Stocks Rallied 20% But Risk Remains Elevated

March 30, 2020

Last week we looked for a counter-trend rally in stocks and we got it. The Nifty 50 rallied 20% from its intra-week low to its intra-week high, leaving a lot market participants asking if Indian stocks are out of the woods.

In this post, we're outlining why our defensive stance remains and how we're approaching the weeks ahead.

First off, last week's rally was a counter-trend move that developed on the back of weakening downside momentum and improving risk appetite in the near-term. All around the globe, Equities that were hit hardest in the selloff were rallying the most, whereas the areas that had held up during the correction paused or went up less aggressively.

Despite a valiant effort, the Nifty 50 was unable to get back above its 2015-2016 highs that's needed to confirm that these breadth and momentum divergences have legs. The market showed us that there is overhead supply at 8,900, so for now, we're stuck between 7,900 and that overhead supply.

Click on chart to enlarge view.

So where does it leave those who caught last week's rally?

Last week's conditions presented the first opportunity in a while to get long with well-defined risk and the probability of success on our side. Despite the rally, we're still not seeing enough data points to support market participants with a timeframe of several weeks to months, or longer, getting aggressive on the long side.

Instead, the weight of the evidence continues to suggest that this is an active trading environment and will remain that way as long as the Nifty 50 is below its 2015-2016 highs.

If you are a short-term trader that caught this move, then taking profits as the index and individual trade ideas hit their upside objectives Friday was the prudent thing to do. If you're in positions that have yet to meet their target and you want to stick with them and see how they develop, then "feeding the ducks" and raising stops on your remaining position to protect your capital makes sense.

In this environment, it's important from a physical and emotional capital standpoint to prevent a winning trade from turning into a loser. We caught a nice move, the market hit our upside objective and backed off, and now it's our job to wait for more data before getting long or short again.

How this market handles the overhead supply at this level will tell us about how to move forward.

Does it consolidate tightly below 8,900 and then break out again? or does it retrace a large part of the move and retest its November-December 2016 lows near 7,900?

That's what we're looking at, particularly because the structural issues in Mid and Small-Caps remain a heavy weight on stocks as an asset class.

Here's the Nifty Free-Float Mid-Cap 100 Index trying to reclaim support from 2015-2016 and the 61.8% Fibonacci Retracement of its 2013-2018 rally. 12,250 is the line in the sand. Above that, we can start to have a conversation about this downtrend reversing and a move back up towards 14,200...but below that the risk remains lower towards 8,800.

The Nifty Free-Float Small-Cap 100 is in a similar position. If prices can get back above their 2013 highs that would be extremely constructive and open the doors up for a move towards 4,750 where the majority of its overhead supply lies. With that said, as long as we're below 3,900 then the risk remains to the 2012-2013 lows of 2,700.

Bear market rallies can be just as vicious as the declines that preceded them. Protecting capital remains our number one priority in this environment, which means exercising patience and waiting for "fat pitch" conditions like last week before putting meaningful risk on the table.

If the Large-Cap Nifty 50 Index that's been leading for the last two years is able to reclaim its 2015-2016 highs, then Mid and Small-Caps are likely able to reclaim the key levels discussed above as well.

It's in that environment, and only in that environment, where we can start to talk about those with a several week to several month or longer horizon getting back into positions on the long side.

Premium Members can follow this link to view the inter-market signal that's signaling weakness is ahead for stocks.

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

Allstarcharts Team