Ajitansh Kar, Gurugram, 5 January 2024
“Vadhare vadhare levanu, ghatare ghatare bechvanu” is one of the most popular quotes of the beloved Big Bull of India, Late Mr. Rakesh Jhunjhunwala, which simply translates to ‘buy when the price is rising and sell when the price is falling’. Today the markets are at an all-time high and have given returns of almost 20% in the past one year on broader indices while many stocks have given triple digit returns in the small and midcap space. Over the past few days, this euphoria has led many to believe that there is an impending market crash and correction that lies ahead of us. On the contrary, the market keeps on scaling new highs and stocks kept reaching the upper range of their 52-week scale. Fearing a crash, many market participants who invested their capital at lower levels liquidated their portfolios early and saw the market climb higher touching new highs. Disappointed with their actions the investors feel helpless and regret their choices.
There is a way to avoid this from happening to you and it is to follow the wonderful approach of trend following. This method is dependent more on the technical style of investing rather than fundamentally analysing companies to invest in. As the name suggests, all you have to do is follow the trend (buy the uptrend and sell the downtrend) and remember what Mr. Jhunjhunwala told us. There is no single method of trend following and each investor modifies his/her strategy according to their needs and comfort. Today I will be discussing my variation of trend following which I believe is simple to follow and execute. There are three things that you need to look at to be a good trend follower and that is the knowledge of exponential moving averages, price action, and stop loss (SL).
All you need to do is plot two exponential moving averages with lengths of 20 and 200. The first rule of the strategy is to never buy when price is below the 200 EMA and never sell when the price is above it. In a trend remember that the 20 EMA acts as your “Laxman Rekha” and if the price moves below (in case of uptrend) or up (in case of downtrend), then immediately exit your positions. Always remember to trail your SLs in accordance with the 20 EMA.
There is a small hiccup in the above paragraph with regards to using the 20 EMA as a trailing SL. Many a times it is observed that the price hovers around the 20 EMA and then continues the trend; in this case your trailing SL would always be hit. So, let’s give the stock some headroom for adjusting itself by placing our trailing SL ± 5% from the moving average. Also, don’t forget to give weightage to price action and always be observant of patterns which indicate the possibility of a trend reversal.
A lot of you might not have understood the strategy and might be confused. Let us now look at an example for more clarity:
The above chart is of SJVN limited which gave a breakout in the month of June in 2023 at around levels 36. According to price action, this is a multi-year breakout and, in my experience, I have learnt that these breakouts give returns of upwards of 1.5X (Around 90). The black line (along the candles) represents the 20 EMA while the blue line represents the 200 EMA. After the breakout it can be observed that SJVN gave an explosive move almost tripling itself and reaching levels of 100 recently. It broke the 20 EMA twice with a 5% downfall in October 2023 and December 2023 but gave re-entries immediately. Even if one did not re-enter and got stopped the first time, it still made approximately 80% on the capital invested during the initial breakout. The uptrend in SJVN is still active and the stock could further scale higher.
I hope you got a good understanding of how useful using trend following in your current investment or trading system can be. Always remember to never cap your profits to certain ratios, levels, or prices and follow the trend for as long as you can to maximize your gains.
