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What is Fundamental Analysis?

 

The day before yesterday, I went to my friend’s house for her daughter’s birthday party. Although such a memorable day, she seemed nervous. On asking her she said that she faced some losses in the stock market. After a detailed conversation, I got to know that she had not done a fundamental analysis of the stocks she invested in. This made me realize that many people fail to fundamentally analyze a stock before investing. But do people know the exact meaning of “Fundamental Analysis”? So, if you are also in the same boat as her, then stay tuned till the end of this blog.

 

What is Fundamental Analysis?

Fundamental Analysis is the study of a business, its financial statements, its peers, its strengths and weaknesses, and the industry and economy the business operates in. This study enables an investor to arrive at an intrinsic value (or fair value) of that company and to form an opinion about the future growth of the company. But what is intrinsic value and why is it calculated? The intrinsic value is what a stock (or any asset, for that matter) is actually worth. The intrinsic value calculated using fundamental analysis is compared with the current market price of the security to know whether the security is undervalued or overvalued. E.g.: - A particular stock has an intrinsic value of Rs.100, but the market price of the stock is Rs.150, then the stock is overvalued, and buying the stock may not be a good decision as all the future growth of the business is already factored into the current price. At this point, you would be eager to know about what is involved in Fundamental Analysis. But first, let us understand why is it so important?Stock Market Courses

 

Why Fundamental Analysis is important?

Fundamental analysis involves the study of everything from generic factors like the state of the economy and industry conditions to specific factors like the effectiveness of the company’s management. Is it important to carry out this fundamental analysis and compute the intrinsic value? Of course, YAAS! If my friend would have invested in fundamentally strong stocks, then she would have been happy on her daughter’s birthday. Fundamental analysis helps an investor to identify whether a stock is worth investing in or not. It helps an investor to frame his/her own view rather than acting on random tips. So, based on Fundamental Analysis, if an investor considers a stock's worth to be more than what it is currently trading at, then he may purchase the stock.

 

 

Who should learn Fundamental Analysis?

Whether you are from a finance background, or you are an artist, an engineer, or a sportsman, or from any other field, and are motivated to increase your wealth, then investing in the stock market can help you. But the investments can also work in the opposite direction if not analyzed properly and this is where learning Fundamental Analysis is useful. Fundamental Analysis helps us identify an inherently strong and sound company. Hence, everyone should learn fundamental analysis and perform fundamental analysis before making any investment decision. Warren Buffett, the world’s most successful investor, is also a promoter of fundamental analysis.

 

 

Approaches to Fundamental Analysis.

Till now, we have discussed the meaning of Fundamental Analysis. But, a very important question “How to do Fundamental Analysis?” is still unanswered. Well, there are two approaches to it. The Top-down approach and the Bottom-up approach. An investor can follow any of the two approaches. Let’s understand them one by one.
a) Top-down investment approach.
As the name suggests, the Top-down approach begins with the study of the overall economy followed by industry analysis and ends with the study of the selected stock. The economic analysis involves the study of inflation, interest rates, GDP growth which helps to determine the overall health of the economy. The investor then identifies the industries and sectors by studying the growth trends of the industry and understanding industry cycles. Finally, the most promising stocks, within the identified industry are selected for further analysis to make an informed decision. Stocks are analyzed based on company-specific metrics such as revenue, profit, earnings, the dividend declared, the integrity of the management personnel, etc. Now, you might wonder about where to find all this data? Don't worry! The data relating to the economy is published in the newspapers as and when released by the government. For studying industry trends websites like ibef.org can be valuable and the company-related data is available in the annual report, which is easily accessible on the company’s website.
b) Bottom-up investment approach.
Alternatively, an investor can use the Bottom-up approach, which is exactly the opposite of the top-down approach. It starts with the analysis of the company, followed by industry and economy analysis. This approach lays more emphasis on the company rather than the industry and the economy. So, what can be the reason behind starting the analysis from the company? The rationale behind this approach is the belief that individual stocks may perform better than the overall industry or the economy. Such belief is built when you are attracted to the company’s innovative business model, strategies, a financial position that is not in line with the industry trend, etc. The metrics studied under both approaches however remain the same. I hope that you have got a basic introduction to Fundamental Analysis. Now, have a look at this video to understand the exact crux of Fundamental Analysis and cement everything you have read in this blog till now.

 

Bottom line:

Fundamental Analysis empowers you to determine the actual worth of a stock and its growth potential by analyzing the characteristics of the economy, the industry, and the company. It is better to invest in a fundamentally strong company for wealth creation in the future. I hope this blog has made understanding “Fundamental Analysis” a bit simpler. If you want to learn more, do check out my course on Fundamental Analysis, where I have taught it systematically and practically. Until next time!

 

Zerodha
What is Fundamental Analysis?
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What is HRA?

 

Let’s say you have received a job opportunity in a big city, far away from your home town. It’s the job of your dreams in the city of dreams, Mumbai!
While discussing with your friend about moving to Mumbai for this amazing job, he tells you about how exciting but challenging it is to live in Mumbai; the crowded local trains, the need for you to constantly be on your toes, and the most important thing, the rent expenses being sky-high.
After giving it a thought, you realize, you are quite excited about the fast life and travelling in local trains, but, oh no!! What about the high rent expenditure? How will you manage that? Will your employer give you any extra money in addition to your salary for the rent expense?

Let’s find out...

Why HRA?
Salaried individuals often need to move out of their respective home towns to big cities for work. Most of them opt for living in an apartment on rent, rather than purchasing property, as it is economically beneficial for them.Keeping the high rental expenses in mind, many employers choose to give an allowance for the rent paid by their employees. This allowance forms part of their salary.

What is HRA?

HRA (House Rent Allowance) is a benefit given by the employer to the employee for his house rent expenses. Okay then! You check your offer letter and YASS! Your problem is solved! Your gross salary includes HRA! But wait, what about the increased tax liability on the increased income? Well, that problem will also be solved in a few minutes!

Tax benefits of HRA
Although the allowance leads to an increase in gross salary, it is not fully taxable under the Income Tax Act, 1961. As per section 10(13A) of the Income Tax Act,1961, read with Rule 2A of the Income Tax Rules, the least of the following will be exempted, and will not form part of the taxable income:

1. Actual HRA received
2. 40%/50%* of salary**
3. Actual Rent paid in excess of 10% of salary**

Salary for this purpose = Basic salary + Dearness allowance (In terms i.e. forming part of retirement benefits)
** 50% for metro cities (which includes Chennai, Kolkata, Delhi, Mumbai) and 40% for other cities
I know, this complex calculation is beyond the understanding capacity of a layman. But don’t worry, let’s see some examples to understand this calculation better.
Example 1:
Let’s say, Mr P, residing in Mumbai has the following receipts from his employer:
Basic Salary (pa) Rs.8,50,000
DA (In terms) Rs.20,000
HRA received Rs.4,20,000
Actual rent paid Rs.5,30,000
Therefore, the exemption shall be the least of the following.
1. Actual HRA received – 4,20,000 
2. 50% of salary - 4,35,000
3. Actual rent paid (–) 10% of salary – 4,43,000 (5,30,000 – 87,000)
Exemption = Rs.4,20,000

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Example 2:
Mr. X, residing in Pune has the following receipts from his employer:
Basic Salary (pa) Rs.6,50,000
DA (In terms) Rs.15,000
HRA received Rs.2,40,000
Actual rent paid Rs.3,00,000
Therefore, the exemption shall be the least of the following:

1.  Actual HRA received - Rs.2,40,000
2 .40% of salary – Rs.2,66,000
3. Actual rent paid (–) 10% of salary – Rs.2,33,500 (3,00,000-66,500)
Exemption = Rs.2,33,500

 

 

Some important points to keep in mind:
1.From FY 2020-21 (AY 21-22), taxpayers have an option to choose from two tax regimes, old or new. So, individuals opting for the new tax regime will not get the benefit of any exemptions, which includes HRA. However, if an individual chooses to opt for the old tax regime, he/she will get the benefit of the exemption.
2.HRA is fully taxable for employees who do not pay any rent or the accommodation occupied is owned by him/her.
3.To avail of the HRA exemption, the employee has to provide rent receipts to the employer as proof of rent payment.
So, I hope you now know what HRA (House Rent Allowance) is and how it is taxed. Until next time!
Zerodha

 

 

What is HRA?
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How much does it cost to gift shares?

 

Valentine’s day is around the corner and I am sure you have already planned a surprise gift for your loved ones. One more thing I am sure of is that CARR students will plan a financial gift for their loved ones. And when it comes to financial gifts, the first choice will obviously be shares. But before you gift shares to your loved ones, you must consider the costs associated with it in the form of charges and taxation.

1. Charges for gifting shares:

Let us say that I have decided to gift a few shares of different companies that I think are good to my husband. It will cost me 0.03% (of gift value) or Rs.25/-, whichever is higher. Additionally, GST @ 18% will be levied on the charges. The Gift charge is charged per company or ISIN. The following example will clear the doubts –

I have decided to gift shares of Jubilant Food Works, Bharti Airtel, and D Mart, before we go ahead let me be very clear that this is not a recommendation. So, the gift charges will be:

There are a few things to keep in mind while calculating the charges
i. The highest closing price of the stock between NSE and BSE is considered for computation
ii. The charges are computed by considering the highest closing price on the day the gift transaction is processed
iii. Charges are rounded off to two decimal places
So that is it about the charges. Now there is another cost involved in gifting shares and that is taxation. Let us see what do we have there.

2. Taxation on gifting shares:

As per the Income Tax Act, 1961 a “gift” can be in the form of money and movable/immovable property that an individual receives from another individual or organization without making a payment. In legal terms, the person or organization providing the gift is termed the transferor while the gift receiver is known as the transferee.
Simplifying the definition further, examples of gifts that are taxable in India include:-
i. Money received by cash, draft, cheque, bank transfer, etc.
ii. Immovable property such as land, building, residential/commercial property.
iii. Movable property such as jewelry, shares, ETFs, bonds, paintings, sculptures, etc.

Now that we know what can be said as a gift let us understand the taxes levied on the transferor as well as the transferee

 

I. Tax in the hands of transferor:

The transferor is not liable to pay any tax on gifts. As per the Income Tax Act, Capital Gains is charged on the transfer of a Capital Asset. But, section 47 specifically excludes ‘gift’ from the definition of ‘transfer’. Therefore, the transferor of a gift is not liable to pay income tax.

 

II. Tax in the hands of transferee :

    A. On receipt of the gift

Section 56(2)(x) of the Income Tax Act, 1961 states that the Gift of movable property such as shares, ETFs, mutual funds, etc. received without consideration and exceeding Fair Market Value of more than Rs. 50,000 is taxable in the hands of the transferee as ' Income from Other Sources ' and tax should be paid at slab rates. This means if the gift amount is Rs. 50,001 then tax is to be paid on the entire Rs. 50,001 and not just Re. 1. Hope this point is clear. There are certain exemptions to it –
          a) Gifts received from any relative. Relative here means:
              a. in case of an individual—
                 i. spouse of the individual;
                 ii. brother or sister of the individual;
                 iii. brother or sister of the spouse of the individual;
                 iv. brother or sister of either of the parents of the individual;
                 v. any lineal ascendant or descendant of the individual;
                 vi. any lineal ascendant or descendant of the spouse of the individual;
                 vii. spouse of the person referred to in items (ii) to (vi); and
             b. in the case of a Hindu undivided family, any member of the HUF; or
          b) Gifts received on the occasion of the marriage of the individual; or
          c) Gifts received by way of inheritance.
In the above three exemptions, there shall be no tax irrespective of the fair market value of the gift received.

    B. On the sale of the gift

The subsequent sale of the gift by the receiver would be taxable under the head Income from Capital Gains. To determine the nature of capital gains whether STCG or LTCG, the holding period would be determined from the date of purchase by the previous owner i.e. the transferor till the date of sale by the transferee. To compute the capital gain, the cost of purchase by the transferor would be considered as the cost of acquisition.

I hope now you have got some clarity on the taxation of gifts. It can be confusing at times, so many people tend to simply ignore it. But, having an idea about taxation helps you take an informed decision. So, if you are planning to get a gift for your special ones this valentine’s day don’t forget to watch my valentine's day special video releasing on Saturday 12th February 2022 at 9:00 PM on my YouTube channel. Until next time!

 

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Descending Triangle Pattern

 

Just like Jay has Veeru, Munna Bhai has Circuit, and Bunny has Avi, even our chart patterns come in duos. Head & shoulder has Inverted head and shoulders, Double top has Double bottom similarly, Ascending Triangle has Descending triangle. We have already discussed the Ascending triangle in our previous blog. If you haven’t read it yet, click here. Now, let’s begin with understanding the Descending triangle pattern.

What is a Descending Triangle Pattern?
The Descending Triangle pattern is a continuation pattern. I am sure you can recall what the continuation pattern means from the previous blog. It just means that the price will ideally continue moving in the same trend as before the consolidation. Since Descending triangle is a bearish formation, it is formed in an ongoing downtrend and the price continues to move downward after consolidating in this pattern. If this pattern is formed at the end of an uptrend, it may signal a bearish reversal.
How is it formed?
This pattern is formed with two lines. The first one is the support level from where the price keeps rebounding. The second line is formed by joining the lower highs in the price movement, making it a descending (Downward sloping) line. This complete formation appears to be like a triangle with a descending line and hence, it’s called a Descending Triangle pattern. Minimum two touchpoints are needed to make the support line and descending line valid.
What does it tell you?
Now, let’s have a look at the price movement in this pattern and understand what it indicates. We already know that the prior trend has been a downtrend for this pattern. After that, the price starts to consolidate. The price reaches the support level multiple times showing buying interest at this level. But whenever the price has bounced back up after testing the support it makes lower highs. These lower highs indicate that the sellers are fighting back to go beyond this support level. This whole scenario creates a bearish build up and eventually, there’s a breakdown at the support level, followed by continuation in the previous downtrend.
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What can be an ideal entry, price target and stop-loss?

 

For this pattern, one may take a short position (F&O) at the breakdown candle. The price target is calculated by taking the distance of the vertical line of the triangle and then adding it to the breakdown candle. Stop-loss can be placed at the recent high.

Example

Below is the daily chart of ITC which formed a Descending triangle pattern between 20th September 2019 till 1st February 2020. The support level is around 210, being tested 4 times (marked with a tick) The lower highs making the descending trendline was tested twice (marked with a tick) before it gave a strong breakdown with significant above 5-day average volume. Post that the price moved in the previously existing downtrend for a while. The price target was around 170 which was achieved on 4th March 2020 (marked with a tick).

Bottom line

As is the case of Ascending triangle, even Descending triangle may give false breakouts and/or longer consolidation duration. Hence, it is the best practice to get multiple confirmations from other indicators like MACD, RSI, etc. before entering into a position. If technical analysis intrigues you, make sure you click on the link to check out my course where I have explained more such patterns, indicators, and strategies in the most simplified way. Until next time!

Zerodha
Descending Triangle Pattern
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What are moving averages?

 

 

Who would have imagined that something as basic as an average can do wonders when extended to the stock market? A concept which we learned in our school days could not only help us identify trends but also take positions and build an overall perspective about the market. Intriguing, isn’t it? So, without any further due, let’s explore everything about averages and how to use it practically.

What are Moving Averages?
Before we move on to moving averages, let me refresh your memory about what are averages. An average is simply a representative figure, calculated by taking a sum of all data points and then dividing the sum by the number of data points. For instance, you know that on average you take 30 mins to reach your office. How did you come upon this number? You simply calculated an average based on the time you took to reach your office in the past. That’s all!

Now let’s come to the Moving average. Talking about the stock market, every day we see a different closing price of the stocks. So, how do we get to know the average market price of a stock and its general trend? This is where the moving averages come into the picture. The Moving average calculations consider the most recent number of data points (closing price of an asset). For example, for 5 days moving average, it will be continuously recalculated by taking the closing price of the recent 5 trading days. So, after every trading session, that day’s closing price would be included, resulting in the exclusion of the oldest closing price from the previous day’s data. This way the data points keep moving ahead every day and hence the name Moving Averages or Simple Moving Averages (SMA).

What is Exponential Moving Average?
EMA is a type of moving average. We can say that it is an extension of SMA. So, what’s different about EMA? The recalculation remains the same. Additionally, weights are given to the prices. The recent data will be assigned more weight compared to the older data. This makes sense because more importance is given to the price which is already discounted based on recent news, events, etc. Hence, EMA tends to react quickly and give early signals than SMA. For all these reasons, EMA is widely used by technical analysts.

How to use Moving Averages?
MA is a lagging indicator as it reacts to the daily closing prices. It is trend friendly and can help us identify trend reversals. As we all know- Trend is our friend, it is widely used by traders because of its simplicity. When the stock price moves above the MA line from below, a bull run can be expected. Therefore, you may explore buying opportunities in such cases. In an uptrend, MA acts as a support level. As long as the price stays above MA the uptrend tends to continue. When a stock price moves below the MA line from above, a bear run can be expected. In such cases, one may explore shorting/exit opportunities. In a downtrend, MA acts as a resistance level. The stock is said to be in the downtrend as long as the price stays below MA. MA won’t work when the price movement is sideways. You can observe the same on the chart of Tata Coffee shared below.

But simply applying a MA on the chart and taking positions based on it is not enough. Hence, we have something known as crossover strategies where a short-term moving average (also known as fast EMA) and a long-term moving average (also known as slow EMA) are combined to give us an overall picture of a stock. So, let’s have a look at 2 crossover strategies, which uses 50-days and 200-days EMA.

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a. Golden Cross
A golden cross is ideally a sign of an upcoming bull market. It is formed when a short-term moving average (50 DEMA) crosses the long-term moving average (200 DEMA) from below. This crossover can help us identify trend reversal from bearish to bullish. If this crossover is backed by strong volumes and bullish signals from other indicators it indicates strength in bullishness. This is when you may explore buying opportunities. Once this crossover takes place, the 200 DEMA will act as an important support level.

This can be observed on Tata Coffee’s daily chart below. A golden cross happened on 26th June 2016 (highlighted) with high volume. After that, the stock continued to move in an uptrend and took support around 200 DEMA multiple times.

b. Death cross
A death cross is ideally a sign of an upcoming bear market. It is formed when a short-term moving average (50 DEMA) crosses the long-term moving average (200 DEMA) from above. This crossover can help us identify trend reversal from bullish to bearish. If this crossover is backed by strong volumes and bearish signals from other indicators, it indicates strength in bearishness. This is when you may explore shorting/exit opportunities. Once this crossover takes place, the 200 DEMA will act as an important resistance level.

This can be observed on Tata Coffee’s daily chart below. A death cross happened on 7th March 2018 (highlighted). After that, the bullish trend was reversed. The stock took resistance around 200 DEMA multiple times.


Bottomline
The important point to remember is that MA works when a stock is trending either on the upside or downside. Hence, you need to take a look at the general trend of the stock before making a trade decision. Avoid using MA in the sideways trend. Another important doubt which my students often ask me is what length should be used while using MA. People use 5 days, 10 days, 25 days or even 200 days. There’s no hard and fast rule about it. It completely depends on your investment horizon. Apart from this, make sure to check other parameters like candlestick patterns, volume, RSI, etc. to get a confident view. If you would love to understand the calculations that go behind MA and how to use these other significant indicators, make sure to check out my course on Technical Analysis. Until next time!
Zerodha

 

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What is Relative Strength Index?

 

Before investing in any asset, one question that pops up in your mind is what is the markets’ view on this stock/asset. Will the bulls remain strong or will the bears take over soon? This is an important point to analyze before entering into a stock. Indicators like moving averages can tell us about the trend in an asset but it does not tell us how strongly the trend will continue or not. For that, we have an indicator called RSI. To put it simply, RSI tells us about the strength in the price movement of an asset. Sounds interesting right? Want to know more about this indicator? Pull up your socks and let’s get started!

What is RSI (Relative Strength Index)?
Before we jump on to understanding RSI, we must learn about oscillators. I know oscillators sound complex but don’t worry, that’s what I am here for. An oscillator is a tool that moves in a range. It has a trend indicator that fluctuates within that range (imagine something like a pendulum). This trend indicator moves in response to the recent price movement of an asset. RSI is the most popular oscillator used by technical analysts.
It was introduced by J. Welles Wilder Jr. in 1978. RSI is a leading indicator that measures the intensity/strength in the price movement during a particular look-back period. Generally, 14 days look-back period is used for calculating RSI. The value of RSI moves between 0 to 100.
RSI = 100 – [100 / (1 + RS)],
Where Relative strength (RS) = Average Gain / Average loss over the look-back period.
As RSI is readily calculated for us on charting platforms, we won’t be focusing on the calculation part. Rather, we would be learning about its application in today’s blog.
What does it tell you?

 

RSI tends to pick up when the average gain is greater than the average loss for a look-back period i.e. an asset has relatively moved up more number of times in the last 14 days than it has fallen. The opposite holds when the average loss is greater than the average gain i.e. an asset has relatively moved down more number of times in the last 14 days than it has moved up.

How to use it?
In a strong uptrend, the RSI value tends to stay above 30 and frequently crosses 70. In a strong downtrend, the RSI value tends to stay below 70 and frequently crosses 30. Through this, investors can interpret the strength in the trend for an asset. Ideally, buying opportunities can be explored when RSI is in the oversold zone and a reversal of the prior downtrend/down move is observed. Similarly, shorting opportunities can be explored, when RSI is in the overbought zone and a reversal of the prior uptrend/up move is observed. Using RSI along with other indicators like moving averages, MACD, pivot points, etc. can help you gain a more confident view.
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How to analyse RSI along with price movement?
For that, we need to understand another term called Divergence. A divergence is when the price of an asset moves in the opposite direction of a technical indicator. Even divergences can be used to take positions. We already know that the price can either move up or down. Hence, we have 2 kinds of divergences- Bullish and Bearish divergence. Confused? No worries! Let’s understand divergences one by one with an example.

a. Bullish Divergence
A bullish divergence is observed when the price of an asset makes a lower low and RSI makes a higher low. This means that bullishness is strengthening and the prior downtrend/down move might reverse. If this divergence is observed when the RSI is in the oversold zone then a strong up move is possible. Hence, buying opportunities can be explored in such cases with confirmations from other patterns and indicators. You can observe this on the PVR chart below. A bullish divergence was observed on 18th May 2020, when the stock price made lower lows but RSI made higher lows, after which the stock moved upward.

b.Bearish Divergence
A bearish divergence is observed when the price of an asset makes a higher high and RSI makes a lower high. This means that bearishness is strengthening and the prior uptrend/up move might reverse. If it is observed when the RSI is in the overbought zone then a strong down move is possible. Hence, shorting opportunities can be explored in such cases with confirmations from other patterns and indicators. You may observe this on the chart of PVR. A bearish divergence was observed on 21st Jan 2021, when the stock made a higher high but RSI made a lower high after which the stock moved downward.

RSI is an oscillator that indicates whether a stock is overbought or oversold based on the magnitude of price movement. It can work best in a trending asset when combined with other indicators like MACD, Pivot, BB, etc. Technical analysts around the world use different RSI levels as per their strategy. You can also increase or decrease the look-back period for the same. If you decrease it then RSI will react faster and reach the overbought/oversold zone frequently. If it is increased then the opposite holds. After reading this blog if you felt like “Ye Dil mange more” then I have one more RSI strategy for you which I have discussed in my extensive yet simplified course on Technical Analysis. I am sure you would love it so don’t forget to check out the link. Until next time!

Zerodha
What is Relative Strength Index?
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Cup and Handle Chart Pattern

 

It’s a bright sunny day. You are traveling from Bangalore to Pune by road. You have reached midway somewhere near Hubli when you stop for some rest and refreshment. What is the first thing that comes to your mind? Chai… That cup of tea freshens you up and you are ready to move north. Similar is the case in technical analysis. A cup and handle pattern is a chart pattern that takes the shape of a cup with a handle. It is a trend continuation chart pattern. The stock price is moving north. In between it takes a break, it forms a pattern that resembles a cup with a handle. After that break, the stock again starts heading towards north. The Cup with Handle formation was popularized by William J. O’Neil in his book “How to make money in stocks?”.

What is a Cup with Handle chart pattern?
As the name suggests a cup with a handle chart pattern is a pattern of price movement on the trading chart that looks similar to a cup with a handle. A “U” shaped price movement forms the cup section and a short price pullback from the edge of the cup forms the handle. The pattern shows the movement of the stock in the past and helps us predict the stock's movement in the future. However, this pattern takes time to form. The formation may be as short as seven weeks or as long as 65 weeks or more. A cup and handle pattern provides a logical entry point, a stop-loss level, and a profit target.

How to identify a cup and handle pattern?
The pattern can be formed in any timeframe. However, it is advisable to focus on the daily timeframe. Being a continuation pattern, there has to be a prior trend and the same needs to be understood first.
Identifying the bullish cup and handle pattern: - There must be an established uptrend for the bullish cup and handle pattern to form. However, the trend should not be a mature one as it would reduce its chances to continue. The cup is formed by a normal fall in prices that gradually reverses forming a “U” shape. It should have a bowl or rounding bottom and not a sharp “V” shaped bottom. A rounding bottom ensures that there is a consolidation with valid support at the bottom of the “U”. The pattern could have equal highs on both sides of the cup, but this is not a necessity. The depth of the cup is another lookout point. The cup should not be too deep.
The fall in security price that forms on the right side after the formation of the cup is the “handle”. It is a short pullback that slopes downward. This can be taken as a small consolidation before the big breakout. While the cup can extend from 7 to 65 weeks, the handle may take about 1 to 4 weeks to form. Let us try to understand this with the help of the following example -

A visible cup and handle pattern followed by a breakout can be seen in the above example of Kolte Patil Developers stock. The black line shows a small uptrend in the stock. The stock has reached Rs.277 from Rs.206. A normal fall in prices to Rs.132 and gradual reversal to Rs.277.3 breaking the previous high leads to the formation of the cup. There is a steady decline till the bottom and steady incline back to the previous high leading to a “U” shape cup and not a “V” shape cup. The security has created two highs near Rs.277 at the start and end of the cup, which is a typical characteristic of the cup. We can see that at the end of the cup, the security has faced a minor correction before giving a breakout at Rs.280. This minor correction is called “The Handle”. The breakout at Rs.280 is also giving a buy signal.
An important point needs to be noted. Volume data can be very helpful in both patterns. Volume should decrease during the formation of the pattern and there should be an increase when breakout/breakdown happens after the formation of the handle.
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What can be an ideal entry, price target, and stop-loss?
The price which breaks out of the upper trend line is an ideal entry price (Rs.466 in our example). Security can be purchased at the close of the breakout candlestick. There are two target prices for this pattern. The first target is an estimated distance equivalent to the depth of the handle. The second target is equivalent to the depth of the cup, starting from the point of breakout. If after buying at the breakout, the price drops, instead of rising, a stop-loss order is needed. The stop-loss should be at a level that is below the lowest point of the handle.

Limitations of the Cup and Handle Pattern.
Every coin has two sides. Similarly, the cup with handle pattern also has certain limitations. The main disadvantage is the time taken to form a clear pattern. A fully developed pattern may take one to six months to form or even more. This might delay the investment decisions. The depth of the cup is another issue. In some cases, a shallower cup can give a strong bull run and, in some cases, a deep cup can be a false signal. In certain exceptional circumstances, Cups forming without handles also limit the utility of this theory. Like other technical patterns, the cup and handle pattern can be unreliable in illiquid markets.

Bottomline
The cup and handle pattern when formed in a nicely rising bull market, tests an old high and encounters selling pressure because of profit booking. The price gradually declines and consolidates over time because the selling pressure is not high. New buyers and old buyers see the reduction as an opportunity to take a long position in the market, leading to a gradual increase and retesting the high from where the pullback initially started. The more the consolidation, the bigger the breakout. It is advisable to use the cup and handle chart pattern with other technical indicators for the best decisions.
If you would love to understand the calculations that go behind Cup and Handle and how to use other significant indicators, make sure to check out my course on Technical Analysis. Until next time!


Zerodha

Cup and Handle Chart Pattern
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The Best and Worst Investments of Mr. Rakesh Jhunjhunwala

 

Rakesh Jhunjhunwala the veteran Indian investor also known as the Big Bull of India recently lost his life on the 14th of August 2022.

Rakesh Jhunjhunwala was the crown jewel of the Indian Stock market who believed in the Indian growth story and was so optimistic about the Indian Capital markets and was always bullish on the Indian stock markets.

As we all know Rakesh Jhunjhunwala started his investing career way back in 1985 with a mere amount of Rs.5,000 with his own investment philosophy which backed every investment he made in the markets but what separated him from the crowd was the size of his bets whenever his conviction was high which led him to invest a large chunk of money in his best stocks which are Titan, Lupin and Crisil back in 2002-03. In an interview, Ramesh Damani pointed out that Jhunjhunwala’s investments logged a whooping CAGR of 54% over the last 35 years.

In an interview, Rakesh Jhunjhunwala said “If a girl is pretty then the suitor will come” which means if the company is good the investors are going to come and invest. He further mentioned that he likes to invest in stocks that are not popular because you get a good company at a cheaper price.

Let us understand what are the top 5 lessons which we can learn from his investing career

1. Be ready to grab an opportunity - He firmly believed that the volatile nature of markets is what creates opportunities

2. Invest in a business that is Hard to replace – Investing in such businesses will give you a competitive advantage.

3. Success requires obsession – He used to say that people become shy of investing in stocks after booking losses. His advice for investors was to prepare themselves for the market and continue investing with a thumb rule of 'buy, hold and forget.' He used to advise investors to hold a stock as long as they can.

4. Never time the market - Stock markets are always right and no one can time the market. He was of the opinion that one should enter or exit on the basis of market timing instead of timing the market on its own.

5. Be Bold - He believed that “whatever you can do or dream you can, begin it. Boldness has genius, power, and magic in it." So, one should take stock market shopping like any other shopping. As you try to buy goods at the cheapest possible rates, you should do the same while buying stocks as well.

When he was asked in an interview about his worst investment, Mr. Jhunjhunwala said that his worst investment was in his own health. Shankar Sharma one of his close friends said that “with Rakesh, you need to have a strong liver to match up to his capabilities both in terms of thinking and drinking as well” So irrespective of the net worth that Mr.Jhunjhunwala had health is something where he got a pullback in life because of his habits.

Finally, India will remember him as the biggest bull, and his investment rules or philosophies cannot be written down in a book as the man himself along with his ideas were unique.

The Best and Worst Investments of Mr. Rakesh Jhunjhunwala
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Investment lessons from the football field

 

The FIFA World Cup is starting tomorrow. Similar to Cricket, football is a ride of emotions for millions of fans across the country. Remember the 2011 Cricket World Cup? It was Sachin’s last World Cup and everyone wanted him to retire with one in his bag of achievements. Similar is the case with Lionel Messi this year. He has already confirmed that it will be his last try to get the Golden Cup, and we all want to see him hold one. Football has given us some very emotional moments. Remember how Russian Prez’s umbrella attracted more lenses than the trophy in the 2018 Finals, for once no one was annoyed that a non-deserving team won when Germany lifted the cup in 2014, and of course, you either need to be dead or not born to not know Shakira’s Waka Waka that took over the universe in 2010, it still does.

Today, we will understand three investment lessons that this phenomenal game can teach us. Let us begin 

1) Choosing a team:

You may have observed that the team the manager chooses prior to every game attracts a lot of interest. Before revealing his starting lineup, the manager assesses the strengths and weaknesses of both his own squad and the opposition. Similar circumstances apply to stock picking. Research is necessary before selecting the best stocks.

The type of players chosen by a football manager is another analogy. If the manager decides to pitch a squad made up entirely of defenders or strikers, he would get himself into trouble. What would a game look like with eleven strikers? The team's composition would be incredibly unbalanced. They may score a hat trick, but they will also give up a lot of goals. Likewise with choosing stocks, choosing only stocks in the same industry or that are similar is not a good strategy. To reduce risk, you must diversify your holdings.

2) Profile of the players:

Players vary from one another, just like stocks do. The energy of the fresh blood, the serenity of the seasoned, and the undisclosed magic of the great players must all be in perfect proportions in order for the team to succeed. Different needs are served by each player. Take Lionel Messi or Cristiano Ronaldo as an example, whichever team they play for they are the ones chosen first by the manager. That's a result of the legends' extraordinary consistency throughout the years. For an investor, they resemble the stocks of reputable businesses that have historically produced significant returns.

Managers love the next-generation players. We are talking about the Mbappes, Kluiverts, and Scholes of the world. The rookies have something to prove, are simple to manage, and have skill reserves that can only be discovered if they are selected for the squad. However, not all young people make a splash. Playing a young gun definitely has its drawbacks. Here, managers take a calculated risk, something like investing in stocks of an unproven small-cap firm. Either these stocks turn out to be multi-baggers or they disappear without a trace. Therefore, a wise bet can be made by researching the company's business plan.

If you gave it any thought, you'd see that stable large-caps have a lot in common with defenders, unstable mid-caps have a lot in common with midfielders, and promising small-caps have a lot in common with forwards.

3) Game plan:

The strategies used on a football pitch also apply to the stock market. The manager chooses a starting lineup for his team based on the team's capabilities and the opposition's strengths. The most common football lineups have been 4-4-2, 4-3-3, and 3-5-2.

Balanced Strategy: 4-4-2 lineup is used when a manager wants to ensure that his side plays creatively while still avoiding taking any unnecessary risks. This is accomplished by keeping the ratio of defenders, midfielders, and strikers in check. The following strategy can be used by an investor to balance his portfolio for the best outcomes: He can invest 20% in small-cap stocks, 40% in mid-cap stocks, and 40% in large-cap stocks.

Aggressive strategy: When the manager decides it is time to put all of his efforts into scoring goals, he deploys a 4-3-3 aggressive lineup that consists of three strikers, three midfielders, and four defenders. The manager needs to choose players with excellent offensive talent in order for this method to succeed.

Defensive strategy: The manager occasionally wants to be conservative and avoid giving up goals. This is where he uses the 3-5-2 formation. To support the three midfielders and two tenacious strikers up front, he deploys three central defenders and two fullbacks. This is comparable to a person who prefers to take small risks and is content with steady profits. Such investors choose portfolios that are heavily weighted in defensive large-cap stocks, with the balance held in mid-cap stocks that are performing well.

Hah! I somehow see finance in everything that I see around me. But, enough learning for today, now let us drench ourselves in the wild energy and emotions that this World Cup has in its purse for us. Until then Tsamina mina, eh, eh Waka waka, eh, eh…

Investment lessons from the football field
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