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Saturday, March 24, 2012

What are the market breadth indicators signalling?

What are market breadth indicators and why should we look at what they are signalling? Investors tend to focus on Sensex or Nifty movements. These indices comprise 30 and 50 stocks respectively, and are supposed to represent overall market trends and movements. But thousands of stocks are traded every day. Market breadth indicators try to capture the mood of the broader markets by measuring how many shares went up in price versus how many went down.

Last week, the stock market turned quite volatile. The Nifty went up 90 points one day, only to fall 130 points the next day, followed by an up move of 50 points. What caused this volatility and what should investors do in such a situation? The main reason for volatility is near-term uncertainty about market movements. All the major trigger events that were supposed to boost the bullishness caused by FII buying – state election results, RBI’s policy review and the budget – turned out to be damp squibs. The next trigger event – Q4 results – is still three weeks away.

No wonder investors are not sure what is going to happen next. A look at the market breadth indicators may provide some clues.

Nifty A-D Line

Nifty A-D line_Mar2312

The A-D line (in red) has been falling along with the Nifty (in blue) since both touched their recent (Feb ‘12) peaks. This is normal behaviour. The A-D line is supposed to follow the Nifty. So, we need to look at divergences or differences in patterns. Note that last week’s bottom in the Nifty was slightly higher than its previous bottom. But the A-D line dropped to a lower bottom. Also note that the Feb ‘12 top on the Nifty was higher than its Nov ‘11 top, but the A-D line reached a lower top. These are negative divergences (similar to the ones that occurred in Jun-Jul ‘11 and in Sep-Nov ‘11), which could be signalling a deeper correction.

Remember that there are no certainties in technical analysis – only possibilities and their probabilities. If you are holding longs, maintain proper stop-losses.

Nifty TRIN

Nifty TRIN_Mar2312

The TRIN has bounced up from the edge of its overbought zone (below 0.7). Note that the TRIN had reached heavily oversold zone (above 1.2) back in Dec ‘11, just before the sharp rally started. But the heavily overbought situation in Jan ‘12 – when the TRIN dropped to 0.5 – did not trigger a correction. However, the sharp correction in Jul ‘11 started when the TRIN had bounced up from 0.7. So, be prepared but not afraid of a correction.

In a mid-week update of the Nifty chart, it was mentioned that all four technical criteria of a bull market have been met. So, the strategy from here on should be to buy the dips. But ‘recency bias’ may be preventing investors from entering. The FIIs are continuing with their buying. If they suddenly start selling then only can one expect a steep fall. But why would they do so? Asian indices are in bull markets. So are FTSE and S&P 500 indices. Compared to the global indices, Sensex and Nifty suffered much more prolonged bear markets, though current valuations are not exactly cheap. Neither are they too expensive.

Moral of the story? Investors can stay invested as per their asset allocation plans. Traders can try to make some quick money from the daily price swings. Both should maintain appropriate stop-losses.

Related Post

Two market breadth indicators

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