How to call a bottom

As the markets head south, anxiety levels are rushing northwards.

Not without reason, the erstwhile supports expected at the 4365 (minor support) and 3960 (intermediate support) stand conclusively violated.

The despondency levels in the markets are hitting new highs as the headline indices plumb to new year 2008 lows.

But before you write off equities just yet, consider the following:

- Markets cannot rally or decline perpetually. It is against the laws of physics, finance and common sense. The markets can, however, remain illogically bearish far longer than you can remain solvent, so there is no point in fighting the markets.

- Fibonacci studies indicate that the next support level is at 3600-3625 band and we need to watch whether the bears cover their shorts aggressively, bulls emerge as strong buyers at those levels, and the retail segment abstains. Generally, bull markets emerge during times of extreme pessimism and especially when the retail players have abandoned all hope and the markets. It may also be noted that the overall bull market that unfolded since May 2003 is not dead till the Nifty spot starts trading below the 2900-3000 levels on a consistent closing basis. That doesn’t seem to be happening.

- As per time studies, the first inflection point in the markets where a bottom could have been made was in 24-26 weeks after the collapse was triggered. Since that time has elapsed, that timeline is no more of any validity. The next time point is end of October 2008 where players may expect some kind of support emerging, though it cannot be construed as infallible unless confirmed by other studies.Turn to Page 24How to call a bottom

How to call a market bottom: No one can stake a claim to having a magic formula for accurately forecasting an absolute top or bottom. However, we have some high probability events that warn us of a turning point in the markets. They are:

- BUYING BY STRONGER HANDS: Bad news if any, fails to drive indices lower on a closing basis. Even if the indices plunge due to negative triggers, they bounce back and close in the green. Downtick days are accompanied by poor volumes and uptick days by higher volumes. The trading activity shows signs of picking up when markets rally. Consensus is slowly shifting towards buying. The average ticket size per trade (total turnover in rupees divided by total number of trades executed) is at least 30% higher than the recent average of Rs 25,000 per day. That indicates buying by stronger hands and possibly even institutional players.

- OVERSOLD SIGN: Technically, the oscillators are deeply entrenched in the oversold zone and are showing signs of positive divergence - prices inching lower whereas the oscillators are nudging higher.

- LOOK AT TRADED VOLUMES: The upmove will be qualitatively better —- don’t look at headline indices in isolation. If the Nifty rallies and Bank Nifty, CNX IT and CNX Midcap indices are falling, suspect the upmove. It could be operator mischief to lure in the retail players. Should most or all indices move upwards in tandem, the rally is fuelled by broad-based buying consensus and will therefore have stronger cushions on declines as averaging maybe seen coming from bulls. Pay particular attention to the overall traded volumes. In the initial part of the upmove, volumes maybe thin as scepticism is higher but the follow up buying must be on high volumes or the upmove can terminate with a nasty fall.

- RISE IN TANDEM UNTENABLE: Currently, the cues coming in from alternate asset classes are indicating a deep sense of insecurity. The upmove in prices of gold, silver, platinum and palladium indicate a “flight towards safety”. This process should reverse and money needs to flow out of hard assets into equities. Resources being finite, equities and hard assets cannot appreciate for long in tandem. Remember what happened in 2006-2007?

When that turning point does come, what will you buy?
Stocks that have historically outperformed the Nifty —- by a very wide margin —- for at least 36 months in a row, or a decent margin for 60 months in a row.

The logic is simple. When you buy the Nifty, you spread your risk across 50 stocks. On the other hand, buying a single stock is higher risk, it can go down 50% within a week after you buy it. For the risk to be justified, the return must be at least 100% higher than the “basket” safety of the Nifty, if not higher.

This aspect is known as the Relative Strength Comparative (RSC) by technical experts.
It deploys your funds in the strongest possible stocks so your money works the hardest and appreciates the fastest and with the least amount of risk.

Besides, the tough criteria of outperformance for 3-5 years will filter out many operator manipulated stocks.

Till such a turning point occurs, keep your ears to the ground and hope in your hearts. Equities are not dead - yet.

The author is a Mumbai based investment consultant and invites feedback at vijay@BSPLindia.com  or ( 022 ) 23438482  23400345.