Markets look for steady level as Donald Trump's actions create turmoil

Last week, I wrote about market trends being dependent on follow-up action from participants. The action was half-hearted as traded turnover fell over a cliff. The index futures weekly turnover was a meagre 8,14,108 lots, constituting no more than two trading sessions. The last three sessions of the week saw delivery segment clock turnover of under ₹1 trillion consecutively. This is worrying. Admittedly, Friday's RBI policy announcement on interest rates played a major role in this reticence.

The 25 basis point (bps) rate cut was met with nervousness as the markets fell on Friday. Indian 10-year benchmark bond yields spiked after the rate cut was announced. Yields spike when bond prices fall. Bond traders were not entirely convinced of future rate cuts. Coming as it does, the first rate cut after almost five years, the nervousness is noteworthy. Do remember what I wrote last week. The government intends to borrow ₹11.54 trillion in the coming fiscal year. It depends upon the cheque-writer whether to deploy the money or not. Bond markets seem to be indicating the real cost of funds will stay elevated. Notwithstanding the headline coupon (interest) rates, fresh loans may not be available to all and sundry borrowers at those reduced rates.

That means the natural fallout for the markets will mean increased action on interest rate-sensitive stocks. Sectors like banks, non-banking financial companies (NBFCs), real estate, commercial vehicles, consumer goods, equated monthly instalment (EMI) dependent sectors, and heavily debt-laden stocks could witness sluggishness. I have advocated larger-than-average price ranges in public sector undertakings (PSUs), power, energy, logistics and defence stocks. These large price moves are likely to continue. That means traders will get ample two-way opportunities this week to avail trading opportunities.

Also Read: Markets are correcting. It's time to consider contrarian investing.

However, it should be noted that abysmally lower traded volumes present a challenge to real-world traders. The bid and offer spreads (the price difference between buy and sell limit orders) usually widen, thereby cutting down a trader's take-home profits by a sizable amount. This means this is a phase when traders should trade on light exposure and remain vigilant about stop-loss limits.

In the commodities space, bullion may see some profit-taking as the dollar shows signs of some strength, but lower levels are likely to witness a buying cushion. Oil and gas are showing signs of being top-heavy. Oil fell for the third consecutive week, a good sign for inflation watchers. Upsides in energy markets are likely to run into resistance. I reaffirm my view that energy markets are well supplied. Industrial metals may see some short covering as the Chinese markets opened after their New Year holidays. That may cheer metal mining companies’ stock prices in the near term.

Fixed-income investors must keep the powder dry as bond markets indicate that the rate cycle may not have peaked yet.

Trade with stop-losses and tail-risk hedges in place.

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

Rear-view mirror

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

The Bank Nifty led the rally as the RBI rate cut announcement and lower oil prices eased inflationary fears. With a 34.35% weightage in the Nifty, banking and financial stocks also boosted the Nifty 50.

 

The dollar index fell in the first half of the week but recovered in the fag end. The fall was more pronounced than the rally. Bullion rose as haven buying continued. Oil fell as Trump’s pressure to ease prices had the desired effect. Concerns over European gas storage levels boosted gas prices. This is a seasonal factor as gas is a fuel of choice for heating in winter.

The rupee fell to a new low versus the dollar, which restricted the upmove in equity markets. Indian 10-year bond yields fell mildly as bond prices were firm before the rate cut announcement on Friday.

NSE market capitalisation gained mildly, though headline indices showed higher relative gains. That tells us broader markets were sluggish. Market-wide position limits (MWPL) rose routinely.

Also Read: RBI kicks off rate cut cycle—what it means for borrowers and markets

US markets were shaky, which caused headwinds in 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 money. I measure what percentage of the turnover the lower- and higher-risk instruments contributed.

If they trade more futures that require sizable capital, their risk appetite will be 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):

The turnover contribution in the high-volatility, high-capital-intensive futures segment fell as risk appetite contracted sharply. Remember that index futures turnover is at multi-year lows.

Turnover contribution increased sharply in the lowest risk and capital-intensive index options. That tells me derivatives traders are going long but in the least challenging segment. This is hardly a sign of buying conviction.

Matryoshka analysis

Let us peel the layers off the 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 gauges the risk appetite of one-marshmallow traders or pure intraday traders.

While the Nifty logged smaller gains, the advance-decline ratio eased substantially, too. At 1.23 (prior week: 1.77), it indicates 123 gainers for every loser. Though bulls remain dominant, they need to offer proactive support to keep the upward trajectory intact.

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/s.

The market-wide position limits reflect an increased exposure build-up by swing traders after expiry. These are buy-and-hold derivatives traders who have more firepower and patience. The increased conviction brings with itself higher volatility, as any negative development also witnesses bigger unwinding or even a crowded exit. With markets swinging to global cues more than domestic factors, rising market-wide position limits need higher monitoring.

Also Read: Budget has delivered the tax break, but will the markets bite?

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 rallied, but their impetus readings were subdued. That tells us there was no force in the upmove.

For a sustainable upthrust, any counter's price and impetus readings should rise together.

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

The Nifty recorded smaller gains last week, and the LWTD mirrored that move by falling to the -0.03 level (prior week 0.39). That tells me fresh buying support at lower levels may be subdued. Short covering may occur, but that can cushion declines at best. A powerful rally can be seen only with aggressive fresh buying.

A tutorial video on interpreting the LWTD indicator is here.

Nifty’s verdict

The weekly chart of the Nifty shows the index staying below the 24,000 mark that was advocated last week as a trend-determining threshold. The last candle is bullish but with a prominent upper shadow. That tells me higher levels are encountering selling pressure. The price remains below the 25-week moving average, a proxy for the six-month holding on cost for an average investor.

The 24,000 level remains a hurdle this week. The bearish triangle marked by red trendlines is still underway. Falling below the 23,200 sustainably may open up the downsides further.

Markets are finicky and nervous as they twitch to Donald Trump’s announcement, which can trigger whipsaws (sudden sharp contrarian price moves) leading to large losses. Be cautious and trade light.

Your call to action – Watch the 24,000 level as a near-term hurdle. If the Nifty stays above this level on a sustained closing basis, markets may witness short covering and fresh buying. Conversely, staying below 23,200 opens the doors for fresh declines.

 

Last week, I estimated ranges between 51,400 – 47,775 and 24,125 – 22,850 on the Bank Nifty and Nifty. Both indices traded within the specified support levels.

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This week, I estimate ranges between 52,025 – 48,275 and 24,225 – 22,875 on the Bank Nifty and Nifty.

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.