In case you are an existing investor who fiddles a lot with your portfolio, this post might be more relevant. Though for long-term investing this also be equally informative. Stock entry is very critical as technically you get one shot at it! You can choose to exit at various points (and circumvent your mistakes), but a bad call on buy can sometimes be an eternal loss-making proposition.
Many times retail investors blind speculation on the price movements. The stock market has speculation ingrained, but when I say “blind speculation”, it means one does not have any data backing the decision at that moment. It is as good as pure gambling. Over time, I have been trying to form a limited and uncomplicated set of principles that I stick to while making buying decisions. No one is capable of making 100% right choices, but if you keep a template in front of you, and learn and iterate over it, you could be moving in a better direction. In this post are listed some of the decision-making pivots I follow. The outcomes aren’t favorable all the time, but in retrospect, I have found more value through this instead of outright gambles.
01
VolatiLE TRADING ZONE
Avoid
Markets are volatile with sharp price movements during open/close of session.
02
SUPPORT LEVEL
Accumulate
Build conviction to buy at technical support levels.
03
RESISTANCE LEVEL
Avoid
Wait for resistance level breaches even though it means lost opportunity in price spurts.
04
TreND SIGNALs
Depends
Rely on signals such as MACD and Volume Indicators
05
52 WEEK LOW
Avoid
Do not catch a falling knife. Wait for trend reversals.
06
UNDERVALUED PE
Accumulate
Avoid PE well above historical average, and wait for price/time correction.
VOLATILE TRADING ZONE [SHORT-TERM]
Markets fluctuate a lot during open of the session just after the opening bell. This is when the traders are also most active. There is a tendency to make instinctive buys seeing price movements. Many times this has backfired, especially when there is a strong bearish wave due to some broader news or sentiments, and one can get into a downward spiral of averaging. I tend to wait for the price to stabilize over the day. This helps in extreme volatility, especially on high beta stocks where the price can move even 5-10% on either side in an hour.
SUPPORT LEVEL [MID-TERM]
Support levels are price zones where technical indicators say that the stock is getting oversold and started to gain buyers’ interest. There will be different support levels based on various retrofitted time ranges (hourly, daily, weekly, and monthly). If you are an investor (and not an intraday trader), a weekly/monthly range is something that would be preferable to track.
My strategy employs setting aside a cap on the amount to invest for the stock, and distributing buy actions near to support level in a downward averaging method. It essentially means buying a fraction near each support zone when there is a bearish trend. I build conviction around these zones, even though there is always a probability of a downtrend.
RESISTANCE LEVEL [MID-TERM]
I strictly avoid building additional positions in stocks when the prices are near resistance levels. Resistance levels are zones where the stock gets into selling pressure and you start to see a lot more sellers. Similar to Support Level, you find zones based on the time ranges. I tend to wait for “convincing” breaches of resistance levels and not the teasers. Price movements with relatively low volumes are best avoided because there just isn’t enough interest to propel the stock upwards. Here is one example of TATAPOWER stock where you can loosely relate to some of the price movements. The stock seemed to have resistance around the 220-225 range for a while.
TREND SIGNALS [MID-TERM]
These are signals which can vary from simple ones to more complicated pattern analyses. You can find a ton of literature on various indicators such as RSI and Stochastic Oscillators. The one which I check from time to time is the MACD indicator. Put in simple terms, the MACD (Moving Average Convergence Divergence) is a lagging indicator that tracks the Moving Average prices and derives a result on the price trend of the stock at that moment. As with all lagging indicators, they cannot be very accurate, especially in a side-moving market where the price keeps oscillating within a range for a long time. Nevertheless, this can be taken as one parameter for judgment.
In the above snapshot, the MACD indicator shows trend reversals based on price movements in the recent past.
52 WEEK LOW PRICE [LONG-TERM]
Unless there are certain strong trend reversal signals, such as high volume price movements in the reverse direction, as the saying goes, catching a falling knife is dangerous. A stock with a 52-week low price level is on a strong bear grip. So I generally avoid it until the upturn starts showing over some time. It is impossible to guess the bottom of the stock, and I am okay with missing out on gains during a reversal start. But if you intend to cut your losses more than maximize profits, downward averaging at the 52-week low is a dangerous proposition.
UNDERVALUED PE (PRICE/EARNING) RATIO [LONG-TERM]
Every stock has a historical PE rating that the market (i.e. investors) find justified. There isn’t any universal PE number for each stock. Growth stocks can have high PE numbers compared to more stable stocks. So instead of pitting one stock versus another, I look for that stock’s historical PE (say over the last 2-3 years) and see if the current ratio indicates overbought or oversold territory. Take the case of a fundamentally strong stock like HDFC.
At one of the lowest PE values in the last 3 years, and the consistent earnings growth, I see very less reason not to build positions.
Similarly, stocks with PE well above the historical average are best avoided, and wait for price/time correction before they get into saner levels.
I try to keep the list of indicators short and simple. Neither I am an aggressive intra-day trader, nor have the time I can dedicate to over-analysis. At the same time, to be able to convince yourself about your decisions through data and logic is better than leaving all to fate!
