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As 85% stocks from BSE 500 trade below 200-day average, experts advise caution

A stock trading below 200 DMA does not mean it is available at attractive levels. It can remain below 200 DMA for a prolonged period of time depending on the overall structure of the price action

June 22, 2022 / 01:01 PM IST

With the storm raging in the Indian equity space through the past six to nine months, the benchmark indices have gone into a tailspin. The market is singed by an unabated flight of capital by foreign portfolio investors, economic challenges, and geopolitical uncertainties.

The benchmarks are trailing more than 16 percent from their all-time highs scaled in October 2021. The 30-share BSE Sensex has lost close to 16 percent from its peak while the widely tracked Nifty 50 has tumbled nearly 18 percent from its all-time high.

So far in 2022, the Nifty 500 index lost 12 percent, while the BSE Sensex and Nifty 50 have declined nearly 10 percent each.

The kind of beating suffered by stocks across sectors can be gauged from the fact that more than 85 percent of them from the universe of BSE 500, which is a collection of biggest companies in the country, are trading well below their 200-day moving average (DMA).

Now what is this 200 DMA and what does it indicate?

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The 200-day moving average is represented as a line on charts and represents the average price over the past 200 days or 40 weeks. The moving average is commonly used in stock trading to determine the general market trend and can give traders a sense whether the trend is up or down, while also identifying potential support or resistance areas.

As long as a stock price remains above the 200-day average on the daily time frame, the stock is generally considered to be in an overall uptrend. “This also acts as a support when the prices are above the DMA and resistance when the prices are below the DMA,” said Green Portfolio founder Divam Sharma.

When the number of companies trading below 200 DMA is significantly larger than the ones trading above 200 DMA, it is an indication of the pessimism in the markets, Sharma said.

At the same time, experts caution that 200 DMA should not be used in isolation. “It should be used in combination with other technical tools to arrive at a holistic view,” said Gaurav Ratnaparkhi, Head of Technical Research at Sharekhan by BNP Paribas.

Suman Bannerjee, CIO, Hedonova, doesn’t believe that 200 DMA holds a significant importance. According to him, it's just a psychological number and nothing else. “A year has 225 trading days, so people just rounded that down to the nearest 100 and it's a very rough indicator of which stocks have fallen below their annual average,” he said. It's not very important other than using it as a visual reference.

Is it time to buy stocks trading below their 200 DMA?

A general perception is that when a stock sinks below its 200 DMA, it enters a territory where it has already bottomed out or is about to see a reversal in trend towards the upside.

That said, with more than 85 percent of the BSE 500 stocks trading below their 200 DMA, does the makes sense for the investors to build new positions in these stocks.

“A stock trading below 200 DMA does not mean it is available at attractive levels. It can remain below 200 DMA for a prolonged period of time depending on the overall structure of the price action,” Ratnaparkhi said.

It is always important to analyse individual chart structure before drawing any conclusion and it is always better to use a series of indicators along with simple moving averages (SMAs) to confirm the trend reversal and buying decisions.

“Being a simple moving average, 200 DMA has its own pros and cons like it does not respond to the fluctuation that took place recently or any sudden move, for example cycles and seasonal impacts,” said Ravi Singh, Vice-President and Head of Research at ShareIndia.

The 200 DMA is primarily a tool to indicate the trend of scrip or a better price level to buy a scrip. “However, one should not only look at the indicator level but also investigate the company on its fundamentals and for its future growth prospects to invest in the company,” said Mohit Nigam, Head of PMS, Hem Securities.

He recommends that investors should believe in the company’s business model and portfolio and if they feel that the business looks strong in the longer run, then they can invest in these stocks regardless of them trading below their 200 DMA.

Advice for investors

The data shows that the stocks which are trading above 200 DMA are mostly companies which have benefitted from the broader economic developments like energy and commodities, hotels or have value and were underperformers in last year’s rally.

From an investment standpoint, one should look at the impact of inflation and interest rates on the companies they are considering to invest.

“The 200 DMA data of BSE 500 suggests that there is a broad-based weakness in the market as the broader end of the market, especially the small-caps have seen significant correction and can remain subdued for the next few months,” said Ratnaparkhi of Sharekhan by BNP Paribas. He has been recommending investors to avoid this space and be very cautious while building exposure in the small caps.

Bannerjee of Hedonova said that it's best to stay away from the current markets for most investors. “Industries change fundamentally during downturns, high-flying industries cannot live up to expectations, weak business models don't survive and investors look towards actual cash flows rather than vanity metrics,” he said. Recovery from the current levels will be difficult for many companies.

Some experts, however, believe the current market scenario is ideal to start building a portfolio from a long-term perspective. They believe that though the impact of global sentiments is having a weight on the Indian markets, Indian companies, from an impact standpoint, are comparatively isolated from the global peers.

“For investors with 2-3 years of minimum horizon, the markets are offering a great opportunity,” said Sharma of Green Portfolio. “We see a lot of portfolio companies available at single digit PE multiples.”

Disclaimer: The views and investment tips of investment experts on Moneycontrol.com are their own and not those of the website or its management. Moneycontrol.com advises users to check with certified experts before taking any investment decisions.
Gaurav Sharma
first published: Jun 22, 2022 01:01 pm
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