The Hindu Business Line : Trader's Corner

Anyone who has been involved with the stock market for more than a decade would know the futility in trying to predict the market’s top or the bottom. Buying the stock near its low and selling just before a downward reversal is a rare occurrence.

Staying on the right side of the trend for a major part of the up or down trend is what most traders aim to do, in order to stay afloat.

The key question is — how long should one hold on to a profitable trade? Most of us are familiar with the vexing situation when we have exited the stock with a ‘handsome profit’ only to see it turning in to a multi-bagger. The other common occurrence is when we wait for the stock to bounce from a correction and regain the former peak; only to find it sliding unrelentingly until all the gains are erased and the stock is back where it started from.

Charles Dow addresses this issue in the Dow Theory that was expounded in a series of Wall Street Journal articles in the beginning of the twentieth century.

The market is said to be in an up-trend as long as it records successive higher peaks and troughs. The up-trend reverses when the market fails to record a higher peak and the trough that follows falls below the previous trough. The reverse would be true in a downtrend. The index would be construed to be in a downtrend as long as it records lower peaks and troughs. The downtrend will reverse when the index records a higher trough and then moves above the preceding peak.

If we consider the movement of the Sensex in 2006, the index fell 30 per cent from the peak of 12671 formed in May 2006. But the long-term up-trend was confirmed when it moved past 12671 in October of that year. The higher trough at 8800 and the next peak at 14723 helped to maintain the sequence of higher peaks and troughs.

— Lokeshwarri S. K.