Vijay L. Bhambwani's Ticker: Nifty in blue sky territory

Happy New Year!

Last week, I wrote monthly derivatives expiry and calendar year-end could cap gains in the markets, which otherwise showed signs of optimism. Read that piece here. The Nifty managed to test new highs and is now in blue sky territory. This is the zone where the traded security is at a lifetime high, and therefore every buyer is in the money. Which means there is nearly a zero probability of distress selling by losing traders. Routine profit taking can occur, however. Traded volumes were subdued, as expected, due to the holiday season.

Public sector undertakings experienced a significant rise in their stock prices during the week. This is something I have been advocating week after week. Banking and financial sector stocks rose more than the broader market average due to their sheer weightage. Unless banking stocks rally, there can be no sustainable rally in the broader markets.

Bullion witnessed above-average volatility coupled with profit-taking as I warned you last week. The parabolic rise in prices is likely to witness a routine shakeout as weaker hands exit and stronger hands offer support on declines. This process can take some time, and till then, the short-term outlook can remain clouded. The long-term (multi-year) story remains intact as the underlying reasons for going long on bullion remain intact. Just do not leverage (buy with borrowed funds) and invite stress upon yourself.

Banking and public sector undertaking stocks can remain in the limelight as trader exposure has increased in this segment of the market. The biggest percentage movers on Friday last week are likely to be the ones that attract the most activity.

Energy prices remained subdued as I expected. I remain of my long-standing opinion that energy markets remain well supplied. Rallies are likely to be brief and can encounter selling pressure on advances. Stocks of companies that utilise petroleum-based raw materials may witness bullishness as corporate profitability may be higher as long as energy prices remain subdued.

The outlier event that can send oil and gas prices higher is the social unrest in Iran. It has the world’s fourth-largest oil reserves and is a major exporter of natural gas. Keep an eye on developments in Venezuela, too, as the US action is likely to impact oil markets in the near term. Venezuela has huge oil reserves and is strategically important. The stand-off between the Saudis and the UAE in Yemen is another minor pressure point. However, any upthrust in oil and gas will tend to be short-lived lived and higher levels are likely to meet resistance for now.

Industrial metals saw volatility in line with silver, as some profit-taking was seen on many metals on commodity exchanges. If the profit continues, it could mean limited upside for base metal mining stocks, or maybe some profit-taking as well.

Fixed income investors would have noticed the rising benchmark bond yield, which indicates that the cost of funds is likely to stay elevated. Keep the powder dry in anticipation of improved yields.

Continue to trade with stop losses and tail risk hedges in place. 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 rally was led by the Bank Nifty while the Nifty brought up the rear. A strong US dollar index (DXY) triggered profit-taking in commodities—energy and bullion both. The rupee continued to remain weak against the dollar, limiting the upthrust.

Indian 10-year bond yields rose and limited the rally in the Bank Nifty, which could have otherwise risen higher. The National Stock Exchange (NSE) market capitalisation rose 1.58% which indicates the rally was broad-based. The market-wide position limits (MWPL) fell routinely after expiry.

US indices fell across the board, providing headwinds to our markets. This more or less negated the impact of a strong dollar.

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 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 arethe average of all trading days of the week) –

The turnover contribution in the capital-intensive, higher volatility futures segment fell noticeably. In the relatively lower volatility options segment, the turnover contribution was higher in index options at the expense of stock options. Index options are the least volatile instruments. That tells me risk appetite fell off the cliff last week. We can attribute that partially to the holiday season.

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 compared to falling stocks. As long as gaining stocks outnumber the losers, the bulls are dominant. This metric is a gauge of the risk appetite of one marshmallow traders. These are pure intraday traders.

The Nifty logged bigger gains last week, but the advance-decline ratio, though positive, eased a bit to 1.45 (prior week 1.51). This could also be attributed to the lower trader participation due to holidays. As long as this ratio remains above 1.0 with rising prices, the outlook remains optimistic.

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 is a gauge of 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 reading fell routinely post expiry. The post-expiry low at 45.95 (prior month: 46.25) indicates that retail traders marginally reduced their positions on expiry compared to the prior month. We should monitor the follow-up action keenly. If the MWPL picks up rapidly and keeps pace with rising prices, the upthrust can gain momentum.

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, the Bank Nifty rose relatively firmly and with higher impetus readings. That tells me the momentum was strong on the upside. Should this buying momentum sustain, expect more upsides.

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 clocked bigger gains last week, and the rally was accompanied by a higher LWTD reading. That raises the probability of buying support on declines this week.

A tutorial video on interpreting the LWTD indicator is here.

Nifty's Verdict

The weekly candle chart of the Nifty displays a bullish candle, with the price reaching a new high. The 26,325 condition that I was specifying recently has finally been fulfilled. This opens up the possibility of further upsides as long as even mild fresh buying occurs. That is because we expect some short covering to occur as well.

The price is above its 25-week average, which is a proxy for the six-month average buying price of a retail trader. That means the medium-term outlook is optimistic for now. In case of declines, bulls must defend the 25,800 levels aggressively, markets can witness some downsides.

Your Call to Action

Sustained trade above the 26,325 level confirms the possibility of a fresh rally. In case of declines, the 25,800 level needs defending.

Last week, I estimated ranges between 60,000 – 58,025 and 26,500 – 25,600 on the Bank Nifty and Nifty, respectively. Bank Nifty exceeded the specified resistance by ₹340. Nifty 50 traded within the specified range.

This week, I estimate the ranges to be between 61,175 – 59,125 and 26,775 – 25,875 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.