Coppock signal: Don’t be a sucker

The markets have reacted positively to the poll results of the world’s largest democracy. The historic dual circuit filters on the upside have cheered many on the fifth anniversary of “black Monday” in May 2004.

Should we then assume the markets are now undisputedly in bullish hands and fresh buying is advisable?

We refer to the Coppock indicator, which has stood the test of time and accurately predicted market bottoms for over four decades.

Edwin Coppock was an economist in the UK who was approached by the Church to help with investing the church funds at the appropriate time in the middle of the last century. The Church was not sure how long the then recessionary phase would last and wanted to be absolutely sure before committing funds to equities.

Coppock set to work, formulating an indicator, now known as the ‘Coppock indicator’. It consists of plotting 11-month and 14-month rate of change oscillators and smoothening the same by a common average.

This indicator has accurately predicted 99% of market bottoms, sometimes a while in advance. However, it fails miserably when it comes to predicting market tops.
Coppock had also incorporated some behavioural economics in its parameters, the primary one being the average period of mourning by an average person after losing a near and dear one. He found that an average individual overcomes the loss of a near and dear one, no matter how painful, and slowly but surely stops reacting to painful memories of the departed member. Similarly, markets are known to stop reacting to negative news over a period of time, especially after a sustained decline. That would be an ideal time to deploy funds into equity markets.

Currently, Coppock’s indicator has signalled a possible market bottom in the domestic context as the headline indices have zoomed to stratospheric levels where a single day gains are concerned.

The burning question is, should you enter now, or wait? The answer is yes to both the questions, depending on the type of market player you are.

If you are an aggressive, risk-taking leveraged player, you should not think of jumping into the markets on the long side afresh.

But, if you are a long-term investor who thinks nothing of 24-30 months as a timeframe, by all means, go ahead and buy.

Just remember the following points before you buy:
The markets have been rallying before the poll results announcements, which means the ‘positive surprise’ aspect is not really as surprising for all players concerned

The kind of buying that is required to propel markets higher on the eve of poll results means ‘smart money’ was at work here

‘Smart money’ is also mathematical and un-emotional. It realises that such spikes are invariably followed by consolidation/ corrections. Once the news is out, profit-taking will set in. Remember the old saying, ‘buy on expectations, sell on news’?

Once smart money starts selling, it will sell in the same quantum as it bought earlier. A corrective decline that can occur will not be easily absorbed by retail players without suffering significant losses to capital in the futures segment

The corrective decline that will occur will be a much safer point of entry as the process of price discovery will be more logical than knee jerk

While the short-term pressures of covering shorts, margin calls and systemic stop-loss orders may fire another round of buying, I feel there is a significant risk to bulls who initiate leveraged purchases at current levels.

Traders/ speculators should not only know when and what to buy, but also at what price to buy and when not to buy at all.

If you are a long-term investor, by all means, go ahead and buy. But be prepared to average downwards.

If you are trader, make haste, but slowly.

The writer is a Mumbai-based investment consultant and can be reached at vijay@BSPLindia.com.
Mandatory disclosure: The analyst has long exposure in the delivery/ futures markets.