Taking investing cues from FIIs

Major stock market indices have risen for simple reason that FII buying has dwarfed domestic selling in terms of scale

One clear trend through 2012 and 2013 has been the foreign institutional investor (FII) attitude. FIIs have been net sellers in only three of the past 18 months. Domestic investors, on the other hand, have been net buyers in only three of those months. The major stock market indices have risen for the simple reason that FII buying has dwarfed domestic selling in terms of scale.  This pattern has also led to a divorce between the behaviour of large stocks and small stocks. Large stocks – broadly the 200-odd counters available in the derivatives segment and a few other mid-caps – have gone up because FIIs can focus on these.

It is not worth the time and trouble for the FIIs to research or invest in stocks that don’t have a certain threshold market capitalisation and basic float quantity. Since domestic investors have been sellers, these relatively smaller stocks have underperformed the larger ones.

If you look at the FII net buy-sell positions on a month by month basis, some correlations become obvious. If there has been high FII buying (or heavy FII selling) in a particular month, the market is very likely to have hit an intermediate peak (or trough) in that month.

Major 52-week highs and lows also coincide with periods of strong buying or selling, respectively. The last 52-week high in January 2013 came on the back of Rs 33,500 crore in net FII buying across December 2012 and January 2013. In April, the FIIs bought a moderate Rs 4,600 crore and they have, till May 16 bought Rs 9,500 crore net.

This coincidence of tops with FII buying is not necessarily because FIIs mistime their trades or chase momentum though that may account for some correlation. It is because FIIs are the market in terms of delivery-based operations. There are no domestic counter-parties with sufficient resources to move the market in the opposite direction. This holds good for the top 200-odd stocks only. The rest of the market is less correlated to FII attitude.

A trader can take positions with a somewhat greater degree of confidence if his view appears to coincide with the FIIs. This is especially important if he intends to short. On the long side, he can also look for buying above a certain threshold in the past four weeks, using a four-week or a six-week moving average (MA) of FII buying volume. If FII buying exceeds the four-week MA, the market is very likely to go up. A retail investor is unlikely to want to short. But he can play contrarian to the FIIs while making his purchases. A long-term investor is likely to get a better price if he’s buying at points in time when the FIIs are selling, since prices will be lower.

The author is an equity and technical analyst