[Premium] Scale Up or Scale Out?

The first "lens" we want to look at this question through is the broader market.

Although the major Nifty indexes aren't going to tell you what every stock is doing, they give you a general view of what's happening with Equities as an asset class. The purpose of this lens is to identify the levels that would change your overall view for Equities over your timeframe. For us, we're looking to make money over the next quarter, so we're looking primarily at weekly and daily charts.

With that in mind, here's the Nifty 50.

Click on chart to enlarge view.

In the near-term, if prices broke below their late June highs near 10,525, then that'd likely take some upside momentum out of the market. At that point we'd have to wait and see how the new range develops and resolves itself. Do prices correct through time and then break out again? or do we quickly move to the next level of support near 10,000?

The point is we don't know and nobody else does either. What we do know is that if prices are below 10,525 then the conditions are in place for sellers to take control.

Looking out longer-term, as we've spoken about at length, if prices are above 10,000 in the Nifty 50 then our "new bull market in stocks" thesis remains intact.

For the Nifty Mid-Cap 100, the short-term momentum level is 15,100, while the structural level is 14,000. Notice here that there's a bearish momentum divergence, which would also confirm with a break of 15,100...another reason for a more cautious short-term view if that level breaks.

In the Nifty Small-Cap 100, the short-term momentum level is 4,800 (with a bearish momentum divergence too), while the structural level is 4,300.

So that's the first piece of the puzzle. The short-term level of support we've outlined will determine whether the next 5-10% move in the Nifty will be higher or lower. The structural level will determine whether the next major move (20%, 50%, 100%) will be higher or lower. So it's important to know what timeframe you care about. For us, we're more focused on the structural trend given we're looking out over the next 90 days and beyond.

The other aspect to remember is that just because the indexes are doing one thing doesn't mean every stock is going to do that as well. We know that's not true. There are some stocks going up, some stocks going down, and others going nowhere. That will always be the case, though a majority of stocks tend to be correlated with the broader market so having an understanding of where the indexes could go is important.

The second "lens" we want to look at this question through is the individual stock we're analyzing. And not without context. We want to look at the stock within the context of the initial trade thesis.

Why are we in this stock? Where did we get in, where did we think it could go upon entry, how long did we intend to hold it, and where is it today?

If you want to know if you should be buying or selling an individual stock, analyze the individual stock. It doesn't matter if the broader market is going up if your stock is down, just as it doesn't matter if the broader market is going down and your stock is up. You're holding the stock, not the market, so your risk management strategy needs to be based on the asset you actually own.

Analyze the stock you're trading, don't get caught up in every other supplemental piece of information.

A good way to think about this question is by asking if I had cash today would I enter this position again at current levels? If the answer is no, then maybe it's time to pare back the position or wait until better prices present themselves to buy more. If the answer is yes, then maybe it's an okay time to be adding to the position. That'll depend on each individual's acceptable reward/risk ratio and the answer to lens #1 (broader market view).

Let's look at some examples.

Here's Bharat Electronics. We originally wanted to buy this with the stock at 80, with the thesis that if prices were above 74 then the bias was higher towards 120. If you werent' scaling into the stock as it began to run above 74 and 80, then adding it here at 103 probably doesn't make much sense. You'd be dealing with 29 points of potential downside and only 17 points of potential upside.

So in this case we don't want to be scaling up, we'd be holding until our target near 120 is reached and buying any weakness back towards 74 if we got it. OR if you want to get really tactical and take some risk off the table and try to buy it back lower, that's an option as well.

On the other hand, something like PI Industries that is just now breaking out to the upside is something you could be scaling into as it continues to work. Prices just exceeded our breakout level of 1,615 and still have over 500 points of potential upside from current levels, so scaling in as the stock goes higher would likely still present a solid reward/risk opportunity.

The third "lens" we want to look at this question through is your own portfolio management practices. Everyone has different objectives. Some people don't care if the next 8% move in the Nifty is lower if the next 50% move is higher. Others want to micro-manage their longer-term positions by catching small turns in the market and adding back stock exposure.

Take Bharat Electronics for example. Some people are fine with the potential of riding it back down towards 80 if it eventually gets to 120...while others don't have any interest in that and would rather just sell it and move on if the bias shifts to the downside in the near-term.

We can't figure that out for you.

What we do know is that if the Nifty 50 breaks 10,525, then the risk is elevated in the short-term and stocks likely experience some weakness. At that point, we need to see how prices react to lower levels of support. Do they digest through time and then break out again? Or do they slice through support and ruin the "new bull market" thesis?

Who knows? We need to take it one step at a time.

So what does that look like from a portfolio perspective? If prices break their upper level of support as we outlined above, there are a variety of ways to reduce the risk of your portfolio.

1. Raising cash by selling stocks at/near price targets AND/OR stocks showing relative weakness (i.e. the weeds)
2. Adding short exposure (via indexes or stocks showing relative weakness)
3. Using puts or other derivatives to hedge your long exposure
4. Adding uncorrelated trades like Gold/Silver or other Commodities to your portfolio

Now is probably a great time to be asking yourselves these questions as our view is that a break of these short-term levels of support is likely. Maybe these risks don't trigger significant downside like the Global Equity Risks we outlined several weeks ago, but at least you know what to be doing if/when the current risks do trigger.

And make sure to bookmark this post as these questions will be helpful in any market environment.

As you're reviewing your portfolio, feel free to contact us if you have any questions about individual stocks and we'll get back to you within 24 hours.

Allstarcharts Team