Market Technicals: Volatility Tossing Traders, Is The Dryer Next?
Clothes are washed in the laundry in Khanbogd, Mongolia. (Photographer: Taylor Weidman/Bloomberg)

Market Technicals: Volatility Tossing Traders, Is The Dryer Next?

BloombergQuintOpinion

We are all familiar with the good ol’ washing machine. Top-loading, front-loading, it doesn’t matter. If we look at it, we can see the clothes being tossed around in a totally random fashion and for the clothes, it would be a hell of a ride being thrown one way when the drum rotates clockwise and then the other way when the drum changes its rotation. Of course, after undergoing all these travails, the squeeze of the dryer awaits those clothes.

Traders would be feeling somewhat like that at the end of another week of a totally topsy-turvy market. Since the start of March, it has been a tremendously volatile market with opening gaps being seen almost every day, alternating between down and up directions. As though the gaps weren’t enough to cause trouble, the intraday swings too have been all over the place. Here is a small depiction of how the prices have gone.

Market Technicals: Volatility Tossing Traders, Is The Dryer Next?

It all started with that spike on Feb. 24, when the NSE system crashed. On that day, the resumption of trading saw the Nifty trade up to a huge gap price (15,524) and then drop from there. Since then there have been a series of opening gaps (marked with an ellipse) and you can count 8 of them in 10 sessions.

The problem was that these gaps alternated. So if you were left with any kind of overnight position, you got slammed.

The most painful were gaps 5 and 8. They both raised visions of collapse (gap 5) and new highs (gap 8) only to reverse strongly from there. And essentially what have prices done? Stayed largely between 14,950-15,250 – a measly 300-point range. But they traversed that range so much and in such quick succession that it became well-nigh impossible to tell whether we were going or we were coming.

No wonder, traders at the end of the week are feeling like they are looking out from inside of a washing machine. They are now wondering whether the dryer is still waiting for them next week. Last week I wrote about taking a few guesses and the upshot of those guesses was that the main trend is unchanged and we should therefore continue to be buyers at lower levels and maintain our bullish bias.

Well, last week we all found out that it is so much harder to hold those views and maintain our equipoise when actually going through the wringer. Every gap, unfortunately, looks like the start of a new move, and hence as a trader, one wants to be in on it. But most traders are unprepared to deal with the reversal of a gap and hence pay a heavy price. Words of a famous philosopher and priest Franz Bentano comes to mind, “What is at first small is often extremely large in the end.”

Each of those losses may not have been much but when added up across ten sessions, they become a lot.

Two behavioural patterns emerge from such trauma.

  • First up, traders retreat to the side-line to lick their wounds and hence trading volumes drop. This makes it even worse because volumes are needed to temper volatility.

  • Second, the willingness to hold positions drops so the market becomes even choppier.

Now that doesn’t bode too well for what is in store ahead. The only way this can be redeemed is by big players stepping in. They seem to have been absent in the market much thru early March.

Perhaps it has to do with the conflicting signals coming from across the shores. The 10-year bond yield in the U.S. has been on a sudden tear. This has laid asunder several well-laid plans (which were moving along smoothly earlier), thus creating some volatility. The Dow Jones fluctuated a bit, gold tanked, oil sped, the dollar dropped and then looked up, commodities were a bit all over the place, Nasdaq was hit, etc. etc. It’s been a while since the yields have seen these current levels. Take a look at the next chart.

Market Technicals: Volatility Tossing Traders, Is The Dryer Next?

People had gotten so used to low yields that the sudden reversal has caught many unawares. Now, as we can see on the chart prices are at former swing low pivots. Can this now act as a resistance? It should, ideally. Maybe a bit of a spillover but the pace ought to slacken.

We can see that the whole move is a corrective – U.S. bond yields have been falling since 1981.

So how did those corrections pan out? See the long-term chart of U.S. bond yields. It makes for some interesting readings.

Market Technicals: Volatility Tossing Traders, Is The Dryer Next?

I have marked the retracements during the fall and we can see that mostly, it is a 62% pullback, and a couple of times it has been a 50% pullback. That sets the tone of what to expect from the current rally. Second, we can note that U.S. bond yields have been falling in a very orderly manner, adhering to a channel. The last of the two lows have been on the midline of the channel because the yields would then go negative if they had to fall to the lower end of the channel. Not something that hasn’t happened in the world but not yet in the United States. Next, note that the plot is very close to the top channel.

So make-or-break time is coming up soon! So far, we have seen 38% retracement happen at current levels. The ‘normal’ expectations would suggest 1.80 (50%) or 2.18 (62%).

So we need to watch the upper boundary of this channel rather closely. It will certainly be a disturbance, particularly in the global arena (and perhaps not so much locally). But I really wouldn’t believe that until we are beyond the 62% levels in any decisive manner, there is going to be too much roiling of the current market rallies. The fears that the FII funds may flow out I think is a bit of a stretch to make at this juncture.

But, I hear you say, that is all fine. Tell us how to handle this blasted volatility! Well, here are a few:

  1. Stay out.

  2. Stay put with your longs.

  3. Reduce quantity.

  4. Have stops on intraday charts.

  5. Pray.

Most, particularly those that are in the washing machine, are into option 5.

The best is to move to the sidelines and wait out this phase. Obviously, the market is not going to announce the end of the phase, so that means one has to keep watching for tell-tale signs that it is over. Those will be many and multifarious in their manifestation. However, for the committed trader, that is not an option. In that case, please refer to choices 2 through 5 listed above.

For now, I would want to keep track of the following level. See chart.

Market Technicals: Volatility Tossing Traders, Is The Dryer Next?

That’s around 14,900. May not want to hold on to short-term bullish views if that is lost decisively. Until then, however, I will continue to grit my teeth and see out this phase. Faith in the philosophy “this too shall pass” should keep us going.

CK Narayan is an expert in technical analysis; founder of Growth Avenues, Chartadvise and NeoTrader; and chief investment officer of Plus Delta Portfolios.

The views expressed here are those of the author, and do not necessarily represent the views of BloombergQuint or its editorial team.

BQ Install

Bloomberg Quint

Add BloombergQuint App to Home screen.