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Markets shrug off S&P rating: Smart money already knew it PDF Print E-mail
Written by George Albert   

Written for First Post
April 28, 2012: The Indian equity markets and the rupee shrugged off Standard and Poors downgrade with the currency pausing its depreciation and stocks falling only marginally.

One would have expected the stock market and the Rupee to fall sharply given the downgrade, but no such thing happened. S&P is generally behind the curve and the markets react with much earlier than the rating agencies. And this has been proven time and again. The latest example is the price action of the Sensex and the Indian Rupee. 

Sensex has been falling since early February this year discounting the economic and fiscal ailments of the country. In the middle of February the Sensex peaked a little above 18,400 and has since fallen to 17,134 as of last Friday which is more than 1000 point drop.  In fact after the S&P action the Sensex did not see any major move.

The same is true of the Indian Rupee.  After appreciating to 48.50 levels in February the USDINR pair depreciated and peaked at 52.85 last week. After the S&P announcement the USDINR pair did not make a new low as one would have expected but moved in a narrow range of 52.40 and 52.80

So what's happening? Has the Indian equity and currency market lost all rationality? That is the question asked by people making news-based investment decisions. And a majority of retail investors make decisions based on news which is one of the biggest errors small investors make. Journalists are the penultimate people to know important news and the last one to know are you the readers. The big investors who move markets are already taking action much before we know it.

For instance a recent report in the Wall Street Journal stated that "FII equity inflows so far in April total just $171.8 million, down from more than $5 billion in February." So the FIIs already know the market trends before the reporter or retail investors know and the rupee and Sensex were already reacting to it. FIIs who are connected to markets knew the circumstances that led to S&P action well in advance were bearish. So by the time S&P announced the rating decision the big investors were already light on their holdings due to which there was not much movement in markets.

So what should retail investors who don't have early access to information do? They must study charts to identify areas of demand and supply imbalances. When supply exceeds demand prices drop and vice versa. The easiest way to see high demand areas to look where prices turned to rally higher in the past and the high supply areas are where prices turned to fall lower. This is the first step of identifying supply demand imbalance and we will go into other steps in future articles. At the very least one should never buy in a supply area or sell in a demand area.

Going back to the market's reaction to the S&P rating action the rupee and Sensex did not slide as both are near demand areas. Last week we had mentioned that Rupee faces a lot of demand in the 53 area against the dollar. Once the USDINR pair reached 52.85 on Tuesday it has not been able to go lower as there is huge demand from 53 all the way to 53.70.  That was the all time low of the from where a flood of demand pushed the currency all the way up to 48.50 level in a month. So unless the 54 level is broken the Rupee will not depreciate no matter what S&P throws at it. 

We had also written about the demand area on the Sensex in previous articles. The demand area is the price gap in the Sensex shown on the chart (Click here for Sensex chart ). A price gap happens when the opening price of a day is higher or lower than the closing price of the previous day. When there is extreme demand prices open much higher than they closed the previous day. That's what happened to the Sensex on January 31 when it opened at 16,965 after closing at 16,863 on the previous day.

On the chart you'll see two horizontal lines with the upper one starting on the day prices opened higher and the lower one showing where the prices closed the previous day. Given the high demand in the area you'll notice that prices have come down to gap many times but never closed below it. So unless prices fall below the gap the Sensex will not go lower. 

What the Rupee and Sensex did last week in the face of S&P's rating decision shows that the markets dance to a different tune and news media is not the music director. It is important to identify demand and supply imbalance levels in the market to be a profitable investor.