Warning bells

Time is Ripe to Exercise Caution

Tring!... Tring!... Tring!... No, its not a School Bell. Well, not even a Telephone Ring. Than What? May be, an Alarm Bell.

Actually, I just want to convey that stock markets don't ring such 'bells' before they start correcting. They do not provide warning bells stating that, "This is enough mate. Now, pack your bags & stay away from markets." We ourselves have to catch the market signals the cues of which can be in various diferent forms, not necessarily explicit in nature.

Yes! Be cautious... Read this post till last to understand what I mean to say. We may already be in the last stage of the ongoing 'Mini' bull phase which has followed directly from the lower tip of bear market phase. The momentum is strong. Stock are flying high resembling the exuberance of the tip of any bull phase. The momentum may last a bit longer. But, who knows till when? Can you time the exit at the right moment? Not really!... you have to exercise caution & strategise your part-exit plan.

Current Market Scenario:

1) Large-caps are quoting at Expensive Valuations.
2) Mid-caps already catching up & Some even Fully Valued.
3) Small-caps have been moving up from Circuit to Circuit.

Exuberance Levels: High, with Sensex gaining 80% in 3 months.
Nearest Event: Budget & Corporate Results after 1 month.

Part 1: Denial Mode

First the markets recovers from the depression with an all round pessimistic mood and sentiment. Usually, Insurance companies, especially the Bid Daddy L.I.C., keeps munching equity stocks at such times. It plays an important role to support markets at lower levels with the mandate from the Centre. At such time, investors are in denial mode to buy, they think markets will further move down. Then the markets further recover all of a sudden leaving most investors in the lurch. There is a feeling of being left out due to such unexpected rise. They still don't buy aggressively as mood is largely negative.

During this stage, all the counters from different market capitalization are largely under-valued & in over-sold territory.

Part 2: Feeling of being Left Out:

Just as the rally grows into larger proportion investors jump in expecting another big up move. No, the markets still don't go down from there. It rises further to give the feeling of optimism to the cash waiting on side lines. Investors pump-in yet another bout of funds to capture the bullish trend. Regarding Mutual funds, they are the wiser people who entered during the first or second round of euphoria. Foreign funds usually enter aggressively when markets show some signs of positive recovery.

By this stage, Large-cap counters are not under-valued. Though, mid-caps & small-cap are relatively under-valued and in the grip of pessimism.

Part 3: The Real Exuberance

During this stage, the real exuberance is witnessed in terms of buying. Straight gains are made day after day. Positive cash inflow is continuously witnessed with every passing week. Large-cap counters become fully valued during this stage. Still, there is further room for up side in them on the back of momentum.

Mid-caps are the flavour of the season during this stage of market ruled by sheer momentum and exuberance. Small-caps gradually find their feet and they rise the fastest with a series of up circuits on the bourses. Large-cap counters usually rise at a slower pace but their up ward momentum is not completely lost.

Part 4: The Final Countdown:

The last phase of the exuberance is characterized by Analyst visions going forward into future for the company's prospects and earning potential. Large-cap counters start being valued on not current year valuations, but 1 or 2 years down the line. This is the first and perhaps the last sign to exercise complete caution.

During this stage, Mid-caps catch up with their lag to large-cap counters. This stage witnesses participation of the retail traders more actively with the perspective of making some quick gains from the market momentum. Small-caps, usually, are in up circuits with unavailability of sellers on the bourses.

The extra exuberance in the last stage is often forged and supported with new 'logic' that are put forward by the Analyst community such as 'Decoupling Theory', 'Upgraded Fundamentals', 'Strong Potential for the Economy' and so on. The momentum of the last few weeks is attempted to be stretched as much as possible.

Prolific Gains, witnessed in individual stocks, to the extent of whooping 10-15% are notched on an almost daily basis. The proportion of returns which usually take 1 year in Debt instruments like FD, PPF, etc. are usually acquired in time as short as few countable sessions from equity markets. Till when can such times last?

Exercise Discipline & Control:

During this stage, caution should be exercised with utmost discipline, patience and perseverance. Investors would find the situation extremely terrible of being missed-out by huge extent. They have to control the urge of entering the markets at such moments. Traders should apply Strict Stop losses to their each and every trade. If they don't do so, markets will retract in a big way some time or other & at such times traders will be left with their trading favourites which shall eventually turn into papers when their value goes down. When the value starts falling, traders won't feel like exiting their positions at nominal gains or even losses.

The above does not mean to convey that a huge correction is on the anvil. Nor does it mean to say that the markets won't go up any more. It simply is a cautionary posting to put the readers of this blog on a 'Warning' note that valuations are no more cheap as may be 3 months ago. On that note, even a small correction of 10-20% should not be ruled in coming times. The momentum can take markets up- to surprising & unexpected levels, but the crux of the matter is that you won't be able to time out during such exuberant times with ease. Greed takes over from the fear factor during such times of euphoria, from which you have to save yourself swiftly.

Same Old Evergreen Strategy:

The last stage is the hogged by the moment of uncertainty. There is lack of clarity as to what the next big leg of trend would be. Whether markets will stay afloat or give up substantial gains? During such scenarios, my first posting of this blog related to 'Strategy for Investment' would come healthy.

This time, you have to follow 'Sell in small qty on Every Rise' and not 'Buy in Small qty on every Dip'. Minimize your risk with every rally. Accumulate cash with every bout of sell-off you exercise on incremental rallies. The main benefit of using this strategy is, you cut your risk to the extent you sell. But if markets rise, you still tend to benefit from the rally as your major portfolio still remains invested and that you have sold only a fraction of your stocks and portfolio. The money and opportunity that you lose from any potential rally is far less than the benefit that accrues to you for your remaining 'invested' portfolio.