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200-DMA: The Sacrosanct Lakshman Rekha

Posted Date: December 01 2020
India market declined more than 35% from January ATH during a fall in March and entered bear territory. Nifty had dropped ~20% below its 50- and 200-DMA for the first time after the 2008 crash. The three C’s (Corona, Credit Risk, and Crude Oil) have made a deep crack in a well-paved D-street. However, Nifty saw a phenomenal rise and hit an all-time high of 13,145 on Wednesday from a low of 7,515 hit on March 24. While a sharp correction in February and March this year was triggered by the fear of a sharp contraction in economic activity and corporate earnings, the rally was driven by optimism of a faster than estimated recovery in headline macroeconomic and corporate parameters. Number of factors such as ample liquidity, record low interest rates, and expectations of a fresh stimulus are acting as key tailwinds for the current buoyancy in the market.
 
Indian market is currently in a Confirmed Uptrend and Nifty is currently trading ~20% above its 200-DMA, which is rare. Let us have a look on how indices behaved during the previous crisis and after the bottom formation, how much has the market extended from its 200-DMA during the rally period. 
 
Period 2004-2008
 
Nifty fell nearly 42% from its high during this crisis. Nifty Bank, Finance, and FMCG were the major decliners. Nifty FMCG and Nifty Finance declined 34% and 27%, respectively. Nifty Finance emerged as the new leading sector during the rally, followed by Nifty Bank and Nifty FMCG. Nifty Finance rallied the highest of 481% followed by Nifty Bank and Nifty FMCG which posted significant gains of 391% and 238%, respectively.
 

Indices vs 200-SMA: 2004-2008
 
When Nifty peaked in January 2004, it was extended 33.6% from its 200-DMA. During the fall, it breached its 200-DMA and traded 18.3% below the level. During the reversal, it went 23.8% above its 200-DMA.
 

 
Period 2008-2010
 
Nifty fell nearly 59% from its high during this crisis. Nifty Bank, Finance, and Auto were the major laggards. Nifty Finance and Nifty Bank performed in line with the frontline index and declined 61% and 58%, respectively. When the market started reversal after forming a button, Nifty Auto emerged as the new leading sector during the rally, followed by Nifty Bank and Nifty Finance. Nifty Auto rallied the highest of 292% followed by Nifty IT and Nifty Finance which posted significant gains of 208% and 203%, respectively.
 

 
Indices vs 200-SMA: 2008-2010
 
When Nifty peaked in January 2008, it was extended 23.8% from its 200-DMA. During the fall, it breached its 200-DMA and traded 79% below the level. During the reversal, it went 14.8% above its 200-DMA.
 

 
Period 2010-2015
 
During the period, Nifty FMCG did not decline, instead it provided support to the otherwise worsening market. Nifty Bank (-41%), Financial Services (-38%) declined the most, Once the market reversed, Nifty Pharma(+179%), Auto(+172%) and Bank(+163%) showed strength.
 

 
Indices vs 200-SMA: 2010-2015
 
When Nifty peaked in November 2010, it was extended 14.8% from its 200-DMA. During the fall, it breached its 200-DMA and traded 16.9% below the level. During the reversal, it went 9.8% above its 200-DMA.
 


 
Period 2015-2020
 
Nifty Bank and financial services declined the most. Once the market reversed Nifty Bank(+129%), Financial services(+152%), and FMCG (+74%) showed strength.
 

 
Indices vs 200-SMA: 2015-2020
 
When Nifty peaked in March 2015, it was extended 9.8% from its 200-DMA. During the fall, it breached its 200-DMA and traded 10.9% below the level. During the reversal, it went 4.8% above its 200-DMA.
 

 
2020 
 
Nifty fell nearly 36% from its high during this crisis. Nifty Bank, Finance, and Auto were the major laggards. Nifty Finance and Nifty Bank declined 45% and 41%, respectively. When the market started reversal after forming a button, Nifty Auto emerged as the new leading sector during the rally, followed by Nifty Pharma and Nifty Bank. Nifty Auto rallied the highest of 89% followed by Nifty Pharma and Nifty Bank which posted significant gains of 80% and 74%, respectively.
 

 
Indices vs 200-SMA: 2020
 
When Nifty peaked in January 2020, it was extended 4.8% from its 200-DMA. During the fall, it breached its 200-DMA and traded 48% below the level. During the reversal, it went 16.3% above its 200-DMA.
 


 
Summary:
 
In 2020, market participants witnessed a four-year low and an all-time high in the same year. The index had fallen about 48% from its 200-DMA during the March low and from there, it has registered a phenomenal rise. It is currently trading about 22% above its 200-DMA. If we look into the past data, only during the 2004 bull cycle, the index had extended more than 20% from its 200-DMA. However, in the other bull cycle, the index had extended in the range of 5–15% from its 200-DMA.
 

 
Approach to the current market
 
The Indian market is currently in a Confirmed Uptrend and we need to be prudent and cautious while adding fresh positions, as Nifty is currently trading ~20% above its 200-DMA, which is rare. We expect some pullback in the market. However, a small pullback/consolidation is a constructive sign if Nifty holds its 21-DMA. Hence, we advise our clients to closely review the existing positions and book partial profits in stocks that are extended from their moving averages. However, the broader indices had a sharp recovery in the last few months after going through a rough patch for more than two years in a row. Nifty Midcap100 and Smallcap100 made an all-time high in January 2018 and have remained under pressure since then. In the current rally, these indices have outperformed benchmark indices, which made a fresh all-time high. However, Nifty midcap100 and smallcap100 are 10% and 35%, respectively, below their all-time high. So, on the charts, the broader universe has more room for an uptrend compared with the benchmark indices.  So, if a stock has superior fundamentals and breaks out from an early stage base, it can be considered for investing. 
 

What do you think? Please email us any questions or comments.

Disclaimer: Information contained herein is not and should not be construed as an offer, solicitation, or recommendation to buy or sell securities. It is for educational purposes only.For more information, see our Legal disclosures here.

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