Column

Are the markets tethering on the brink of a decline?

That’s the moot question on top of every trader’s/investor’s mind.
The recent truncated intra-day range seen on the benchmark indices seems to indicate a lack of clear direction as bulls and bears have been refraining from enhancing their exposure with equal disdain.

What has been the empirical experience when this kind of sideways movement is witnessed in the markets? Not good for the bulls, unfortunately.

In a (headless) ‘chicken’ market (one that’s going nowhere), the dice is invariably loaded against the bulls.

This is because of the cost of capital factor (the market men prefer to call it the cost of carry factor).

For a bull to roll over longs from one series to another, there is an addition to the acquisition cost, which is justified if and only if the markets are rallying faster than the costs of carry are adding up.

Conversely, the cost of carry is an immediate profit for a bear who rolls over the short positions from one settlement to another and pockets the cost of carry as a short term profit.

Therefore, the weight of evidence seems to suggest that extended periods of inactivity will be followed by a decline as the bulls get exhausted on paying rollover costs without seeing a commensurate reward in terms of price appreciation.

In terms of basic chart reading, Nifty 5150 will be a rough and ready support for the Nifty spot.

A sustained trade below this threshold will see an acceleration in the unwinding of long positions and will probably be accompanied by fresh short sales.

The Nifty has been going nowhere since January 5, 2010 — that is a long time for any trader to be incurring mark-to-market margins, impeding rollover costs and be faced with the prospect of a capital loss.

It may also be remembered that the Budget is barely a month away and wild swings are usually seen at this time as traders second-guess the market direction.

Bulls are likely to get relief only if the Nifty breaks out of the present range-bound pattern and trades consistently above the 5325 levels. Then the long positions will get comfort in holding on to existing positions and possibly adding on fresh buys.

Such a breakout must be accompanied by at least a 30% increase in average traded volumes and open interest on long positions over the previous 10 sessions prior to such a breakout. Till such an event unfolds, put off buy decisions, atleast in the leveraged segment.

The analyst is the author of the book A Traders Guide to Indian Commodity Markets and invites feedback at vijay@BSPLindia.com.