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Do FII Flows Foretell Stock Market Trends?
Oct 19, 2015

Which way are the Indian stock markets headed now? Will we see the BSE Sensex crossing the 30,000 mark anytime soon? Many traders and investors are perpetually on the lookout for the right signals that would give them a sense of where the markets will move. It appears that there is one indicator that tends to reflect the short to medium term market outlook. That indicator is none other than FII flows.

Today's chart of the day shows net annual foreign institutional investors (FIIs) flows over the last few years and the corresponding Sensex returns in those particular years. As you can see, there seems to be a strong correlation between FII flows and the direction of the market. In 2011, the net FII flows were negative. The markets tanked nearly 25% that year. In the years when FII flows were strong, the annual Sensex returns were positive.

What does this relationship between FII flows and the direction of Sensex indicate now? In the year 2015, while FII flows have been positive so far, they are significantly lower than the flows witnessed in the preceding three years. Does this mean that the outlook for the Sensex is bearish? Should you stay away from the markets now?

The answer is no. It is important to put the FII flows in the right perspective.

First, given the lack of volume depth in the Indian stock markets, FIIs tend to be the biggest market movers. As such, they do affect short to medium term market trends. If you are a short-term trader, then it might make sense for you to follow FII flow trends.

Second, FII flows are driven by a slew of factors other than economic fundamentals. Global macro economic factors, interest rates, currency exchange rates, relative attractiveness of other markets, etc. play a key role in determining FII activity in the medium term. For serious long-term Indian investors who are focussed on business fundamentals, these factors may not be quite relevant. For them, a panic FII sell-off may, in fact, throw up great long-term investing opportunities.

Data Source: NSDL;*Calendar year 2015 data up to October 19

This Chart Of The Day was published in The 5 Minute WrapUp - Stocks at 52-Week Lows... Should You Buy?

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