A rectangular Sensex chart pattern

In a prior post on July 13, 2008 I had discussed about identifying stock market trends using moving averages. It is time to take a re-look at the current market trend.

After the prolonged bull market that started in May 2003 at about 2900 and took the Sensex all the way up to 21200 in Jan 2008, a  bear market reversal pulled the Sensex down to 7700 in Oct 2008.

We had a clear up trend for close to 5 years - interspersed with several bull market reactions, followed by a sharp down trend for 10 months - with a few bear market rallies.

After the Oct 2008 low of 7700, a swift rally took the Sensex to 10950. Thereafter, the Sensex seems to be meandering sideways with apparently no clearly visible up or down trend.

Let us take a look at the Sensex chart of the past 3 months.

The 200 day EMA is still moving down. The 50 day EMA and the Sensex are well below the 200 day EMA. So we are still firmly in a bear market.

But the Sensex is bouncing along sideways within a rectangular band between 7700 and 10950. Volume of transactions - given in the lower chart - are low. What does this indicate?

A rectangular chart pattern is a period of consolidation before the market makes up its mind where it wants to go. Such indecision amongst bulls and bears typically happens after a sharp move up or down.

A market consolidation - represented by a sideways rectangular chart pattern - can be of three types: accumulation, distribution or continuation.

At market tops the 'smart money', i.e. institutional and high net worth investors, sell. The 'weaker hands', i.e. retail investors and funds, buy. Shares are 'distributed' from stronger to weaker players.

At market bottoms, the opposite happens. The stronger hands 'accumulate' the shares from the weaker investors, who get tired of waiting for the market to move up.

In the middle of a clear up (or down) trend, a consolidation period is called a 'continuation', as the market pauses for breath before continuing the up ward (or down ward) journey.

Since we are not at a market top, this is not a distribution pattern. Is it then a period of accumulation at a market bottom or continuation for a further fall? There lies the conundrum.

The short answer is: we don't know. When and how will we know? Only when the market makes up its mind and decides to either move above 10950 or break below 7700.

Fundamentally, the macro economic situation is showing improvement. Inflation, as indicated by the WPI (Wholesale Price Index) is moving down. Oil prices have fallen drastically in the international market. Interest rates are also coming down.

We are now in the midst of the results season with companies declaring their Q3 or Q4 results for the period Sep to Dec 2008. Consensus amongst the experts is that most companies will declare awful results.

But the market is already expecting (i.e. 'discounting') that and unless there are more Satyam-like skeletons, it is unlikely that there will be a big fall below 7700.

On the day the Satyam scam broke, the volumes were very high and the market dropped 750 points but remained well within the rectangular pattern. The following two trading days also saw high volumes but much smaller falls. These are positives.

So, the scales look slightly tipped towards this pattern being an accumulation rather than a continuation. Why slightly? Because on some of the recent up days, the volume of transactions has been less than on down days. This goes against conventional wisdom of higher volume on up days and lower volume on down days.

If you are a patient investor, wait out this consolidation period. Such patterns can continue for a very long time - months, may be even years.

If you are itching for some action, start putting in small amounts of money in Nifty BeES or any good index fund. I would not rely on stock-picking skills at such a time.