11 December 2010

Advance - Decline : Leading Nifty Indicator ?

I am using NSE F&O data to try to get find some pattern and get insight on how trading is going on and what can we make out of it. Not necessarily there will be any relation between a metric and the Nifty, but surely we can gauge the sentiment and mood of traders at work!

Lets look at "Advances - Declines" of 200 odd NSE F&O stocks and see what its going through. As the name suggests we take the difference of number of stocks gaining and losing in price and then smooth it out by taking a 5 day simple moving average. This simple construct, gives us an idea as to how many stocks are there where money is flowing in and how many from where the money is flowing out. So a value around 0 would be very neutral and a sign of equal forces on both sides. A positive value favors the bulls and a negative the bears.

The chart above shows how our indicator declines while nifty consolidates above 6000 and then make a valiant attempt to take out 6357, which was and still is an all time high. This attempt failed and the little rise in the 5day moving average of "adv-dec' also gave way to bigger fall. We see here how a negative divergence between nifty and our indicator showed that something was wrong and the rally should not be trusted.

Now check the period when this indicator made a new low, while Nifty gained negative momentum during the fall. Our indicator stopped making new lows, but Nifty made a new low (a positive divergence here!). Interestingly markets rallied after that though it lost its way below 6100.

Now check the action of last few days, our indicator has made a new low on 9th December and then bounced taking Nifty along with it. If this indicator has to be believed we should see Nifty making new low in coming days.

This indicator that I illustrated is very much in line with Mclean indicator, though much simpler. The concept behind this indicator is that if the market is weakening overall it would be first noticed on the broader market then on the index, where more blue chip are concentrated. This also reflects the common sentiment of moving into stronger companies (which generally are in index) during periods of over-valuation and caution.

I will be checking if this really works or are these observations mere coincidence!


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