We don’t like the sideways option because we are emotionally biased. Simple probability tells us markets have a 33 per cent chance of being sideways. And, if we take the 80-20 rule that has been proved to work in every aspect of nature, including stock markets, then markets should really trend (big moves) 20 per cent of the time and remain sideways to marginal trended 80 per cent of the time.
Now, if we take out marginal positive changes from the 80 per cent time duration, we can reach a sideways action probability of 64 per cent (0.8 x 0.8). This is the minimum time during which markets could remain sideways. No wonder, the real profiteer is the one who really has patience to traverse through his whipsawing time.
In simple, what we are suggesting is that whether you are a trader or investor, your profit making opportunities are only 36 per cent (100 - 64) of your time. This means the remaining 36 per cent of trading days for a day trader and 4.32 months (0.36 x 12 months) for an investor looking for profiting from the whole of 2011.
Now that we have the time duration sorted out, let’s understand where the Sensex could be headed — up, down or sideways. Orpheus performance cycles are another way to understand time durations. The performance cycle is a statistical cycle indicator that ranks performance of assets on various time frames on a scale of 0 to 100. Just like the mean reversion, performance cycles suggest extreme reversion. Long-term cycles have a more than 60 per cent chance of reversal. This is why a top performer underperforms and vice versa. Performance cycles not only improve the behavioural finance observation about serial correlation in long term, but also create a workable indicator.
Now, if this extreme reversion is true, the half-yearly ranking of Indian indices (table) suggests we have still lower to go and Indian markets are not out the woods yet. Bank Nifty, BSE Realty, CNX100, Nifty VIX and BSE Power are the worst ranking assets giving signs of outperformance, as they revert from worst performance.
However, the rest of the sector indices like BSE Capital Goods, BSE Healthcare, BSE Consumer Durables, BSE Oil & Gas, BSE500, CNXIT, BSE FMCG, BSE Auto, Nifty, Sensex, BSE Small Cap and BSE Metals are still near 70 per cent i.e. top performers among a group of global assets.
What does this mean? This means the weight of evidence is still pointing lower, suggesting Nifty 4,000 and Sensex 12,000 might very well still be in and the ongoing negativity could extend well into the end of the year. The BSE 500 (broad market index) is also a top performer. This does not make for a positive market case. The Nifty VIX stagnating at a low also calls for more panic and volatility moving ahead. Markets can’t go up if the cycles (time durations) are pointing lower for majority of sector indices. Markets can only go up, if CNXIT, Healthcare, FMCG and Nifty fall more and head into neutral ground, while Bankex, Small Cap and Metals join Realty and Power at the bottom of the rankings.
From the commodity perspective (alpha global energy and metals), metals look weak and even oil seems to have further downside left. The weakness in the commodity complex should also have a negative drag on the BSE Metals and BSE Oil & Gas sectors. Reliance should take more time to bottom and contribute to the market growth.
Markets can only go higher if the weight of evidence turns overwhelming negative and the picture looks darker than it looks now. So, for us, any bounces still are testing grounds, we are looking lower for firmer and stronger bottoms. The time duration for a multi-month rise for India does not seem to be here yet.
The author is CMT and co-founder, Orpheus CAPITALS, a global alternative research firm
