Through the Looking-Glass, & what NiftyScalper found there | Market Internals - Part 1

In this earlier post here we talked a bit about what moves an index, specifically what moves NIFTY, in today’s post we will take that idea a bit further and look at the internals from different lenses.

Long back I came across this idea on the Traderfeed blog. I thought of testing it out for NIFTY and see if it helps understand the market moves any better.

So here is a brief about the idea.

1) Identify a basket of stocks - In case of NIFTY I choose to use the top 25 stocks by market cap, which constitutes close to 80% of index by weight-age.

2) The math - I extended Brett’s logic a bit by including not just VWAP but also (+/- 1) SD (Standard Deviation) from VWAP as reference points. The idea is to see the % of stocks above and below these references. I have also added % of stocks above or below their PDC (Previous Day Close) as well.

The concept is as simple as that, now lets see if helps us understand the index moves better.

We will look at three types of days. First a Trend Day, Second a Mean Reverting Day, and Third a Low/Narrow Range Day

Trend Day

Here is how the internals looked like on this up trending day. As you can see the lines are all clear.

The blue line is % of stocks above VWAP, Green is % of stocks above 1 SD of VWAP and Red is % of stocks below 1 SD of VWAP, and the yellow line is % of stocks above its Previous Day Close (PDC)

NIFTY Futures 12th November’18

Look at how the Blue and Yellow lines are quite stable around the 60% level and 90% level. The way to read this is 90% of the basket stocks were trading above their PDC all through the day, and 60% of stocks were trading above their VWAP all through the day. And around 25% of stocks were trading above 1SD of VWAP largely all through the day.

While this is how the basket constituents behaved, we would need to test if all trend days demonstrate similar patterns, more importantly we would need to identify ‘markers’ which occur in the first hour of the day that could further point to a trend day.

However the +/- SD Lines can offer good short term trading entries.

Mean Reverting Day

Compare this with Trend Day image above, and you will see clearly the Blue Line is not holding up as it did earlier. Here the Red line (-1 SD) crosses both (+1 SD) and VWAP (Blue) line multiple times, indicating a dispersion in the basket stocks which perhaps leads to a more Mean Reverting day. Again the crossovers and divergences offer good entry points for trades.

Narrow Range Day

In this chart, you can see a large part of the day is extremely constricted, all lines overlapping with a minor downside bias in the early part of the day and a minor upward bias during the last hour.

We are still back-testing setups on this indicator, to isolate high probability contexts. But nevertheless its interesting to view the index almost like an X-ray to see what is happening and this gives you a far better and nuanced sense of the Market Internals than the usual Advance Decline indicators.

Do write to me if you have some ideas to improve this, or any thoughts for that matter.