Markets rally post-Assembly election results: Prices might pause for breath, will even give up recently recovered ground

There is an old saying in the armed forces – the most formidable advantage in a combat situation is the element of surprise. A small band of soldiers can vanquish a larger foe when they spring a surprise. That is the basis of guerilla warfare. And we know that financial markets are also about passive warfare. In combat, one wields a gun and bullets whereas, in financial markets, one has a keyboard and mouse. The underlying principles of combat apply almost equally to both scenarios.The election results announced on Tuesday saw this element of surprise emerging to the fore yet again. The resemblance to the 18 December, 2017 results in the Gujarat state elections and the markets roaring higher is uncanny.The present financial markets are digital beasts so the mathematically inclined trader can trace the “digital footprint” in the markets. On both days 18 December, 2017  and 11 December, 2018 the headline indices opened with a gap down and lulled the day traders into pressing short sales in anticipation of even bigger declines.[caption id="attachment_4343711" align="alignleft" width="380"]

Representational image. Reuters.[/caption]The December 2017 decline was little more accommodating to the bears. Last year, the headline indices fell after opening lower, thereby allowing at least a fraction of the short sellers to exit from their shorts profitably. This year, however, the lows logged at the open of the session were not breached and the indices roared higher.Anybody who dared to short sell at any price point had a mark-to-market loss to show for his endeavour. This is known as a “bear squeeze” in traders’ circles when the bears are caught on the wrong foot and are forced to square up their positions at progressively higher prices.There is a temporary disequilibrium in the markets as the bulls are buying to go long and the bears are buying to square up their shorts. This results in double the impetus upwards as compared to a bull market. This is why bear market rallies are far more vicious than bull market upthrusts. Money flow from both camps is flowing into the markets on the buy side in a bear market rally.Before you jump to conclusions that this is a recent phenomenon, think again. History is replete with such examples when the markets have shrugged off scary news and roared higher – former prime minister Indira Gandhi and Rajiv Gandhi’s assassination, Gulf War I & II, US attacks on Afghanistan, missile attacks on Riyadh international airport, terror attacks on London red fleet bus etc. The markets are known to go into a ‘business as usual’ mode unexpectedly. That is what happened on 11 and 12^th December 2018.Cause and effectJust as bears are squeezed into submission, it is not necessary to squeeze every bear on all counters in the markets. The bulls need a focused approach to the exercise. In our markets, broader based indices are NSE Nifty 50 and the sectoral index is NSE Bank Nifty which are traded heavily.The composition of the Nifty 50 is heavily skewed in favour of the financial sector services (37.54 percent), energy (14.48 percent), IT (13.91 percent) with individual stocks representing these sectors being HDFC Bank (10.54 percent), Reliance Industries (9.23 percent ), HDFC Ltd (7.47 percent), Infosys (5.86 percent) and ITC Ltd (5.65 percent).Therefore, if you were to push up HFDC Bank by 10.54 percent, the Nifty would rally by 1 percent. Let us take a look at the Bank Nifty’s composition – HDFC Bank 36.80 percent, ICICI Bank 18.42 percent, Kotak Bank 13.28 percent, Axis Bank 8.94 percent and SBI 8.60 percent.It becomes clear that HDFC Bank is a critical stock to watch out for, both for Nifty and Bank Nifty traders. Then comes Reliance Industries, Infosys, HDFC Ltd and ITC.Apart from HDFC Bank which was more or less steady when the share price was compared from open to close, the other ‘heavy-weights’ saw concerted buying momentum, leading to a bear squeeze. The buying frenzy on Wednesday was even more pronounced, and included HDFC Bank, so the headline indices are reporting a stronger upthrust.The bear squeeze continued for the second day, both on the X&Y Axis (time and price fronts). What follows invariably when the element of surprise has worn out, is mean reversion where prices pause for breath and might give up some of the recently recovered ground. Since the surprise element triggered unexpected price mobility, it is categorised as volatility, and volatility of this magnitude is largely unsustainable and therefore moves in short bursts and ‘clusters’.Remember it takes a huge effort in terms of capital, overcoming selling pressure from bears and gravitational forces to sustain a constant state of bullishness. Much will depend on just how much of follow up buying support emerges in the coming days, before one can call a conclusive return of the bulls in the trading ring.(The writer heads Bhambwani Securities Pvt Ltd and is the author of 'A Traders Guide to Indian Commodity Markets')