Waiting for price breakouts

Stick to stop losses as bearishness is likely to continue.

The Nifty rose one per cent on Friday, May 13. This was supposedly because assembly election results were business-friendly. The Left Front was blown away in Bengal by the Trinamool-Congress combine; ditto for the DMK which was tossed out by the AIADMK in Tamil Nadu; also the Congress took Kerala and Assam. Earlier, on Thursday May 12, the Nifty fell 1.4 per cent. This was supposedly because IIP data and inflation statistics looked to be unsatisfactory.

The explanations are convenient media constructs since IIP data was released on May 12, and election results on May 13. The Nifty has an averaged movement of around 1.4 per cent (median) to 1.5 per cent (mean) per session for the past year. Neither trading session was therefore, extraordinary. These were just two normal trading days. The movements did not require explanation, except in the context of desperately seeking sound bytes.

It is possible that there will be some positive impact on the markets due to election results. There may also be a focus on businesses centred in Bengal, Assam or Tamil Nadu in the near future. Indian markets do prefer decisive election results. It doesn't really matter who wins, so long as somebody gains a clear mandate.

Public expectations about political performances are low. Nothing in the track records of Mamata Banerjee or Jayalalithaa suggests that they would be either markedly better or worse at governance than their respective predecessors. But a decisive mandate reduces infighting, and horse-trading, and businesses know who they must cultivate or pay off if there's a guarantee of stable government.

The drop on Thursday was not completely attributable to IIP or food inflation data. If one must seek causes, the reasons for that fall would be more nuanced. Sure, the FY11 IIP growth rate of 7.8 per cent was lower than the FY10 growth rate of 10.5 per cent. But 7.8 per cent is nevertheless excellent, given a higher base. March 2011 data in particular, was well above expectation. Food inflation data also showed a toning down of the inflationary trend. The combination should have enthused bulls - it obviously didn't.

In fact, some “experts” argued in convoluted fashion, that the combination of the IIP and food inflation data was too good! It would trigger another rate hike, which would be bad for equity valuation. According to this logic, the RBI's internal models would assess the IIP growth as strong enough to sustain a hike. Since the RBI wants to further tame inflation, it would put the squeeze on.

Again, this explanation can be used to construct elegant sound bytes but it is not necessarily within the ball park of reality. The stock market continuously discounts multiple variables affecting fundamentals and sentiment. It's usually impossible to tell which of those variables has exerted greater influence in a given session. If the session itself doesn't see extraordinary movement, searching for explanation is likely to lead to finding non-existent patterns.

This is one of the joys and perils of day-trading. A day-trader, who seeks to ride market sentiment, will scan the headers every morning, and pick a few items of news that he believes will influence the herd. If he correctly decodes consensus, he makes money that day. If not, too bad.

It should be noted that a day-trader, who is trying to second guess market sentiment in this fashion, isn't interested in the actual fundamental impact of anything. He is only interested in knowing the way the market will interpret events.

Operating this way in short time frames, requires fine-tuned instincts for sentimental shifts, a strong sense of monetary discipline, and a good grasp of technical factors. Anybody who possesses those attributes can probably make more money simply by ignoring the headlines, focussing on price-volume data, and extending trading timeframes from the daily to multi-session.

Purely on technical data, last week's trading patterns were not clear-cut. The Nifty was locked inside a narrow trading range, suggesting the short term trend is indeterminate. It stayed below the 200 Day Moving Averages, suggesting this is a long-term bear market. There was heavy selling above 5575. There was buying above 5475. Given a 50-point buffer, continued movements within 5425- 5625 will not be worth trading except for “scalpers”, operating on sub-hourly timeframes.

A trend-following technician will ignore the headlines and wait for price breakouts beyond that 5425-5625 range. As and when those occur, he will trade with the breakout. Given long-term bearishness, a downside bias seems somewhat more likely. Either way, the technician will set stop losses and stick to them.