Vipin Khare William O'Neil India
In the stock market, nothing works 100 percent as how you would expect it. That's why you have to prepare to deal with failed signals.
In CAN SLIM, which is referred to as growth stock investing strategy, the market itself – the M in CAN SLIM – is the most important factor for making money. Your chances of grabbing profits in growth stocks increase when the market is acting right.
According to William O’Neil methodology, every major stock market bottom featured a follow-through day. It essentially confirms that a fledgling uptrend in stocks is underway.
After a significant decline in major indices such as the Nifty and the Sensex (think 10 percent or more), the follow-through marks a significant gain that typically takes place on the fourth day or later of a new rally attempt.
The gain usually must be a minimum of 1.5 percent, but it can be as high as 3–4 percent or more. Without exception, the follow-through must also feature a higher total volume versus the prior session.
All follow-throughs don't always result in a lasting market uptrend. So, it is important for an investor to reduce the risk of capital loss if the market fails to rally.
How does the 'pyramiding' buying strategy reduce portfolio risk? One thing investors can do to reduce risk is avoid buying stocks anew, with reckless abandon, when a follow-through occurs. Use the pyramid method to enter your trades. That way, you test the water and put more money to work only if the trades go in your favour.
Pyramiding involves buying in instalments instead of all at once. You buy the first piece with half of your allocated capital toward a single stock.
If the stock moves up 2–3 percent from your initial purchase price, make a second buy with 30 percent of your allotted funds. If the stock goes up 4–5 percent from the proper entry point, use your remaining allocated capital to make a final buy.
Example: Dr Reddy’s Laboratories has a strong fundamental and growth story. The breakout (1) from a flat base was on above-average volumes. If an investor wants to invest Rs 5,00,000 in the stock, then start by investing 50 percent (Rs 2,50,000) on the day it breaks out.
You can see that the stock fell after the breakout and a sell signal (2) was triggered as it breached its 21-day moving average. Had the investor invested Rs 5,00,000 the loss would be Rs 25,000 (around 5 percent). But, with pyramiding, the loss would be Rs 12,500 as the initial investment was only Rs 2,50,000.
One red flag that a follow-through may fail: Follow-through signals are more likely to fail if distribution days occur in the first few days of a new uptrend. This is one key red flag.
A distribution day, which points to institutional selling, involves a drop of 0.2 percent or more in the Nifty on higher volumes than a previous trading session.
Generally, a distribution day, within a few days of a follow-through, leads to a failed rally. The risk drops off sharply after the fifth day.
A second red flag: In the early stages of a new uptrend, strong action among leading stocks is crucial. Top-rated stocks should be breaking out of bases in big volumes. Strong breakouts signal that professional investors are stepping back to buy stocks.
Disclaimer: The author is Director- Research, William O'Neil India. The views and investment tips expressed by investment experts on Moneycontrol are his own, and not that of the website or its management. Moneycontrol advises users to check with certified experts before taking any investment decisions.
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