In my last post about Nifty and Bank Nifty Positional charts i had spoken about price divergence between nifty and bank nifty. But the question that comes to your mind is how one can understand that price divergence is happening between two underlying instruments? And how to benefit from the price divergence? The answer is ratio charts.
What information we can get from ratio charts?
1)The above charts shows the ratio charts between bank nifty and nifty. Decreasing ratio charts indicates bank nifty is underperforming nifty in terms of price. And a increasing ratio indicates banknifty is outperforming its benchmark index. From the investment point of view ratio charts are often used across Sectors to identify sectors with relative weakness in a measure against the benchmark index so that you can avoid yourself investing your money in sectors that are likely to underperform with respect to the benchmark index.
2)Pair Traders often use ratio charts to identify low risk opportunities. Since Apr/May 2013 the Bank Nifty/Nifty ratio charts moved from 2.10 to 1.74 which indicates bank nifty underperforms nifty in terms of price performance. Even though bank nifty had taken a huge downside fall and nifty relatively haven’t lost its equal weight. So pair traders in this case often long nifty and short bank nifty to execute low risk strategies with controlled risk. And they do reverse their strategies when the banknifty/nifty ratio starts likely to decline from the peak.