Vijay L Bhambwani's Ticker: Volatility can remain elevated
Traded turnover can fall drastically in the holiday-shortened festive week, making volatility spike even further.
Dear reader,
Wish you a very happy Diwali and a prosperous new year!
Last week, I wrote that you should gear up for higher volatility. A statistical hypothesis that stands validated by the price action. I have been expressing my concerns since late September about the recent run-up in equity markets, which is not adequately supported by statistical data, read here.
Last week, I warned you against buying bullion due to fear of missing out (Fomo) and definitely not in the leveraged segment (futures options, or via margin-funded trading). Read it here. My view of last week remains unchanged—the absolute long term is bullish, but in the near term, the waters are muddied. Retail traders have borrowed up to ₹509 crore to buy gold bees and ₹ 630 crore to buy silver bees. Remember, this is just one exchange-traded fund (ETF). The total borrowing against all ETFs will still be higher. Last week, the crux of my cautious view was that the empirical discount (backwardation) in bullion ETFs shifted to a premium (contango) compared to futures. This was the anomaly that sucked in retail investors. Thursday saw the premium turn to a discount, thereby spiking the total loss figure.
Should the prices of gold and silver fall further and losses in the leveraged segment increase, it could have a material impact on sentiment in the equity markets as well. This risk is not being taken seriously enough, given the unusually high optimism levels. This week, being a holiday-shortened festive week, the traded turnover is expected to fall drastically. That means volatility can spike even further. Where sentiments are concerned, there is optimism over the possible trade deal with US, a peaceful solution to the Ukraine war and a trade deal between US and China. Institutional buying is likely to be proactive till the Bihar elections commence early next month. Follow-up buying will determine the actual price trends thereafter.
Sector-wise banking and finance will continue to receive buying support due to the heavy weightage that these stocks command in the broad-based Nifty 50 index. I expect the public sector banks to witness larger-than-usual price ranges. Public sector undertakings (PSUs) will generally experience increased activity. Metal mining stocks may witness some profit-taking, but the commodity markets may see month-end routine short covering in metals. That can cushion metal prices mildly and limit the falls in metal mining stocks.
Oil and gas prices remain under pressure, barring seasonal rallies as I have been advocating since I started writing this column. The energy market remains well supplied. Bullion is a long-term investment for patient investors holding non-leveraged deliveries, with a view to looking far beyond calendar 2025. Traded volumes are likely to be low, so trade with thin exposure and keep stop-losses in place. Continue to maintain tail risk (Hacienda) hedges. A tutorial video on tail risk (Hacienda) hedges is here.
Fixed-income investors should continue to keep their powder dry and await better yields.
Rear View Mirror
Let us assess what happened last week so we can guesstimate what to expect in the coming week.
The rally was once again led by the Bank Nifty, whereas the broad-based Nifty 50 brought up the rear. A weakening US dollar index (DXY) triggered a flight to safety, and bullion rallied. Oil and gas prices fell as traders worried about demand prospects and peace in Ukraine, which would improve supply chains.
The rupee gained against the dollar, which further cheered traders. Indian 10-year benchmark bond yields fell, which boosted sentiments for banking stocks. The National Stock Exchange (NSE) market capitalisation rose, indicating a broad-based buying bias.
US headline indices rallied, providing 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 their money? I measure the percentage of turnover contributed by 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, high-volatility futures segment was higher. That shows traders were gung-ho about short-term trends. In the relatively safer options segment, the contribution to turnover in index options was lower and shifted to relatively riskier stock options. Overall, these factors indicate rising risk appetite in the leveraged space.
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 the number of gaining stocks exceeds the number of losers, bulls are dominant. This metric gauges the risk appetite of one marshmallow traders. These are pure intraday traders.
The Nifty showed bigger week-on-week gains, but the advance-decline ratio barely showed any improvement. At 1.01 (compared to 0.95 in the prior week), it indicates that there were 101 gaining stocks for every 100 losing shares. Bulls appear to be walking on eggshells rather than buying with confidence. This ratio must stay above 1.0 with rising prices if bulls are to have an upper hand.
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 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.
The MWPL figure continued to rise after the method for computing this yardstick was adjusted as of 1 October. Even if the older method is to be used, the exposure levels of retail traders appear to have risen significantly. That is a double-edged sword. As long as prices are rising, all is well. If any adverse trigger hits the market, there is a likelihood of a crowded exit.
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 rallied, but their impetus readings have fallen. This suggests that the rally was more driven by short-covering-led purchases. For a sustainable rally, it is crucial that price and impetus rally in tandem. This reading is a minor red flag.
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.
While the Nifty clocked bigger week-on-week gains, the LWTD reading fell sharply to -0.50 (prior week -0.03). That suggests to me that fresh buying support may be tepid this week. Short covering can cushion declines or even trigger a temporary upthrust, but it takes fresh buying to hit new highs.
A tutorial video on interpreting the LWTD indicator is here.
Nifty's Verdict
For a fortnight, I have been advocating watching the 25,550 level as a last-mile hurdle that bulls needed to overcome before any sustainable upthrust could commence. That condition was met, and the Nifty closed above this resistance. The weekly candle is a larger-bodied bullish candle and appears to be placed on the verge of the next upthrust, subject to follow-up buying emerging.
The price is above the 25-week moving average, which serves as a proxy for the average holding price of a retail investor over a six-month period. That means the medium-term outlook is currently positive. As long as the 25,100 level is defended by bulls in case of declines, the outlook remains optimistic. The longer the index closes above 25,550, the better the chances for bulls to push prices higher.
Your call to action—Only a sustained trade above the 25,550 level confirms the possibility of a fresh rally.
Last week, I estimated ranges between 57,675 – 55,550 and 25,725 – 24,825 on the Bank Nifty and Nifty, respectively. Both indices rallied past their resistance levels by a narrow margin due to strong buying activity for the second consecutive week.
This week, I estimate ranges between 58,850 – 56,575 and 26,200 – 25,225 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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