The upside breakout has been driven by banking and metals. In September, while the Nifty has gained nine per cent, the BankNifty gained 12.5 per cent and several metal stocks have similar out-performances. Sterlite is up 12 per cent, while Hindalco and Tata Steel are up 10 per cent and 14.5 per cent, respectively.
The metals surge reflects global sentiment. September has seen positive action on the London Metal Exchange (LME), as speculators bid up base metals on anticipated strength in Chinese (and Indian) demand, and reports of global inventory depletions. A glance at NSE data also suggests that foreign institutional investors (FIIs) have been net buyers, pumping in Rs 12,000 crore in September. They’ve probably been mirroring positions overseas.
Metals will see a correction when profit-booking starts. The current bullishness is driven partly by hopes that the US will recover quicker than assumed earlier. Sooner or later, some influential analyst will issue an advisory suggesting this is unlikely. Or, some data suggesting weakness will be released.
In banking, the moves are largely driven by Indian money as most bank stocks are at, or near, regulatory FII limits. Earlier in 2010, the BankNifty rose despite higher interest rates because speculators believed the Indian economic rebound was strong enough to generate larger credit off-take.
In the past six weeks, the BankNifty has moved up since it seems likely the RBI won’t hike rates immediately. However, Q1, 2010-11 data also makes it obvious that margins across India Inc have been adversely hit by interest rates and a slowdown in earnings momentum is very likely.
The fact that the BankNifty has moved to a new all-time high, leaving the broader market behind, has both positive and negative implications. The positive is that the financial index is well-correlated with the broader market and often a leading indicator of trends in the real economy. Incidentally, the charts suggest the BankNifty could have a medium-term target of 12,500-odd over the next two-three months. The negative is that, at current valuations of 21, the BankNifty looks over-priced and due for a bout of profit-booking. When that happens, the Nifty is also likely to correct sharply.
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You shouldn’t short a North-bound index until there’s some sign of correction. A long trader on the BankNifty can use sensitive trend-following tools like a standard short-duration daily moving average (DMA) crossover systems. For example, a combination like five-DMA versus 20-DMA has worked well in the past.
That 5-20 DMA combination gave a buy signal on July 12 (when BankNifty hit 9,850 – higher than both DMAs and the five-DMA was also above the 20-DMA) and that signal is still live. A conservative trader using an moving average crossover system would exit a long trade if, (1) the BankNifty dropped below either average, or (2) the five-DMA was lower than the 20-DMA. He would short only if the index was below both averages and the five-DMA was lower than the 20-DMA.
The author is a technical and equity analyst