Below is a review of the Sensex Velocity Indicator. In this piece, we’ll examine prior comparable “peaks” to determine potential downside risk.
Review
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September 2, 2020: “If the BSE returns to the last moderate peak (34% in attached chart), then it would bring the index to 49,704.30.” link.
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September 2, 2021: “The current rise is running out of energy.” link.
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September 21, 2021: “The Sensex has reach a point of exhaustion based on the historical precedent established in 1994, 2000, 2004, 2006, & 2010. This doesn't mean the party is over, as the prior years prove. Just that there will be some temporary churn or downside risk from this level.” link.
Velocity Exhaustion
As noted above, the periods of 1994, 2000, 2004, 2006, & 2010 were equivalent levels of velocity exhaustion for the Sensex Index. This means that the index would trade in a range or experience a decline in price. Below, we examine the quality of the data for the years in question.
When reviewing the data, we get a sense of the potential outcomes. However, when we look at the charts, we realize the potential for error is significant if we’re not careful about how we use the concept of velocity exhaustion.
Graphical View
1994-1996:
This is one of the better examples of velocity exhausting where the index effectively declines and turns at a point where we can consider the opportunity to accumulate.
2000-2001:
Another example of how the velocity indicator highlighted the decline well in advance. Worth noting is the indicator low of June 18, 2001 while the actual low was September 21, 2001, a decline of -22.46%. While a large drop, it needs to be put in perspective of the relative decline that preceded it. Investors should always build in the expectation of a decline in value.
2004:
This is one of the more fascinating declines where the average daily decline was exceptional. A -25% drop in 91 trading days is quite a lot. We’ve included the 2008 peak that followed the 2004 decline for the purpose of demonstrating what would have been missed if an investor were to sell everything based on the velocity indicator.
2006-2009:
By far the largest decline on a daily basis relative to all other dates. Soon after the decline was over, the Sensex marched higher, more than doubling by the time it reached the 2008 peak.
2010-2012:
This decline was moderate with a duration that stands out, lasting approximately 532 trading days.
Thoughts
From our experience, an exhausted market means that if you have funds to invest then you’ll have a good opportunity to get in. Alternatively, if you’re fully invested, the velocity exhaustion means you have to expect some short term pain. As the data demonstrates, short term could mean as little as 37 trading days (ideal) and as much as 532 trading days (brutal). What an exhausted market does not mean is that you have an automatic sell signal.
In the period from 1993 to 2021, there were eight (8) clear buy signals. In the data that we’ve covered above, there were five (5) exhaustion signals. We think it is best to build in the average decline of -28.73%. Timing has never be our strong suit, so we’ll have to wait and see if the velocity indicator can give a clear buy indication when that time arrives.
The way an investor could strategize their investing is to go in 100% at the buy signals and accumulate cash until the next exhaustion signal. At which point, after a considerable decline, investing the funds that were accumulated from the last buy signal.