock!
A tide, a wave, and a ripple. These are the three larger phenomenons of which water can be a part of.
Tide is usually high or low. Waves make up a tide, coming in and moving out in intervals. A ripple is a minor disturbance that occasionally happens due to some external activity, like when you throw a stone in, and it flutters for a moment.
I will own up that these aren’t ideal definitions, but then you guys get my point! 🙂
Similarly, the price of an index or any instrument for that matter like commodities or stocks or currencies, over time will have three parts to it.
Part one is a primary or major trend, akin to a tide. They last for a year or more, showcasing the general direction of the market.
Part two is a secondary or intermediate or interim trend, which moves against the primary trend. It is akin to a wave. Many interim trends make up a major trend and are also called ‘correction.’ These last for anywhere from three or four weeks to twelve months.
Part three is a minor trend, akin to a ripple. They happen for the shortest period, generally classified as noise. These are typically fluctuations in the interim trend helping it take a direction.
Below is a snapshot of the National Stock Exchange (NSE) index – NIFTY50, which consists of 50 stocks acting as the benchmark for Indian Equity Market for the last decade.
AB is a trend line, indicating the major trend in NIFTY50.
A trend line is a line we draw to help us give the direction of the trend. In an uptrend, a trend line is drawn by connecting the bottom of higher lows and in a downtrend; a trend line is penned by connecting the top of lower highs.
It is quite clear that the index is in an insane uptrend since February 2009, climbing up to 10867 points from around 2500 points. It is the primary or major trend!
The rectangle box marked between February 2015 and February 2016, shows an interim trend, when the Nifty fell from around 8800 points to 6900 points, before climbing back to the current levels of 10800.
The little red oval shape inside the interim trend highlights an uptrend from April to July 2015 is a minor trend which is within the interim trend.
Please note that since I have taken a larger window, the minor trend does not comply with the ideal definition of being below three weeks. However, then it is subjective concerning the major trend.
For a technical trader, the primary trend is too large a timeframe to make money. The primary focus should be on the interim trends and the reversals around it while using the minor trend to time market entry.
#2 – Phases of Primary Trend!
‘Dow Theory’ suggests that there are three phases in a major trend which are accumulation, public participation & distribution.
P.S – I have tried to give a graphical representation of the three phases below. It just an indicative figure for understanding.
Accumulation Phase – This is the beginning of a reversal. Imagine that a stock is in a downtrend, but there are signs that things are turning around in the company — a change in management or a fresh lease of investment or positive government reform. In general, two kinds of investors pick these signs up at the earliest.
First are the ones who are astute investors, who pick up on the cues. Second, are the ones who are close to the company. Both realize that a turnaround is around the corner and start ‘accumulating,’ typically in large numbers which initiate the turnaround.
Public Participation Phase – This is the second phase when the reversal starts reflecting in the technical chart, which gets picked up by technical trend followers. Prices begin to advance rapidly, and traders form entry and exit criteria. As and when the trend shows continuation, traders increase position size based on the available capital.
Distribution Phase – This is the third and final phase when the news breaks out about the turnaround in the stock gets mass coverage. Every possible tip service starts covering the positivity around the stock. The general public and novice traders jump into the bandwagon.
People who accumulated during the first phase tend to liquidate their position as during the distribution phase. The stock manages to climb up steeply during the first half of this phase before losing steam.
When the technical indicators give out the exit signal, people who entered in the second phase start to exit. Eventually, the late joiners get trapped in the market, losing capital. 🙁
The bottom line is that, to make money profitable, one need to enter during the first two phases and as traders, we come only during the second phase as we don’t have the know-how or resources to capitalize the first phase!
#3 – Volume and Trend!
It is probably the oldest thumb rule. A trend is decisively stronger clear when it combined with an increase in the volume of shares traded.
Suppose a piece of news about a particular stock let’s say a merger comes out. There will be overall positive sentiments, and there will be more buy orders, which in turn will reflect in the volume.
Same way, if news about a negative regulation comes up, there will be an overall negative sentiment, and there will be more sells orders, which will again show a spike in volume.
I will have a more detailed post on volume analysis in future.
Getting the foundation right is important towards building any structure.
The three features mentioned above are the foundation of technical analysis driven by trend and understanding this is important to proceed further. Looking out for these should eventually become an instinct with practice.
An obvious question that would arise once we understand the basics of trends is – “Do we enter every trend, and how do we go about deciding it?
Though it is a vast area, I will share my initial notes in the next post.
Until Then, Cheers,
N.B – Below are the resources I referred to for this post:
- The usual suspect – “Technical Analysis of the Financial Markets” by John J Murphy
- I did use a lot of blogs and videos for this post but almost all of them were a subset of what is mentioned in the above book. Hence, I am not quoting it specifically.
- Charts are as usual from www.investing.com