Low Risk outperforms High Risk.

On CNBC, I have said this for the past 11 years: Always go for blue chips. Keep risk at minimum. Be a conservative trader. The reason is simple: Low risk is more profitable than high risk.

Now, Engineering Returns  – says that “Low volatility (low risk) outperforms high volatility (high risk) on an absolute as well as risk adjusted basis.”. Read the full post Here.

Surely, this is common sense. Let us talk about a person crossing the street. The person can cross at the zebra crossing (low risk), or he can cross the street at random (high risk).  What will you do?

The study referred above suggests that stocks that have high volatility are not always profitable in trading. Stocks with low volatility, outperform the high volatility stocks. Again, let us take some practical examples. High volatility stocks include VIP Inds, Educomp, Sintex, while a low key, low volatility stock example is Hind Unilever. It is no surprise to find that Hind Unilever has outperformed the Highly volatile concept stocks.

Divergence Trading

Most technical traders know about divergences between indicators and price charts. A bearish divergence comes about when prices make a new high but indicator fails to do so. Bullish divergences require prices to make new lows with the indicator failing to do so.

The novice trader will find divergences on all types of charts. She will observe prices rising but the RSI (for example) remains flat and makes a lower high. The text books will describe this as a bearish divergence, so the trader goes short. Much to her dismay, she finds that prices continue to rise and the indicator continues to make lower highs. So, the trade starts losing money. Most traders have had similar experiences with bullish divergences where prices continue falling while the indicator rises.

The divergence by itself has little technical significance. Yet, the pattern can be helpful in ascertaining the strength of another technical setup. Here is an example. Assume that prices are in a trading range. Price moves up and comes close to the top of the range which should act as resistance. But, it is also possible that prices may breakout from the range and enter a new trend. If the trader sells near resistance and finds that prices are breaking out, she faces an unnecessary loss while finding herself on the wrong side of the market.

Here, a bearish divergence between prices and indicator can suggest that prices have a stronger probability of retreating from resistance. The resistance zone warns that prices may retreat. A similar message comes from bearish divergence. This leads the trader to go short near the resistance area.

Divergences can be useful in cases where loss of momentum can confirm another technical pattern.

Better late than Never

I missed out on writing the blog for a few days. then, I felt embarrassed at the absence and awkward in starting to write again. Therefore, more days elapsed, so more embarrassment and more days.

To break this cycle, I am writing this post to say that maintaining this blog is one of my favorite tasks each day. Not writing is my loss.

The Nifty

The Nifty has seen a spectacular decline and now seems to be making a trading range. Markets go through cycles of expansion and contraction. We saw the expansion process when the Index fell from 5400 to 4650. Now, we are probably in the contraction process.  It seems that a trading range between 4700 and 4900 may be developing. These boundaries are tentative.

Now, trading inside a trading range is NOT a profitable proposition. There may be day trades, or trades that sell at resistance and buy at support. Except these methods, trying to catch a trend when inside a trading range is a losing proposition. The trend can reverse many times inside these boundaries.