Focus on quality stocks, keep stop loss for trading bets

The domestic stock market remained bullish as the benchmark indices closed higher for the fifth consecutive week. It is the longest winning streak in the year. The NSE Nifty made an all-time high of 17947.65 before it closed at 17853.20 on Friday. On a weekly basis, it gained by 268.05 points or 1.52 per cent. The BSE Sensex zoomed above the 60,000 level with a 1.8 per cent weekly gain. For the first time, the BSE market capitalisation has reached to Rs 261 lakh crores. On the Sectoral front, the Nifty Realty and Media are the top gainers with 21.2 per cent and 11.7 per cent, respectively. The PSU Bank index and Metal indices declined by 4.4 per cent and 3.3 per cent. The Pharma index is also down by 0.5 per cent. The remaining sector indices are in rally condition. During the month, FIIs bought Rs. 7132.72 crores, and DIIs bought Rs1,030.37 crores. Overall market breadth is at 1:1.

The NSE Nifty has registered the longest winning streak in this year by closing higher for the fifth consecutive week. It formed a higher high and higher low and strong bullish candle. Even though the market overextended and overbought condition, the benchmark index is resilient to decline. The market is alive because of a perfect sector rotation and stock rotation. It is also resilient to global markets and outperformed last week. But, over 620 points weekly trading range, a spike in volatility is worry point now. The Nifty has extended over 127.6 per cent of the prior swings, which we projected earlier. It closed much above the 17740 levels decisively, so it may test the 144 per cent extension of 18055. The 161.8 per cent extension level is at 18368. For, we can't forecast more than this level. Most probably, the market top will be formed at one of these levels.

Now, we will discuss the downside probabilities. On a daily chart, the index has formed a spinning top candle. In any case, the Nifty opens with a gap down and closes below 17,819 points, and the reversal is a reality. In this reversal, the Nifty must not breach 17,326 level. As long as it's trading in the 17326 - 17947 range, the Nifty will consolidate. The 20DMA is at 17375, is another important level to watch. In the last three weeks, the bottoms are at 17254, 17269 and 17326. These almost identical bottoms are also an essential support for the market. The 23.6 per cent of the current upswing from 25th July is at 17373.

For the first time after November 2014, the RSI has reached 80 zone on a monthly chart. And Only after April 2006, it closed above the 80 on a weekly chart. Whenever 14 periods RSI has reached 80, it has made a top in the past on a longer period chart. This time too, it has reached the extreme overbought condition in all timeframes. As the RSI historically high overbought condition and the rally extended beyond the expected 127.6 level of 17740, the higher probability is consolidation for some time above the 17254.

India VIX traded below 18 for many weeks; it has even tested the level of 10 on the downside multiple times. Interestingly, the India VIX currently, for the 16-week period, is trading below the 18 mark. A similar pattern was witnessed just before the March 2020 fall, when India VIX traded below the 18 mark for almost 18 weeks. As mentioned earlier, as had been witnessed many times in the past, the prolonged period of low VIX will result in an impulsive and volatile move. That is exactly what has been happening for the last two consecutive days. A new high has been witnessed in India VIX with a three-month range breakout and a closing near the day highs.

With a serious increase in volatility and a weekly close above the 18 zone, bears, in all probability, will dominate the market for some time. Even during the top of 2014, the VIX had broken out of the range and closed above the 18 mark on a weekly basis. Hence, keep a close watch on India VIX; a close above the 18 mark would be a red flag. Another interesting observation is that the Mansfield relative strength indicator shows that the Nifty is underperforming compared to the Nifty 500.

The outperformance of mid-cap and small-cap stocks is one of the major factors for the market rally. These two important market drivers underperformed last week. Though the midcap-100 index made a new high, it declined below the previous day low and formed a bearish engulfing. The smallcap-100 index has made a lower high with a big bearish bar. The leading sector index, the Nifty IT has made a gravestone Doji and all the major IT stocks are also formed similar bearish candles. The Bank Nifty formed a double top.

Historically, in 16 out of 21 years, the Nifty formed a major top in the January-March quarter. The October-December quarter has been the most bullish in the last 15 years as per the seasonality charts. This historical fact shows a lower probability of a big bear market ahead. The volatility will increase in the near term, and it will become extremely challenging to trade in shorter periods. Hence, we would advise traders to concentrate on quality names and maintain strict stop loss for trading bets. In history, only in 2016 did Nifty make an intermediate top in September, and in 2010 it made a top in October. The Nifty must form a lower high and lower the low bar on a weekly timeframe. Then only one has to change the stance towards the bearish.

(The author is financial

journalist, technical analyst, family fund manager)