Market Notes 17.09.23

Bharat. Hot Sectors. How to level up your game.

Bharat.

I had mentioned in my last note, “I think the small and midcap segment as a whole has overshot a bit in the short term and i won’t be surprised to see some pullback and/or consolidation over the next few months.”

But the small and midcap segment remained relentless and continued to move up, before on one fine day giving a “ sudden shock” by crashing almost 4-5% in a single session. Most stocks fell 8-10% and most portfolios fell 4-6%. A lot of people were surprised by this move. I was not. That doesn’t mean i could predict it but the fact that we have had such a relentless rally we have to expect pullbacks or even a small correction may be. It’s natural that it happens and it’s good if it happens as it releases the so called pressure valve that builds up from continuous buying or selling.

This rubber band effect is one of the structural patterns in the market, traditionally called mean reversion. A non stop buying will almost always resolve in a sharp pullback or a consolidation. Similarly a non stop selling resolves typically in a sharp bounce back rally.

This counter-trend doesn’t signal end of the move - just a break, before the original trend restarts, unless the consolidation results in a breakdown. There is always an if-else-if in the markets :)

Now the thing is it’s impossible to predict markets over the short term i.e. a few months out hence we have to keep evaluating as we go. For now, to me it looks like we go into a pullback/consolidation/chop mode and then continue to trend up. Caveat Emptor.

Sectors/Themes

Every market has hot sectors or themes which are leading it. Our job is to identify those themes and position ourselves into them depending on our strategy.

No matter whether you trade intraday, swing, positional or you’re investing for a few years out - the best returns and the best hit rates will be in the sectors which are leading the market.

This time around we are spoilt for choice and the rally has been very broad based with several sectors participating, several of which we have discussed in the past newsletters.

This time, i want to discuss some important concepts that should help one level up their game, just like it did for me.

Key elements of profitability.

I want to discuss a bit about how one can massively improve their odds of success in the market.

To massively improve your odds of success you need to have clarity at multiple levels:

1. Set Up Clarity - We all need to work with set-ups which are clearly defined and are backed by structural patterns on which the markets operate. Most of us don’t operate from set ups and randomly build a portfolio which is a mix of five different types of opportunities. This lack of clarity around set ups leads to sub-optimal decision making when the crunch time comes. A set up is a clearly defined pattern or situation which defines when you will buy, hold and sell a stock. For eg. momentum is a structural pattern - on this structural patterns you can create many set ups. Mean reversion is a structural pattern on which most value investing strategies are built. Even within value investing strategies different people have different nuances that they exploit. A set up is not only well defined but also is often very deeply personalized with several nuances - which magnify the edge.

2. Time Frame Clarity - We need to have utmost clarity that for a given portfolio which timeframe are we playing the game. Are we a swing trader who is looking for a few days to few weeks hold or are we more positional in nature and looking to hold for a few to several months or are we playing a game where we hold 2-3 years or do we play the hold forever type of game. The time-frame often decides what type of set ups you choose and what type of stock universe you operate in. Again most people have no idea what timeframe they are playing. They start as long term investors, buy stocks which are good only for the short to medium term and get the whole process wrong.

3. Set Up-Market Fit - A value investor cannot thrive in a market like this which is running high on momentum. Similarly none of the momentum set ups will work in a bearish or a corrective phase. Every set up has its season and its most important to know when our set-up will work like a charm and when it will be a damp squib. Without this knowledge one will keep jumping from set up to set up and blame markets.

These three ideas form the building block of my framework and how i look at the markets. These are like the core concepts or pillars on which you have to build your house. If you do not have these three clarities chances are you are very much a random investor or trader. Anyone who is successful in the market - no exceptions - will have these three clarities in place.

One of my favourite set ups is the earnings surprise set up - which is a based on another structural tendency which is that earnings or perception of earnings change is what drives the biggest gainers in any market. The time-frame here is typically 3-12 months. It works best in bullish phases but also works with lower intensity in bearish or choppy phases which makes it an all weather strategy.

I also run a pure price based set up which is based on momentum and the concept of volatility contraction. The timeframe here is typically few weeks to few months. This works well only during bullish phases and is prone to extreme failures in choppy and bearish phases.

Now, none of these are original strategies that only i know or have come up with but what is original is the nuances that have been developed over many years of intensely studying them.

So this is the framework one should target to really level up your game.

Happy to help anyone that needs guidance.