MUMBAI: The stock market selloff may be overdone if the extent of shares that have fallen below a key technical indicator is anything to go by.
In the past, the market has rebounded whenever 400 stocks or 80 per cent of the BSE-500 index fell below the 200-day moving average (DMA) — a trend indicator.
After the drop in the markets — especially in mid- and small-cap shares — in the past five months, 101of BSE 500 stocks are currently trading above their 200 DMA. When an index or a stock closes below the 200-DMA, it is said to be in a long-term downtrend. But the indicator is also considered to be a reversal sign when too many stocks in an index fall below 200 DMA.
The findings are based on Edelweiss SAT-DMA Index, which shows the stocks trading above their 200 DMAs.
“The analysis revolves around the hypothesis that the market tends to bottom out when less than 20 per cent of BSE500 stocks are above the 200 DMA,” said Yogesh Radke, head of alternative & quantitative research, Edelweiss Securities.
But the rebound may not happen in a hurry. In the past 15 years, the market has remained sluggish for 46 days from the day when the SAT-DMA Index hits the 20 per cent mark.
“Going by history, the extrapolation indicates the likelihood of the market languishing for the next 40 days before resuming its upward trajectory,” Radke said.
The trend of SAT-DMA Index hitting the 20 per cent mark and a subsequent bounce-back was seen on six occasions in the past 15 years — June 2006, March-April 2008, February-March 2011, November-January 2012, August-September 2013 and February-March 2016.
The sell-off in the stock market has been on account of liquidity concerns in NBFCs, outflows by foreign portfolio investors, uncertainty ahead of elections and steep share valuations. Since September 1, the Sensex has declined 6 per cent, the mid-cap index has dropped 16 per cent and the small-cap has tumbled 22 per cent. The fall in Sensex and Nifty has been moderated by strength in a few bluechips.
Stocks in the BSE 500 index that are currently trading above 200 DMA include large-caps such as WiproNSE 1.12 %, Axis BankNSE 0.70 %, Reliance IndustriesNSE -1.17 %, InfosysNSE 0.20 % and Bajaj Finance, and mid-cap stocks, such as Bata India, Power Finance Corp, Aditya Birla Fashion, UPL and Divi’s Lab.
In the past, the BSE500 Index has dropped by 5 per cent on an average from the day the SAT-DMA Index hit the 20 per cent mark. As the SAT–DMA Index moved above 20 per cent, average returns are 7-8 per cent in the next 2-3 months and 25 per cent in the next year.
“The sharp correction especially in mid- and small-cap stocks is overdone and I believe Indian market will bounce back soon as the valuations of many quality stocks are attractive,” said Raamdeo Agrawal, joint MD, Motilal Oswal Financial Services. “The current valuations of several quality stocks have improved the risk reward ratio in favour and offering a buying opportunity in the beaten down mid-cap and small-cap stocks.”