When the markets are moving up, the big question for you is whether this uptrend is sustainable or not. Normally, investors are worried that they may enter the markets at higher level and then see the value of their holdings coming down. How do they prevent this occurrence? There are some basic market level ratios that can help you take a view. Of course, the market uptrend will be broadly determined by the fundamentals of the market. If companies are growing and stocks are at attractive valuations, then market uptrend is likely to continue. Technically, if the markets are still making higher tops and higher bottoms, then the market uptrend is likely to continue. But from a more basic perspective, are there some ratios that investors can look at? Actually, there are five such important ratios that can give a quick view on wither the uptrend is sustainable or not.
Advance Decline ratio
This Advance/Decline ratio or simply the A/D ratio is the ratio of stocks that advanced to the stocks that declined on a daily basis. This is reported by the exchanges on a daily basis. One can express the A/D ratio as under:
A/D ratio = Number of stocks that advanced / Number of stocks that declined
On 05th June if 800 stocks advanced and 500 stocks declined then the ratio will be:
A/D = 800/500 = 1.60.
Intuitively, the A/D ratio of more than 1 is considered to a signal of positive market and an A/D ratio of less than 1 is indicative of a negative market. But A/D ratio can never be looked at in isolation. It has to be looked at as a trend over a period of 3-4 months to get a clearer picture. It shows how broad-based the rally in the market is.
New highs to New lows ratio
This is the ratio of stocks that hit new highs to the stocks that hit new lows. There are two ways to look at this ratio. You can either look at this ratio in terms of all time highs and all time lows or you can also look at this ratio in terms of 52-week highs and 52-week lows. Normally the 52-week number will be a good indication of the short to medium term trend. When there are more stock hitting 52 week highs compared to stocks hitting 52 week lows, it is a positive signal. Again this indicator has to be looked as a periodic trend rather than as an absolute number at a point of time. Also, this indicator can be useful in identifying turnaround in the market. When a market tops out, you will typically see this ratio turn in favour of the lows.
Upper Circuit to Lower Circuit ratio
All non-F&O stocks have circuit filters. These are the levels at which trading stops. All such stocks have upper circuit limits and lower circuit limits. This circuit filter limits range from 5% to 20% depending on the volatility of the stock. The ratio can be expressed as under:
Number of stocks in Upper Circuit / Number of stocks in lower circuit
If on a trading day 150 stocks hit upper circuit and 75 stocks hit lower circuit then
Circuit ratio – 150/75 = 2.00
Here again a positive circuit ratio is considered to be supportive of an uptrend. There is an important factor to remember here. Circuit filters exclude the top 200 stocks that are in F&O and hence this ratio is really indicative of how the mid caps and small caps are participating in the rally. Normally rallies are sustainable if the mid caps and the small caps also participate in the rally. The combination of the above 3 ratios gives a clear idea of mid cap and small cap participation and, therefore, the sustainability of the uptrend in the market.
Delivery trades ratio
During any trading day, there is a combination of delivery and intraday trades. Intraday trades are closed on the same day (buy and sell legs) whereas delivery trades result in the stock going into your demat account or going out of your demat account. The typical delivery trades on any average day could range from 30% to 50% depending on the extent of speculative activity in the market. A higher ratio of delivery trades in the midst of a market uptrend is a signal that investors are taking a long term view on the stock and the trend becomes more sustainable. Delivery ratio can also work the opposite way in a falling market.
Upgrades to downgrades ratio
This is a subjective approach but again very useful to gauge the mood of the market. Upgrades here have two implications:
Ratio of analyst upgrades to analyst downgrades of the stock
Ratio of credit rating upgrades to rating downgrades
While one measure pertains to equities and one measure pertains to the debt component, it is only when you see a shift towards upgrades in both these variable that you can be reassured of the uptrend in the market continuing. These two measures are also very important in identifying the turnaround points at the top and at the bottom.
There is a word of caution of investors. All the above are just indicators and need to be treated as such. It is always advisable to consult your financial advisor or broker before taking a market investment decision based on these indicators.