Mistakes of 2022, Technical Analysis, Role of Luck & The Cycle of Learning

If you have ever pained by huge losses hanging in your portfolio in certain stocks and want to know how to handle such situations, this is worth a read

Overconfidence leads to the most disastrous mistakes. Overconfidence comes from repeated success. These blunders teach us something. The lessons learned help improve the success rate. The higher success rate sometimes led to repeated success. Repeated success leads to overconfidence. Overconfidence leads to the most disastrous mistakes. Just like the market is a cycle, learning is also a cycle. If we stop making mistakes, we stop learning.

So, it has been an annual ritual for me to make mistakes every year, but the quest has been to learn from those mistakes and either not repeat them or repeat them with less damage or to make new kinds of mistakes for new learning. Self-review is the best form of learning, and whether I invest or trade, I make it a practice to learn from these experiences. In this blog, I want to touch upon two key factors:

• One of biggest mistakes of 2022 in the investing journey

• Importance of technical analysis in reducing losses (sorry for optimistic angle as it is talked with the angle of making money)

One of the things that has consistently worked for me is making money in the 2nd cycle in the same stock where I made money in the 1st cycle of investment. Some of the reasons for this include:

• Better fundamental understanding: A tracking of business across years and multiple cycles helps to get a better grasp of business and valuation and hence, ability to time it.

• Better technical understanding: Continuous tracking of specific company charts over charts along with other data points helps to understand the patterns behind price movement, fundamentals, shareholder data and overall news flow.

There were repeated success stories, which kind of gave me this confidence or overconfidence that I could do it repeatedly. This is where the mistakes happened, and this time I ended up booking losses. Also, this exercise highlighted a few things:

• The role of luck in investing where the gains we think came out of our analysis could be sheer luck in a 1–2-year kind of time frame. What if the issue of inflated revenues would have come prior to 1st round of price runup?

• Never ever believe in due diligence of others. This has been a kind of repeat lesson. Though I was aware of possible issues due to previous management, could not extrapolate its ramifications and assumed due diligence by new promoter would take care.

• The role of multi-disciplinary learning which may help not only in making money but also in reducing losses

The stock has been Sequent Scientific, where in the first cycle, I had good success accumulating from Rs 98 to about Rs 200, riding the cycle, and exiting with decent gains above Rs 200. However, the stock did top out due to multiple factors, including valuation, margin top out, sector headwinds, country issues, and the most important corporate governance issues in terms of historically inflating revenues. The last item was not a big surprise given the old ownership, however, where I failed was to judge the quantum of impact. When prices were in a downtrend, I reinitiated my position around 160, assuming:

• Revenue inflated issues have been taken care of

• Industry margins should factor the worst.

• The hidden bias of last time I made money from here and hence that psychological comfort of repeatability of success.

• Ignoring the charts which were telling different story.

However, the problems for the stock were not short lived and some of the events led to a complete change in company fundamentals – replacement of management, declaration of new ESOPs and so on. Now, the whole story was different. The old assumptions went for toss. Also, there were no immediate tailwinds and there was no respite from headwinds. The losses ran in 20%+ (of courses, I did not execute stoploss having thought I understand the company well in terms of worst-case scenarios) and whole assumptions changed in the meantime. So, now it was more a question of how to minimize losses.

Now, at this juncture, let me introduce you to a few concepts of technical analysis that I utilized to minimize my losses despite my mistakes. These are:

• Concept of trend: A trend is visually identified by higher highs and higher lows in uptrend and lower highs and lower lows in downtrend. Below chart provides an example of uptrend between August to Dec marked by arrows highlighting higher highs and higher lows

A trend is supposed to continue in its direction unless and until it changes its direction as per fundamental theories of technical analysis popularized as Dow theory.

• Support, Resistance and Moving Averages: A support is a zone of demand where buyers dominate sellers and a supply is a zone where sellers dominate buyers and at these zones, either a stock reverses its direction or does a breakout where big parties exchange hands and create new equations for support and resistance. We teach these concepts in detail and currently running a 10-session webinar on core concepts of technical analysis. You can join it by signing to our technical analysis course or annual learning program called “Scientific investing Practitioner Membership” where we cover application-based learning in terms of stock, sector and market analysis leveraging fundamental and technical analysis.

  

  https://learn.scientificinvesting.in/learn/SI-PRACTITIONER-MEMBERSHIP

  There are 2 types of support and resistance – static and dynamic. Moving averages of price has ability to act as dynamic support and resistance based on historical charting experiences. A chartist job is to identify such patterns and leverage it to his advantage. Please look at below charts:

If you notice, you will record following observations:

• All these stocks have right now been in downtrend and their primary trend.

• Though these stocks are in downtrend, in between these stocks tried to go for an up move but it fails and the high still remains lower than previous high.

• What is interesting is if you see the moving average lines (I have used 13W, 20W and 40W exponential moving average lines for closing price on a weekly chart, you can google more about these concepts), you will observe that, most of the times when stocks try for up move, it is restricted around these moving average lines highlighted by red arrows.

• This is where these moving averages lines act as dynamic resistance zone.

Whether the resistance would come at 13W, 20W, or 40W is a question of detailed analysis depending on multiple factors, and I would keep this topic for another blog.

The funny thing is that many times the buyer thinks that he has hit a jackpot by catching the bottom, however, it is only a trap by the big seller to distribute his holdings to more and more buyers by luring them through a transitionary up move.

Now, coming to Sequent Scientific, it was in a downtrend, but there was a hope to reduce losses through a lower high by timing the exit at the high. Here, let me introduce you to one more concept.

I had my buy position built around Rs 155 at the end of 2021, and the stock hit a low of Rs 85 in June 2022. This was almost a 45% fall. However, the stock did make some intermediate up moves in the longer-term downtrend and touched the Rs 125–130 zone in August 2022, and the 13 and 20 W EMA zones acted as resistance.

This was the zone where I sold off my positions and reduced my losses to 19%. Now, whether the stock could have continuously fallen, hit resistance at a much higher level at the 40-week EMA, or something else is a game of probability. However, being aware and prepared with continuous tracking with marked levels aided in swaying those probabilities in favor, and luck also swung in favor of hitting the EMA level dynamic resistances. Though it was the worst loss I faced in 2022, with the help of these concepts and a little bit of luck, I was able to minimize losses from 45% (imagine selling in panic at the worst price) to 19%. We are done with 2022, and the stock is languishing at Rs 85. Time will tell whether the stock finds consistent support at Rs 85 or falls further.

This was a lesson of mistakes, learning, and implementing some of the hybrid learnings with a share of luck, which helped me derive something good from a negative situation. I hope this was useful to you. There is a lot of science and mathematics involved in these things, and we regularly try to teach them through webinars and super sessions. We are conducting a super session on one of the most important technical analysis and quantitative tools called chartink, which I use heavily for more efficient stock and market opportunity tracking. You can register here to attend this super session. Also, such sessions are free for our PRACTITIONER members.

Link to Register: https://rzp.io/l/Tfo5r5kzVZ

So, this was all about our biggest failure in 2022. We are not that pessimistic by nature and do like to talk about what worked for us. Here is a YouTube video we made on all the stocks we studied in 2022 and our key learnings, performance, and attributes to this performance. You can view it here.

Thanks for reading. If you like our work, please spread it by liking and forwarding it, as we do not have any marketing budgets and it is the word-of-mouth publicity that helps us reach more people. I'll see you in the next blog post.