Identifying signs of sideway markets & stocks, strategies to build a portfolio
More than investing wisely the cash in hand, what is more important is for traders and investors to not get caught in stocks, which are going nowhere.
Sideways markets are some of the most frustrating period in the life of an investor or a trader. Money is blocked and the only thing to do is wait it out, either hoping that the price targets are hit or the stop loss gets triggered. In such times, one feels that the capital could have been effectively deployed by parking it in a liquid fund. For a very long term investor, who intends to hold the company perpetually, such sideways market does not matter, but for most of us who are in and out of the market regularly, sideways market are those pain points that are best avoided.
Treasury departments of a corporate house and the banks have a job where they have to ensure that excess money is always deployed in some interest-bearing instrument. Money is therefore placed either in call money markets or in some liquid funds, which earns interests.
Many households do not manage their money as aggressively and prefer in keeping cash at home or are in low interest bearing instrument like a savings bank account. Even small, the incremental money saved by selecting a higher yielding product adds up to a tidy sum over the years.
For investors and traders, their equivalent of keeping cash idle is being invested in a dud stock, which is not going anywhere. Though there might be market conditions where the investor or trader would not like to be in the market, he can keep the money in a liquid mutual fund. The interest earned can help him take care of some of the losses, which he will be taking in the course of his trades.
However, more than investing wisely the cash in hand, what is more important for the traders and investors are to not get caught in stocks, which are going nowhere. But that’s easier said than done as it is not easy to predict if a stock is likely to move or hover around the same place.
FOR A FUNDAMENTAL INVESTOR
A fundamental investor needs to track is if the growth of the company is flattening. Normally two quarters of flat or negative growth results in many savvy investors exiting from the company. If big money is getting out of the stock, it is a first sign of the stock topping out. In case of commodity companies, investors also track the prices of underlying commodity to get an idea of where the stock is expected to move in future. If commodity prices have started to fall the stock follows with a lag. This method is generally used to judge stock direction and not the overall direction of the market. Judging the overall direction of the market needs a better understanding of money flow and macro-economic environment, both in the domestic as well as international markets.
FOR A TRADER
A trader faces more difficulty in identifying sideways direction. Often the answer to his question comes a bit later, but that is the nature of the game. A trader, especially those who trade with price action as a basis for information have to identify a trend very early in their diagnosis of the trade. After preparing the market structure, it is important to know the trend and then be ready to search for opportunity in direction of the trend. The answer to this question will decide the approach to take in placing a trade.
For those traders who use chart patterns and other input signals like a moving average crossover, there are signals, which directly tell you the direction of the market. However, let us first look at the market from the point of view of a price action trader. A price action trader only has the price and volume chart in front of him. He generally does not use any other technical tools to analyze and trade the market. For him an uptrend is when the market is making successive higher highs and higher lows. A down market is when the market is making successive lower lows and lower highs.
A change of direction from an uptrend to a downtrend takes place when the market pierces the first higher low in an uptrend and makes a lower high. In the case when a downtrend changes direction to an uptrend the market should be piercing the most recent lower high and then making a higher low than the previous one.
Trend identification and identifying a change of trend is the easier part, but the problem comes to identify the start of a sideways market.
A sideways market has started after an uptrend when after a higher low, the market is not able to pierce the previous high nor the correction is able to pierce the previous low. Even if the second such attempt fails, then the price action trader calls it a sideways market. In the case of a downtrend if the recent low is not broken and the lower high preceding it is also not pierced then the market is said to be in a sideways direction.
During such markets, a trader looks for opportunities when the stock approaches the support or resistance levels. An easier way to find the direction of the stock or the market is to look at the same chart in a line graph rather than the traditional bar chart or candlestick chart. The line graph clearly displays the direction of the market, which is easier to see minus the noise of the other data points like open, high and low makes.
For a technical trader who bases his trading by looking at patterns or input signals there are various tools that inform about the direction of the market. Moving averages are the smoother version of a line chart, if the slope of a shorter period moving average has flattened then it is a sideways market.
However, professional traders use more complex tools like the Average directional index popularly known as the ADX. This index is not only used to inform about the direction of the trend but also the strength of the trend. A value of over 20 of the ADX is considered that the stock is in a strong directional movement.
Finally, many traders use the trendlines to determine the direction of the market. An upward directional trendline is created by connecting the first low of the trend to the most recent low that resulted in a new high. In the case of a downtrend the first lower high is connected to the most recent high, which had resulted in the price touching a new low. The slope of the trendline determines the direction of the market. If the slope starts flattening, it indicates a sideways market.(The writer is executive director of Trade Smart Online)