Expect a volatile but optimistic week for Nifty 50

Last week, I wrote that the markets would experience above-average volatility, and the market validated it. I believe volatility will likely persist. However, there are early signs of optimism, as market data shows accumulation on dips. Last week, I warned you about the sharp sell-off in bullion, which triggered selling across other asset classes. That phenomenon was in evidence in the first half of the week. News of a possible quick resolution of the US-India trade impasse cheered markets in the second half of the week.

What seems to have gone unnoticed by most market players is the announcement by the Reserve Bank of India (RBI) governor on incorporated companies. Earlier incorporated companies were governed by the 50:50 rule. If these companies had invested 50% or more in financial assets and derived 50% or more of their income from them, they had to register with RBI as Non-Banking Financial Companies (NBFCs).

The RBI governor changed things drastically by raising the threshold to ₹1,000 crore before companies had to register as NBFCs. This means a whole lot of family wealth, which was lying idle in closely held (family members as promoters and shareholders) private limited or unlisted public companies, can now enter the stock market without having to meet compliance and registration requirements as NBFCs. Family-owned wealth is substantial in India in these closely held companies due to taxation reasons. Stock prices react to money flows, and this move is money flow positive. I expect more family office entities to be established to deploy capital in financial markets. Markets sensing this trigger marked stock prices higher on Friday. The US markets witnessed a spectacular rally on Friday night, which will be factored into our markets this week. The minor geopolitical worry is over Iran.

This week, I expect action to remain polarised around public sector undertakings (PSUs), which witnessed concerted buying on declines. Banking stocks will remain in the limelight due to their 36% weightage in the Nifty. Without a rally in banking, no sustainable rally in broader markets is possible. Other sectors and stocks to witness action will be those that stand to benefit from the US-India trade deal. FMCG may be one such sector.

In the commodities space, bullion traded mixed, with gold rallying and silver falling on profit-taking. The biggest worry for silver is the massive leverage built up in the margin-funded segment. Typically, brokers fund 70% of the investment and the investor chips in 30%. He pays interest on the 70% amount to the broker. MTF buying in gold and silver Nippon exchange-traded funds (the largest ETFs in India) stood at ₹1,276 crore and ₹1,347 crore, respectively. That is still near the all-time borrowing figure and shows extreme leverage. As long as this level of borrowing persists, these ETFs will continue to trade at a discount to futures and spot prices. Barring the near-term turbulence, the absolute long-term outlook for the patient delivery investor remains optimistic. The underlying reasons for investing in bullion remain in place.

Industrial metals may attempt to seek support. Higher levels are encountering resistance, so a complete trend reversal is still some time away. Stock prices of metal mining companies may experience froth coupled with some optimism on declines.

Oil prices may witness some defensive buying not on fundamental strength but due to geopolitical reasons as insurance against any US strikes on Iran. Gas prices are likely to remain subdued, as higher levels are being sold off as the peak winter has almost run its course. Overall, I maintain my long-standing view that energy markets are adequately supplied and there is no supercycle here.

Even though the RBI governor has kept rates unchanged, I expect the cost of funds to rise over time. Therefore, fixed-income investors should keep the powder dry in anticipation of higher yields.

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 broad-based Nifty 50 index showed greater relative strength than the Bank Nifty. A strong US dollar index (DXY) capped gains in emerging markets. Gold and silver diverged as silver entered a deleveraging phase.

Oil and gas continued to witness selling on advances as the DXY strengthened. The INR gained versus the dollar, boosting local sentiment. Indian 10-year sovereign bond yields rose, and that created a mild drag on the Bank Nifty. The National Stock Exchange (NSE) gained 1.61% in market capitalisation, indicating a broad-based rally. Marketwide position limits (MWPL) rose routinely after expiry.

The US indices were mixed, but the late Friday rally is likely to boost sentiment in our markets in the first half of the week.

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 futures, which require sizeable 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) —

Turnover in the capital-intensive, higher-risk futures segment was lower, suggesting a lower risk appetite. In the relatively lower-volatility options segment, turnover was higher in index options. These are the least risky of the 4 derivative instruments. That tells me optimism was prevalent but was guarded.

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.

With the gains logged by the Nifty 50, the advance-decline ratio also rose spectacularly. At 1.86 (prior week 1.34), there were 186 gainers for every 100 losers. This is the highest in the 20-week chart period. While this ratio may not sustain, as long as it remains above 1.0, the advantage vests with bulls.

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 traders use 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 routinely after expiry but remained below the comparable week last month. That reinforces my view that swing traders were guardedly optimistic. For a sustainable rally, it is important that MWPL rises in tandem with prices.

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 divergent impetus readings. Now, both indices and their impetus readings are uniformly aligned and indicate a relatively improved outlook.

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 Nifty clocked smart gains, but the LWTD plunged into negative territory at -0.07 (prior week: 0.48), suggesting fresh buying support may be a bit sluggish. Short covering can, of course, occur. We need concerted buying to lift markets to new highs.

A tutorial video on interpreting the LWTD indicator is here:

Nifty’s verdict

The weekly candle chart shows a large-bodied bullish candle that overshadows the body of the prior week’s bearish candle. Japanese candle chartists call this a ‘bullish engulfing’ candle, as the bulls are deemed to have overcome the bears. The long upper shadow indicates some profit-taking on advances. The close has been above the 25-week moving average, which is a proxy for the six-month average holding cost. That indicates that the medium-term outlook is positive for now.

While it is critical for the Nifty to stay above the 25,700 level, which is the closing of the week, the true test of the bulls will be above the 26,400 level, which is a swing high of the index. Bulls must be ready to absorb all the sales that bears and delivery-based sellers have to offer.

Your call to action

Sustained trade above the 25,700 level indicates the possibility of a fresh rally. I expect some resistance near the 26,400 mark. If this is overcome confidently, a new, higher level of confidence can emerge.

Last week, I estimated ranges of 60,800–58,400 and 25,800–24,825 for the Bank Nifty and Nifty, respectively. Both indices exceeded the specified resistance. That indicates price range expansion.

This week, I estimate ranges of 61,500–58,750 and 26,300–25,100 for 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 is the CEO of www.Bsplindia.com, a proprietary trading firm. He tweets at @vijaybhambwani.