Nifty 50 in throes of hopium high, exercise caution

Last week, I wrote that the markets would possibly witness a hopium-based rally, but it was doubtful that it would sustain. That hypothesis, based on statistical signals sent out by the markets, was proven right. The initial upthrust failed to imbibe follow-up buying, and the markets slipped in the latter half of the week. The geopolitical arena was the usual see-saw of hope and despair. The stock market is slowly getting immune to the war news and focusing on routine indicators.

Returning to routine indicators, I noticed the initial optimism in the stock market triggered a hopium-based feel-good factor last week. This is because leveraged exposure (buying stocks with borrowed money) in MTF (margin-funded trading) segment went up noticeably last week—5.52% in five trading sessions to ₹1.13 trillion. What is immediately apparent is that buy-on-dips was at play in the retail investors’ camp. If aggressive follow-up buying emerges (a relatively lower probability occurrence), this hopium may get some justification. Failing which, the impending expiry of the April derivatives series can see “last in, first out” (LIFO) style exit from long positions.

This week is shorter due to a market holiday on Friday. Barring unforeseen circumstances, shorter weeks tend to favour bulls. Combine a short week with a monthly expiry, and you may see higher than average volatility.

Last week, we saw a late sell-off in tech stocks. That may see unwinding on higher levels as trapped bulls may attempt to exit long positions at break-even prices. Trading activity may remain polarised around public sector undertakings (PSUs) as they have been in the news recently. Pay particular attention to banking and financial sector stocks as they command a 35.45% weightage in the Nifty 50. In the commodity space, oil and gas will remain subject to geopolitical news flow and likely higher-than-average volatility. This may be particularly so in the case of oil. Higher levels are likely to witness profit-taking. I maintain my long-standing view that there is no supercycle in the energy markets.

Bullion may see short-term turbulence. If the news of hostilities turns sharper and more adverse, there is a possibility of increased flight-to-cash and some declines in bullion. While the short-term waters may be muddied, the long-term picture for the very patient delivery-based investors remains unchanged. Just do not leverage your purchases.

Industrial metals may see a routine month-end short covering, and that can boost prospects for metal stocks. Talks of a “supercycle” in copper have resurfaced as prices showed signs of firming up. This is routine in markets, which are triggered by momentum. While commodity prices are firming up as faith in fiat (paper) currencies erodes, this does not necessarily imply a supercycle. The near term may see higher levels.

Being a short, expiry week, traders are likely to focus on closing and/or rolling over their trades. The post-expiry leverage levels will tell us the risk appetite prevalent in the markets. For now, trade light and maintain stop losses diligently. Tail risk (Hacienda) hedges would be in order.

Fixed-income investors should continue to 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 gauge what to expect in the coming week.

The fall was led by the broad-based Nifty as the late selloff in technology stocks dragged this index lower. Bank Nifty brought up the rear as the 10-year Indian sovereign bond yields firmed up. The rupee slipped against the US dollar and eroded confidence in the bull camp.

A strong dollar exerted pressure on bullion, which saw profit-taking. Oil rallied on fears of supply disruptions, and gas fell on warm weather. The National Stock Exchange (NSE) market capitalisation declined 0.61%, which tells us the selling was broad-based. Market-wide position limits (MWPL) rose routinely.

US indices saw mixed activity, with the Dow Jones Industrial Average slipping while other indices gained. This did not give any concrete guidance 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 the percentage of turnover contributed by the lower- and higher-risk instruments.

If they trade more of futures, which require sizeable 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 the average of all trading days of the week):

Turnover contribution in the high capital-intensive, higher volatility futures segment rose. This is partially attributed to the impending expiry of the April series. Traders close their positions in the expiring month and initiate the same trades in the next month series, which results in higher turnover.

In the relatively lower-risk options segment, turnover in the index options segment fell. These are the least volatile and capital-intensive in derivatives segment. Overall outlook points towards optimism ahead of the expiry of the April derivatives contracts.

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 the number of rising stocks to falling stocks. As long as the gaining stocks outnumber the losers, bulls are dominant. This metric gauges the risk appetite of one marshmallow traders. These are pure intraday traders.

The Nifty fell 1.87%, and the advance-decline ratio eased to 0.95 (prior week 3.21), which means there were 95 gainers for every 100 losers. A reading of 3 or higher is deemed unsustainable and hints of unwinding by strong hands.

Unless this ratio stays above 1.0 with rising prices, bulls are likely to remain under pressure. A tutorial video on the Marshmallow trading theory is here.

The second chart I share is the market-wide position limits. This measures the amount of exposure utilised 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 MWPL rose routinely ahead of expiry, but overall level remained below the commensurate week in prior months. That tells us swing traders are cautiously optimistic rather than outright euphoric. Watch out for monthly decline in MWPL post-expiry for signs of how much exposure bulls rollover to the next month.

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 fell, but so did their impetus readings. That tells us the falls were on lower momentum. This is a minor comfort, at best, since markets can decline on lower momentum for prolonged periods.

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 them to traded securities helps a trader estimate prevalent sentiments.

The LWTD reading fell in tandem with the Nifty to 0.07 level (prior week 0.41). That means fresh buying support may be limited or half-hearted. This is not unusual in a monthly expiry week. Markets are indicating caution, so my readers should be cautious when building fresh long exposure.

A tutorial video on interpreting the LWTD indicator is here.

The Nifty 50 verdict

I have been advocating resistance at the 24,400 level on Nifty 50 for a couple of weeks. Last week, I advocated that the 25-week average at 24,650 (which is a proxy for the six-month average holding cost of a retail investor) needs to be overcome to trigger a rally. Note how this very average proved to be a reversal point for the index.

The resistance at 24,650 remains the hurdle for bulls to overcome. Only above this threshold will short-covering cum fresh buying, accelerate. On the flip side, sustained trade below the weekly low at 23,800 can open the doors to further downsides. Aggressive bottom fishing should be avoided for now.

Your call to action

Sustained trade above the 24,650 level indicates the possibility of a fresh rally. Only if this level is overcome confidently can a new bullish phase begin. A sustained trade below the 23,800 level can trigger fresh weakness.

Last week, I estimated ranges between 59,050-54,100 and 25,250-23,450 on the Bank Nifty and Nifty 50, respectively. Both indices traded within their specified ranges. This week, I estimate ranges between 58,650-53,525 and 24,800-23,000 on the Bank Nifty and Nifty 50, respectively.

Trade light with strict stop losses. Avoid trading counters with spreads wider than 8 ticks. Have a profitable week.

Mint Ticker ia a weekly analysis of India's stock market—technical, incisive and a must-read for the seasoned investor as well as the amateur testing the choppy waters of Dalal Street. Want this newsletter delivered to your inbox? Subscribe here.