CRYSTAL BALL FOR NIFTY

USING TRANSITION PROBABILITY MATRIX

Just like forecasts about weather, every time the market heats up or crashes down, an investor wonders about tomorrow.

The Nifty has risen 40% in 52 weeks. Where does it go from here?

NIFTY Index Price (1990 to 28 Aug 2014)

‘Seasons’ are trend points where we can expect different price movements. Nifty is currently in

Season 3

Season 1 = Price above Upper Limit

Season 6 = Price below Lower Limit

Season-wise 52-week Returns

As we go from season 1 to season 6, the return distribution keeps on shifting towards right.

More and larger wins appear with lesser and smaller losses.

The average annual returns for coming period turn progressively higher as the seasons change.It shows the harder the season today, the better the next year’s harvest will be.Season 1 & Season 6 – are very rare, but the profits and losses in these cases are sure events. Seasons 3 & 4 are the most frequent seasons, with season 3 taking almost half of the trading horizon.

**Using weekly data, this is the distribution of seasons along with the vital statistics of every season.

It has rained today, will it rain tomorrow as well?

Given that it is a sunny day today, tomorrow it can either transition to a rainy day or remain sunny with some probabilities. The table that summarizes these probabilities of transitions is called ‘Transition probability matrix’

P1: Transition Probability of Sunny day to Rainy P2: Transition probability from Rainy Day to SunnySince it can be either rainy or sunny day, the horizontal sum of all rows will be 1.

Sunny Tomorrow Rainy TomorrowSunny Today 1-P1 P1Rainy Today P2 1-P2

Transition Probability Matrix For Season 3

Since Nifty is up 40%, its future 52 weeks return is probably going to be above 30% as highlighted.

Season 4’s Transition Probability Matrix

The table shows that profit is highly probable than loss in future irrespective of current returns.

Conclusion• The changing of seasons is not a sudden phenomenon (except the

extremes).

• Currently Nifty is in Season 3, and unless a drastic change occurs, it will likely stay in that state.

• This tool gives an additional edge to an analyst to confirm/reassess his short and long term market views.

• Since most stocks have a large beta, a good understanding about the potential future movement of the index is a valuable tool for an investor

Thank You