Sunday, January 31, 2010

Locate Cyclical Tops in Stock Market

There are few questions which has haunted mankind for long .Even when we are not sure if there is any one answer which could be proved to be correct accepted by all , we dont stop in formulating some answers every now and then .

One such question among Investing community is
"How to pin point cyclical tops and bottom of a stock market "
There is NO single proven solution available readily and wont be available in future too .
All we can do is to identify indicators which can predict it with some degree of accuracy.

Here we try to look into one indicator which can approximatly locate over bought and over sold positions in market. Its PE .We can take Nifty for reference and consider its movement in correlation with its PE .

Below is the graph showing Nifty Value Vs Nifty PE for a period from Jan 1 2001 to Jan 6 2010 .



Average PE for Nifty over this period is 17.32

Max PE 28.29 reached on 8-Jan-08 at Nifty value of 6178.55
Min PE 10.68 reached on 27-Oct-08 at Nifty value of 3065.15

A priliminary glance on the chart shows at most of short term upswings get reversed at horizontal red line which translates to PE of 21 ( approx) .

The exception to this generic trend is the euporic run in Sep 07 - Dec 07 which now many will accept as madness in the market .Market auto corrected this error by a substantial fall in Jan 08.

Will this hold good for different time frames ??

Following are 9 year , 8 year ... average PEs leading to Jan 2010 and their is not much divergence in the value

Average Jan 01-Jan10 17.32096616
Average Jan 02-Jan10 17.44404607
Average Jan 03-Jan10 17.63979393
Average Jan 04-Jan10 18.16745151
Average Jan 05-Jan10 18.54976632
Average Jan 06-Jan10 19.49262361
Average Jan 07-Jan10 19.59989204
Average Jan 08-Jan10 18.72044715
Average Jan 09-Jan10 18.77077236

Even for the best bull run in our market ie) from 3-Jan-05 to 11-Jan-08 where Nifty moved from 2059.8 to 6287.85 (where we saw a 300% returns in 3 years) PE average was 18.55

So based on the abvove facts we can derive the following :

Nifty's equilibrium level is at PE of 18 and gets oversold
when PE moves around 21 .
Any further up move in PE
which most probably bring a sharp downfall

The values are taken from http://nseindia.com/ .

1 comment:

  1. Prem, this is greek and latin to me..:) I think i should get tips from you for good investments!!

    ReplyDelete