Value averaging is an investment technique that was proposed by Michael Edleson to assist investors in making decision related to the amount of money and the time to be assigned to an investment portfolio.
Darvas Box system Every great trader/investor in the history of the markets had a specific method to approach the markets, which eventually led them to create a good fortune, Darvas Box system is one such method. It is a trend following strategy developed by Nicholas Darvas in the 1950s to identify stocks for good upside potential. This is one of the few methods to trade the markets which uses the combination of both the technical analysis and fundamental analysis for a much more refined decision. The fundamentals were used to identify the stocks, and technical analysis was used to time the entry and exits. Who was Nicholas Darvas? Nicholas Darvas was arguably one of the greatest stock traders/investors during 1950s – 1960s, but surprisingly he was a ball dancer by profession and not a professional stock trader. Even while trading and building his fortune, he was on a world tour for his performances in many countries and took up trading as a part-time job. In November 1952 he was invited to a Toronto Nightclub for which he received an unusual proposition of getting paid in shares by the club owners. At that time, all he knew was there is something called stocks which moves up and down in value, that’s it. He accepted the offer and received 6k shares of a Canadian mining company Brilund at 60 cents per share, with the condition that if the stock falls below this price within six months, then the owners would make up the difference. This was the introduction of a professional ball dancer to the stock market. Nicholas Darvas couldn’t perform at the club, so he bought those shares as a gesture. Within two months, Brilund touched $1.9, and his initial investment of $3000 turned to $11400, netting in almost three times of his investment. This triggered a curiosity into the stock markets, and he started to explore trading. Origin of the Darvas Box theory Initially, he was trading on his broker’s recommendation, tips from wealthy businessmen, he even approached some advisory services or any source that he could get his hands on for the tips, but all led him to losses. After losing a lot of money, he decided to develop his own theory, and after a lot of trial and error, his observations and continuous refinements he eventually invented his theory “The Box Theory”. So what exactly is the Box Theory? Fundamentals Analysis As stated earlier, the box theory uses a judicious bend of both the technical and fundamentals. Darvas believed that in order to spot a good stock or even a multibagger, there should be something brewing up in the respective sector as a whole or some major fundamental change in that specific company. Generally, the fundamentals that Darvas used to study were on a broader sector level, and not the company-specific fundamentals. Even for the specific company Darvas used to look from a general perspective like, is the company launching a new product which could be a blockbuster hit. He completely refrained from looking at numbers and financial statements as his initial experiment with ratios and financial statements didn’t yield any good result. To know more on the three financial statements read: Income Statement (P&L) Balance Sheet Cash Flow Statement Technical Analysis Darvas was a big believer in price action and volume of the stock. He believed if some major fundamental changes were to take place in a company, this soon shows up in the stock price and its volume of trading as more people get interested in buying or selling the stock. With his observations here realized by just observing the price action, he can participate in the rally which gets triggered by some major fundamental development without actually knowing about the change. Using the box theory, Darvas used to scan stocks based on rising volume as he needed mass participation in the rally. Also, he only picked up those stocks that were already rising. His theory is all about “buy high, sell higher” instead of the conventional belief of “buy low, sell high”. After the stock satisfies both the parameters of increasing price and volume with major underlying fundamental change, Darvas looks to enter the stock. Good read on momentum trading. How and where to enter? Major part of the box theory is based on entry and exit levels. To enter a stock, Darvas looked for a consolidation phase preceded by a rally. A consolidation phase is the price action wherein the price moves up and down in a tight range, that is, a non-directional move. He would then mark the high and low of the consolidation phase with the horizontal line, essentially making it a box-like structure, hence the name “Box Theory”. The high point is called the ceiling, and low is called the floor. Whenever the stocks break above the ceiling, Darvas would look to buy one tick above the ceiling with one tick below floor as a stop-loss point. Pyramiding Darvas discovered early on, in order to become successful in the market your winning bets should yield much more profit than the loss in the losing bets. This led him to do pyramiding in his winning trade, which is clearly defined in the box theory. Pyramiding means to increase the existing position if the stock is going in the favour, which leads to a much higher profit in the winning trades. According to the box theory, the repetition of the entry criterion is the new signal for adding onto the existing position. In other words, after a position, if the stocks stage the same setup, that is, a consolidation after a rally, then the break above the ceiling of this new box would signal to increase position with the revised stop loss of 1 tick below the new floor. In any case, whenever the stock falls below the current floor, the entire position would we sold off at once. This is the only exit condition in the box theory, and there is no method of booking profit upfront as Darvas believed in holding on to a rising stock. The only way to book profit is to let the stock to take out the revised stop loss.
David Ricardo, a renowned economist, is majorly recognised for his theory on wages and profits, theory of international trade, theory of rents and labor theory of value. His economic thinking dominated throughout majority of the 19th century.
Dead Cat Bounce Dead Cat bounce is a colloquial phrase which is quite popular in the financial markets. The term was coined a long time ago and generally referred to the peculiar behaviour of the price. The phrase denotes a recovery in the asset’s price, often a sharp one after a prolonged downtrend. Sometimes it is also referred to a short but sharp fall, succeeded by an equally sharp recovery. How does a downtrend continue for a long time? Quite often, some securities in the financial markets depict a very long downtrend which may last from a few months to a few years depending on the severity of the fundamental headwinds. These prolonged downtrends are so strong that no support levels can withhold the downtrend and the prices keep on falling. Every support level gets taken out by excessive selling, which pushes the prices even lower. These lower prices force the long holders to liquidate their positions as no visible halt in the downtrend is noticed. This liquidation from existing buyers further fuels the selling, leading to the continuation of the downtrend. As the price keeps on falling, the buyers do not get enough confidence to buy and consequently keep getting overpowered by selling pressure continues the downtrend. So what is the ideology behind “Dead Cat Bounce”? In due course of a downtrend, the security tends to become oversold for the time being. Oversold is a technical term is used for security which seems to have fallen quite a bit in a specified period. In other words, a security that has been continually sold in a specified period tends to reach a level wherein the sellers are no more interested in selling at further lower rates. This is where the buyers’ step in and try to buy these stocks at low prices, leading to an increase in demand over the supply. This fresh buying tends to push the price up hence resulting in a short upside movement or, in technical parlance a “Bounce”. This point is where the downtrend witnesses a temporary upside momentum which is exactly quoted as a “Dead Cat Bounce”. The ideology is “Even a dead cat will bounce if fallen from a great height.” Likewise, a short bounce is quite expected after a prolonged downtrend which does not change the trend as a bounce does not mean the cat has become alive. Image Source ©Kalkine Group Does it signify a reversal from a downtrend? A Dead Cat bounce is an upside momentum, witnessed after a prolonged downward trend, generally near the oversold price region. But it is to be noted that this price bounce is merely a reaction of the downtrend which is often witnessed in the oversold areas. This does not change the entire trend, and more often than not, the trend continues in the primary direction after the bounce fizzles out. Why is it difficult to trade a Dead Cat Bounce? Most of the time it is difficult to trade a move like a Dead Cat Bounce as the bounce is often very quick and short-lived. The overall trend remains negative, which is in contradictory to the short-term bounce. Also, few investors mistake it for the trend change, which often proves to be a mistake. It generally becomes difficult to estimate some key support areas from where the bounce may occur as the downtrend is quite strong and lacks demand to support the price. However, there are some momentum indicators like RSI (Relative Strength Index), Stochastics oscillator etc. which may help to gauge oversold zones from where the bounce may occur. What are the reasons for a Dead Cat Bounce? There could be many reasons for a Dead Cat Bounce to occur on the charts as the sudden demand may come due to numerous reasons. Some of the reasons are Oversold Price As discussed, due to a prolonged downtrend and continued selling the price often comes to a level wherein the sellers are no more interested in selling at these lower prices and at the same time buyers often find a value proposition. This leads to a spike in demand, which ultimately results in a Dead Cat Bounce. Strong support area There are some levels of support on the price chart that are quite prominent. In other words, there are some regions of support which are quite strong and may remain relevant for years. These support levels are generally hard to break at the first attempt, which results in a bounce or a complete reversal. How to profit from a Dead Cat Bounce There are two different strategies when it comes to trading these kinds of sharp and against the trend moves. They are contradictory to each other, but both are based on proven price behaviour. Short Selling the rally As the primary trend of the underlying is still downward, one thought arises to go short on the bounce. This strategy one to participate in the downtrend but with a much better price. If these rallies are met with a resistance level like a falling trendline, horizontal price resistance etc. then these areas are ideal to sell the bounce in a downtrend. Buying into the rally Another opinion arises, why not to participate in the bounce? This strategy can also be fruitful provided the bounce should be stronger and last for a while, which is not always the case. This essentially calls for a very quick decision making while capitalising on the temporary bounce. Bottomline A Dead Cat Bounce is a prolonged downtrend followed by a short-term bounce. These bounces generally don’t last long, and once they fade, the trend continues towards the south. However, sometimes a bounce may also act as a reversal, but for the added confirmation a trader should also look at other signals of a reversal like bullish divergence at the bottom or a double bottom chart pattern.
What is EBITDA? Earnings Before Interest, Taxes, Depreciation, and Amortisation (EBITDA) is a widely used financial metric in evaluating cash flows and profitability of a business. Market participants closely track EBITDA and apply it in decision making extensively. Although conventional investors like Charlie Munger had raised concerns over the use of EBITDA, it is very popular in markets, and M&A transactions are mostly priced on EBITDA-based valuation like EV/EBITDA (x). EBITDA is not recognised by IFRS and GAAP but is used extensively in the Corporate Finance world. It is now a mainstream financial metric that companies look to target. EBITDA depicts operational cash generation capacity of a firm in a given period. It acts as an alternative to financial metrics like revenue, profit or earnings per share. EBITDA allows to evaluate a business operationally and outcomes of operating decisions. Non-operating items are excluded to arrive at EBITDA. EBITDA excludes the impact of capital structure or debt/equity, and non-cash expenses like depreciation and amortisation. A particular criticism of EBITDA has been the inappropriate outlook of capital intensive businesses, which incur large depreciation expenses. Business with large assets incurs substantial costs related to repair and maintenance, which are not captured in EBITDA because depreciation expenses are accounted to calculate EBITDA. Meanwhile, EBITDA can paint an appropriate picture for asset-light business with lower capital intensity. While revenue, profit and earning per share remain sought-after headline generators for corporates, EBITDA has also found its growing application in the corporate finance world and is now a mainstream metric to evaluate a business financially. Perhaps the growth of asset-light business models has also added to the use of EBITDA. Its debt-agnostic approach to evaluate businesses has given reasons to investors, especially for high growth firms during capital expenditure cycles. But EBITDA has been present for close to four decades now. In the 1980s, the growth in corporate takeovers through leverage buyout transaction was on a boom. EBITDA grew popular to value heavy industries like broadcasting, telecommunication, utilities. John Malone is credited for coining this term. He was working at TCI- a cable TV provider. Since EBITDA has remained an important metric to determine purchase price multiples and is highly used in M&A transactions. EBITDA’s application in large businesses with capital intensive assets that are written down over a long period has been a source of concern for many investors. Although EBITDA is an effective metric to evaluate the profitability of a firm, it does not reflect actual cash flow picture of a firm during a period. Also, it does not account for capital expenditures of the firm, which are crucial in successfully running a business. EBITDA does not give a fair cash flow position because it leaves out crucial items like working capital, debt and interest repayments, fixed expenses, capital expenditure. At the outset, there can be times when EBITDA may overstate performance, value and ability to repay debt. How to calculate EBITDA? NPAT: Net Profit after tax is the amount reported by a firm in the given period. It is present on the income statement of the firm and is used in the calculation of earnings per share of an entity. To calculate EBITDA, interest expense, tax, depreciation and amortisation are added to NPAT. Interest Expense: Firms can employ debt in their capital structure, and interest expense is funds paid to lenders as interest costs on principal debt. Most companies have different financing structure, and excluding interest payments enable comparing firms on operating grounds through EBITDA. Tax: Firms also pay income tax on profits. Excluding taxes gives a fair picture of the operating performance of the business since tax vary across jurisdictions, and sometimes according to size of business as well. Depreciation: Depreciation is the non-cash expense to account for the steady reduction in value of tangible assets. Firms can incur depreciation expense on machinery, vehicles, office assets, equipment etc. Amortisation: Amortisation is the non-cash expense to account for the reduction in the value of intangible assets like patents, copyrights, export license, import license etc. Operating Profit: Operating profit is the core profit of a firm generated out of operations. It includes cash and non-cash expenses of a firm, excluding income tax and interest expenses. Operating Profit is also called Earnings Before Interest and Tax (EBIT). Read: EBIT vs EBITDA What is TTM EBITDA and NTM EBITDA? Trailing Twelve Months (TTM) or Last Twelve Months (LTM) EBITDA represents the EBITDA of the past twelve months of the firm. It allows to review the last operation performance of the business. Whereas NTM EBITDA represents 12-month forward forecast EBITDA of the firm. NTM EBITDA is also one-year forward EBITDA. Market participants are provided with consensus analysts’ estimates for a firm, which also include NTM EBITDA, NTM EPS, NTM Net Income or NPAT. What is EBITDA margin? EBITDA margin is the percentage proportion of a firm EBITDA against total revenue. It indicates the operational profitability of the firm and cash flows to some extent. If a firm has a higher margin, it means the level of EBITDA against revenue is higher. It is widely used in comparing similar companies and enable to evaluate businesses relatively. If a firm has a total revenue of $1 million and EBITDA is $800k, the EBITDA margin is 80%. What is adjusted EBITDA? Adjusted EBITDA is calculated to provide a fair view business after adding back non-cash items, one-time expenses, unrealised gains and losses, share-based payments, goodwill impairments, asset write-downs etc.