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Last week, I wrote that the Nifty 50 was close to a breakout, but buying was half-hearted. Read that column here. The nervousness in buying conviction was apparent again as sentiments turned nervous on Friday. Veteran market trader Richard Donchian, who was an active trader in the US in the 1960s and 1970s, advocated that Friday’s closing prices often indicated how the markets would trade in the coming week. Unless follow-up buying emerges this week, this overhang of overhead supply may continue.

Last week, it was suggested that optimism over a possible US-India trade deal could buoy sentiments. That hypothesis was validated in the first half of the week. In the second half of the week, we saw many prominent CEOs, money managers, and market mavens advocating caution in artificial intelligence (AI)- related stocks, as stock prices were in ecstasy. The results announced by AI leader Nvidia validated that hypothesis after a brief lag. The stock sold off and lost its highest-ever market capitalisation in a single session in stock market history. If this nervousness extends this week, global markets may experience a crowded exit. In stock market parlance, a crowded exit occurs when a large number of traders attempt to exit their positions simultaneously, driving prices substantially lower.

Statistical data of our markets suggests nervousness in the undertone as we analyse the data in the following paragraphs. The biggest giveaway was the weakness in the rupee, which made a new low versus the US dollar. That raises the spectre of “imported inflation." India, being a net importer since independence, will have to pay a higher landed price of imported goods and services. More critically, that included oil and gas, which are “multiplier commodities." The prices of oil and gas impact prices of everything from food and medicines to power and transport, as well as overall inflation. That means lower average household savings and therefore lower retail investments. The financial market understands this aspect and marked prices lower.

In the commodities space, bullion was a mixed bag, with silver experiencing a larger price increase. Please remember that I raised red flags for at least three weeks regarding excessive leveraged buying of silver in the margin-funded trading (MTF) segment. Complacent and greedy bulls are now realising that this is turning into a double jeopardy. They are paying mark-to-market margin calls and interest costs. Their drawdown is significantly larger than that of non-leveraged delivery buyers. In the near term, the waters are muddied thanks to this excess leverage. In the absolute long term, the reasons for asset allocation to bullion remain just as valid.

Oil prices eased and gas prices witnessed buoyancy thanks to the winter demand for indoor heating. Gas is the fuel of choice for indoor heating due to its low cost and relatively cleaner ecological footprint compared to coal. I maintain my view that the energy markets are well supplied. Prices in India may rise disproportionately on the Multi Commodity Exchange of India Ltd (MCX) due to the weaker rupee. Rookies must realise that aspect.

Industrial metals are witnessing a mini selloff as the AI dream which triggered exuberant buy calls in copper due to an expected surge in power demand, ran out of some steam. Commodity traders should not forget that commodities have telescopic demand and supply (unlike equities where the paid up capital remains constant and demand can be “stimulated"). Therefore the old maxim of “the cure for high commodity prices is high commodity prices" is a postulate (undeniable truth). The usual month end short covering may have limited impact on metal prices. That, in turn, means stock prices of metal mining companies may witness milder upsides.

Fixed income investors should tread water and wait for higher yields that are almost a given what with the rupee easing against the US greenback.

This week may be slippery for retail traders as new triggers and derivatives expire, which means stop losses must be diligently enforced and tail risk (Hacienda) hedges should be a compulsory part of your trading blueprint.

A tutorial video on tail risk (Hacienda) hedges is here - https://www.youtube.com/watch?v=7AunGqXHBfk

Rear-view Mirror

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

Both indices managed to log almost identical gains last week. A strong dollar fuelled by expectations that the Fed may not cut rates anytime soon weighed on emerging markets, including India. That triggered profit taking in commodities like crude oil and silver. Gas rose due to seasonal considerations.

The USDINR logged a new higher level and created downward pressure on our markets. The yields of Indian 10-year sovereign bonds rose and exerted pressure on banking stocks. The news of the Reserve Bank of India (RBI) planning to infuse liquidity up to ₹50,000 crore had little to no impact.

NSE lost market capitalisation, which suggests thate nervousness was widespread. Market-wide position limits (MWPL) rose mildly ahead of approaching expiry. US headline indices fell uniformly 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 the percentage of turnover contributed by the lower- and higher-risk instruments.

If they trade more of futures, which require sizable capital, their risk appetite is higher. Within the futures space, index futures are generally 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 capital-intensive and high-volatility futures segment saw a significant rise in turnover contribution. Traders were optimistic.

In the relatively lower volatility options segment, turnover rose in the relatively higher risk stock options segment, which suggests traders preferred to bet on further bullishness in the markets.

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 National Stock Exchange (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. These are pure intraday traders.

Even as the Nifty clocked gains of 0.61% the advance-decline ratio was weak at 0.74 (previous week 1.08) which means only 74 stocks gained for every 100 that lost. That tells us intraday buying conviction was poor.

A tutorial video on the Marshmallow theory in trading is here - www.youtube.com/watch?v=gFNKvtsCwFY

The second chart I share is the market-wide position limits. 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.

MWPL rose marginally ahead of expiry this week. At 58.58% it indicates some exuberance and mild overheating of expectations. Do remember my warning—high MWPL translates to high statistical ßeta (pure price volatility) as bigger positions get churned. That may be a bit too much for an average retail trader to handle. Trade on a light footprint.

A dedicated tutorial video on how to interpret MWPL data in more ways than one is available here - https://www.youtube.com/watch?v=t2qbGuk7qrI

The third chart I share is my in-house indicator ‘impetus.’ It measures the force in any price move. Last week, both indices logged small gains, but the Bank Nifty showed higher impetus readings. That means momentum was relatively more forceful on that index. Do remember that banking and financial stocks command the highest weightage in the Nifty 50. Without a sustainable rally in the banking sector, achieving a marketwide rally may be challenging.

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 sentiments.

Even though the Nifty logged gains, the LWTD readings fell to -0.41 (prior week 0.06), which suggests fresh buying may be poor. Though short covering can occur, it can at best cushion declines. Aggressive fresh buying is required to propel markets to new highs.

A tutorial video on interpreting the LWTD indicator is here - https://www.youtube.com/watch?v=yag076z1ADk

Nifty's Verdict

The weekly chart shows a smaller-bodied bullish candle with a prominent upper shadow (wick). That tells us that bulls attempted to push prices higher but encountered resistance and yielded some ground. Last week, I advocated that the 26,100 hurdle must be crossed on a sustained closing basis if the upthrust is to continue. The weekly closing was below that level, and bulls need to push harder and take the Nifty past the 26,277 swing pivot to regain their initiative.

The price remains above the 25-week average, which is the six-month holding cost of an average investor. That means the medium-term outlook is currently positive. In case of declines, bulls must defend the 25,600 level or risk further downside.

Your call to action

Only sustained trading above the 26,277 level can confirm the possibility of a fresh rally. In case of declines the 25,600 level needs defending.

Last week, I estimated ranges between 59,675 – 57,350 and 26,425 – 25,400 on the Bank Nifty and Nifty, respectively. Both indices traded within their specified ranges.

This week I estimate ranges between 60,050 – 57,700 and 26,575 – 25,550 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.