Technical Insights, September 2020

Nifty continued its strong rebound that has been in place post the lows seen in March 2020. While July had ended strongly with a net monthly gain of 771.35 points (+7.49%), August too ended on a positive note posting a net gain of 314.05 points (+2.84%).

With August closing in the green, the headline index has posted gains for three consecutive months. However, despite a 3-month return of a 13.18%, NIFTY return YTD is negative 6.42%.

The benchmark Index is placed at a  critical juncture. The markets have seen a V-Shaped recovery on the monthly charts. What the NIFTY lost in the month of March is now recovered over the past five months. The previous month saw the benchmark oscillating in a wide 912 points range; and the last day of the month saw the NIFTY knocking off 260 points eroding nearly half of the monthly gains. The volatility, which was at one of its lowest levels over the past four months, spiked 24% on the last trading day of the month. However, on a monthly note, it still declined as the INDIAVIX came off by 5.61% to 22.83.

For the coming month and beyond, the monthly high point of 11784 would be crucial to watch. The global risk-on setup and the liquidity driven push to equities stays very much in place, but the domestic concerns like renewed geopolitical tensions with Chine, worse GDP data, and enforcement of the new margin rules saw the NIFTY shedding nearly 460-points from the monthly high levels and may cause some short-term hiccups.

The  close of 11387 is very near to 11500; this level represents the lower trend line of the channel that the NIFTY broke on the downside. On the way up, this zone represents a strong pattern resistance area followed by 11800 level. On the lower side, the zone of 10900-11000 is expected to act as strong support area.

There are a couple of factors that may lead us to adopt a cautious view for the coming month. The NIFTY has seen a distinct bearish divergence on the RSI over the past several months as the incremental monthly highs have come with a bearish divergence on the RSI. Volatility, as represented by INDIAVIX, has also tapered off nearly 80% from the highs seen in March 2020 and it is now at one of its lowest levels over recent months.  

Prolonged periods of low levels of VIX also reflects complacency of the market participants. With the NIFTY failing to sustain above 11500, which is a  crucial pattern resistance area and with VIX near its multi-month lows, all up moves need to be chased cautiously. To avoid any incremental weakness, it would be important for the NIFTY to crawl back above 11500 levels. The general performance of the markets is likely to stay highly stock specific in nature.

If the weakness in the US Dollar continues, it will continue to drive rally in the Emerging Markets. If such liquidity driven rally stays on, one may follow the momentum on the upside. However, positions should be protected by strict trailing of stop-losses at higher levels.

If we benchmark the Indian broader Index, NIFTY 500 along with other global markets against MSCI World Index, India has just crawled inside the leading Quadrant on the RRG. The NIFTY500 Index is seen making a north-easterly rotation while steadily maintaining its relative momentum against the benchmark on a weekly time frame. Domestic concerns may lead to knee-jerk reactions in the Indian equity market. However, the placement of the broader NIFTY500 Index ensures that given any move that we see on the global equity landscape, the Indian equities is likely to relatively outperform the Asian peers and the European Indexes over the coming weeks.

During the lockdown, the world came to a standstill and uncertainty reached an all-time high. Our members responded by stepping up to help each other and the financial services industry navigate the uncertain times ahead.

Welcome to Technical Insights – the first CMT India Newsletter.

This is a labour of love, born out of our members’ passion for the discipline of technical analysis and a desire to elevate the discourse around its practice. It is a platform to share our insights into how domestic and international events impact the behaviour of market instruments. Technical analysis provides anyone facing the markets, or engaging with clients about the markets, a toolkit to navigate market risk. The newsletter therefore is a perspective, for market participants to respond to factors that will affect their top line even when reasons are not immediately apparent.

We set up CMT Association’s India office, our first outside New York, in December 2018. In the year and three quarters since then, there has been steady growth in our active member base and their commitment to the profession. Under the stewardship of Rashmi Shastry, CMT, the newsletter is the first public manifestation of this.

Our members have also organised into volunteer teams that work with 6 strategic pillars of the financial services ecosystem. These pillars are Employers, Regulators, Academia, Media, Membership, and the execution of the India Summit. Visit our experimental microsite bit.ly/CMTIVolunteer to learn more.

As time progress, you will hear more about the work our members are doing. I invite you to participate in this narrative. Visit our website: www.cmtassociation.org, reach out to me, and engage with us.

I will use this section of the newsletter to keep you abreast with the work our volunteers are doing across our strategic pillars.

Onward…

USDINR RELATIVE VALUATION:

Dollar Rupee has perplexed many even though it has had a mild downward drift. The confusion has stemmed from the resilience of US Dollar against Rupee, even when it witnessed broad based depreciation against almost all major currencies. The question is how the Rupee has fared vis-à-vis its peers. I have taken the time series data from BIS who publishes the 60 currency (trade-weighted) nominal effective exchange rate index for Rupee. It shows how Rupee has fared against a broad basket of currencies. I have computed Z-score on the data with a rolling standard deviation of 5 years. An oscillation function, between +2.00 to -3.50 standard deviation is visible. A negative Z-score denoted periods of Rupee depreciation and vice a versa. Currently, Rupee is hovering between -2.00 to -2.5 standard deviation, denoting extreme undervaluation. Over the past 20 years, out of 11 times, only 4 times has it depreciated close to 3.5 standard deviations but that is during crises years: 2008, 2013 and 2018. If over the next 6-9 months, the global economy recovers and so does Indian economy, then in absence of any major crises, there exists a strong possibility of Rupee witnessing broad based appreciation.

USDINR WEEKLY PRICE ACTION:

USDINR is trading near 72.86 levels on spot. The life-time high is 76.90, mid-April 2020. Prices have been drifting downward since then. Pace of descent has increased over the past couple of weeks. Intermediate trend is downward within a long term uptrend. The current phase can be seen as a multi-month correction within a multi-year uptrend. Historically, such corrective phases have lasted anywhere between 10-14 months. USDINR is likely to find support near its immediate supporting trend line, around 72.30/40 zone. Whether the test of trend line will hold or not is still an open question, as downward momentum remains strong and Rupee is catching up to its peers in the EM and DM. In case the support fails to arrest the downward trend, then it can extend towards the second and major trend line, near 71.30 levels on spot.

EURUSD WEEKLY PRICE ACTION:

The reversal in structure of the primary trend occurred after nearly 12 long years, with prices sustainably breaking above the falling trend line. The pair is likely to test 2018 high near 1.25 levels. However, the journey may turn out to be bumpy as there are numerous overhead resistances. Nevertheless, in case prices fail to sustain above 1.1400 levels, bullish view will be negated.

Three charts portray a coherent picture of Rupee strengthening against US Dollar, partly to correct its undervaluation and rest to move in line with expected appreciation of major currencies like Euro against USD. As every view needs to have a level where it needs a rethink. For me, that is if USDINR trades above 74.50 levels on spot.

Theme of the Month: EUR/USD

The common currency has been on a tear recently against the dollar and has in its sights the second largest QoQ % change over the decade, i.e. Q2 2017 when the % change over the prior quarter was a little over 7.25%. The recent rally however, has resulted in Non-Commercial Net Futures positions (Sources: CFTC, Commitment of Traders Report, Bloomberg) going past their Q2 ’18 highs and in doing so, making the current reading in speculative long positions the highest this decade. Non-commercials tend to be trend followers, so tracking their activity at extremes, particularly close to major support and resistance levels determined using technical research, does warrant attention.

Weekly Ichimoku Cloud Analysis:

No doubting that the EURUSD is in a clear uptrend, but there are warning signs flashing. For one, notice that the difference between the Kijun-Sen/Base-line (Orange, 26 bar Highest high + Lowest low midpoint, often called “medium term equilibrium”) and the current price is reaching levels that last saw prices retracing back to the Kijun in late ’17 (black oval). The nature of this relationship is that when prices drift far away from the Kijun, the higher the odds of a pullback to the Kijun.

Monthly Ichimoku Cloud Analysis:

The pair is approaching formidable resistance on the monthlies offered by Senkou B/Leading Line 2 (Highest high + Lowest low for the last 52 periods, pushed forward 26 periods). Notice how the 2014 and the 2018 peaks occurred here (black ovals). Currently, the cloud border offers resistance at 1.2173 for Aug and Sept ’20, post which it drops off, reducing the burden of resistance for the EURUSD to break through.

Given the negative news press that the Dollar has been receiving lately, it’s important to use history as a guide. In the below analysis, we have measured where the DXY has been 12 months out each time the 3-month Rate of Change (ROC) has been atleast -5%.

Surprisingly, or maybe not surprisingly for people who have been in the FX markets long enough to understand how they work, running this analysis starting Q2 2008 (when the bear market in the dollar ended) shows that there have been 13 occasions when the 3m ROC was -5% or worse. 12 months later, in 9 out of 13 cases (70% of the time), the dollar index was higher by an average of 5.80% after accounting for 2 cases which resulted in a loss and 2 cases which can’t be evaluated since 12 months haven’t passed since they occurred (see below)

In conclusion, it is fair to say that the consensus trade right now is to be short dollars and the macros certainly align in that direction. However, as has been statistically shown in the above analysis, the dollar has had a tendency to end up in the opposite direction 12 months out (and significantly so, with an average gain of 5.8%) whenever the easiest trade on the street was continuing to be dismissive of the greenback. Will history repeat this time too? That’s something worth waiting for.

Technical Analysis is primarily the study of price and volume. In addition to this, there are several indicators just like several components in a toolbox. To arrive at a complete and well-rounded view, one must consider the signals from these indicators.

The attached snapshot is an analysis that combines price action, direction, volatility, volume, and relative strength. The stock covered in this section belongs to the Pharmaceutical sector, which has witnessed a dramatic turnaround since the onset of the pandemic.

LUPIN had been in a long-term negative trend for almost five years now and has resurfaced from close to seven-year lows as seen on the monthly chart.

Price action: During the month of August, we saw the stock hitting Rs. 1035 for the first time since Jan. 2018. The stock has witnessed 4 consecutive months of bullish candles, for the first time after 2014, indicating that the bulls are confident and are accumulating this stock on every dip. At the moment, the stock is facing strong resistance near Rs. 950 to Rs. 1000 levels. A close above Rs. 1000 levels might trigger a further upside.

Volume: August also clocked the highest monthly volumes over the past 15 years, indicating strong accumulation by the market participants at lower levels.  A price breakout supported by strong volumes is a text-book pattern of a strong trend.

Direction: The 20-period moving average has started rising, indicating the shift of trend to the upside. April’s monthly candle breached a declining trendline, drawn from the 2015 highs, indicating a trend reversal.

Volatility: Bollinger bands have started expanding indicating that there might be a directional movement into the stock. The expansion of Bollinger bands after a sustained contraction as can be seen in the chart, suggests a strong price movement. A close above the upper Bollinger band will indicate that the stock is expected to move on the upside.

Relative Strength Index (RSI): In the month of March’18, the stock had made a low of Rs.727 while RSI was 28.28. But in the month of March’20, the price made a lower low of Rs. 504.75 whereas the RSI clocked a higher low of 33.53. This is a case of positive divergence indicating that the bullish momentum is improving. It was further confirmed when the indicator broke the trendline resistance in the month of April’ 20 further adding to the bullish thesis.

800 will act as a crucial level going forward while the price movement in the stock is expected to remain positive. Below Rs.800, the bears might start taking control and we may see further consolidation in the stock. On the upside, we may see the stock scaling up to levels of Rs.1130 (38.20% Fibonacci retracement) and 1300 (50% Fibonacci retracement) in medium term. Fibonacci retracements have been used to estimate price targets.

In Conclusion:  As can be seen from above, indicators help in reasserting a view and strengthening conviction in one’s outlook. There is a sea of indicators to choose from depending on your time horizon and trading style. Select the ones that are most suitable for your analysis.

Market Wizards: Interviews with Top Traders by Jack D. Schwager 

“I read a book one day and my whole life was changed.” – Orhan Pamuk

This quote best describes my experience when I read Market Wizard. “Market Wizard” and “Reminiscences of a Stock Operator” are two of the most popular book references I had come across while starting my career. Reading Market Wizards, I thought I would find trading strategies that would help me make a quick buck, but I was disappointed to find interview after interview with no application-based inputs. To be honest I stopped reading and immediately picked up other books that dived into strategies. To my surprise, upon applying these strategies to my capital, I was still not making money! Reading more books only redirected me back towards Market Wizards and so I picked it up again. This time with the idea to learn and not a short-cut earn.

The book is divided into five major parts that cover numerous interviews of renowned traders discussing different asset classes and trading styles. Also included are interesting anecdotes about Richard Dennis’ turtle traders, Ed Seykota’s disciplined trading, Van Tharp’s Psychology trading etc.

There are mind-boggling stories here such as:

• A down and out trader who converted $30K into $80Million
• A Fund Manager who achieved five consecutive years of triple digit returns
• An electrical engineer from MIT who earned a 2,50,000% return over sixteen years and many more

My suggestion: Don’t make the mistake of seeing these as just interviews. Read between the lines. These interviews describe the journey that all traders go through. Legendary traders have made the same mistakes that we make today, such as listening to others, ignoring risk management, booking profits early, not following trading systems etc.

My number 1 book recommendation is Market Wizard, because once you go through all the interviews you will be able to relate to one or more traders and understand your personal style of trading.

You can buy the book here: https://www.amazon.in/Market-Wizards-Interviews-Traders-Updated/dp/B07MNNGDWX/ref=tmm_pap_swatch_0?_encoding=UTF8&qid=&sr=

Cover Image credit: Wiley.com