Vijay L. Bhambwani's Ticker: The Nifty just hit a key hurdle. What happens next?

Last week I wrote that the coming rally would be a unique one because it was not backed by indicators that displayed strength of buying conviction. I also noted that short covering can spark brief but intense buying sprees that often mislead traders. Which is why I suggested protective tail risk (Hacienda) hedges on long positions. Read last week's column here - https://www.livemint.com/mint-top-newsletter/ticker15092025.html

The feel-good-factor triggers I mentioned last week of US President Donald Trump sounding amicable towards India and Indian 10-year bond yields indicating calm returning to money markets, continued to play out. Markets continue to ignore the weakness in the rupee versus the US dollar. The playbook in the market was simple yet effective—the rally was focused on banking and financial sector stocks which command a weightage of 36.82% in the Nifty. Not only is the sector heaviest weighted but is also heavier than the next four sectors combined. The next hotspot was the oil, gas and consumable fuels sector which is dominated by PSUs (public sector undertakings). With a weightage of 9.90%, this segment too boosted the markets.

The week ahead is likely to witness continuation of the sectoral focus. PSUs, banks and oil & gas stocks will continue to attract trader attention. Larger than average intraday ranges may be seen in either direction. That provides trading opportunities to risk efficient and savvy traders. The fact that the RBI (Reserve Bank of India) is expected to announce the decision on interest rates on 1 October will see increased attention on banking stocks. Traders will try to second guess the direction that interest rates may take.

In the commodity space bullion remains a long-term bullish story for the delivery-based long-term investors. Avoid speculation and leveraged buying which is counter productive as interest costs can eat into a trader’s profits. Look beyond the year 2025 if not longer. Oil and gas prices are likely to see selling advances. I continue to stick my neck out that oil and gas markets are adequately supplied. My readers should note that winter officially begins in Europe on 1 October every year. Natural gas is the fuel of choice for indoor heating and prices tend to jump during winter months. Naturally there are price gaps (contango or cost of carry) between one month and the next. Which may suck in the naïve trader into believing it to be a new bull market which it is not. Industrial metals may see routine month-end short covering and lend some more support to metal mining companies’ stock prices.

Fixed income investors should await the RBI decision on coupon rates before deploying funds. I maintain my view that cost of funds will continue to remain elevated in spite of any cut in the headline coupon rates.

My readers should continue to exercise caution and deploy tail risk (Hacienda) hedges. 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.

The rally was led by the Bank Nifty and by virtue of the weightage of banking and financial stocks lifted the Nifty 50 as well. The dollar index remains more or less constant which buoyed emerging markets including India.

A stagnant dollar boosted bullion as safe-haven buying escalated. Oil and gas prices eased along expected lines. The rupee gained versus the dollar which added to the relief. Indian 10-year benchmark yields were almost unchanged. That indicates money markets were calm ahead of the upcoming RBI meet on 1 October.

The National Stock Exchange (NSE) gained 1.64% market capitalization which indicates the rally was broadbased. Market-wide position limits (MWPL) rose routinely. The US headline 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 what percentage of the turnover was contributed by the lower- and higher-risk instruments.

If they trade more futures which 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 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) –

Turnover contribution rose mildly in the high-risk and capital-intensive futures segment. In the relatively safer options segment the turnover contribution was higher in stock options which are relatively more volatile than index options.

Overall risk appetite was higher than the prior week.

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 clocked lower weekly gains but the advance-decline ratio was an improvement over the previous week. At 1.22 (prior week 1.11) it indicates 122 gaining stocks for every 100 losing stocks, the buying conviction in intraday traders was higher. As long as the ratio remains above 1.0 with rising prices, bulls remain dominant.

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.

The MWPL rose with strength and it should be noted that this month is a longer one for derivatives traders. At 35.15% the MWPL is higher than the prior one and closer to the prior two months. That tells us swing traders increased their bullish bets even at higher levels. That is a positive sign.

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 I raised a red flag as the impetus readings were divergent for both indices. The impetus readings for both indices have risen simultaneously. That indicates they are moving in sync as of now. As long as this continues bulls are likely to have an upper hand.

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.

While the Nifty clocked smaller gains the LWTD reading rose smartly to 0.49 (prior week -0.08) which indicates a possibility of improved fresh buying support. While short covering can boost sentiments in the near term, it takes fresh buying to trigger a sustainable rally.

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

Nifty's Verdict

Last week I advocated watching the 24,550 level as a support that bulls needed to defend in case of declines. That level held. The price remains above its 25-week average which is a proxy for six-monthly average acquisition cost. That means the medium-term outlook remains positive.

On the flipside I advocated watching the 25,100 threshold as a near term hurdle which needed to be overcome on a sustained closing basis if bulls were to retain their initiative. This condition, too, was fulfilled. The Nifty is now headed into resistance of the downward sloping trend which must be overcome to trigger some more short covering and fresh buying. That level is at 25,550 on the Nifty spot. Once the index trades above this threshold continuously the probability of further upsides improves.

Your Call to Action

Watch the 24,550 level as a near-term support. Only a sustained trade above the 25,550-level confirms the possibility of a fresh rally.

Last week I estimated ranges between 55,725 – 53,875 and 25,550 – 24,700 on the Bank Nifty and Nifty, respectively. The Bank Nifty tested 55,835 levels briefly on the upside. Nifty stayed within specified parameters.

This week I estimate ranges between 56,425 – 54,500 and 25,750 – 24,900 on the Bank Nifty and Nifty, respectively.

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

Have a profitable week.

Vijay L. Bhambwani

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