Did the Nifty warn you to beware the Ides of March?

Just like the Ides of March proved to be a tumultuous time for the Roman Empire, it is also proving to be tumultuous for the Indian markets.

March 18, 2020 12:33 IST | India Infoline News Service
There is an interesting story behind the use of the phrase “Beware the Ides of March”. The Ides of March corresponds to the 15th of March in the ancient calendar and it was the date when Romans were supposed to settle all their debts. Interestingly, Julius Caesar was  warned by a Soothsayer to Beware the Ides of March. Caesar meets the Soothsayer on the morning of mid-March and reminds him that the Ides of March had come. The soothsayer’s response was, “The Ides of March may have come, but the Ides of March have not gone”. The same evening Caesar is assassinated by Brutus outside the Roman Senate. Now let us come back to the modern story.

Why did the markets not warn about the Ides of March?

“Beware the Ides of March”, was best popularized by Shakespeare in his play, “Julius Caesar”. Just like the Ides of March proved to be a tumultuous time for the Roman Empire, it is also proving to be tumultuous for the Indian markets. That begs the question, “Why did the soothsayers not warn of the Ides of March in stock markets” That means, was it possible for an investor to foresee this kind of a massive crash. The answer is you can do it yourself. Sharp  market crashes can be predicted based on 3 parameters. Here is how!

1.VIX Chart versus Nifty Chart can be useful to predict such crashes

If you look at the chart below, you will be struck by how the Nifty chart and the VIX chart almost look like a mirror image of one another.
Data Source: NSE
VIX or the volatility Index is created by aggregating the implied volatility (IV) of the most liquid Nifty Options. VIX is also called the Fear Index, meaning higher the VIX, greater are the chances of fear and panic in the market. A higher VIX shows panic in the market and that is not conducive for Nifty levels as it indicates higher risk.

If you look at the VIX chart above, it is clear that the sharp fall in the Nifty from February onwards is simultaneously supported by VIX rising sharply. For example, from early February there were sufficient indications of the VIX rising and the markets falling. Since then, the Nifty has been falling and VIX rising consistently. Nifty lost 3500 points and VIX was up nearly four-fold in that period.  In short, the warnings of the Nifty turning down and the VIX turning up were available from the first week of February. That is warning enough that markets could correct. This negative relationship between VIX and the Nifty has general held under most market conditions. It can be best used to predict such crashes.

2.Watch out for consistent selling by Foreign Portfolio Investors (FPIs)

This has been virtually unmistakable in the last 40 days. FPIs have sold more than Rs.55,000 crore worth of equities in a little over 25 trading sessions. This is not a only huge in quantity but also the selling has happened in a short span. When you see FIIs consistently selling for a few days in succession, it is time to prepare for a fall in the market. FPIs are effective because they impact the stock markets and also the rupee value and it becomes like a double whammy. But nevertheless, it is a very useful indicator.

3. Look for the daily High / Low differential ratio for the Nifty
Data Source: NSE
This is the third factor you must look to be able to predict a fall in the markets. But how do you interpret the above chart? Look for the High / Low Differential ratio greater than 3%. Just to give you an idea, in the last 2500 trading sessions between January 2010 and March 2020, the High/Low differential exceeded 3% only on 50 occasions. That is about 2% of the trading days; so it should not be hard to find. What exactly to look for? Firstly, look if the High/Low differential ratio is gradually settling at a higher plane. Normally, market corrections are preceded by cluster of occasions when the ratio was above 3%. In the past, such clusters were seen in Dec-10, Aug-13, Dec-15 and Sep-18. On all the occasions, the subsequent correction was quite steep. Secondly, look for consistent spikes.

Putting these data points together

Ideally,  look for multiple signals  i.e. at least 2 of the above 3 signals must give you an indication of a sharp correction. When you get confirmation from 2 out of the 3 above signals, you can be sure of an impending correction in the market. Now you don’t need the Soothsayer to warn you about the Ides of March or any other month. The data points will provide the answer.

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