The Stress Test and Some Speculative Thoughts ... !!!
By the time this article appears on the web, readers might have already seen the results of the stress test conducted on the European Banks. Yes, out of the ninety one banks tested, just seven banks failed in the test and those failed banks would require an additional 3.5 billion Euros ( 4.5 billion USD ) capital.
What are these so called stress tests ? It's just like the scenario analysis used by the intelligence community. The regulators would have calculated what happens to these banks if and when one or two negative market scenarios like a 3 % negative growth in GDP or a 3% fall in prices of sovereign debts, are played out in the next two years or so. Obviously, most banks would make some losses but this test would bring out which banks would be affected more and would require more capital.
Now, readers may ask what is the relevance of these tests on the traders in the Indian market ?
BSE SENSEX - Weekly Chart
As you can see from the above weekly chart of the BSE Sensex, the Indian markets have been trading in a comparatively narrow range for almost eleven months now. We have also seen four up trends and three down trends which were symmetrical. Let's also do a scenario analysis in which the present pattern continues. In the first scenario, the Sensex is expected to fall from the present area and test the lower support line obtained by joining the lows of the pattern. If this scenario plays out, the Sensex may correct to the 16500 area. The second scenario involves the break of the lower support line of the pattern. In this case the Sensex may correct even to the 14500 area. These two scenarios involve corrections to the magnitude of 10 and 20 % respectively.
Readers may note that these scenarios are not presented here as predictions and there are so many ifs and buts involved when it comes the markets before these scenarios are actually played out. The market may do whatever it likes to do, no matter what you expect it to do. It is even capable of trapping the maximum number participants when it reverses from the direction to which it is expected to move.
Even though this article is written with a label "Some Speculative Thoughts" and with so many ifs and buts whistles added, these scenarios are not completely out of the realm of the possible, especially in this era of "unusual uncertainty". Hence the importance of these stress tests.
It is advisable for all traders to stress test their positions once in a while, especially the leveraged ones ( positions on the margin ) and the derivative positions to find out whether their trading accounts are over stretched and would require additional margin. For more information on risk management tools like money management and position limits, which help traders from risk of ruin, please click here.
Cheers and Prosperous Investing and Trading !!!
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