Last week, I wrote about the average retail trader getting into overdrive and raising his stakes in the markets. That is a sure-shot indication of higher greed levels. The market-wide position limits (MWPL) and margin trading facility (MTF) data suggest the retail trader has been stepping up his borrowing to buy stocks. This was pointed out in my last week’s column here.

I have also warned you time and again that rising retail exposure elevates the risks of a “crowded exit.” As unexpected adversity hits the markets, retail traders (the weakest of all segments among players) surrender their positions en masse.

Last week, we saw some signs of that capitulation. The role of Israel’s attack on Iran cannot be denied in weakening sentiments further. The sabre rattling between the US, Israel, and Iran was showing signs of heating up. Wednesday saw a clear indication of bullish sentiments stalling, and Thursday triggered a decline after the US pulled out their diplomatic staff from their Iraqi embassy. The ongoing Securities and Exchange Board of India (Sebi) investigation of Jane Street’s Indian operations has resulted in a sharp fall in algo trading volumes, which has further stunted the bullish sentiments. 

Markets will now worry about a few issues that will set the tone and tenor of prices in the near term. These are – a) will oil prices continue to spike and trigger inflationary fears, b) will Iran attempt to block the Gulf of Hormuz and create a chokepoint in international oil and gas trade, and c) will Iran attempt retaliatory attacks that can prolong the hostilities.

My two bits—shutting the Gulf of Hormuz will be Iran’s last resort of desperation and not a priority. Oil prices may rise in the very near term unless fresh catalytic news sparks another panic buying and/or short covering. And yes, Iran will attempt a retaliatory attack since many of its senior military commanders, including the chief of staff, have been killed in this attack. If no retaliation is attempted, public anger may overthrow the regime. Which means there is a 1 in 3 probability of oil prices rising over the medium term. All other factors remaining constant, I maintain my view that the energy markets are comfortably supplied.

This week will see the continuation of the nervousness on multiple triggers. Algo and AI (artificial intelligence) trading now accounts for almost three-fourths of derivatives turnover. Continued investigation of Jane Street may crimp trading turnover as institutional traders are going easy on their trades. That means wider bid/offer spreads and increased impact costs, which, in turn, means lower take-home profits for retail traders.

Again, this week, public sector undertakings (PSUs) will attract trader attention. Particular focus will be on public sector banks (PSBs), as the FM has convened a meeting of PSBs on 27 June. Market players expect positive announcements at this meeting. Pharma, defence, and energy-related stocks will see hectic two-way action, too, due to geopolitical considerations.

Industrial metals may run into resistance at higher levels, which means metal mining companies’ stock prices may see limited upside. Oil and gas will be news-driven and may go up on short covering. My long-term bullish view on bullion remains unchanged, as the rally is not over yet for the patient long-term investor. Continue to hold delivery investments and avoid leveraged longs, as the cost of carry is prohibitively high.

I continue to advise caution as volatility levels are far above the comfort levels of retail traders. Maintain and enforce stop losses and initiate trades with tail risk hedges. 

A tutorial video on tail risk (Hacienda) hedges is here – https://www.youtube.com/watch?v=7AunGqXHBfk 

Rearview 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 banking and financial sector, as their weightage is the highest in the Nifty. The US dollar index (DXY) fell after the war of words between the US and Iran. That cushioned the fall in our market, which could have otherwise fallen further. Bullion rose on defensive buying as geopolitical stress escalated. Oil and gas went up on similar concerns.

The rupee fell against a weakening dollar, which spooked bulls. Indian 10-year bond yields rose, pressurising the Bank Nifty. The NSE lost 0.92% in market capitalisation, which indicates the selling was broad-based. Market-wide position limits rose routinely post-expiry. US indices fell uniformly, creating headwinds for 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 the average of all trading days of the week) –

Turnover contribution eased in the index futures segment but rose in the stock futures segment. That tells us retail traders participated in the intraday selling process last week.

In the relatively less volatile and less capital-intensive options segment, turnover contribution fell in the least risk index options space and jumped in the stocks options space.

Overall the risk appetite seems to have climbed but on the selling side.

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 the number of rising to falling stocks. As long as the stocks that are gaining outnumber the losers, bulls are dominant. This metric gauges the risk appetite of one marshmallow traders. These are pure intraday traders.

The Nifty lost 1.14% last week, but intraday traders still seemed to exhibit optimism, as the ratio was at 1.12 (prior week: 1.15). This means there were 112 gainers for every 100 losers. That is because the sell-off was seen on Thursday and Friday. Intraday traders were gung-ho between Monday and Wednesday.

Ideally, this ratio must rise with prices to indicate a sustainable rally. Watch this ratio keenly. As long as it stays above the 1.0 level, bulls are doing ok.

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.

Traders expanded their exposure significantly last week. The MWPL reading is the highest in the commensurate week after the January series expired. Do note that there have been approximately four dozen new stocks added to the derivatives list. A high MWPL reading means the absolute rupee figure is significantly high.

High MWPL remains a double-edged sword as it leaves the possibility open for “crowded exits” in case of any bad news. Coupled with a margin trading facility wherein retail investors can borrow money from brokers to buy stocks, MWPL is a good gauge of risk appetite. MTF is at highs, which means retail traders may be biting off more than they can chew. 

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, both indices fell with rising impetus readings. That tells us the selling was forceful and participation levels were relatively higher. This indicates a possibility that short sales may have increased, and they may cushion declines if any big-ticket buying emerges.

 

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.

Last week, the LWTD indicator warned of limited fresh buying, and sure enough, the markets lacked the firepower to absorb all selling. Now, the LWTD indicator has risen to 0.11 (prior week -0.21), which indicates that short covering could cushion declines and/or trigger a temporary rally.

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

Nifty’s Verdict

 

The weekly chart of the Nifty indicates a bearish piercing candle. That occurs when the last bearish candle’s body pierces the prior bullish candle’s body by at least 50%. It is equivalent to a knife attack on a person. Though it may not be fatal, it is enough to wound the victim.

Last week, I advocated a last-mile hurdle at the 25,250 level, and the same proved prescient as the weekly high was 25,222. The same level remains as a hurdle to watch this week. On the flip side, staying below the 24,400 sustainably opens the door to fresh potential declines.

The price is above its 25-week average, which is a proxy for a retail trader’s six-month average cost. That tells me the medium-term outlook remains optimistic for now. The market will continue to be news-driven and nervous. Trade light.

Your Call to Action

 

Watch the 25,250 level as a near-term resistance. Staying above this level strengthens bulls.

Last week, I estimated ranges between 58,200 – 54,950 and 25,725 – 24,300 on the Bank Nifty and Nifty, respectively.  Both indices traded within their specified resistance levels.

This week, I estimate ranges between 57,175 – 53,850 and 25,400 – 24,025 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

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