Look Out Below If These Divergences Fail

JC Parets
March 23, 2020

Last week we started to see a few momentum and breadth divergences form in Indian stocks, however, they've not yet been confirmed by price.

In this post, we're going to outline what price level in the Nifty 500 would confirm them, what confirmation would mean for our intermediate-term outlook, and how we're managing risk in both scenarios.

First, let's start with the number of stocks hitting 52-week lows in the Nifty 500. Two weeks ago that number reached nearly 50%, however, when the Nifty 500 made new lows just last week, we saw only 22% of stocks in the index making new 52-week lows. Fewer stocks participating to the downside is a positive development.

Click on chart to enlarge view. 

If we look at new 63-day lows in the index, the improvement is even more clear with it falling from roughly 75% two weeks ago to 30% last week.

Another measure of breadth we look at is the number of stocks hitting oversold conditions. Again, the idea here is that we want to see fewer stocks getting oversold, as measured by the 14-day Relative Strength Index (RSI). While we don't have a divergence just yet, we do have a very elevated reading, nearly 85% of stocks, which suggests we may be at a high enough level to signal a selling climax.

While these developments are certainly positive, the problem is they have yet to be confirmed by price. Until prices in the Nifty 500 can get decisively back above 7,300, then these divergences remain unconfirmed and suggest that downside risk remains elevated. 

If prices in the Nifty 500 can get back above 7,300, we can start to have a discussion about anyone with a timeframe of several weeks to several months beginning to buy stocks again. Until then, we'd expect cash to remain the best course of action as the market experiences continued volatility in both directions.

Based on our work, divergences like the ones above failing to produce any sort of meaningful rally is a very bad sign for stocks. Bulls want to see 7,300 in the Nifty 500 reclaimed...and very quickly or another 15-20% downside is ahead.

Also, check out the three charts that'll determine risk appetite for stocks in the coming week.

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Thanks for reading and let us know if you have any questions!

Allstarcharts Team

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