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Horse Sense

Mukul Pal · January 29, 2007

horse_sense
Al Ries and Jack Trout summed it beautifully. To become successful in life, you need horse sense to ride a winner. When to get on a sector horse and when to get off is a sense not every body has. Identifying outperformers from underperformers needs home work.
For example, sector risk is the greatest contributor to price fluctuation in a stock, it is very important to determine sector relative strength. Relative strength is a ratio line, a tool so simple and effective that it generally gets overlooked. “How can something so simple work?”. The beauty of Relative strength is that it can keep you invested in strong stocks for a long time, allowing you to participate in the gains. If the sector or stock continues to have positive RS for years on end, while broad market moves up, this would mean higher returns for the sector or stock under study. Relative strength allows you to let your profits run.
And on the other hand if the indicator is negative, it allows you to get off a horse not running the race and to move to one that is. Given that market goes up two thirds of the time and down one thirds of the time, going to 100 per cent cash by selling all your positions is a huge bet. A more sensible approach is to weed out the poor RS performers and sell those stocks to raise the cash level in your portfolio. The charts on the right are the RS chart of CNXIT (Tech Index) against rest of the sectors in India. CNXIT has clearly underperformed Auto, Capital Goods and Oil sector in India. The ratio stands clearly below 1 and technically we don’t see the ratio coming above Parity soon. This means continued underperformance. Then we have CNXIT vs. BSE BANK. The ratio line rules near 1. This is in sync with CNXIT vs. Sensex RS, which moved up after the Jun 06 dip. But the bounce back on the RS is hardly encouraging. This leaves us with FMCG, Health Care and Public Sector. Even here CNXIT seems to have hit if not significant atleast intermediate resistance.
Now, if this is too simple a portrayal for us to convince you to reduce your Technology allocations. Then it’s our horse against yours. Let the best one win.

The legend of Cornucopia
Who is killing the cotton farmer?

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