"How the market reacts to news flow indicates the underlying sentiment"

Vikas Khemani, CEO, Edelweiss Securities, on five indicators to gauge market sentiment 

Published 8 years ago on Aug 04, 2016 1 minute Read

Cash market: This includes the advance-decline ratio and how it moves over a period of time. However, one should look at the moving average (5-20 days) instead of the daily ratio to get a proper trend. Secondly, you can look at market volume coupled with delivery volume. Typically, rising volume with higher delivery volume indicates increased interest.

Derivatives: Here, you can look at cost of carry and implied volatility. Rising cost of carry in stock futures reflects positive sentiment. The market always peaks at a very high cost of carry (13-14% p.a.) and bottoms at negative or negligible cost of carry (reflecting heavy short position in the market). Secondly, consider the ratio of Nifty’s open interest vis-à-vis stock futures. As this ratio peaks, the market reflects overbought sentiment and signals a high probability of impending correction.

Liquidity-related: Liquidity has two dimensions: systemic liquidity and flows into the market. To get a proper hang of market sentiment, understanding the liquidity situation is crucial. The easy liquidity scenario in the global and domestic banking system always works positively in the short term.  

Market-reaction: How market reacts to news flow indicates the underlying sentiment. If the market reacts negatively to positive news flow, or ignores positive news flow, you know it is heavy and topping out. The market is, therefore, not cheering even good news and there is inherent weakness. The same is true the other way around. 

Economic: If broad macroeconomic indicators such as GDP growth, inflation rate, interest rate, IIP numbers and corporate earnings are doing well, you will see the market perform well over time. Some other proxy indicators are Freight volume & rate, Auto sales, Cement sales, Power consumption, Credit off-take and Order books.