‘Hopium’ may drive up market, but will the high last?

Last week, I wrote there was a relief rally likely in our equity markets. Markets validated that hypothesis based on statistical and behavioural data. This week too, there exists a possibility of a continued upthrust though it is likely to be triggered more by “hopium” than fundamental strength. Friday saw a surprise late announcement that the Strait of Hormuz was thrown open to global shipping. The same announcement was reversed within 12 hours as the Iranians objected to continued attacks on Lebanon by Israel. The positive fallout of the announcement was a crash in oil prices. That signalled to the global markets that fears of $150, 200 and 250 per barrel were unfounded. Remember, I have been stating since many quarters that energy markets remain adequately supplied.

It is the feel-good-factor of lower oil prices that may trigger the “hopium” rally, though I expect oil prices to rise marginally after the closure of the Strait of Hormuz. At the time of writing this piece on Saturday afternoon, the Iranians seem unrelenting about Hormuz. Volatility is likely to remain elevated and may even test new highs. That means retail traders are unlikely to make sizable trading profits this week.

Trading action is likely to remain polarized around public sector undertakings (PSUs), particularly banking stocks. Banking stocks are the highest weighted stocks in the Nifty and are a swing factor. Whichever way banking stocks go, they tend to take the broader markets with themselves. In the commodities space, we saw a mini-crash in oil prices, even as natural gas prices have remained dull and listless throughout the war. This is along the lines of my view that higher levels would attract profit taking. Barring an initial jump in oil prices, higher levels will witness resistance.

Industrial metals may witness routine month-end short-covering, but the overall outlook is that of resistance at higher levels. That means stock prices of metal and mining companies may have limited upside potential this week. Bullion witnessed some clawback as the US dollar weakened. I maintain my long-standing view that patient, long-term delivery-based investors can still expect more profits as long as they avoid leveraged buying.

Fixed income investors should keep the powder dry even though yields on fixed income products have improved recently. I expect even higher yields going forward.

Continue to trade light with stop losses in place as volatility is likely to remain above average. Continue to deploy tail risk (Hacienda) hedges as a standard operating procedure.

A tutorial video on tail risk (Hacienda) hedges is here

Rear View Mirror

Let us assess what happened last week, so we can guesstimate what to expect in the coming week.

The rally was led by the broad-based Nifty, while the Bank Nifty brought up the rear. Bullion saw fresh safe-haven buying. Oilprices fell and gas prices inched higher. A falling US dollar (DXY) boosted bullion. The rupee firmed up against the dollar.

The Indian 10-year bond yields were unchanged. NSE market capitalization rose smartly as buying was broad-based. Market wide position limits rose routinely. The US indices rose uniformly and provided tail winds 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 of futures which require sizable capital, their risk appetite is higher. Within the futures space, index futures are less volatile compared to 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):

The high-volatility, higher capital-intensive futures segment saw higher turnover contribution, which is a sign of increased risk appetite.

In the relatively lower-risk options segment, the turnover was higher in stock options, which are more volatile compared to index options. Overall risk appetite was significantly higher.

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 winds are blowing. This simple yet accurate indicator computes the ratio of number of the rising stocks compared to falling stocks. As long as gaining stocks outnumber the losers, bulls are dominant. This metric is a gauge of the risk appetite of one marshmallow traders. These are pure intraday traders.

The Nifty clocked lower gains which trickled down to the advance-decline ratio too. At 3.21 (prior week 3.73) there were 321 gaining stocks for every 100 losers. That number is highly optimistic and may slip this week. However, as long as this ratio stays above 1.0 with higher prices, bulls remain in the driver’s seat.

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 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 rose past 50%, but remained at its lowest in the commensurate week in many months. Swing traders are returning back to the markets albeit a bit carefully. I don’t blame them, what with the extreme volatility and war news. Swing traders are showing higher risk appetite compared to the prior week.

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 rose, but on lower impetus readings. That means momentum was weak and maybe even triggered by some short-covering. Ideally, prices and impetus should have risen together to indicate a sustainable upthrust.

The final chart I share is my in-house indicator ‘LWTD.’ It computes the 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.

The Nifty clocked smaller gains, but the LWTD reading continued to rise. That indicates the probability of fresh buying remains above normal. We can expect declines to be cushioned, barring unforeseen circumstances.

A tutorial video on interpreting the LWTD indicator is here

Nifty’s Verdict

Last week, we saw a bullish power candle which indicated resurgence in the bull camp. We see a sizable bullish candle yet again and that tells us follow-up buying was forthcoming. The price remains below its 25-week average, which is a proxy for the six-month holding cost of an average investor. I have been advocating resistance at 24,400 level since a fortnight. Note how the weekly high of the Nifty is exactly 24,400.

Now, it is important that the Nifty not only surpass the 24,400 hurdle on a sustained closing basis, but also stay above the 25-week average currently poised near 24,625 levels. That will raise the odds of a fresh upmove. Do note that follow-up buying will really need to be aggressive to maintain the upward momentum.

Bullish bets are off if the Nifty falls below the weekly low of 23,555, which appears to be a long shot.

Your Call to Action – Sustained trade above the 24,650 level indicates the possibility of a fresh rally. Only if this level is overcome confidently can a new bullish phase begin. A sustained trade below the 23,550 level can trigger fresh weakness.

Last week, I estimated ranges between 58,425 – 53,400 and 25,000 – 23,100 on the Bank Nifty and Nifty respectively. Both indices traded within their specified ranges.

This week, I estimate ranges between 59,050 – 54,100 and 25,250 – 23,450 on the Bank Nifty and Nifty respectively.

Trade light with strict stop losses. Avoid trading counters with spreads wider than 8 ticks. Have a profitable week.

Vijay L. Bhambwani has been trading in the markets since 1986 and is the CEO of www.bsplindia.com, a proprietary trading firm. He tweets at @vijaybhambwani.