Ticker by Vijay L. Bhambwani: Markets may attempt to claw back
Future RBI rate cuts, trade deal with US, festival season may help.
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Last week, I wrote that bulls were on the ropes and were unlikely to offer any big-ticket support to the markets. Read that piece here. I also noted that the expiry of September derivatives contracts could trigger short covering and a temporary rally, which was validated as headline indices managed to claw back their losses weakly.
The Reserve Bank of India (RBI) forward guidance on interest rates raised hopes of future rate cuts even as no cuts were announced immediately. Hopes of a favourable trade deal with the US also cheered sentiment. This increases the probability of a pullback rally; however, even a pullback rally cannot confirm the sustainability of any such upthrust with the data available as of now. Cyclically speaking, the second half of the financial year triggers festival buying as a line-up of festivals kicks off after Ganesh Chaturthi. That lends a feel-good factor to market sentiment as well. Follow-up buying is a critical element in sustaining any upthrust, and my readers should watch their trading terminal screens carefully this week onwards.
In the commodity space, oil prices fell as the Organization of the Petroleum Exporting Countries (Opec) announced further output hikes in the near future, triggering a fresh bout of selling. Gas prices increased seasonally as expected. I maintain that energy markets remain well supplied. Rallies, if any, are seasonal rather than structural in nature. Bullion remains on the watchlist of institutional and individual traders. The long-term story remains as intact as ever. Avoid speculative or leveraged buying, as you will be working for the financiers. Avoid fear of missing out-based (Fomo) buying for now.
Industrial metals rose as expected due to month-end short covering. Supply outages in copper triggered a sharp bout of buying and short-covering. The debasement of global fiat currencies added impetus to the upthrust. That means stocks of metal mining companies can see some upside.
Public sector undertakings (PSUs) saw focused buying as expected. I have been advocating that readers who are savvy with risk management systems should consider trading this segment of the market due to its large intraday ranges and large moves in both directions.
As of 1 October, new regulations governing derivatives (futures and options) took effect. The changes in rules also alter the computation of market-wide position limits (MWPL). The Securities and Exchange Board of India (SEBI) will monitor the tweaks every quarter. In addition to futures open interest, exposure levels in the delivery segment will also be taken into account. Sebi has cut the minimum price difference, or tick size, for options premiums from ₹0.05 to ₹0.01. This applies to stock options where the underlying stock trades up to ₹250. The first regulation on MWPL means traders will have to shelve higher span (initial) margins since MWPL readings will be higher. Span margins rise telescopically once MWPL crosses 60%. Refer to the MWPL segment below. The second regulation will enable big-ticket traders with deep pockets to flip their trades at smaller profits, allowing them to turn their capital around multiple times during a trading session. This is typical of high-frequency trading (HFT) desks. It is a domain where retail traders cannot compete with big money.
Fixed-income investors can continue to keep the powder dry for now. Trade with a tail-risk hedge as a standard operating procedure due to the elevated statistical ßeta (pure-price volatility). Maintain stop losses diligently.
A tutorial video on tail risk (Hacienda) hedges is here.
Rear-view mirror
Let us assess what happened last week so we can gauge what to expect in the coming week.
The Bank Nifty led the rally while the broad-based Nifty 50 brought up the rear. This is not a surprise, as I have been pointing out the skewed weightage that the banking and financial sector enjoys in the Nifty. That weightage is cumulatively higher than the combined weightage of the following four sectors. There can be no sustainable rally in the markets unless banking stocks rise firmly.
The US dollar index (DXY) declined, triggering a relief rally in emerging markets, including India. It also led to increased defensive buying in bullion. The rupee firmed slightly against the dollar. Indian 10-year sovereign bond yields eased mildly. That was a small feel-good factor for banking stocks.
The National Stock Exchange (NSE) market capitalisation rose 1.8% which shows the rally was broad based. Market-wide position limits rose due to the change in the computation method. The US markets rallied, 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 are they deploying their money? I measure the percentage of turnover contributed by the lower- and higher-risk instruments.
If they trade more futures, which require sizable capital, their risk appetite is higher. Within the futures space, index futures tend to be less volatile than stock futures. A higher footprint in stock futures shows higher aggression levels. The same applies to 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 high-risk, high-capital outlay futures segment, we saw a sharp decline in turnover contribution. That tells me retail traders were cautious and played a safe hand. In the lower-volatility, lower-risk options segment, turnover contribution rose in the relatively safest segment of the derivatives market—index options.
Overall risk appetite was noticeably lower.
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 the gaining stocks outnumber the losers, the bulls are in the dominant position. This metric gauges the risk appetite of one marshmallow traders. These are pure intraday traders.
The Nifty logged mild gains, and the advance-decline ratio saw a smart rally to 1.27 levels (from 0.47 in the prior week). That tells me intraday risk appetite was higher last week. As long as the reading stays above 1.0, the outlook remains optimistic.
A tutorial video on the Marshmallow theory in trading is here.
The second chart I share is the MWPL, which measures the exposure that traders utilize 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.
As I wrote earlier, the MWPL computation method changed from 1 October. Note how the reading is at a multi-month high after the change. The fact that Sebi can tweak the method in the future presents challenges, as comparisons with past metrics will be uneven and akin to comparing apples with oranges. For now, the rising level indicates a growing sense of buying optimism. We will have to note how this number changes in the coming weeks. Follow-up buying is crucial for sustaining a rally.
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 the impetus readings were divergent. That divergence continued yet again. While the headline indices rallied, the Nifty impetus fell. That suggests the Nifty rose more due to short covering rather than aggressive, fresh buying.
I have often written in my columns that both these indices are like the wheels of a bicycle. Unless the wheels move in the same direction, the bicycle risks toppling. The Bank Nifty can lift the Nifty 50 due to the weightage banking enjoys, but sustainability comes from fresh buying in both the indices.
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 small gains last week, but the LWTD indicator rose noticeably. The reading last week at 0.32 (prior week -0.54) shows optimism as there may be fresh buying on declines.
A tutorial video on interpreting the LWTD indicator is here.
Nifty’s verdict
Last week saw a small-bodied bullish candle contained within the larger-bodied previous bearish candle. This phenomenon is known as an “inside pattern". It suggests consolidation and some indecision. Follow-up action determines the immediate outlook. Bulls will need to be aggressive in supporting prices this week.
I suggested watching the 24,550 level as a meaningful support in the near term. The bulls defended this support well, which validates my hypothesis that this threshold is a critical area of support. Continue to monitor this threshold. The price is above its 25-week average, which is a proxy for the six-month average buying price of a retail investor. As long as the price is above this average, the medium-term outlook remains optimistic.
On the other hand, I advocated watching the 25,550-level as a hurdle in the near term. A fresh rally is possible after overcoming this resistance on a sustained closing basis.
Your call to action – Watch the 24,550-level as a near-term support. Only sustained trade above the 25,550 level can confirm the possibility of a fresh rally.
Last week, I estimated ranges of 55,375 – 53,400 and 25,100 – 24,200 on the Bank Nifty and Nifty, respectively. The Bank Nifty rallied past its resistance by a thin margin due to concerted buying activity.
This week, I estimate ranges between 56,625 – 54,550 and 25,325 – 24,450 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 L. Bhambwani
Vijay is the CEO of www.Bsplindia.com, a proprietary trading firm. He tweets at @vijaybhambwani
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