Good Morning!

Banking stocks hold the key

Dear Reader,

Last week, I wrote that it was time to prioritise capital preservation over capital appreciation due to higher statistical ßeta (pure price volatility) readings. Market price action validated that hypothesis. Read last week's piece here. The Nifty 50 just managed to hold on to minor gains, with Friday’s trading pattern being an interesting one. While the day began with fire and fury, it ended as a damp squib. Higher levels are proving unsustainable. Add the rollover costs and the margin-funded trading interest paid, and you know the bulls are under some duress.

Markets heaved a sigh of relief as active US intervention in Iran was averted. Had this event occurred, there would have potentially been a minor blood bath. Last week, I expected public sector undertakings (PSUs) to witness hectic trading activity. That expectation was fulfilled by the markets. I expect this process to continue this week as well. Market players are expecting some favourable announcements for PSUs in the coming budget.

Oil and gas prices traded higher as expected. I maintain my long-standing view that the global energy markets are adequately supplied. The talk of a supercycle in energy commodities is premature and overly optimistic. Higher levels are likely to get sold into. Geopolitical events, if any, may trigger a short-term spike, but mean reversion will see equilibrium return to these markets.

Industrial (base) metals also saw heavy profit-taking. I wrote in my previous column that I do not subscribe to a supercycle theory in base metals either. AI demand notwithstanding. Do note that, unlike equities, where demand is elastic and supply is limited to paid-up capital, commodities have both demand and supply elasticity. Dig deeper into the earth, and you can mine more metals. There can be bull markets, though. The difference between supercycles and bull markets is a critical one—supercycles endure, bull markets fizzle out. I expect profit-taking in industrial metals to be reflected in the stock prices of metal mining stocks this week.

     

Rear View Mirror

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

The broad-based Nifty 50 just managed to keep its head above water, whereas the Bank Nifty surged higher. This was the sheer weightage aspect at play in the markets. Bullion rallied on safe-haven buying. Oil rose mildly while gas came under selling pressure.

The US dollar index rose amid a flight to safety. The rupee fell against the dollar, which put pressure on our markets. Indian 10-year bond yields rose, limiting the rally in the bank Nifty. The National Stock Exchange (NSE) barely managed to gain market capitalisation, which indicates nervousness in the undertone.

Retail Risk Appetite – I use a simple yet highly accurate yardstick to measure the conviction levels of retail traders—where are they 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. In 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) –

The high-volatility, capital-intensive futures segment saw a smaller turnover contribution, indicating risk contraction. In the options segment, turnover rose in the (relatively) lowest-risk index options. These are signs of caution. 

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, the bulls are dominant. This metric is a gauge of the risk appetite of one marshmallow traders. These are pure intraday traders.

The Nifty 50 managed to notch mild gains of 0.04% and the advance-decline ratio kept pace with the gains. At 0.74 (prior week 0.59), it indicates there were 74 gainers for every 100 losing stocks. That is way below the 1.0 level, which is the bare minimum to keep buoyancy intact in the undertone. 

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 is a gauge of 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 rapidly to 59.14% last week. This is the biggest gain in a fortnight after expiry since the method for computing MWPL was tweaked. That means swing traders increased their exposure. That increases the probability of high volatility as larger positions are churned. The risk of a crowded exit triggered by a negative news event is slightly elevated. Don’t forget the Hacienda hedges, please.

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, I raised a red flag as both indices showed diverging trends in impetus. That persisted again. The red flag is that both indices are wheels of a bicycle. Unless they move in unison, the bicycle can topple. Watch the Bank Nifty this week, given the high weightage of banking stocks in the Nifty.

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 any powered aircraft faces in flight, so applying them to traded securities helps a trader estimate prevailing sentiment.

Last week, the LWTD warned us that fresh buying would be limited. That predictive analysis was on the ball. The current reading shows a mild improvement as the LWTD edged higher to -0.18 (prior week -0.22). That means short covering may improve this week, but overall fresh buying would probably remain limited.

A tutorial video on interpreting the LWTD indicator is here

Nifty’s Verdict

The weekly chart of the Nifty shows a small-bodied candle, indicating indecision and consolidation. The candle took support at the 25-week moving average, which is a proxy for the six-month average cost of a retail trader. As long as the price remains above this average, the medium-term outlook remains broadly optimistic.

The resistance I specified last week at 26,373 remains in place, which means bulls need to try harder this week to overcome it. On the flip side, a sustained trade below the weekly low at 25,473 opens the door to fresh downside.  

Bulls must defend 25,400 this week
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Your Call to Action – Sustained trade above the 26,375 level confirms the possibility of a fresh rally. In the event of declines, the 25,400 level needs to be defended.

Last week, I estimated ranges between 60,250 – 58,225 and 26,150 – 25,200 for the Bank Nifty and Nifty, respectively.  Nifty exceeded the specified support by ₹252. Both indices traded within their specified ranges.

This week, I estimate ranges between 61,125 – 59,050 and 26,150 – 25,225 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.

Vijay Bhambwani is the CEO of www.Bsplindia.com. He tweets at @vijaybhambwani. Edited by Michael Correya. Produced by Shad Hasnain.