A severe crash one day and a sharp rally the next. What is causing such volatility in stock markets and what direction will it take from here? Thursday’s nearly 2 per cent gain in benchmark indices Sensex and Nifty can be purely attributed to one ‘giant short squeeze’, in the index derivatives segment, experts say.

Foreign portfolio investors (FPIs) went into trade on Thursday with the highest short positions in five years in Nifty index futures. According to data, FPIs held 1,34,006 contracts as net short positions as on Wednesday’s closing in the Nifty, which is the largest component of the derivative segment in India. The last time such a massive built-up of short position in Nifty index was seen in August 2013, data show. Experts say, it is this ‘short squeeze’ that saw the stock markets rally. Experts believe the rally could continue further till the FPIs have squared off their short positions substantially.

Going short in the market is when one sells futures contracts at the current date to buy it back later at a lower price and gain from the difference. But when it is anticipated that the market is not likely to fall, these same short-sellers are forced to buy back the contracts they sold at a higher price, resulting into a rally in the market.

On Thursday, FPIs were net buyers in the derivative segment to the tune of ₹6,084 crore, which is among their highest single-day purchase so far this year. Index futures worth ₹1,195 crore were bought by FPIs. In the cash segment, FPIs were net sellers of ₹108 crore worth of stocks, indicating that some of them were liquidating their equity holdings to manage derivative trades, experts said. The domestic institutions were net buyers of stocks worth ₹615 crore.

Nifty at 10,500 likely

“Extreme readings in the positions always show up at a point that the market changes trend for the coming weeks. This short position indicates that a short-covering rally in the stock indices is likely in the next few weeks and Nifty could bounce back to 10,500-10,700 range,” said Rohit Srivastava, fund manager, Sharekhan BNP Paribas.

Around 2 pm India time on Wednesday, stock markets around the world fell by nearly 2 per cent as China retaliated with tariffs on goods worth more than $50 billion being imported from the US. China, which escalated the global trade war on Wednesday by its actions, said it was just replying to the US that had slapped high tariffs on Chinese goods worth around $60 billion. But stock markets saw an impressive surge a few hours after US indices commenced trading. The fact that both countries were just using rhetoric for trade negotiations had calmed frayed nerves.

Otherwise, on Thursday nothing much had changed in India, which is witnessing a crisis in the banking sector due to frauds and high corporate NPAs. The Reserve Bank of India did not hike key lending rates, which, coupled with the short-covering, could keep the rally alive for a while, experts said.

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