Good Morning!

Santa Claus rally ahead?

Dear Reader,

Last week, I wrote that bulls appeared to have an upper hand, read here. The markets barely managed to stay above water after the participants saw the rupee weaken further against the US dollar. This raised concerns about imported inflation in the coming months. The firming up of oil and gas prices also added to the worries. It was only after the Reserve Bank of India (RBI) cut interest rates by 0.25% that markets recovered.

As I have been writing for the last few weeks, follow-up buying is of extreme importance as bulls must absorb all selling that emerges at higher levels to express the intent of propelling markets higher. Historically, December tends to be bullish (at least in the second half) as institutional buying emerges to boost NAVs (net asset values). This determines the performance bonus payable to foreign institutional investors (FII) fund managers. This bullishness is called a ‘Santa Claus’ rally in the markets. Only aggressive buying can make a Santa Claus rally possible this year.

Banks remained in the limelight along expected lines as RBI eased interest rates. Being the heaviest-weighted sector in the Nifty, banking must participate in the upthrust to lend credibility and sustainability to any upmove. Public sector undertakings (PSUs) also attracted the attention of traders. That may continue this week as well.

A weak rupee is likely to see bullishness in bullion or at least smaller declines in prices, even if overseas prices fall. This is due to the currency factor. The long-term bullish story in bullion remains intact even if there is volatility in the near term.

     

Rear View Mirror

Let us assess what happened last week so we can gauge what to expect in the coming week.

The indices moved marginally but in divergence. The Nifty lost small ground, whereas the Bank Nifty gained marginally. This was due to the rate cut on Friday, which resulted in significant gains in the markets. But for which the indices would have ended the week in the red.

Bullion rose as the dollar index eased and haven buying resurfaced. The National Stock Exchange (NSE) lost 0.74% of its market capitalisation, suggesting that the broader market witnessed unwinding. The market-wide position limits rose routinely after expiry.

US headline indices gained uniformly, providing tailwinds to our markets.

Retail Risk Appetite – I use a simple yet highly accurate yardstick for measuring the conviction levels of retail traders, where they are deploying their money. I measure the percentage of turnover contributed by the lower- and higher-risk instruments.

If they trade more of futures, which require sizable capital, their risk appetite is higher. Within the futures space, index futures are generally less volatile than stock futures. A higher footprint in stock futures shows higher aggression levels. Ditto for stock and index options. 

Last week, this is what their footprint looked like (the numbers are the average of all trading days of the week) –

Turnover contribution in the capital-intensive and higher volatility futures segment eased significantly. In the relatively calmer options markets, turnover rose only in index options—relatively speaking, the safest instrument in the derivatives segment. That indicates that the conviction levels were very weak among the derivatives traders.  

Matryoshka Analysis

Let us peel layer after layer of statistical data to arrive at the core message of the markets.

The first chart I share is the NSE advance-decline ratio. After the price itself, this indicator is the fastest (leading) indicator of which way the winds are blowing. This simple yet accurate indicator calculates the ratio of rising to falling stocks. As long as the number of gaining stocks exceeds the number of losers, bulls are dominant. This metric gauges the risk appetite of one marshmallow traders. These are pure intraday traders.

The Nifty logged small losses last week, and this was reflected in the advance-decline ratio, which fell to 0.68 (from 1.25 in the prior week). That means there were only 68 gaining stocks for every 100 losers. This shows poor intraday buying conviction. If there is to be a rally, this ratio must stay above 1.0 with rising prices. 

A tutorial video on the Marshmallow theory in trading is here

The second chart I share is the market-wide position limits (MWPL). This measures the amount of exposure utilized by traders in the derivatives (F&O) space as a component of the total exposure allowed by the regulator. This metric gauges the risk appetite of two marshmallow traders. These are deep-pocketed, high-conviction traders who roll over their trades to the next session.

The MWPL reading rose routinely after expiry of the November derivatives series. However, the rise in the week after expiry was marginally lower than the commensurate week last month. It takes aggressive fresh buying to keep pushing prices higher. Watch the MWPL reading. It must rise in line with prices if the rally is to be sustained. However, it is worth noting that higher volatility typically accompanies higher MWPL readings. This is because bigger positions will churn if any adverse trigger emerges.

A dedicated tutorial video on how to interpret MWPL data in more ways than one is available here

The third chart I share is my in-house indicator ‘impetus.’ It measures the force in any price move. Last week, both indices were range-bound on a week-on-week closing basis. The impetus readings fell, indicating that both indices lacked strong momentum.

For a rally to commence, impetus readings must rise with prices.

The final chart I share is my in-house indicator ‘LWTD.’ It computes lift, weight, thrust and drag encountered by any security. These are four forces that any powered aircraft faces during flight, so applying them to traded securities helps a trader estimate prevalent sentiments.

Last week, the Nifty eased slightly, and the LWTD fell to -0.38 (from 0.08 in the prior week), indicating that fresh buying support may be weaker than it was last week. Short covering may cushion declines, but fresh buying will be necessary to sustain the upward momentum.

A tutorial video on interpreting the LWTD indicator is here

Nifty’s Verdict

Last week, we saw a bearish hammer forming on the candle chart. A hammer occurs when the price opens steady, attempts to rally, fails, falls sharply, but recovers to close mildly lower than the opening levels. The body of the candle is small, and the lower shadow (wick) is far longer. It shows that the bears tried, but the bulls managed to lift prices higher. By itself, this signal does not say anything conclusive. Though it warns of weakness, it also indicates lower levels attract buying.

A follow-up action will determine what unfolds next. If bulls manage to keep the Nifty above the 26,325 levels on a sustained closing basis, that indicates selling pressure is being absorbed. On the other hand, bulls must maintain the Nifty above the 25,850 levels to sustain the upward momentum.

The price managed to stay above the 25-week moving average, which is a proxy for the six-month average holding cost of an average investor. That indicates the medium-term outlook remains optimistic. 

Nifty must stay above the 26,325 levels
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Your Call to Action – Only a sustained trade above the 26,325 level confirms the possibility of a fresh rally. In the event of declines, the 25,850 level needs to be defended.

Last week, I estimated ranges of 60,975 – 58,525 and 26,750 – 25,675 for the Bank Nifty and Nifty, respectively.  Both indices traded within their specified ranges.

This week, I estimate ranges between 60,950 – 58,600 and 26,700 – 25,675 on the Bank Nifty and Nifty, respectively.

Trade light with strict stop losses. Avoid trading counters with spreads wider than 6 ticks. 

Have a profitable week.

Written by Vijay L Bhambwani, Vijay is the Ceo of www.Bsplindia.com. He tweets at @vijaybhambwani. Edited by Michael Steve Correya. Produced by Shad Hasnain.