Vijay L Bhambwani's Ticker: Bulls need to do heavy lifting

Dear reader,

Last week, I wrote that a weakening rupee was casting a shadow on bullish sentiments. A ‘Santa Claus’ rally was possible only after the Nifty closed sustainably above the 26,325 threshold. The bulls failed to meet this precondition, and the markets surrendered ground for the second consecutive week. The rupee slipped further against the US dollar (which ironically was weakening itself) and unnerved bulls. According to media reports, leading bankers have assured big-ticket depositors that fixed deposit rates will not fall despite rate cuts, which means the cost of funds will remain elevated. Easy and low-cost money is mother’s milk to a bull market. Turn off the money tap, and asset prices tend to slide.

The US Federal Reserve announced a rate cut, which limited the decline in our markets, but the selling could have accelerated. Cash carry considerations (borrowing from low interest-yielding nations and investing in higher interest-yielding nations) kept hopes alive for emerging markets. Falling oil and gas prices also helped cushion the declines. The window for the ‘Santa Claus’ rally will close shortly unless bulls manage to lend aggressive buying support.

This week, we are likely to see bullion remain buoyant, as long-term prospects remain bullish. As long as you can digest the short-term volatility, the prospects remain positive. I remain of the view that my readers should avoid leveraging (buying with borrowed funds, such as MTF and/or futures and options).

Oil and gas prices reacted lower, as I have been maintaining that the energy markets are well supplied. Gas prices fell by over 25% from their peak on 5 to 12 December. That places it in bear market territory, according to the classic Dow theory. I remain apprehensive about the supercycle theory in energy commodities.

Industrial metals witnessed a sharp sell-off on Friday. This occurred despite a weak dollar, which serves as the invoicing currency in commodity markets. That tells me that higher levels are attracting some profit taking. The bellwether metal—copper—showed signs of profit-taking, which impacted sentiments for other metals. I repeat my hypothesis about the popular supercycle theory in industrial metals—I don’t buy it. Yes, it is a bull market (not a supercycle!) triggered by the decline in purchasing power parity of global fiat (paper) currencies. Supercycles do not experience deep price cuts, as seen in metal counters periodically. There may be some profit taking in the stock prices of metal mining companies in tandem with commodity prices.

Public sector undertakings (PSUs) will remain in the spotlight, offering two-way trading opportunities for risk-savvy traders. As we approach Christmas, trading volumes may taper off as institutional investors go on annual holidays. That means bid-ask spreads (the difference in buy and sell order price limits) may widen, and the take-home profits of traders may decrease. Trade with stop losses in place and maintain tail risk (Hacienda) hedges as a standard operating procedure.

Fixed-income investors should continue to keep the powder dry and wait for better opportunities.

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 Bank Nifty, and the Nifty brought up the rear. The weakening rupee has a greater impact on banking and financial sector stocks, as evident in their declining performance. A weak dollar index (DXY) cushioned the declines, which would have been deeper otherwise.

Oil and gas prices fell sharply, cheering market sentiments. Bullion rose sharply as safe-haven buying returned in force. The rupee eased against the dollar, dragging sentiment. Indian 10-year bond yields rose, indicating that the bond markets were not overly enthusiastic about the recent rate cut. The National Stock Exchange (NSE) lost 0.16% of its market capitalisation, indicating that the weakness was broad based.

Marketwide position limits (MWPL) rose routinely. The US headline indices were a mixed bag, not providing any clear direction for 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 of 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. 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 contribution to turnover of the capital-intensive and higher-volatility futures segment declined. The relatively lower-risk options segment contributed to a hike in turnover. That suggests traders were optimistic but took a cautious approach to risk taking.

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

The Nifty logged deeper declines at 0.53% (prior week 0.06% fall), but the weekly average advance-decline ratio rose to 1.27 (prior week 0.68). That tells us there were 127 gainers for every 100 losers. That implies that intraday traders were relatively more aggressive than they were in the prior week. But their optimism fell short of lifting markets higher. Bulls need to step up their efforts if they are to get back their dominance.

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 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.

The MWPL reading was higher, as is the routine after expiry. However, the gains were smaller compared to the commensurate week last month. That tells me swing traders are building fresh positions at a slower pace. Buying momentum must step up if the markets are to rally strongly.

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.

While both indices fell last week, the Nifty shows a higher impetus reading, indicating that the Nifty declined with forceful selling pressure. The Bank Nifty, on the other hand, fell on a lower impetus reading. It seemed to have drifted due to a lack of buying momentum.

Ideally, both indices should rally with higher momentum to indicate a sustainable rally.

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.

Last week, I warned you that fresh buying could be weak, which was validated by the market price action. We find that the LWTD reading has rallied to 0.21 (from a prior week of -0.38). That tells me there is a probability of lower levels attracting buying momentum and or proactive short covering.

A tutorial video on interpreting the LWTD indicator is here.

Nifty's Verdict

Last week, I warned you of the bearish hammer that was formed on the weekly chart. The same pattern has been repeated, and the weekly low was lower than the prior week's low. That tells us the bulls were attempting to limit the decline but had limited success. The 26,325 resistance I mentioned last week remains in place and must be overcome on a sustained closing basis for the Nifty to scale new highs this week.

The price remains above its 25-week moving average, which is a proxy for the six-month holding cost of an average investor. That means the medium-term outlook is currently positive. In the event of declines, bulls must defend the 25,675 level as support; otherwise, further declines may occur.

Your call to action – Only a sustained trade above the 26,325 level confirms the possibility of a fresh rally. In the case of declines, the 25,675 level needs to be defended.

Last week, I estimated ranges of 60,950–58,600 and 26,700–25,675 for the Bank Nifty and Nifty, respectively. Both indices traded within their specified ranges.

This week, I estimate ranges of 60,525–58,250 and 26,575–25,525 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.