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A Unique Rally

Dear Reader,

 Last week I wrote that bullish efforts were falling short and were inadequate to sustain a convincing upthrust. The markets rallied however and it may appear that my statistical hypothesis may be off the mark. However, the data has not changed much and the rally does appear to be powered by fumes rather than solid fuel. While the headline indices rose, retail participation levels were noticeably subdued. The week-on-week index futures turnover recorded a 27.97% fall and the market-wide stock futures turnover was 2.02% down. That raises the probability of a high degree of short covering (bear squeeze) being responsible for the rally last week.

Is it possible for short covering to take the headline indices higher? Yes! Bear squeezes (forcing bears to cover their short sales) have been known to cushion price falls and also trigger viciously sharp but temporary rallies. But sustainability is suspect till aggressive fresh buying occurs. This fresh buying is what we must watch this week in the statistical data. Since this is a media column based on mathematical models and is logic oriented, we need to analyse what triggered the rally. President Trump did a volte face and termed India as a great friend and expressed hope of a trade deal in the near future. Last week I wrote about the optimism triggered by announcements of government disinvestment in public sector banks that remained in the funnel too.

Bullish traders considered these as positive cues and raised prices higher. Bears were forced to cover shorts. A nervous US dollar index added to the optimism as did the subdued Indian 10-year sovereign bond yields. The feel-good-factor was so strong that it ignored the all-time low levels that the rupee tested. I expect some of this optimism to trickle down to this week as well. While I personally won’t be buying anything as yet, if my readers choose to go long, their positions must be protected with tail risk (Hacienda) hedges.

     

Rear View Mirror

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

The upthrust was led by the broader based Nifty 50 while the Bank Nifty brought up the rear. A weak dollar index (DXY) triggered a relief rally in emerging markets including India. It also triggered safe haven buying in bullion and short covering in oil and gas.

The rupee tested a new low versus the dollar intraweek before settling higher. Indian 10-year bond yields eased which cushioned declines in the Bank Nifty. NSE gained 1.65% in market capitalisation which tells us the rally was broad based. Market-wide position limits (MWPL) rose routinely.

US indices rallied and provided tail winds to our markets.

Retail Risk Appetite – I use a simple yet highly accurate yardstick for measuring the conviction levels of retail traders – where are they deploying money. I measure what percentage of the turnover was contributed by 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 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) –

In the capital-intensive, high-volatility futures segment the turnover contribution was marginally higher. That tells me risk appetite was mild. In the relatively safer (less volatile and lower capital requirement) options segment the turnover contribution rose in the stock segment at the expense of the index options.

Overall risk appetite seems to be cautiously optimistic. Traders need to be a whole lot more aggressive to push markets significantly and sustainably higher. 

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 computes the ratio of rising to falling stocks. As long as gaining stocks outnumber the losers, bulls are dominant. This metric is a gauge of the risk appetite of one marshmallow traders. These are pure intraday traders.

The Nifty clocked bigger gains last week but intraday traders showed lower buying conviction as is borne by the advance-decline ratio. The reading at 1.11 (prior week 1.50) indicates there were 111 gainers for every 100 losers. This ratio needs to stay above the 1.0 levels continuously to indicate continued bullishness. 

A tutorial video on the Marshmallow theory in trading is here

The second chart I share is the market-wide position limits. 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/s.

The MWPL rose routinely after expiry. However the reading was the lowest in the comparable week in five months. That tells us the buying momentum even in the swing traders camp was milder compared to the recent months. In order to keep the bullish momentum going at higher levels buying momentum has to be far more aggressive.

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 the headline indices rose in unison but the impetus readings diverged. The rally in the Bank Nifty was milder and lacked momentum. The heavy weightage of banking and financial stocks makes it crucial for both indices to rise strongly on higher momentum. Watch the Bank Nifty keenly this week for cues.

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 it to traded securities helps a trader estimate prevalent sentiment.

The Nifty clocked bigger weekly gains but the LWTD indicator slipped into negative territory. The reading at -0.08 (prior week 0.02) suggests a milder fresh buying support likely this week.

Sure enough short covering can be seen but that is a short term measure for bulls. Sustainable rallies require large scale and aggressive fresh buying. 

A tutorial video on interpreting the LWTD indicator is here

Nifty’s Verdict

The weekly chart of the Nifty shows a bullish candle and the highest closing in over two months. The price is above its 25-week average which is a proxy for a six month long average holding cost of a retail investor. That means the medium term outlook is positive for now. The average itself doubles up as a support area at the 24,550 threshold.

Last week I advocated resistance at the 25,100 level which was overcome on a closing basis. Bulls must keep the Nifty trading above this threshold on a closing basis to indicate intent to continue buying. 

Medium term outlook has turned positive
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Your Call to Action – Watch the 24,550 level as a near-term support. Only a sustained trade above the 25,100 level confirms the possibility of a fresh rally.

Last week I estimated ranges between 55,050 – 53,175 and 25,150 – 24,325 on the Bank Nifty and Nifty, respectively.  Both indices stayed within their specified parameters.

This week I estimate ranges between 55,725 – 53,875 and 25,550 – 24,700 on the Bank Nifty and Nifty, respectively.

Trade light with strict stop losses. Avoid trading counters with spreads wider than 8 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.