Vijay L Bhambwani's Ticker: Time to prioritise capital preservation
This week may be a time to prioritise capital preservation over capital appreciation. Capital is your freedom to trade the next day.
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Dear reader,
Last week, I wrote that the Nifty was in a blue-sky zone, where not much overhead supply was expected. However, routine profit taking was possible. Read last week's article here . This hypothesis did not play out as expected, as negative news triggers emerged to weaken sentiments every single day of the week. US President Donald Trump kept pressuring bullish sentiments for emerging markets. Sentiments were nervous following the US action against Venezuela over the weekend. However, it did not end there.
Trump continued his sabre-rattling and threatened to take similar action against some other South American nations. His demands on Greenland also escalated, leading to diplomatic friction and unnerving markets. In the Middle East, Iran saw huge crowds in the streets and internet shutdowns, which were noted by global markets. Iran is a major exporter of oil and gas, and the riots triggered short covering in the oil market, which pushed prices higher. Since oil prices jumped late on Friday, that factor will get discounted in our markets this week. Elevated oil prices can raise concerns over inflation and the rupee-dollar peg. All in all, the situation appears to be fluid in the near term.
This week, public sector undertakings (PSUs) will continue to witness hectic trading activity. There is a likelihood of profit-taking on long positions, as the options data on select PSU counters suggests from last week. The stock prices of metal mining companies may also experience volatility, as industrial metal prices have exhibited extreme volatility with an unwinding bias. Since oil (and potentially gas) prices are in the eye of the storm, companies that require petrochemical products and their derivatives as raw materials may see their stock prices soften in the near term. I remain of the opinion that energy markets are well supplied and prices are being pushed higher due to geopolitical reasons.
Bullion prices saw listless action in the first half of the week and revived towards the fag end. This was due to Iranian political unrest. Barring a short-term haze, the long-term outlook remains bullish for a patient delivery investor. I repeat my advice—do not leverage (buy with borrowed money) bullion and wait patiently for your deliveries.
With Indian foreign exchange reserves falling by $9.8 billion to $686.8 billion, there may be near-term downward pressure on the rupee. Indian bond markets are not even masking their nervousness as sovereign yields are firming up noticeably. Fresh mop-ups will have to be at higher coupon rates.
Fixed-income investors should continue to keep their powder dry and wait for higher levels.
This week, I suggest my readers prioritise capital preservation over capital appreciation. Capital is your freedom to trade the next day. Keep it intact to stay in the game. Trade with strict 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 fall was led by the broad-based Nifty 50, and the Bank Nifty brought up the rear. The US dollar index (DXY) firmed up, and that weighed on emerging market sentiments (including India). Defensive buying continued in bullion as flight to safety was the mantra last week. Oil staged a late recovery due to Iranian riots, whereas gas prices remained under pressure.
The rupee gained marginally versus the dollar, which limited the fall in our markets. The yields of the benchmark Indian 10-year bond continued to firm up, suggesting a rising cost of funds. The National Stock Exchange (NSE) saw a 2.81% decline in market capitalisation, indicating broad-based weakness.
Market-wide position limits (MWPL) rose routinely. US indices rallied uniformly, providing tailwinds to our markets and thereby cushioning their fall.
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 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 are the 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-risk options segment, turnover contribution rose in index options, which are the least risky leveraged assets.
The overall picture suggests risk appetite falling off a cliff last 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 calculates the ratio of rising stocks to falling stocks. As long as the number of gaining stocks exceeds the number of 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 fell 2.45% last week, which is the biggest weekly fall in four months. The advance-decline ratio fell sharply too and stood at 0.59 (prior week: 1.45). That tells us there were only 59 gainers for every 100 losers. Buying conviction was eroded with negative news flow on a daily basis. Ideally, this ratio should be above 1.0, particularly with rising prices, to support a sustainable rally.
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 rose smartly after the monthly expiry week, which is routine. However, the magnitude of the rise was noteworthy, as MWPL climbed the fastest in two months during the corresponding week. This raises the possibility of a crowded exit if negative sentiments persist. Even if a crowded exit is averted, pure price volatility is likely to stay elevated. That will be a challenge for retail traders.
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, Nifty fell harder than the Bank Nifty. Unfortunately, the impetus reading of the Nifty was higher too. That tells us the fall was on higher momentum. Ideally, both indices should trade in unison to maintain statistical equilibrium. Due to the significant weightage of banking and financial stocks in the Nifty, it was a minor mercy that the Bank Nifty did not fall sharply. That saves the bulls some blushes.
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.
Even as the Nifty clocked the biggest weekly losses in four months, the LWTD reading fell through the floor to -0.22 (prior week 0.20). That tells us fresh buying support will be weak. Short covering can occur to cushion declines, but it will require fresh buying to sustainably take indices higher.
A tutorial video on interpreting the LWTD indicator is here.
Nifty's Verdict
Last week, we saw a big (power) bearish candle as the body of this candle was the largest in many weeks. It overshadowed the prior bullish candle, indicating a bearish engulfing pattern. It has bearish implications unless the high of the bearish candle is overcome sustainably. That means bulls must keep the Nifty trading above the 26,373 levels to regain their lost initiative.
The price is above its 25-week average, which is a proxy for the six-month holding cost of an average investor. The medium-term outlook will remain positive as long as the price stays above this threshold. The same is currently poised at 25,512. Any sustained trade below this level can further expose the downsides.
Your call to action – Sustained trade above the 26,375 level confirms the possibility of a fresh rally. In case of declines, the 25,500 level needs defending.
Last week, I estimated ranges between 61,175 – 59,125 and 26,775 – 25,875 on the Bank Nifty and Nifty, respectively. Nifty exceeded the specified support by 252 points. Bank Nifty traded within the specified range.
This week, I estimate the ranges between 60,250 – 58,225 and 26,150 – 25,200 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.
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