Vijay L. Bhambwani's Ticker: Retail investors appear exhausted

Last week, I wrote about the near-term trends being dependent on institutional investors. Another factor that would curtail the participation of retail investors was the end of the financial year. That hypothesis played out along expected lines as headline indices slipped marginally in the truncated week.

Last week I also wrote about the importance of monitoring marketwide position limits (MWPL) after the expiry of the February derivatives series. This indicator is a good way to determine the buying enthusiasm of deeper-pocketed players. MWPL levels indicate fatigue in the retail traders' camp. They are buying, albeit in far smaller quantities. More on this in the Matryoshka analysis segment below.

Index futures turnover hit multi-month lows as a shorter week and higher span (initial) margin requirements curtailed trader participation. Though higher traded volumes are critical while markets are rising, the same is not true on the way down. Markets are known to slide on extensively lower volumes as retail traders have limited resources. This fortifies my view that retail traders and investors are exhausted. Buying the dip may be an aspiration but monetary constraints are a bigger hurdle.

This week will see continued action on public sector undertaking (PSU) stocks, particularly PSU banks. Defence, power, energy and logistics are the other PSU segments that may witness above-average participation. In the private sector, interest-rate sensitives (banks, NBFCs, EMI-dependent sectors, heavily debt-laden companies and highly capital-intensive sectors) may see large price moves. The cost of funds is something my readers must understand deeply and immediately. Start with Dick Stoken’s books. Last week, we saw French, Italian, German and Chinese 10-year sovereign bond yields jump sharply to significant highs. This is a cause of concern for emerging markets (including India). If yields rise in overseas markets, our cash carry arbitrage advantage may shrink further and foreign institutional (FII) selling can accelerate.

Being a financial year end, a technical pullback can occur any time without warning but the same would not be a complete trend reversal. There is a likelihood of retail traders attempting to lighten up their holdings as the same approach purchase price levels. This selling at higher levels by trapped bulls is called overhead supply. Should this overhead supply be sizable, it can trigger a crowded exit—when panic-struck retail traders attempt to exit en masse.

Also read: Equity rush, capex halt, bond’s lure: What strategy will companies opt for amid market corrections? 

In the commodities space bullion remains a strong long-term investment theme as both gold and silver are scaling new highs. Oil and gas fell along expected lines as I have been maintaining that these markets are well supplied. The recent rally in energy commodities was seasonal in nature. Industrial metals have risen due to tariff imposition threats rather than demand expansion. Which means stock prices of metal mining companies have limited upsides in the week ahead.

Fixed-income investors must keep the powder dry in anticipation of higher yields in future.

Trade light as volumes are low and spreads are wide. This means lower take-home profits.

A tutorial video on tail risk (Hacienda) hedges is here.

 

Rear view mirror

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

The fall was led by Bank Nifty whereas the broad-based Nifty brought up the rear. The sheer weightage of the banking and financial sector in the Nifty brought down this index rapidly. The US dollar index (DXY) continued to fall and triggered haven buying in bullion. Oil and gas fell as profit taking halted the upsides.

The rupee gained mildly versus the dollar. Indian 10-year bond yields rose mildly which dragged the Bank Nifty further. The National Stock Exchange (NSE) lost 1.8% in market capitalisation which means the sell-off was broad based. Marketwide position limits rose routinely.

US markets fell and provided headwinds 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 lower- and higher-risk instruments contributed.

If they trade more 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 average of all trading days of the week) –

Turnover contribution in the capital-intensive and higher-volatility futures segment shrank. That tells me retail traders were risk averse.

Also read: Bears arrived at IndusInd months before the bad news broke

In the relatively less volatile options segment, turnover rose in the index options space. These trades demand the least capital involvement from participants. That tells me risk appetite was very poor last week.

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 wind is blowing. This simple yet accurate indicator computes the ratio of number of the rising stocks compared 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 decline and the advance-decline ratio fell sharply, too. At 0.68 (prior week 2.59) it indicates there were 68 gainers for every 100 losers. Do remember that I had warned last week about the ratio at 2.59 being unsustainably high. Bulls must keep this ratio above 1.0 to get an upper hand in the markets.

A tutorial video on the Marshmallow theory in trading is here.

The second chart I share is the market wide position limits. This measures traders' exposure 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.

After the expiry of the February series, MWPL has risen rather sluggishly. That is due to poor buying support from traders. This is a clear warning that follow up buying is poor and needs to perk up if markets are to rise.

Also read: How you can invest in a fully valued market

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, the Bank Nifty was the bigger loser than the Nifty 50. The fall was accompanied by higher impetus readings. That tells me there was relatively higher selling pressure on the Bank Nifty. Do remember that banking and financial sector stocks command a weightage of 34.35% in the Nifty. If the Bank Nifty is sluggish, it can drag the Nifty 50, too.

The final chart I share is my in-house indicator ‘LWTD.’ It computes lift, weight, thrust and drag any security encounters. 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 fell sharply after showing hope in the previous week. The LWTD reading fell to -0.11 (prior week 0.13) that tells us fresh buying support may be insufficient. While short covering may trigger a short-term rally, it will be feeble.

A tutorial video on interpreting the LWTD indicator is here.

Nifty’s verdict

The Nifty weekly chart shows a smaller bodied bearish candle contained within the body of the prior weeks' bullish candle. That is called an “inside" formation as per Dow Theory of technical analysis. This signals indecision, consolidation or pause before the next phase of the price move unfolds.

Much depends on the follow-up action in the markets. The price is significantly below its 25-week moving average which is a proxy for a six-month long holding on cost of an average retail investor. That tells me that the medium-term outlook remains under pressure.

The big gap between the price and the average implies the possibility of a mean reversion pull back rally may be possible. Last week, I specified the 23,200 level as the primary hurdle which bulls must overcome if a rally was to occur. Bulls failed to manage that and markets remained weak. The 23,200 hurdle remains a condition that must be met before any upthrust can be bought into.

Your Call to Action – Watch the 23,200 level as a near-term hurdle. Staying below this level opens the doors for fresh declines.

Last week, I estimated ranges between 50,050 – 46,950 and 23,150 – 21,950 on the Bank Nifty and Nifty, respectively. Both indices traded within the specified support levels.

Also read: Inflation eases in February, but one-fifth of items still record steep price rises

This week I estimate ranges between 49,550 – 46,550 and 22,950 – 21,850 on the Bank Nifty and Nifty, respectively.

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

Have a profitable week.

 

Vijay L. Bhambwani

Vijay is the CEO of www.Bsplindia.com, a proprietary trading firm. He tweets at @vijaybhambwani