The equity markets ended off their intra-day lows on Friday, but the bulls' confidence was far lower than warranted by such a relatively muted erosion in prices on a close-on-close basis. At the heart of the matter was what any decline consists of – crisis of confidence.
Any screen reading trader could have observed that nervousness in the markets just after noon when prices went into a free fall. The decline between 1230 – 1400 hours spoke louder than words since the traders’ screens showed mark-to-market losses that were not seen since the post-Budget decline in the markets in February 2018.
True, the prices recovered on bear covering coupled with some buying support, but the damage was already done. The back offices of brokers would have squared up many a long positioned trader’s holdings due to mark-to-market losses.
A basic understanding of behavioral science would tell you that money lost can be regained by a trader, but an emotional draw-down is a far more damaging event. No drug, no therapy, no panacea cure exists when the trader is psychologically 'broken'. The screens showed a mid-session 'break' in confidence intra-day on Friday.
The fall was polarised around financials, especially NBFCs, banks and interest rate sensitive stocks. While the fall maybe attributed to weekend considerations (traders generally do not like to take 'over nighters' on weekends due to the uncertainty presented by potential news triggers), it may be remembered that the headline indices have been falling for four consecutive sessions.
The intra-day low was the lowest after 10 July 2018, which means the indices tested a 9-week low before recovering towards close. That also means the pre-Budget peak made on 29 Janurary was breached intra-day.
The impact again is more psychological as compared to merely financial. Consider this – You are a buy-and-hold futures trader; every derivative cycle you roll over your trade, you incur a cost (cost of carry). Friday’s intra-day fall negated all the C-o-C you’ve incurred after the budget and some more. This is the psychological tipping point that will hit trader confidence the hardest.
Admittedly, markets are known to recover in a 'V' shaped manner, should follow-up buying be seen after a sell-off. If one was to understand the cause, it would be easier to gauge the effect.
Since the decline was triggered by concerns of the debt servicing capability of IL&FS, a big-ticket NBFC, the ripple effect can only be of sizable nature. There were concerns about DHFL as well, a housing finance company offering above market rates return on investment.
It's when risk appetite was on the wane that traders feared the high return on investment could jeopardise the return of the investment (capital invested) itself.
Secondly, it is the nature of the markets to over-react and especially so on weekends when risk appetite tends to be low. Veteran traders know that emotions of greed and fear (especially) tend to get stretched on weekend sessions. The sell-off therefore is a combination of the fears of these NBFC’s cash crunch and the over cautious, risk-off approach of the market players.
The late recovery was a result of the exhaustion of the selling forces coupled with some strong handed support. What will be mission critical to watch is whether that follow-up buying support is forthcoming in the coming week.
Markets are after all a mathematical beast – more buyers than sellers mean the direction is upwards and vice versa. This is an aspect that we need to monitor: Is follow-up buying likely to be seen in the coming weeks? The bulls need that feel-good factor desperately. Will the markets be kind to them? Time alone can tell.
While we play the waiting game for Father Time to tell us what lies in store, let us fall back on economics and market dynamics.
In a bull phase the markets need to overcome three obstacles – finite resources of the bulls, selling pressure, and gravity. In a downward phase, these very forces accelerate the declines. Exhaustion of resources means the bulls cannot buy aggressively anymore.
Selling forces and gravity catalyse the decline and lend momentum to the fall. Which is why the momentum on the downside is often far more vicious and painful to bystanders.
To the uninitiated, it may even appear surprising, but the mathematically-inclined traders and investors who have seen at least two bull and bear phases will attest as the ultimate truth.
Traders who have understood these market dynamics manage to protect and grow their capital decade after decade. The playground you call the market is actually a logical machine that works on the principles of forensic medicine (cause and effect theory).
As long as you can decipher the numbers that constitute any directional move, you can gauge the effect of these numbers as per the cause and effect theory. Admittedly, it is not as easy as it sounds. But then, as the old Wall Street saying goes: “Trading profit is the most difficult easy money you will ever earn”
(The writer heads Bhambwani Securities Pvt Ltd and is the author of 'A Traders Guide to Indian Commodity Markets')
Updated Date: Sep 22, 2018 11:13 AM