Vijay L. Bhambwani's Ticker: Expiry may usher higher volatility

Last week, I wrote that the average retail trader appeared exhausted. I also advocated that the end of March was likely to be dominated by institutional players. Mutual funds, hedge funds, and corporate promoters have a vested interest in seeing stock prices rise higher. Last week, we saw the market validate this hypothesis.

Last week, I advocated increasing activity in public sector undertakings (PSU) stocks, which occurred along expected lines. Many of these stocks had fallen extensively in recent weeks, and a minuscule amount of short covering triggered an upthrust. This may continue this week as well provided follow-up buying continues. Traded volumes rose which tells us intraday traders’ participation improved over the prior week.

The market had a feel-good factor due to expectations of a peaceful solution to the Russia-Ukraine war in the near term. The US Federal Reserve provided guidance about possibly lowering rates this year. That raised hopes of lower coupon rates in India, too, in the coming Reserve Bank of India (RBI) monetary policy committee (MPC) meeting. Lower bond yields in India reflected the same. Lower yields translate to higher bond prices, boosting banking stocks since banks are the biggest bond investors. Since the banking and financial sector commands a weightage of about 34% in the Nifty 50, the rally becomes broad based. This is why watching heavily index weighted banking stocks becomes crucial in the week ahead.

In the commodities space, oil and gas witnessed selling at higher levels. This is along expected lines as I have been advocating that these are well supplied markets. Talks of supply shortages and bottlenecks seem to be misplaced and/or exaggerated. Industrial metals witnessed selling in the latter half of the week. Barring the routine month end short covering higher levels may encounter profit taking on advances. That means stock prices of metal mining companies may see limited upside too.

Bullion is witnessing selling as hopes of peace in the Middle East and Eastern Europe may see some unwinding. The long term story for the delivery based investor looking far beyond 2025 remains intact. Where stocks are concerned focused activity will be seen in public sector undertakings, banks, defence, logistics, infrastructure and consumer goods companies. As we head towards expiry volatility may rise and traders may remain pre-occupied with squaring up and/or rollover. Trade with smaller exposure and maintain stop losses diligently. Tail risk (Hacienda) hedges would provide significant protection against surprise adverse price moves.

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 to gauge what to expect in the coming week.

The rally was led by banking and financial stocks, and the broader markets followed suit. The US dollar index (DXY) rose and exerted profit-taking pressure on bullion and energy. The rupee gained smartly against the dollar, cheering domestic sentiment, too. The yields of Indian 10-year bonds fell noticeably, cheering banking stocks. The National Stock Exchange (NSE) market capitalisation rose 5.7%, which tells us the rally was broad-based. Market-wide position limits (MWPL) rose routinely.

US market indices rallied and provided 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 money. I measure the percentage of turnover lower- and higher-risk instruments contribute.

If they trade more futures that require sizable 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. Ditto for stock and index options.

Last week, this is what their footprint looked like (the numbers are average of all trading days of the week) –

The futures segment turnover contributed more turnover as traders rolled over their open positions from the March series to April derivatives contracts. That results in a higher turnover count. The relatively lower-risk, lower-volatility options segment saw turnover contribution rise in the higher-risk stock options segment. That means the overall risk appetite was higher.

It seems derivatives traders are betting on prices trading firmly in the near term.

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, bulls are dominant. This metric gauges the risk appetite of one marshmallow traders. These are pure intraday traders.

The Nifty rose 4.3% and this was reflected in the advance-decline ratio. The ratio stood at 2.47 (prior week 0.68) which means 247 stocks rose for every 100 losers. That tells us intraday buying conviction was higher last week. For a sustainable rally, this ratio must stay above 1.0 all of this week. My readers are advised to watch this ratio keenly, every day this week.

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 (MWPL). 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.

While MWPL rose routinely last week, the quantum of the rise was less than the commensurate week in the prior months. That shows buy-and-hold traders are showing signs of caution even as they remain optimistic. The runaway optimism has sobered down substantially. Being an expiry week, we are unlikely to see the recent highs in MWPL being surpassed. What can be another indicator of risk appetite is how much the MWPL falls post-expiry. If it remains above previous expiry lows, it will mean a higher rollover of positions.

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, the Nifty and Bank Nifty impetus readings diverged, showing a lack of coordinated buying/selling force on both indices. The impetus readings for both indices have risen significantly now with the sharp advance in prices, which shows that buying and/or short covering force was higher in both indices.

Should follow-up buying support continue, expect higher levels. Since this is an expiry week, short-covering is likely. Historically, higher long positions are rolled over than short sales, which are generally squared up.

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 Nifty logged strong gains last week, and so did the LWTD reading, which, at 0.45, is significantly higher than the previous week's -0.11. That tells me there may be improved buying and/or short-covering activity this week. Historically, expiry weeks tend to see higher short covering.

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

Nifty's verdict

The weekly chart of the Nifty shows a large bullish power candle, the largest in many months. That tells us the index has risen sharply higher with momentum. As I have written in recent weeks, this is thanks to institutional players being active in the markets.

The price has almost tested the 25-week moving average level which is the proxy for the six-month holding on cost of an average retail investor. The average itself is sloping downwards. Last week, I said that the Nifty must overcome the 23,200 level to indicate a possibility of bulls getting back in the driver's seat. That condition was fulfilled and still remains a prerequisite for a sustained upthrust. If bulls take the index above the 23,800 levels sustainably on a closing basis, they will have an even better grip on the sentiments.

Your call to action

Watch the 23,200 level as near-term support. Staying above this level strengthens bulls.

Last week, I estimated ranges between 49,550 – 46,550 and 22,950 – 21,850 on the Bank Nifty and Nifty, respectively. Both indices surpassed the specified resistance levels as bulls made their presence felt.

This week I estimate ranges between 52,175 – 49,025 and 23,950 – 22,750 on the Bank Nifty and Nifty, respectively.

Trade with strict stop losses. Avoid trading counters with spreads wider than 8 ticks.

Have a profitable week.

Vijay L. Bhambwani

Vijay is the CEO of www.Bsplindia.com, a proprietary trading firm. He tweets at @vijaybhambwani