Chart Advisor: Are Indian Markets Due for a Correction?

By Vishal Dalvi, CMT

1/ Nifty 2010 & 2015 Top

2/ Nifty 2020 & 2022 Top

3/ Nifty v/s Midcap100/Small cap100 comparison – 2018-2020

4/ 2022 Top – Into the New Era

5/ 2024 The Current Rally

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1/

 Nifty 2010 & 2015 Top

Finding an Index Top is one of the most challenging tasks as a trader/investor. One of the best methodologies to find a potential market top is to identify an extreme or weak breath as the Index price gets overbought.

2 indicators that can help spot a potential peak is

-% of stocks above 200 daily simple moving average (%SMA200)

– % of stocks with Weekly RSI above 50 (%WRSI50)

Let’s look at some historical tops made in the past for Nifty Index and how these indicators have helped to identify a Top.

Plotted above is a Log scale chart of Nifty Index along with the 2 indicators mentioned above.

2009-2010 Bull Market came after a strong bear market in 2008. Post the 2009 Election results, Market hit an upper circuit of 20% in a day and in few days more than 90% stocks in NSE were above their 200-day simple moving average. There are 2 implications of this data. Either Market is extremely overbought given that everything has moved up; or it signals a fresh Market breakout with huge participation. In 2009 this is a strong breakout signal; especially because it comes preceded by strong oversold bear market prices. The second indicator %WRSI50 also went above 90. What is important to note in the following rally is that prices continued to move higher but the %SMA200 continued to fall gradually.

Whenever %SMA200 breaks 50 on the downside (which usually occurs in the first leg of the start of bear market); it is a strong reversal signal and most likely a top is in place. Given that market is scaling new highs and even then, if only 50% of the stocks are above 200 SMA is a sign of weak breath in the Market which leads to a sell off. Markets crashed 24% post the Sell signal till Dec 2011.

Note, just a cross under of 50 level in itself has no importance, unless it is preceded with a crossover of 90 level, signaling a bull market and a full-scale participation.

2014 Bull Market was when BJP government had a clean sweep victory and Narendra Modi became the Prime Minister of India for the first time. Note this bull market is quite different structurally as it comes after 3 years of consolidation unlike 2009-2010 which was preceded by a Bear Market. The same pattern repeats. Market continues to scale higher and less and fewer stocks are able to stay above their 200 daily moving average. Finally, when the fall starts in March 2015 the %SMA200 fell below 50 and markets corrected 20 % post that.

2/

Nifty 2020 & 2022 Top

2020 Top in Indian Stock Market was a unique scenario. 2016-2018 Bull market saw a huge participation of Small and Midcap stocks and those actually topped out in 2018. Somehow the %SMA never crossed 90 in this bull market. While Small and Midcap stocks topped in 2018, the Nifty index kept on making new highs, but the overall breath of the market continued to worsen, which can be seen with the 2 indicators plotted. The %SMA200 crossed under 50 in 2018 itself, except that it wasn’t preceded by a crossover above 90. The Markets finally topped in Jan 2020 and then came the COVID crash and market crashed nearly 40%.

3/

Nifty v/s Midcap100/Small cap100 comparison – 2018-2020

4/

2022 Top – Into the New Era

Indian Markets can be easily divided into 2 regimes. Pre and Post COVID. A lockdown with everyone working from home and a sharp correction in Markets along with Low Interest rates on FDs offered Equity Investment as a good investment opportunity; saw a surge of new Retail investor participation in Indian stock markets that has structurally changed the way market behaves. The %SMA200 crossed above 90 around November 2020 signally a fresh new Bull Market. The %SMA200 cross under happened around Feb 2022. If you observe this correction is quite different than that of the 2010, 2015, or 2020. Reason was that we are in the new regime, where huge FII selling are absorbed by huge domestic flow by new retail investors. The market only corrected around 11% post this sell signal and largely consolidate in a range till June 2023

5/

2024 The Current Rally

The current Bull Run post June 2023 hasn’t seen the %SMA200 or the %WRSI50 cross above the 90 mark. Both the indicators have flittered around 85 levels and haven’t been able to cross under 50 which clearly shows there is no warning signs yet. There are some reasons for this

Regime Change: As explained before every dip so far has been bought given the huge flows and there is a structural change in Market behavior.

Sector Rotation: Anything and everything are not running up at the same time. This Bull Run started with PSE Index taking the lead and it has constantly changed hands with other sectors taking the lead while some sector went into consolidating. This rotation keeps the market healthy and doesn’t lead to excesses.

Also, we need to now check whether 2018-2020 is repeating where the Nifty index keeps increasing and the underlying Midcap, Small cap spaces start correcting. But the below chart shows that isn’t the case yet. There is no divergence, and all 3 indices are strong and moving together.

To summarize, there are no signs to call a Market top yet. A move of %SMA200 above 90 would flag us to look for a break below 50 for signs of a potential top.

Having said that I would still trade this market with a lot of caution and take a cross under of %SMA200 below 50 equally seriously (even though it may have not gone above 90); since we have flirted with 85 levels, and this is a New Regime Markets. A regime change can set new rules and not necessarily replicate the past as it is.

Stay invested with caution.

(PS: The methodology used to calculate these indicators only include valid stocks above a dynamically set Market cap threshold ensuring a certain % of stocks are above it in NSE exchange. Stocks universe is reset quarterly for the purpose of calculation.)

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Originally posted 5th September 2024

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