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I am a very strong believer in the philosophy of trend following and hence this post of mine is a sort of anathema to my doctrine. But a belief in a certain approach should not mean that we close our eyes to strategies which we may not like but one’s which may have their advantages.

While catching a falling knife maybe disastrous to a short term trader who more often than not is leveraged beyond his capacity, the same cannot be said for a investor who is willing to take calculated risks with the intention to profit when the trend shifts to the other side.

As with all such falls, it’s normal for noise to obliterate the signal that is present alongside. As with every other fall, it’s becoming the new normal to see people comparing this to the start of the fall that we saw in 2008. This time around, we have the additional benefit of this being compared to the 1991 payment crisis India faced and the 1997 Asean Crisis (which did not affect India but caused large scale economic devastation across most countries of South East Asia.

Fortunately our current situation is comparable to neither of the two situations being referenced. While it’s true that we are having huge troubles in containing the Rupee, we still have a strong forex backing (which we did not in 1991) plus we have seen a pretty large depreciation already happen without it being a one off shocking event.

As to the Asean crisis, RBI has not tried to act the way the central banks there acted to save their currency from depreciating (since most of them had fixed exchange rates) which made the situation worse than what it was already. While we do have some similarity in the foreign exchange exposure of local companies like they had, as a percentage of total debts, its still very much on the lower side and something that should not break the bank when the time comes for repayments.

The recent sharp depreciation has been due to the lower arbitrage between US yield and India yield and unless we start to believe that companies in US will be able to pay huge costs to borrow, some reversion to the mean is bound to happen and one that should result in some amount of reversal of money back to India.

Having said all this, is this a time to Buy India (or rather Indian stocks), I am not sure on that count since the mere fact that many companies are available cheap does not make them anymore worthwhile then they were a couple of months ago. In fact, many face even bigger problems as Interest rates are not bound to come down anytime soon and that should have an impact on all firms which are leveraged with debt or dependent on leveraged customer for its revenue.

While markets seen to have fallen a great deal in recent times, a cursory analysis seems to suggest that the fall we have seen till date is around the average fall we have been seeing in every correction post 2009. The recovery from the said falls on an average seems to have returned a average gain of 18% which is a pretty fair gain after the bone crushing fall one would have seen just a couple of months earlier.

If anything, volatility was much higher (swings much larger) in the period from 2001 (post IT crash) till 2008 with average fall being to the tune of 20% and average gains being seen at 59%. But the overall bullishness made the deep cuts more acceptable than at the current juncture when with sentiments already running bad, even the slightest of cut seems not tolerable.

While I continue to remain bearish (on medium to long term investment) on the Indian markets, I believe that for a trader, a great opportunity maybe on the horizon with a minimum gain of 10% to a maximum of 18% seemingly in the taking. What that requires is not just the vision of Bharat nirman, but the ability to take long trades whenever one feel s that this maybe a bottom. By using stops, one can ensure that in the worst case scenario, all we suffer is a slight bruise and not fingers lost for life 🙂 

 I for one believe that this fall would not beat 2008 either in speed or magnitude, but if it does, well, we know that my predictive ability is close to zero 🙂

Robert Pretcher’s definitions and observations regarding fundamental analysis are the following:

1. “First let’s define ‘technical’ versus ‘fundamental’ data…technical data is that which is generated by the action of the market under study.”

2. “The main problem with fundamental analysis is that its indicators are removed from the market itself. The analyst assumes causality between external events and market movements, a concept which is almost certainly false. But, just as important, and less recognized, is that fundamental analysis almost always requires a forecast of the fundamental data itself before conclusions about the market are drawn. The analyst is then forced to take a second step in coming to a conclusion about how those forecasted events will affect the markets! Technicians only have one step to take, which gives them an edge right off the bat. Their main advantage is that they don’t have to forecast their indicators.”

3. “What’s worse, even the fundamentalists’ second step is probably a process built on quicksand.… The most common application of fundamental analysis is estimating companies’ earnings for both the current year and next year, and recommending stocks on that basis.… And the record on that basis alone is very poor, as Barron’s pointed out in a June 4 article, which showed that earnings estimates averaged 18% error in the 30 DJIA stocks for any year already completed and 54% error for the year ahead. The weakest link, however, is the assumption that correct earnings estimates are a basis for choosing stock market winners. According to a table in the same Barron’s article, a purchase of the 10 DJIA stocks with the best earnings estimates would have produced a 10-year cumulative gain of 40.5%, while choosing the 10 DJIA with the worst earnings estimates would have produced a whopping 142.50% gain.”

Quoted from the book “Technical Analysis of Stock Trends by Edward & Magee” 

Link: http://is.gd/qwSmO6 (Amazon, India)

Las Vegas attracts a whole lot of people to its casino’s. The mix is varied from the Superstars to the con man on the street and every one of them has only one reason to be there – an attempt to make money at the games. The thrill of making money via luck is not limited to casino’s either with Lottery tickets being there at the top for a long period of time.

In both the cases, it isn’t that the player does not know the adage of “the house always wins” or even the fact that the odds are very strongly aligned against you. But in both the cases, the lure comes from either knowing or actually winning on a casino or hearing about a person who bought a lottery ticket which fetched him millions.

Every one of them hopes that they shall come out with more money than they go in and while not everyone loses, over a long period every one of them would have contributed to the kitty of the casino in one way or the other. The odds aren’t totally skewed in favour of the casino (who would want to play if one cannot see one single guy making money) but the odds are always in favour of the casino. The odds are actually even worse in lottery tickets (with many a jackpot having odds of 1: a couple of million) but since the news program has the winner flushing himself / herself with the winning ticket, the attraction is far too much to ignore for many.

In the markets, I have seen enormous interest in options since the risk is said to be contained while profits unlimited. Charles M. Cottle in his book “Option Trading – The hidden reality” says that the best professional traders earn around 100% per annum which is about 6% after commissions. Most traders on the other hand expect to double their capital within a month if not less.

As a trader, if you want to survive long enough in the market, do remember that it’s not the small wins that count but the big outliers. Small wins may give you the happiness associated with making money, but it’s the big outliers that actually enable your capital to grow exponentially.

One of the often repeated arguments I have heard with regard to trading systems is to be keep it simple (K.I.S.S) with there being no reason for extra complication. To me, that is a lie of the n’th order. Think about it for a moment in the logical sense, if everyone could easily follow a method to endless riches, why should anyone bother to take any risk elsewhere or even strain muscles / brains by working for someone else. All you would need is a PC with Internet connection and you would be good to go.

In the world of Finance, nothing comes without risk. Risk is always lurking in the background, ready to pounce on at a moment’s notice. But since not all risks are evident, we tend to basically ignore that very important aspect.

While there is no such thing as Risk Free investment, some investments do come close in that regard. Bank Fixed Deposit is one of them. If you have placed a deposit in any PSU or even Private Sector bank, the probability of losing money is next to nil (but not nil). Even when private sector banks have collapsed, depositors have not suffered losses thanks to RBI which would force some public sector bank to take it up (remember Global Trust Bank for instance).But there is risk, just that the probability at the current juncture of something on those lines happening being very low.

Other than Bank FD, the simplest way to invest money elsewhere is in Gold and Real Estate. Since cycles in both these asset classes are long, for quite some time, it’s being felt that these are the only two asset classes to own. Unfortunately in the world of cycles, after a big run up, there is a big sideways action or worse a big downside action. Either way, the returns over a long term isn’t great especially if one invested at the top of the previous peak.  But for those who invested prior to 2005, returns have been magnificent to say the least. But the profits one is sitting on is notional and unless removed, the returns can actually dilute over time if prices move either sideways or downward.

So, that leads us to the markets. There are basically two ways to invest in the markets. One is via Mutual Funds who pool the money, hire a professional fund manager and who hopes to beat the market over an extended period of time.  Second is by way of direct investing where you decide what to buy, when to buy and how much to buy as well as when, how and where to sell. Once again, the attempt is to make more money than what can be achieved by either investing in a Mutual Fund or Fixed Deposit though neither is a good benchmark given that risks and returns are different for each of them and most importantly, both of them do not require a significant amount of personal time to monitor.

The set of investors who invest in markets directly can be further separated on the basis of what kind of analysis they do. Most either fall into Fundamental or Technical while quite a few do not have any analysis to speak of but are more or less dependent on their brokers or the talking heads on TV to give them something by which they can make a penny.

While there have been plenty of successful investors whose approach was based on picking up value stocks at a cheap price, the overwhelming fact is that we look at the winners and ignore the losers. Sanjay Bakshi in his interview with Safal Niveshak (Link: http://is.gd/txIPLX ). He says and I quote

“You just have to see how people have got rich in stocks. If you look at genuinely successful people in the stock market, you will find that an over-whelming majority of them bought stocks of good companies at attractive prices and just sat on them for a long-long time.”

Well, the point that is overlooked here is that if you bought a great share which subsequently tanked, you would not be rich by just sitting on it. It also brings to question as to how much part of the success can be allocated to skill and how much to Luck. As Nassim Taleb says “it’s so easy to confuse luck with genius” you may never know the lucky breaks they had which made them the persons they are now. And for a live example, one needs to go not too far but look at the picks of a guy who was once said to the Warren Buffet of India.

Value Investing requires a lot of work, determination, patience and a fistful to luck. Without one of the ingredients, you can always have value stocks but one that never seems to be noticed by the markets. There is nothing simple in terms of work and at the end of the day, you hope that the light you see at the end of the tunnel is the opening to freedom rather than headlight of an oncoming train engine.

That leaves me with only Technical Analysis to talk about. Being a practitioner of technical analysis for more than a decade now, it’s a field that has interested me a lot and one that has provided me the bread and butter over the years. Even among technical analysts, you can find a clear demarcation. There are one set of guys who trade based on discretion and another who wants to follow a tried and tested mechanical approach to trading markets. While there are quite a few guys who are good at reading charts, most of those I know aren’t actually full time traders in the sense that even if the markets provide them with nothing, life goes on as usual.

On the other hand, there is this set of traders (which includes me) who believe that while its acceptable to trade small money based on views, when it comes to managing money professionally or even if you want to take higher risks in anticipation of higher rewards, one cannot blindly bet on our reading of charts and instead would love to have something tried and tested to work with.

But mechanical trading system for many starts and ends with Moving Average Crossovers. It’s not that there is anything wrong with MA cross, many random numbers do somehow come out with positive outputs but the question is, is the positive output alone worth the risk and the efforts that go into making that effort.

Unlike fundamental investing where you buy the shares of a company and sit tight hoping you are right, technical trading requires more attention (depending on the kind of time frame one chooses). While technical analysis offers many tools, due to the ease of use, MA Cross seems to attract the highest attention of investors and traders alike.

But unfortunately the fact of the matter is that the probability of making big money using a MA Cross is very low and if one adjusts the risks taken to get that reward, it does not even start making any sense.

Every one of us has limited time but unlimited requirements and it’s important that the time we have is well utilized instead of being wasted in a venture where the net output was zilch.

I had recently tested out MA Cross on daily time frame and given the results in an attempt to show that it does not make sense. To make it even more hard hitting, I have now tested 19208 combinations under every time frame – starting at 15 minutes to Monthly. As can be seen in the results, nearly every one of them have under-performed the Buy and Hold which suggests that one would have done nearly as well by just sitting as Jesse Livermore is quoted as saying.

In addition to the normal back-test metrics, I have also calculated Expectancy (Link for more on that: http://www.tradermike.net/2004/05/trading_101_expectancy/ ) and if you were to take the best (which you would not possibly have known when you started to trade – Hindsight bias), you shall see that even that under-performs a normal Buy and Hold. And this despite me not taking into calculation any brokerage (since High and Low is taken as entries, slippage can be taken as being included).

The testing was done on Nifty since it absolves one of many biases which can ruin any test if done on any stock or a set of stocks.

You can download the results here (Link: https://dl.dropboxusercontent.com/u/19628087/EMA-Crossover-Intra-D-W-M.zip )- file size is around 40~MB

To conclude, if you are trading on a MA Crossover idea, I would urge you to think deep as to whether it’s worth the time and effort and whether you are better off investing the same into a Index fund and using the time for other pursuits.