Whatever direction the market may take, it is very likely that the May settlement will also be high volatility, warns Devangshu Datta
The Nifty closed on Monday below its own 200-day moving average (200-DMA) at 8,213. The last time this happened was in October 2013.
Then, the market had rallied from 5,800 levels and stayed up above the 200-DMA for the next 18 months.
It has been a roller-coaster ride since the 2015 Budget, which was among the most eagerly awaited in recent memory.
The market swung up to an all time high of 9,119 on March 4.
After that, it dropped to a low of 8,269 (March 27).
Then it recovered to a intermediate high of 8,844 (April 15) before it went into this current correction.
In the past two months, therefore, we have seen a pattern of lower highs, (9,119, followed by 8,844) and lower lows (8,269, followed by 8,202 on 27 April).
The net-result is a 10 per cent correction.
We have also seen the 200-DMA violated. All these signals are conventionally bearish.
Other momentum-based signals have also gone bearish. Breadth has been consistently negative for several sessions and indeed declines have outnumbered advances for several months.
There has been substantial foreign institutional investor selling through April (if we discount the activity in Sun Pharma).
Any trend following trader would say that a downtrend was established when the market dropped from the previous high of 8,844.
The normal method of playing this would be to take a short futures position with a trailing stop-loss.
Is the downtrend likely to sustain and get stronger or is it likely that the trend will reverse with a bounce? Both are possible.
The downtrend could get stronger for a sentiment-based reason.
A lot of technical traders, watch the 200-DMA and a breach of that level is considered a sign that a big bear market could be starting up.
If the 200-DMA is being used as a stop-loss by many traders, a breakdown below could lead to a sequence of big sell orders that force a bigger correction.
On the other hand, trends have to reverse sometime and the 200-DMA is also a strong zone of support.
We are very close to a settlement. There could be short covering going into the last two sessions and that short covering could help to trigger a rebound.
Trying to predict which scenario is more likely is tough.
Whatever direction the market may take, it is very likely that the May settlement will also be high volatility.
The positional trader may want to try wide option strangles to exploit high volatility.
A swing of five per cent plus in either direction is possible.
That could take the Nifty to either 7,500-7,600 or till 8,800-8,900.
Ideally, the trader should wait until Monday (May 4, which is day two of the May settlement) to allow the option market to settle down.
Then, take a long call and long put position, with both strikes set at about 400 points from Friday’s Nifty values.
A similar wide strangle could also work with the Bank Nifty.
This is a strategy with a four week timeframe. What should a more long-term trader or an investor do?
My suggestion would be to implement this wide strangle and wait for a sense of direction.
If there is a 10 per cent move in May, this might decisively move the market into recovery mode, or push it into a long-term bear market.
We will also have a sense of the fundamentals by mid-May because earnings and projections for most companies will be available by then.
Devangshu Datta is a technical and equity analyst