The breakout over the past few sessions has pushed the market indices to new 52-week highs. Under such circumstances, there is only one action for a trend-following trader: Stay long with some sort of trailing stop loss or “sell” signal. One practical difficulty is finding a sell signal that doesn’t have a serious lag.
A breakout this sharp is not amenable to target-setting. The minimum targets have been achieved. The market could reverse from these levels, or the indices could move up by an indefinite amount. So, the upside is indeterminate.
On the downside, possible retraction levels will be easier to set once we see a clear peak established. Then one could use retraction calculations involving Fibonacci levels, or Gann, to find likely points to which the market may correct. In practical terms, traders must watch the 5,450 level from where the breakout started. Corrections or retractions should find support from there. A close below 5,450 would be a serious danger signal.
Typical trend following systems use combinations of moving average crossovers and/or 20-day lows (or 20-day highs in the case of a downtrend) to generate sell signals. The 20-day Nifty low is 5,215, which would not be very useful since it’s way below current prices. A moving average crossover sell signal constructed with say, a 20-day average rising above a 10-day average, also has a great deal of lag. Finetuning sell signals with shorter timeframes (say, 10-day lows, or seven-day moving average (MA) versus 14-day MA) risks being stopped out of a valid long position on a minor correction.
Breadth signals and liquidity can also be brought into the picture. A weighted index like the Nifty or the Sensex can rise on the basis of an upmove in a few high-weighted shares, even if a larger number of low-weighted shares move down. In this case, the advance-declines ratio has been very positive so far. A rise backed by volumes, which has also been the case in this instance, is also likely to be more sustainable. A trader might watch for signals such as an adverse advance-declines ratio and a drop in volumes as potential sell signals. Or he may just hedge with a cheap set of deep puts like say, the 5,200p or the 5,300p.
There is no single fool-proof method of limiting losses if the market suddenly reverses direction at high speed. This is a common problem for the trader. My personal inclination would be to use a combination of signals and maybe, rollover deep long puts if the long position stays alive going into the October settlement.
The author is a technical and equity analyst
