Knowing And Handling Uncharted Territory Phenomenon Better

Nowadays we hear this word quite often from the technical experts on the media or in a publication that the stock prices have reached an “uncharted territory”.  But for many of the individual investors,these words turn out to be a mystery. “Uncharted territory”, what does it mean? Uncharted territory means that the stock prices have reached a level where the stock has not been traded in its long term history. For example,let us assume the stock of ABC Ltd’s all-time high level is Rs 210 and the stock is facing resistance around the levels of Rs 205-210. Now, one day the stock breaks out and moves above the level of Rs 210, since the level of Rs 210 was an all-time high for the stock.Once the stock moves and trades above level of Rs 210, it enters into an uncharted territory as there is no price reference point in the historical charts because the price above Rs210 hasnot been traded in the stock’s long-term history. 

In the past two-three months, many of the small and mid-cap stocks have taken flight, reaching uncharted territory.TheBombay Stock Exchange's benchmark index -Sensex and the NSE's 50-share broadly followed index Niftyhave followed the path and are trading in uncharted territories.

Here is an example from the past: the Nifty50 index, after registering a high of 6357 in the year 2008, entered in a panic sell-off mode, and thereafter, it formed a strong base and entered into an uptrend and made a high of 6338 in the year 2010.Then again, it consolidated for couple of years in a range and in the year 2013 it touched of 6400, so Nifty50 formed multiple resistances in the range of 6330-6400.However, in the early 2014, Nifty50 closed above 6400-mark and entered into an uncharted territory as prices of securities hit all-time high levels. Below is an illustration of how the chart looks like before entering the uncharted territory and after entering it. 

The BSE Sensex registered an all-time high level of 30,000 in the year 2015, and thereafter, it made a couple of attempts to cross this hurdle.Recently, in the month of April 2017, it breached the level of 30,000 convincingly and entered into an uncharted territory. The BSE Sensex, after breaking its all-time-high level, is continuing its upsurge into uncharted territory. This is the longest time in history of the index where BSE Sensex stayed above the 30,000-mark.

Many of investors and traders find it difficult to decide on their approach or plan of investment or trading once the prices enter an uncharted territory as there is not a single price point in the history for reference to find out support or resistance level.

In this special report, we will try to guide our readers to follow some of the key principles once the price runs into an uncharted territory.

Round Numbers: Once a security enter into an uncharted territory, it becomes a little bit difficult for the stock market participant to identify resistance level as there is no price reference. Hence, it is seen that round numbers play an important role in identifying resistance once the price enters into uncharted territory. Have you at any point asked why prices tend to stall at certain levels after entering into an uncharted territory? Is this just a coincidence or is there a valid reason behind this occurrence? Well, this occurrence may actually be explained based on the psychology of market participants. As human beings, we have a tendency tothink in terms of whole, round numbers rather than in terms of uneven random numbers. This happens very regularly in everyday life where numbers tend to be rounded up or down in order to simplify things. For example, if someone asked you the price of your laptop and the price for laptop of is Rs29,984, what would you tell the person? Based on the psychology of rounding, most of the individual would say Rs30,000 rather than saying Rs29,984, since 30,000 is a rounded number while 29,984 is not. A similar thing happens in trading when traders look to taking decisions in the stock market.

Dow Theory Higher Highs and Higher lows: As per the Dow Theory, an upward trend is broken up into several rallies, where each rally has a high and a low. For a security to be considered in an uptrend, each peak in the rally must reach a higher level than the previous rally’s peak and each low in the rally must be higher than the previous rally‘s low. This theory can be applied once the stock has reached an all-time high or breaks into an uncharted territory.As long as the stock continues to maintain its sequence of higher top and higher bottom, one should continue to hold the stock and once the sequence of higher top and higher bottom is breached market participants should look out to lock in profits.

Pyramiding:Many of the investors and traders take a shot at  “averaging down”, which alludes to aninvestment approach where a position is added at a price that is lower than the cost initially paid, efficiently lowering the average entry price of the position.  However, we have seen averaging down is a dangerous strategy if the price of the security is demonstrating weakness, rather than strength. Adding to losing positions is a quick way to the poor house. But what many successful investors and traders do isto follow a pyramiding approach as this helps them to reap great benefits. So let us look at what is pyramiding. The term ‘pyramiding’ approach alludes to adding position to an existing holding as the stock price moves in the direction of the current trend. For pyramiding in a bullish market, this implies adding positions as the price continues to rise.The simple concept of following the trend is to buy strength, buy high and sell higher. The key benefit of pyramiding is that a clean and viable trend will allow excessive gains to be made with nominal additional risk taken. Pyramiding works because a trader will only add to positions that are running into profit and showing signs of continued strength. Also, when a trader or investor starts to implement pyramiding, the issue of locking in profit way to early does not arise. Let us assume that Trader A buys 1000 shares of a stock named ‘ABC’ trading at a price of Rs 100 each and the trader holds it until the exit at, let us say, Rs 250. However, Trader B follows a pyramid approach as he believes in adding position only if the stock runs into profits, so initially he bought 500 shares of ‘ABC’ at Rs 100.However, the price continued to surge higher and reached the level of Rs 125,so he added more 300 shares at Rs125 and the stock moved higher and at Rs 150 he added more 300 shares and as the stock price moved higher, he added 300 more at Rs 175.Similarly,he added 300 more atRs 200 and finally he booked his profits at Rs 250.  Now total profit of Trader A stands at Rs 1,50,000, whereas, Traders B calculation stands at (150*500), (125*300), (100*300), (75*300) and (50*300)= Rs 1,80,000, which is almost 20 per cent higher than Trader A. So this is how pyramiding helps.

Let your profit run but follow a trailing stop loss:When a security has confirmed the breakout and it has pierced all its resistance barriers,one of the most difficult decision market participants have to take is when to take profits home and when to cut losses short. Some participants will prematurely sell as a stock rises, while others will hang onto their shares far too long as prices plummet. How can you prevent from making the latter error? The trailing stop-loss is one of the approaches that can help market participant to protect their profit. The trailing stop-loss order is actually a combination of two concepts. There is trailing component and the stop loss order component. The trailing stop loss order does not put a cap on profits. Shares can continue to rise and market participant will stay invested as long as prices do not dip by your predetermined percentage. In a trailing stop loss, the stop loss is no longer fixed, but rather trails the price by a certain amount or by a certain percentage that an investor or trader specifies. In doing so, one of the key advantages of trailing stop-loss order is that it allows you to lock in profits rather than hold on to a stock for too long to only see your profits diminishing. Here’s an example of trailing stop loss order: You purchase the stock of XYZ Ltd at Rs 200 per share. You set the trailing stop-loss order at 5 per cent. Thus, if the price falls to Rs 190, your stock will automatically be sold. But as the stock price of ABC Ltd rises, so does your trailing stop loss. If the stock price surges to Rs 250, your trailing stop-loss order now stands at Rs 238.50. If it continues to surge higher and reachesthe level of Rs 300, then your trailing stop loss stands at Rs 285. The trailing stop loss limit can vary according to trader or investor. It can be 5-10-15 per cent as per the strategy of the market participant.

As the security breaks out into an uncharted territory, it generallyends up being a riddle for the market participantas to what should be his move, particularly for a technical trader as there is no reference point on the price action. However, the abovementioned key points may help a market participant to take decisionsas the price enters into an uncharted territory. The above points will help a market participant to maximize profit, locate potential resistance and identify when the bullish trend is likely to reverse.

Of late, the Indian equity markets have had a phenomenal run up over the past three-and-half years. From the lows of around 5135 in August 2013, the benchmark Nifty50 has risen nearly 4400 points or 85% as it marked its high of 9532. On a year-to-date basis, the benchmark Nifty50 has gained nearly 17.50%.

During times like these, when large proportion of stocks arerecording their fresh 52-week highs, Investors often face a typical dilemma. They are unable to decide to what extent they should let their profits run on their Investments. Human biases dominate their thinking during such buoyant periods when they often struggle to decide whether to book profits and exit or to let their profits run.

When there is a constant clash between greed and fear in the Investors mind, the investor either ends up selling too early or selling too late when bulk of the profits have been lost.

There is one point that Investors should never forget. Buying at the right time is important,but selling at the right time is equally or even more important.

Protection of Profits: On method that Investors can adopt to protect their profit is using “trailing stop Loss”. These are also known as “progressive stops”. This is used to mainly avoid the potential loss of profits. “Trailing” or “progressive” stops are an absolute necessity because if the stock continues trading in an uptrend overtime, the price gets further higher and higher from the point of entry and at one point of time, it becomes necessary to protect the profits and prevent them from getting washed away due to sudden reversal  or a large corrective decline.

The most common method to plot trailing stop losses is to use trend line joining all minor bottoms.  Usually, whenever a minor bottom is formed and the stock moves up again, that minor bottom or reversal point becomes a “trailing” or a “progressive” stop.

This is the most widely used method of locking profits used by the investors whenever the markets are in an uncharted territory. The golden rule is that 75-80% of the profits should be protected. In other words, in the event of a corrective decline, if the Investor is left with 75-80% of the profits as compared to the peak price of the equity, he should book them and exit. It is perfectly acceptable.

2.   Effectively rotate sectors: In an event when the investor has exited from his investments and realized profits, the right thing that he must to is to effectively rotate sectors. There will always be good stocks from good sectors which would have either lagged or underperformed in the most immediate rally. The key would be to identify such quality stocks and initiate investments again. Usually,these will be the stocks that will take the markets higher when it resumes its upmove after corrective declines, if any.

There are tools like RRG – Relative Rotation Graphs – that can be used to identify sectoral rotation. They show which sectors are leading, which are losing momentum, and which sectors are improving and are likely to lead the next phase of the rally.