Trading rut

This is a trading market. Sell below 1,860 and buy above 1,860 are the kind of recommendations floating around. Markets are unequivocally stuck up between 1,930 and 1,770.

One did get a feeling when Nifty broke 1,770 on February 27, 2004, that may be this time markets might give some trending move, but then volumes dried up at 1,770 for the third time and 1,770 just became a non-descript level.

The markets bounced up with ease and touched 1,870 last week. The index is still attempting to nudge up to the upper range for the seventh week running. Strange as it may appear, markets theoretically have to spend one third of trading time in a non - trending zone.

Whether this week is decisive or the market still remains stuck is tough to forecast. However, what one can attempt is to forecast the direction of the possible breakout whenever it happens or the rut might continue.

Are we seeing a breakout above the 1,930 levels once or are we headed down?

A detailed look and one can see that the ruling price of the Nifty and some heavyweights. Technically most of them are still above the 23 per cent the retracement mark (retracement of the uptrend that started in May 2003).

This is a key support before any signs of bearishness emerge. Reliance, Infosys, State Bank of India and ITC (near all time high) are all above the 23 per cent retracement mark. Wipro is lower than the 23 per cent mark while Hindustan Lever is the only index heavyweight below the 61.8 per cent retracement mark. (What happened to HLL is quite perceptible).

Hence, before markets head lower all the respective heavyweights should first see a break of these critical supports. Incidentally, 1,770 Nifty levels coincide with this 23 per cent retracement level.

So assuming, that the price is indecisive about the ensuing trend and suggests strong support, one can look at trading volumes (TV) and open interest (OI).

Barring Reliance and ITC the volume is negative for most of the other sample heavyweights. On the OI front, most of the index heavyweights have witnessed not only a drop in OI on a month-over-month (m-o-m) basis but also a drop in OI compared to the average OI for 2004. Nifty is the only asset to have witnessed a rise in OI m-o-m.

So before we detail out the above tables we can look at a few interpretation rules: First: only total volumes and OI are used for the purpose of forecasting. Second: OI has a seasonal behaviour. It increases near the start of the current contract and decreases near expiration.

This is the reason we have compared the current OI with annual average and average for the year and 30-day moving average (30 DMA). This takes care of the seasonal adjustment. Third: increasing volume and OI indicate that the current trend will continue.

Fourth: declining volume and OI suggest that the price trend may be changing. Fifth: volumes precedes price. Sixth: within an uptrend a sudden levelling off in OI warns of a changing trend. Seventh: very high OI at tops is dangerous. Eighth: build-up in OI during consolidation periods intensifies the ensuing breakout.

The above two tables can now put the current situation in perspective. Though OI and price suggests positive action in the index, the volume is not reinforcing any uptrend. The very reason why Nifty is in a trading range.

Nifty futures and HLL futures are about 55 per cent and 80 per cent higher than their annual average OI. RIL has both price and volume positive, suggesting more upside despite not much rise in OI. Rise in OI in HLL can be a sign of consolidation considering volumes are not expanding with the price fall and are not suggesting further weakness in the stock.

For Infosys and SBI, both volume and OI change are negative and it suggests negativity at current levels. ITC price and volume suggest upside from current levels despite declining OI. ITC is not a very active counter in F&O and so one can ignore the OI change. Wipro is still in the negative trend, as OI is not rising despite the price action.

Overall, we have three positives - RIL, Nifty and ITC - and three negatives - Infosys, SBI and Wipro. HLL seems to be in the neutral territory.

Hence, on a portfolio of seven stocks we are still half way undivided over where we are headed. One can expect the tug of war - i.e. the trading rut to continue.

Try to sell below 1,860 and buy above 1,860. A short strangle can be a potential strategy on the Nifty, assuming the stocks under study remain above their price supports.

(The author is derivatives strategist at Edelweiss Capital. The views expressed here are his personal views and not those of Edelweiss Capital.)