Dear reader,
Please note that I am writing this piece on Saturday, before the budget is presented.
Last week, I wrote bulls appeared to be on the ropes. Yet the markets notched up gains as geopolitical tensions seemed to abate. Iranian leaders sent feelers indicating openness to peace talks to avoid US military action. Russia and Ukraine appeared to be coming to terms with the possibility of negotiating. With the US dollar index falling last week, emerging markets, including India, received a sentimental boost. Safe-haven buying in bullion peaked on Thursday before crashing on Friday. According to the classic Dow theory of technical analysis, any traded asset that falls 20% is considered to be in bear market territory. Note that bullion achieved this distinction in one trading session. There is a real risk that the stupendous losses in bullion long positions may spill over into equities, triggering panic sales.
I have written in my past articles about the perils of leveraged long positions (purchases with borrowed funds). Especially noteworthy is the margin-funded (MTF) route by which bullion exchange-traded funds (ETFs) have been bought. If you have noticed, bullion ETFs are trading at steep discounts to futures and spot prices. This is because buyers must pay 30% of the value of bullion purchased through MTF and maintain a 30% share of the investment, whereas the broker funds 70%. With a 30%+ price decline on Friday, the investor's share has fallen to zero. That means a margin call-based system-wide sell-off unless retail buyers replenish their accounts with top-up funds before Sunday morning. Since supply is likely to exceed demand in ETFs, the discount will deepen. That can exacerbate the sell-off even further.
If you have been following my advice put forth in this column, you would have bought your physical bullion on down payment, so you are spared from this distress. If you are willing to look beyond the current short to medium-term turbulence, the absolute long-term view for bullion is positive. Be prepared to have your patience tested. Until recently, my view would have been tilted towards silver. However, I now feel the allocation should be 50:50 between gold and silver.
With global investors and traders losing confidence in fiat (paper) currencies, there is a shift towards materials (commodity resources). So gas and/or oil prices may rise as money leaves bullion and moves into other assets. I stick my neck out and maintain my long-standing hypothesis that there is no supercycle in oil and gas. Seasonal factors will trigger upthrusts periodically, but stratospheric levels being discussed in the public domain appear premature and unrealistic.
Industrial metals sold off viciously last week, too. I don’t subscribe to a supercycle in base metals either. I concede a bull market exists due to rampant unbacked currency printing worldwide since the covid lockdowns. The difference between a bull market and a supercycle is sustainability and longevity. Bull markets are volatile and can terminate without warning. Multiple corrective declines occur en route. Supercycles are in a sustainable uptrend with little or no corrections. Bear market-type declines of 20% seen in some base metals don’t occur in supercycles.
This week, public sector undertakings (PSUs) and, in particular, banks will continue to hog the limelight. This is a pure weightage play in action. Given their sizable weight in the headline indices, these stocks will continue to attract trading attention.
I suggest trading light as the volatility is likely to be elevated. Commodity exchanges have sharply raised span margins. If excess volatility visits equities, then this market can witness high volatility too. Even a token exposure in derivatives markets can cause big losses if prices turn hostile. Maintain stop losses diligently and continue to deploy tail risk (Hacienda) hedges.
Fixed-income investors should remain cautious amid rising 10-year benchmark yields in India over the last few weeks. Wait for better yields before deploying funds.
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, with the broad-based Nifty bringing up the rear. Safe-haven buying ran into an abrupt wall, triggering a collapse in gold and silver prices. Oil rose on geopolitical considerations, whereas natural gas appears to have fallen, but it is really the seasonal discount seen every year.
The US dollar index (DXY) eased again, boosting emerging markets. The rupee fell against the dollar, capping gains. Indian 10-year bond yields rose, capping gains in the Bank Nifty. The National Stock Exchange (NSE) market capitalisation rose smartly, indicating a broad-based rally. Marketwide position limits (MWPL) routinely fell post-expiry. US headline indices were under pressure, offering little guidance to our markets.
Retail risk appetite
I use a simple yet highly accurate yardstick to measure the conviction levels of retail traders—where are they deploying their 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. In 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 the average of all trading days of the week) –
The turnover contribution in the highly capital-intensive futures segment was subdued. This is despite expiry, when the rollover process should have seen higher turnover. In the relatively lower risk options segment, the turnover was higher in the stock options series, which are relatively more volatile than futures.
Overall indications point towards subdued risk appetite.
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, 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 gains last week after sharp losses in the prior week. The advance-decline ratio rose, too. At 1.34 (prior week 0.85), it indicates 134 gaining stocks compared to 100 losing ones. Intraday buying improved last week.
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 (s).
The MWPL fell routinely after expiry, but the low was marginally lower than the prior monthly expiry. That suggests swing traders were relatively cautious and may have been waiting for the budget proposals before increasing their exposure.
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 impetus reading for the Nifty fell despite the index rising. That indicates Nifty rallied on lower momentum, possibly due to short covering. It is important that both indices move in unison, otherwise, the markets risk high volatility.
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 any powered aircraft faces in flight, so applying them to traded securities helps a trader estimate prevailing sentiment.
The Nifty rallied sharply, and the LWTD reading followed. Normally, I would say that fresh buying support would be higher this week. But this piece was written before the budget announcement and after the bullion crash, which took place late on Friday night, after our stock markets had shut. These are wildcards that need to be factored in. Should the budget be market neutral-to-positive and bullion stabilizes, expect relatively improved buying sentiment.
A tutorial video on interpreting the LWTD indicator is here.
Nifty’s verdict
Last week, we saw the price falling below the 25-week moving average. This average is a proxy for the six-month holding cost of an average investor. Which means the medium-term outlook remains nervous. It is important that the Nifty spot trade sustainably above the 25,675 levels to indicate that bulls are serious about buying aggressively. Overhead supply must be absorbed before a fresh upthrust can begin.
On the flip side, bulls must defend the 25,000 level firmly to avoid fresh declines. The weekly bullish candle is contained within the prior bearish candle. That indicates indecision and consolidation by the market, preparing for the next move. Volatility is likely to be higher.
Your call to action
Sustained trade above the 25,670 level indicates the possibility of a fresh rally. The 25,000 support must be defended firmly.
Last week, I estimated ranges of 59,550–57,400 and 25,525–24,575 for the Bank Nifty and Nifty, respectively. Bank Nifty exceeded the specified resistance by 510 points.
This week, I estimate ranges of 60,800–58,400 and 25,800–24,825 for 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.