Vijay L. Bhambwani's Ticker: Markets are precariously poised

Last week, I wrote this was a phase when traders should focus on capital preservation and trade light. In my past articles, I have drawn your attention to extremely high volatility and a sharp fall in traded volumes. These are very challenging developments for retail traders as the price discovery mechanism gets inefficient. Low volumes result in wide bid and offer spreads. These are limit price orders of bulls and bears. Wider spreads mean higher trading costs and lower take-home profits. We saw this happen in the markets last week.

US president Donald Trump kept our markets on the edge with tariff announcements. The approaching expiry of the February derivatives contracts added to the nervousness. Traders were preoccupied with rolling over and/or closing their existing trades. This is routine ahead of expiry. It also means fresh buying tends to be limited. Due to liquidity concerns, markets watched the RBI’s withdrawal of an open market operation (OMO) of $3 billion worth of treasury bill sales. The cost of funds is becoming a major concern for traders and investors alike. My readers would do well to read books written by Dick Stoken, whose work on the cost of funds is THE gold standard on the subject.

I believe markets are precariously poised due to the overhead supply (selling pressure from bulls trapped at higher levels) on advances. Sustainable upthrusts will be elusive unless aggressive follow-up buying is seen at rallies. Data shows retail investors have availed broker-financed funding for investing in stocks to the extent of ₹72,634 crore. This figure is marginally lower than the peak funding availed up to last year. This data and MWPL tell me retail traders are still hoping for a rally. Unfortunately, that also raises the probability of a crowded exit if these hopes are dashed over time. Rollover costs and MTF interest charges will continue to eat into a player’s capital and raise stress levels.

This week, traders will remain focused on routine expiry-related activity. Should the rollover data be robust, bulls may heave a sigh of relief. But, if the retail segment surrenders its long positions and lightens up, markets may fall faster.

Regarding activity, PSU (public sector undertaking) stocks will likely attract trader attention this week, too. Recent months have seen a sizable buildup of MWPL on these counters. A substantial amount of hope, emotion, and capital commitments have gone into these stocks. Volatility will, therefore, remain elevated in this segment. Stocks of banks, power, energy, logistics, and defence, in particular, will see polarised action. Bigger than usual intraday price ranges may be seen on these counters.

Also read: Varun Beverages is betting big on growth amid rising competition

In the commodity space bullion is likely to witness continued haven buying support on declines. The long term story remains robust. Industrial metals saw month end short covering and selling on advances along expected lines. Rallies are likely to see limited upsides. That means the stock prices of metal mining stocks will also see limited rallies. 

Gas prices are rising due to a polar vortex (large blocks of ice breaking away from the Arctic Circle and drifting lower towards the northern US and Europe), causing a chilling drop in temperatures. Gas is a fuel of choice for indoor heating and demand spikes during polar vortex. Supply disruptions due to pipeline networks witnessing freezing also exacerbated the panic buying. This is a temporary and seasonal phenomenon.

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

The fall was led yet again by the broad-based Nifty 50, and the Bank Nifty brought up the rear. The dollar index (DXY) eased on profit-taking, boosting bullion and energy prices. The rupee gained versus the dollar, cushioning the declines in our markets. Indian 10-year bond yields were unchanged.

NSE market capitalisation rose mildly after a sizable fall in the prior week. MWPL rose routinely ahead of expiry. US headline indices fell which 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 what percentage of the turnover was contributed by the lower- and higher-risk instruments.

If they trade more futures that require sizeable capital, their risk appetite is higher. Within the futures

space, index futures are less volatile compared to 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 average of all trading days of the week) –

The turnover contribution in the futures segment was higher. This was primarily due to the expiry of the February derivatives contracts. Traders close their trades in the expiring month and initiate similar trades in the next month, boosting turnover.

In the lower-risk options segment, turnover contribution rose in the relatively higher-risk stock options segment. Index options (the lowest risk segment) saw turnover contribution falling. Overall risk appetite was higher in the derivatives segment.

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 winds are blowing. This simple yet accurate indicator computes the ratio of rising and 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.

Also read: PMS vs mutual funds: How have portfolio managers fared on returns?

The Nifty clocked smaller losses last week, and the advance decline ratio improved, too. At 1.38 (prior week 0.39) it shows 138 gainers for every 100 losers. That tells us intraday buying conviction was higher. We need this ratio to remain above 1.0 for one marshmallow bulls to retain their initiative.

A tutorial video on the Marshmallow theory in trading is here.

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. 

The MWPL reading almost flat-lined last week. Usually, MWPL continues to rise till the first one or two days of the expiring week. This time, we saw MWPL falling on Thursday and Friday last week. This tells us swing traders (two marshmallow traders) were cautious. This was expected as prices were falling, and the Nifty tested the lows last seen on 6 June. We need to monitor how low the MWPL falls on expiry day. The lower it falls below recent levels, the tougher bulls will find to revive sentiments.

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 on lower momentum as traders lacked the conviction to short-sell aggressively. While this may be a minor mercy, markets are known to drift lower on poor volumes as gravity pulls prices lower. This also raises the threat of overhead supply (selling by traders stuck with longs at higher levels).

Ideally, the impetus and prices should rise in unison to confirm a sustainable upthrust.

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.

The Nifty lost less ground last week than the prior week. The LWTD reading rose, too, but remained in the negative territory at -0.14 (prior week -1.26). That tells us the possibility of aggressive fresh buying remains low. That is also due to this week being an expiry week when historically, buying is poor.

However, short covering can always occur, which can cushion declines. It will take fresh buying to take markets higher sustainably. Till such buying emerges, rallies are unreliable.

A tutorial video on interpreting the LWTD indicator is here.

Nifty’s verdict

The weekly candle formed is a small range bound one. Traders seemed to have gone into hibernation, which is confirmed by the impetus reading falling sharply. The weekly low was the lowest since 6 June. Factor in rollover costs and cost of funds (reminder—read Dick Stoken’s works), and you see that an average buy-and-hold investor-trader is nursing sizable losses that don’t show on the technical charts.

The price has stayed below the 25-week average for the tenth week. This average is a proxy for the six-month average holding on the cost of a retail investor. That means overhead supply is a clear threat on the upside.

Last week, I advocated that the Nifty must stay above the 23,200 level sustainably to trigger an upside. Bulls were unable to manage this, and that led to persistent weakness. The 22,750 level I advocated last week as a support remains an area to watch. Should the Nifty trade below it continuously, further declines are likely.

Volumes remain poor, as the delivery segment saw sub- ₹1 trillion volumes for seven days in a row. Market capitalisation has remained below the ₹4 trillion mark. Trade light with strict stop losses.

Call to action 

Watch the 23,200 level as a near-term hurdle. If the Nifty stays above this level on a sustained closing basis, markets may witness short covering and fresh buying. Conversely, staying below 22,750 opens the doors for fresh declines.

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Last week, I estimated ranges between 50,900 – 47,325 and 23,600 – 22,275 on the Bank Nifty and Nifty, respectively. Both indices traded within the specified support levels.

This week, I estimate ranges between 50,725 – 47,225 and 23,425 – 22,175 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.