There are more than 3000 stocks in the Indian equity markets. These stocks are tradable but not tradable. By this I mean that even though these stocks can be bought and sold, it is not recommended that majority of the stocks must be traded.

In my experience, and through trial and error, I have learned that a trader has to be very picky about his trading universe in order to be able to earn consistent profits. Every stock goes through the phase of uptrend and downtrend. Because Indian equity markets are inherently bullish, a trader has more probability of success on the long side of the trades. Then, the trader’s stock selection is simplified if he focuses on stocks currently in their uptrend.

In today’s newsletter, we discuss the art of identifying stocks that show this uptrend clearly on the charts.

The Two types of stocks

Even though the trader is able to identify stocks currently in an uptrend, the stock selection doesn’t end there. Widely speaking, there are two types of stocks in an uptrend. First are those which are volatile in nature. The second type are the ones which are clean in nature.

Volatile stocks could go up from 100, for example, to 300 in just one year and then decline to 200 in the same year. These stocks essentially enter an uptrend and downtrend the same year. It would be wise to limit the participation in these kinds of stocks because of their volatile nature.

Clean stocks are the one which are in a consistent uptrend with small retracements in between. These stocks can go up from 100 to 200 in just one year but with a clean uptrend. Once entered into an uptrend, these kinds of stocks can continue their journey upwards for at least a year or two.

Identifying the clean ones

Identifying these stocks is rather objective. The reasons for some stocks entering this phase of clean trend are many. Improving financial performance of the company is one such reason. Relative outperformance and Path of least resistance are the other ones.

One of the major reasons that the stock enters a clean uptrend is because the stock starts to outperform the market. This is just the first condition.

The second condition is just as important. Path of least resistance refers to a price zone where the price is expected to face the least resistance form the market participants. These price zones are near All Time High, after a big consolidation breakout, or price breaking out of a multi-year breakout. These stocks enter a new zone after the breakout.

Confirming the trend

To confirm breakout and the subsequent trend, I use Renko charts. Because of their noiseless nature and diagonal plotting system, these charts are the best to spot consolidation, their breakout, and the subsequent trend. After the breakout, the price must form at least two consecutive swing breakouts to confirm an uptrend.

It is a common mistake made by new traders to try and predict the trend of a stock. Predicting usually takes away the focus from the charts and removes the objectivity. The patterns formed will confirm the trend and not predictions. The patterns are formed on the charts. Therefore, the focus must be on the charts. If the price patterns do not confirm the trend, then the trader must look for other candidates to trade in. It is rather wise to confirm trend by letting go of small portion of a big moves.

When the trend is confirmed, each swing breakout can be traded with appropriate stop-loss.

The trader can start with filtering Relatively outperforming stocks from their trading universe. The second filter will be spotting the stocks currently trading near the path of least resistance. Then it is only a matter of waiting for the price to make the right patterns.

Observe the charts below of TVSMOTOR and GRSE. These stocks were in Consolidation near their ATH price. After the breakout from the consolidation, they both gave clean trend. The red line shows the 2nd Swing breakout formed by the price charts. This confirmed the trend of the stocks.

Renko charts have been long used for identifying trend. Adding TMA adds context to the charts and the principles of swing breakout give the trader an objective entry for participating in the stock. Check the link below to explore more about this charting method.