Leading Constituents of NIFTY50 | My Counter-intuitive Findings

If you follow the blog you would have heard me say our NIFTY-50 index is pretty skewed from a weight-age standpoint, top 10 stocks account for close to 60% of the index, top 25 account for close to 80 and the balance 25 stocks account for just 25% of the index weight-age.

Intuition would tell us, so long as we follow the top 25 constituents i.e. (80% of Weight-age) we should be good. Good in the sense we should be able to predict short term (15 to 60 minutes) trends in the index.

To be frank I along with a few others spent several months in that top 25% rabbit hole, only to realize that the action more often than not begins in the bottom 25 stocks.

Here are some visualizations

Before we move to the visualization, please refer the Legends / Descriptors below

Legends / Descriptors for the NS Advance Relative Strength Indicator

As you see in the Legends we have two indicator panels below the NIFTY Fut price chart. The Top panel refers to the top 25 Stocks and the bottom panel refers to the Next 25 stocks.

Now let me take you though a few sample days when the Bottom 25 Stocks lead the top 25 and also the Index, though I have back-tested this phenomena, I am bound not reveal the specifics, but this is the idea and you can test it for yourself.

29th Aug’19 - Look at the Stocks above +1 SD of VWAP - They lead by close to 15 minutes

5th Sep’19 - Look at the Stocks Above VWAP line - They lead almost all through, even though stocks below -1 SD are fairly high on the top 25 Stocks.

12th Sep’19 - Look at the -1SD line crossing over the % of Stocks above VWAP line - Happened in the bottom 25 Stocks way before it did on the top 25

20th Sep - How can I forget this day - Look at the % of Stocks above 1SD line, again led the upper 25 by close to 20 minutes.

During the trading day, I keep an eye on the bottom 25 stocks and if I notice any divergence, I become cautious, as it could a portent of doom esp., if I am on the wrong side of the trade. Time permitting I also tell my mentees on the slack group.


Something similar happened on the 20th of Sep’19, a day which would be etched in my memory, not because I was positioned on the right side of the trend, but because it was a classic demonstration of almost everything that Mandelbrot says in his book Misbehavior of Markets.

Back to the charts, this phenomena of bottom 25 stocks leading can also be observed through a sectoral index lens, since each of these segments top 25 vs next 25 have a sectoral skew within it, more about it next time.

Before I close -The usual disclaimer applies, don’t use this factor in isolation, there are other factors that I consider before initiating a trade, the purpose of this post is only to illustrate the informational value in tracking the bottom 25 stocks of the NIFTY50 index. About the 20th Sep’19 trade, no I am not saying I predicted it, all that I am saying is the same signal helped me capture a good part of the move.

Educational Explainers - Lead Lag Effect - NIFTY

Last week we looked at what Indexes are (Over here).

This week we are investigating the lead-lag relationship between Spot price and Future prices in NIFTY.

So what does academic research and years of observing the market tell us? The verdict is out..

Allegory of the Cave, Order-flow and Price Discovery

There is this interesting story called “Allegory of the Cave” by Plato.

The story in a way describes what happens to people when they are blinded by a context and fail to see the world outside of it.

I was reminded of it as I saw my twitter feed yesterday.

Instance one below

Next one here

Both the posts allude to the idea that

a) We spotted big buying at that level thanks to Orderflow.

b) Big buying led to the turn in the price.

Point b) is the key. One needs to get an handle on that, and one needs to ask fundamental questions there.

So the question to ask is -

Did the buying happen because the price turned or the price turned because the buying happened?

Yes, that question sounds a lot like Socrates’s Euthyphro Dilemma.

But let me not deviate.

Back to the question.

“Did the buying happen because the price turned or the price turned because the buying happened?”

To answer this question we will turn to what the researches say,

The idea is to understand the location of “Price Discovery” - If price discover happens in the Futures, then we can say - Price turned because buying happened.

However, if the location of price discovery happens to be Spot/Cash market, then it’s the other way round - Buying happened because the price turned.

So what’s the case with NIFTY, where does Price Discovery happen in NIFTY - Spot or Futures ?

Read this post for the evidence - https://www.niftyscalper.com/blogs/2019/1/21/lead-lag-volatility-spillover-effects-some-evidence-from-academic-literature

Kavitha and I will talk about it in our upcoming Explainer tomorrow.

As I sign out - Don’t for heaven’s sake look at the shadows and imagine a non-existing world.

Lead-Lag / Volatility Spillover Effects | Some evidence from academic literature

One of the most fundamental concepts one needs to understand as an Index Trader is that of Lead-Lag effect. I have been reading through several academic papers to get a grasp of it. Here are some that stood out.

Notice the difference between NIFTY and the other markets, I rest my case here.

Price discovery on the S&P 500 index markets: An analysis of spot index, index futures, and SPDRs -  Quentin C.Chu, Wen-liang, Gideon Hsieh, YiumanTse

Price discovery in the German equity index derivatives markets - G. Geoffrey Booth , Raymond W. So , Yiuman Tse

Domestic and international information linkages between NSE Nifty spot and futures markets: an empirical study for India Sanjay Sehgal Mala Dutt