Volatility indicators point to potential retracements

The equity market extended the rally for a fourth successive week and gained over 16 per cent in the current uptrend. The benchmark index NSE Nifty advanced by 300 points or 1.73 per cent during the last week. The BSE Sensex is up by 1.8 per cent. The broader market indices, Nifty Midcap-100, is up by 1.8 per cent and the Smallcap-100 gained by 1.1 per cent. The Nifty Metal index is the top gainer with 4.6 per cent and followed by the Private bank index, 3.6 per cent. The Media and FMCG indices declined by 2.9 per cent and 1.1 per cent, respectively. The broader market breadth is positive. The India VIX is down by 6.91 per cent to 17.61. Even the Implied Volatility also declined to the lower band of 11.27. The FIIs have been continuously buying the equities since the beginning of this month. They bought Rs14,748.28 crore this month and Rs7,850.12 crores last week. The DIIs sold Rs4,243.78 crores in this month.

The Nifty has reached an interesting level. It reached 17724, and testing the sloping trendline resistance, as we forecasted earlier. Now, the question is, will it surpass and sustain above the 17730-18000? Let us examine the pros and cons of the current uptrend. There is no doubt that the FII's buying interest has renewed after several months of selling pressure. The global market is also in a clear uptrend. The current rally is the longest one and registered the highest gain than the prior swings. Many stocks are breaking out of the base formations. Importantly, the market is in a confirmed uptrend, with no distribution day presence. The Nifty is trading above all key moving averages, and they are in an uptrend.

At the same time, there are some worrying points. The VIX and IVs are at the lower band. These volatility indicators have an inverse relationship with the benchmark index. The IV is the lowest since January 2021, and VIX is near to the lower band. When these two indicators are at the lower band, the index makes the top. This evidence shows that there are potential retracements. The historical evidence shows that when the volatility indicators are at the lower band, it is evident that the market experiences bigger declines. So be cautious on the upside targets.

The prior swing high is at 18115, and the sloping trendline resistance is placed at the 17730-80 zone. Before resuming an uptrend, the Nifty has to retrace at least 23.6 per cent to 38.2 per cent from this resistance zone. The Nifty gained 16.73 per cent in the current swing. It met the pattern targets too. It has achieved the downward channel, and the falling wedge measured targets. After meeting the targets, it is common and healthy to correct or retrace some of the gains. Assume that the Nifty has reached 18000. The 23.6 per cent retracement level is at 17335, and the 38.2 per cent retracement level is at 16924.

If there is any correction, we cannot expect more than this now. For the next few days, 18115 is the crucial level on the upside, and the 17442-335 zone of support is important for the ongoing trend. We may see the Nifty consolidate in this zone. But, a decisive close above 18115 will be positive and be with the trend. The Dow and S&P indices broke the key resistances last week. The absence of negative news flow and the decline in inflation across the markets is a sentiment booster for now. A gap-up opening is possible, but sustaining is a question. The derivative data shows 17800 may act as immediate resistance. Watch the index behaviour around the 18000-115 zone. Stock-specific activity is the order of the day. It is better to protect the profits on the table with a strict trialling stop loss.

(The author is Chief Mentor, Indus School of Technical Analysis, Financial Journalist, Technical Analyst, Trainer and Family Fund Manager)