Reading badla signals

Sanjiv Shankaran

BADLA players are usually more clued in to market happenings. While they are not as gullible as retail investors and perhaps not as well-informed as institutions, they are often quick to spot an emerging trend, and that, in turn, is reflected in the pattern of badla activity.

The badla trading pattern is, thus, closely associated with the stock price, and badla trading sessions can be used to second-guess stock prices. This article looks at the interesting badla patterns of the last 20 months, an analysis of which could enhance its effective use as a trading tool.

The analysis has two components. The first deals with the general badla activity between January 1999 and August 2000. This is followed by an analysis of badla trading in a few active stocks.

The aggregate interest in the badla market indicates the state of the market. A change in badla turnover over a period suggests that, at the macro level, the stock price is changing.

The aggregate badla turnover began to increase in mid-1999, in tandem with the market indices. Subsequently, when the stock prices crashed, following the last Budget, the badla turnover also fell.

This is important because, as seen earlier this year, when prices crash, the cry goes out that a great buying opportunity has come up. Somehow, there is a feeling that it is just a matter of time before the prices go back to earlier levels. But the story of technology stocks over the last eight months shows that prices may not quickly bounce back to the earlier highs.

In this context, a general decline in the badla turnover suggests that the market's stock valuations may have been marked down. Investors may, thus, need to be cautious when the aggregate badla turnover declines over a few weeks.

Badla works when rumours abound

The badla turnover appears to be more strongly associated with the stock price of companies about which there is talk of significant developments. Investors following the badla market would reach this conclusion instinctively.

A number of companies caught the public attention quite suddenly last year. Even Infosys Technologies, which has been around since the early 1990s, shot into prominence only last year. Zee Telefilms, Satyam Computers, Himachal Futuristic and Global Tele-Systems were the others that grabbed attention in a short time.

But since then, the companies are no longer mentioned in the same breath. Zee Telefilms and even Satyam Computers are no longer ranked on a par with Infosys Technologies. The others, including Himachal Futuristic and Global Tele-Systems, are considered relatively shaky, though the shaky companies show the strongest association between badla turnover and stock price. In Himachal Futuristic, Global Tele-Systems and Zee Telefilms, this degree of association is fairly high. And Ranbaxy Laboratories showed the highest association.

On the face of it, Ranbaxy does not seem to belong in the category of technology companies. But a closer look suggests that Ranbaxy, and a few technology companies, saw a lot of speculation on material developments. Ranbaxy signed a landmark drug research deal with Bayer AG in September 1999, before which rumours about it constantly made the rounds.

A similar phenomenon was common to other companies that showed a higher degree of association. There had been rumours about material developments.

It seems almost obvious, given the nature of the badla market, that the stocks propelled by rumours, among other factors, seem to show the strongest association between the stock price and the badla turnover.

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Not all rumours are good

To take Ranbaxy again. After the deal was announced, there was considerable speculation on how close other companies were to striking a similar deal. Cipla, another pharma major, was brought into the specified group stocks which are up for badla trading towards end-1999. Around the time Cipla was brought in, speculation was rife that it was close to announcing a drug research breakthrough.

A mutual fund newsletter also mentioned the possibility of Cipla announcing a big deal. Expectedly, the badla market took the cue and badla turnover increased between November 1999 and end January 2000. The stock price, however, did not move in the same direction. And the correlation between the badla turnover and the stock price movement was negative. An occasion when the badla traders completely misread the situation.

A study of the relation between the badla turnover and stock prices at different phases suggests that there will always be times when the market misreads the situation. In Cipla's case, expectations were not fulfilled, and traders may have closed their exposures without a profit.

Other surprises

In the context of the Cipla story, it is interesting to note the trend in Reliance Industries between January and April 1999. The period was marked by a gentle decline in the price trend, though, at the same time, the badla volume increased gradually.

In spite of the increase in badla volumes, there was no perceptible change in price. It almost seems as if traders were waiting for a big change that did not happen. As a consequence, the correlation between the badla turnover and the Reliance stock price was negative.

If the impression conveyed thus far is that only stocks that generate a lot of speculation show a strong association between badla turnover and stock price, it must be dispelled. Gujarat Gas is an instance of a stock that showed a strong association between badla turnover and stock price in April-August 2000 -- the phase when other stocks were losing value quickly. Gujarat Gas announced improved financial performance this year, and the stock price has moved up. At the same time, the badla value, too, moved up steadily to propel Gujarat Gas to the league of the most active stocks in the badla session.

This fits in with the overall pattern, where a sustained change in badla turnover accompanies an uptrend or downtrend. At a time when the equity market was rapidly marking down erstwhile favourites, the badla sessions saw the Gujarat Gas counter come alive.

Eyes on exit

A look at the strong association between the badla turnover and stock price for the sample of companies reveals an interesting pattern. The relatively stronger companies, in terms of fundamentals, such as Housing Development Finance Company (HDFC) and Infosys, did not display all that strong an association between badla turnover and stock price.

In HDFC, between March and August 2000, the badla activity dropped, but the stock continued to post steady returns. An investor relying purely on the badla turnover would have got the wrong signal.

The lower association between the badla turnover and stock prices for the bluechips has implications for the companies where the association is strong. In Zee Telefilms and Himachal Futuristic, where the association is stronger, the fall in stock price after the bull run was also sharp. Compared to HDFC, the rate at which the stock price fell in Zee, for instance, stands out.

It is imperative that investors quickly exit such companies as Zee and even Satyam Computers. These stocks may be traders' favourites but, when the good times are over, the fall is swift. It may be better to err on the safe side by selling stock such as Zee Telefilms and Himachal Futuristic even if investors feel the price has not yet peaked. That way investors may eventually exit with greater returns.

Good in a bull run

Badla turnover, as a signal, shares a trait with pundits in investment banks, broking houses and the media. When the going is good, that is, in a bull run, badla trading patterns seem near-perfect in their predicting power. The highest degree of association came about between November 1999 and March 2000, when the market peaked.

Subsequently, the swift fall in stock price gave rise to confusing patterns. In Infosys, between June and August, while the badla volume kept increasing, the stock price continued to drift downwards. In Reliance Industries, too, the signals were confused between March and August, when the price moved in a narrow range.

Badla trading patterns may not be just fairweather friends, but the patterns are more difficult to discern in a volatile market. With index futures yet to gain popularity, the badla trading patterns still provide signals on where the key stocks are headed, and, thereby, the general price level. But it is important to exercise caution in interpreting the signals in a volatile market, such as now.