Nifty has seen a scintillating rally of more than 11 per cent from the lows of 14,151.40 and it has registered a fresh all-time high of 15,800 on Wednesday.
Milestones like these come with inevitable questions such as, are markets in a euphoric phase? Haven’t we heard before that the market is in a euphoria or bubble zone, every time it scales to new heights? So, this is one of the shortcomings when it comes to investing or trading. We make decisions based on where the markets are trading. If the markets are trading at a lifetime high, we term it as an overheated or euphoric and vice-versa.
This method is obsolete but a more proficient way to draw a conclusion as to whether the markets are overheated or not, can be done by considering the breadth indicators, which explain the movements of an index by examining the collective behaviour of its component.
We will use the relative strength index (RSI) as a parameter to determine whether the markets are overheated or not. Firstly, we will consider Nifty 500 index and classify stocks into two categories 1. Stocks with RSI above 70 (overbought) and 2. Stocks with RSI below 30 (oversold). So, if the number of stocks in the overbought region is greater in percentage, it indicates that the market is overheated.
Currently, 94 stocks from Nifty 500 have RSI above 70. On the other hand, stocks that have RSI value below 30 are zero. Now, let’s compare this with the scenario when Nifty had hit an all-time high in February 2021. There were 90 stocks with RSI value of above 70 while on the flip side, there was only a single that had a value of RSI below 30. So, this gives us a sense that the stocks trading above the RSI value of 70 are greater than the previous instance.